Audit Class Units 1-4

[1] Gleim #: 1.1.7 -- Source: CPA 1175 A-52

Independent auditing can best be described as

A branch of accounting.A.A discipline that attests to the results of accounting and other functional operations anddata.

B.

A professional activity that measures and communicates financial and business data.C.A regulatory function that prevents the issuance of improper financial information.D.

Answer (A) is incorrect. Accounting identifies, assembles, analyzes, classifies, records,and reports transactions, whereas independent auditing encompasses an examination ofthe financial statements, accounting records, etc., produced by the accounting process.Answer (B) is correct. According to AU 508, Reports on Audited Financial Statements,the standard independent auditor’s report states that an audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statement presentation.The objective of the audit is to express an opinion on (attest to) the fairness of thepresentation and conformity with GAAP.Answer (C) is incorrect. The accounting process is a professional activity that measuresand communicates financial and business data.Answer (D) is incorrect. An auditor lacks the authority of a regulator to punish improperreporting.

[2] Gleim #: 1.1.11 -- Source: CPA 0407 AUD-04

Which of the following procedures would be most effective in reducing attestation risk?

Discussion with responsible individuals.A.Examination of evidence.B.Inquiries of senior management.C.Analytical procedures.D.

Gleim CPA Test Prep: Auditing(100 questions)

Copyright 2010 Gleim Publications Inc. Page 1Printed for Willis Johnson

Answer (A) is incorrect. Discussion with responsible individuals would not reduce attestationrisk to the same extent as the examination of evidence.Answer (B) is correct. To express an opinion, the practitioner must gather sufficient evidenceto reduce attestation risk to an acceptably low level.Answer (C) is incorrect. Inquiries of senior management is a risk assessment procedureperformed by the auditor to obtain an understanding of the entity and its environment, not toreduce attestation risk.Answer (D) is incorrect. Analytical procedures are performed by the auditor to obtain anunderstanding of the entity and its environment. The procedures would not reduce attestationrisk to the same extent that the examination of evidence would.

[3] Gleim #: 1.2.15 -- Source: CPA 595 L-2

Which of the following best describes what is meant by the term “generally accepted auditingstandards”?

Rules acknowledged by the accounting profession because of their universal application.A.Pronouncements issued by the Auditing Standards Board.B.Measures of the audit quality.C.Procedures to be used to gather evidence to support financial statements.D.

Answer (A) is incorrect. Auditing standards are not elective guidelines but standardsrequired of all accountants during the performance of an audit.Answer (B) is incorrect. Although Statements on Auditing Standards (SASs) issued bythe ASB are now deemed to be GAAS, they do not constitute all GAAS. Additionally, thePublic Company Accounting Oversight Board (PCAOB) establishes auditing standardsfor public companies.Answer (C) is correct. An audit should be planned, performed, and reported on inaccordance with GAAS. Auditing standards are concerned with audit quality and theobjectives to be attained (AU 150).Answer (D) is incorrect. Auditing procedures are acts that the auditor performs during thecourse of an audit to comply with auditing standards (AU 150).



[4] Gleim #: 1.2.16 -- Source: CPA 595 A-23The third general standard states that due professional care is to be exercised in the planningand performance of the audit and the preparation of the report. This standard requires

Thorough review of the existing safeguards over access to assets and records.A.Limited review of the indications of employee fraud and illegal acts.B.Objective review of the adequacy of the technical training and proficiency of firmpersonnel.

C.

Supervision of assistants by the auditor with final responsibility for the audit.D.

Answer (A) is incorrect. Although a review of safeguards over access to assets andrecords relates to the conduct of the audit, this procedure is not required specifically bythe third general standard.Answer (B) is incorrect. Although a review of the likelihood of employee fraud andillegal acts relates to the conduct of the audit, this procedure is not required specifically bythe third general standard.Answer (C) is incorrect. Objective review of the adequacy of the technical training andproficiency of firm personnel relates to the first general standard (adequate technicaltraining and proficiency as an auditor).Answer (D) is correct. According to AU 230, Due Professional Care in the Performanceof Work, due professional care imposes a responsibility upon each professional within anindependent auditor’s organization to observe the standards of field work and reporting.The first standard of field work requires proper supervision of assistants (AU 150). Thus,AU 230 states that the auditor with final responsibility is responsible for the assignmentof tasks to, and the supervision of, assistants.


In testing the existence assertion for an asset, an auditor ordinarily works from the

Financial statements to the potentially unrecorded items.A.Potentially unrecorded items to the financial statements.B.Accounting records to the supporting evidence.C.Supporting evidence to the accounting records.D.



Answer (A) is incorrect. Unrecorded items relate to the completeness assertion. The auditorshould select evidence indicating that an item should be included in an amount and theninvestigate.Answer (B) is incorrect. Unrecorded items relate to the completeness assertion. The auditorshould select evidence indicating that an item should be included in an amount and theninvestigate.Answer (C) is correct. The existence assertion concerns whether assets, liabilities, or equityinterests of the entity exist at a given time. The direction of testing is ordinarily from theaccounting records to the supporting evidence, often including direct observation of the asset.Thus, the auditor selects from items contained in a financial statement amount and searches forrelevant evidential matter (AU 326).Answer (D) is incorrect. Proceeding from the supporting evidence to the accounting recordsmight detect unrecorded assets.


What is the nature of the three generally accepted auditing standards classified as standards offield work?

The competence, independence, and professional care of persons performing the audit.A.Criteria for the content of the auditor’s report on financial statements and related notedisclosures.

B.

The criteria for audit planning and evidence-gathering.C.The need to maintain an independence in mental attitude in all matters relating to theaudit.

D.

Answer (A) is incorrect. The competence, independence, and professional care of personsperforming the audit relate to the general standards.Answer (B) is incorrect. Criteria for the content of the auditor’s report on financialstatements and related note disclosures concern the standards of reporting.Answer (C) is correct. The three standards classified as standards of field work relate to

The planning of the audit and supervision of assistants,1.Obtaining a sufficient understanding of the entity and its environment, including itsinternal control, and

2.

The gathering of sufficient appropriate evidence.3.Answer (D) is incorrect. Independence relates to the second general standard.



[7] Gleim #: 1.2.27 -- Source: CPA 1177 A-58During the course of an audit, an auditor required additional research and consultation withothers. This additional research and consultation is considered to be

An appropriate part of the professional conduct of the engagement.A.A responsibility of the management, not the auditor.B.A failure on the part of the CPA to comply with GAAS because of a lack of competence.C.An unusual practice indicating that the CPA should not have accepted the engagement.D.

Answer (A) is correct. An Interpretation of Conduct Rule 201 states that in many casesadditional research and consultation with others may be necessary during an engagement.The auditor should not undertake the engagement unless (s)he has or expects to gain theknowledge to complete the audit with professional competence.Answer (B) is incorrect. Management is not responsible for ensuring that the auditor hasthe competence to perform the audit.Answer (C) is incorrect. GAAS are complied with when the auditor undertakesadditional research and consultation.Answer (D) is incorrect. Additional research and consultation are customary, especiallyon audits of new clients.

[8] Gleim #: 1.3.38 -- Source: CPA 0410-24A

Which of the following components is appropriate in a practitioner’s report on the results ofapplying agreed-upon procedures?

A list of the procedures performed, as agreed to by the specified parties identified in thereport.

A.

A statement that management is responsible for expressing an opinion.B.A title that includes the phrase “independent audit.”C.A statement that the report is unrestricted in its use.D.

Answer (A) is correct. In an agreed-upon procedures engagement, the practitioner isengaged to report on the results of performing specific procedures set forth by specifiedparties. The report would list the procedures performed and provide the results of thoseprocedures but would provide no form of positive or negative assurance.Answer (B) is incorrect. No opinion is expressed in an agreed-upon procedures report.Answer (C) is incorrect. The report would not have a title referring to an audit.Answer (D) is incorrect. An agreed-upon procedures report should have a statementrestricting the use to the specified parties who set forth the procedures to be performed.



[9] Gleim #: 1.3.39 -- Source: CPA 1190 A-40The authoritative body designated to promulgate standards concerning an accountant’sassociation with unaudited financial statements of an entity that is not required to file financialstatements with an agency regulating the issuance of the entity’s securities is the

Financial Accounting Standards Board.A.Government Accountability Office.B.Accounting and Review Services Committee.C.Auditing Standards Board.D.

Answer (A) is incorrect. The FASB is charged with establishing GAAP.Answer (B) is incorrect. The GAO is the federal agency headed by the ComptrollerGeneral that issues Government Auditing Standards (the Yellow Book).Answer (C) is correct. The AICPA bylaws designate the Accounting and ReviewServices Committee as the senior technical committee authorized to issuepronouncements in connection with the unaudited financial statements or other unauditedfinancial information of a nonissuer.Answer (D) is incorrect. The ASB is the AICPA senior technical committee responsiblefor issuing auditing and attest standards and procedures.


The party responsible for assumptions identified in the preparation of prospective financialstatements is usually

A third-party lending institution.A.The client’s management.B.The reporting accountant.C.The client’s independent auditor.D.

Answer (A) is incorrect. Management is usually the responsible party.Answer (B) is correct. Management is usually the responsible party, that is, the person(s)responsible for the assumptions underlying prospective financial statements. However, theresponsible party may be a party outside the entity, such as a possible acquirer.Answer (C) is incorrect. Management is usually the responsible party.Answer (D) is incorrect. Management is usually the responsible party.



[11] Gleim #: 1.4.52 -- Source: CPA AUD R99-3An entity engaged a CPA to determine whether the client’s web sites comply with definedWebTrust principles and criteria. In performing this engagement, the CPA should apply theprovisions of

Statements on Assurance Standards.A.Statements on Standards for Attestation Engagements.B.Statements on Standards for Management Consulting Services.C.Statements on Auditing Standards.D.

Answer (A) is incorrect. The AICPA has not issued specific Statements on AssuranceStandards.Answer (B) is correct. An attest engagement involves reporting on subject matter, or anassurance about subject matter, that is the responsibility of another party. When providingWebTrust assurance, the accountant must address written assertions by management.Thus, Statements on Standards for Attestation Engagements are applicable.Answer (C) is incorrect. WebTrust is not considered a management consulting service.Answer (D) is incorrect. Statements on Auditing Standards are applicable to audits offinancial statements.

[12] Gleim #: 1.4.53 -- Source: Publisher, adapted

A WebTrust engagement on processing integrity requires from client management a

Written assertion.A.Set of financial statements.B.Third-party verification letter.C.Statement about the integrity of top management.D.



Answer (A) is correct. WebTrust was developed from the attestation standards and requires awritten assertion by management for each principle reported on. When the assertion about awebsite complies with WebTrust principles, it is granted the CPA WebTrust seal to bedisplayed on the entity’s web page. Consumers may access the examination report and CPAWebTrust principles and criteria through the entity’s web page.Answer (B) is incorrect. WebTrust is an assurance service developed under the attestationstandards. Thus, the practitioner must obtain a written assertion from the responsible partybefore a WebTrust seal is granted. The assertion in an engagement to assess processingintegrity should relate to whether system processing is complete, accurate, timely, andauthorized.Answer (C) is incorrect. WebTrust is an assurance service developed under the attestationstandards. Thus, the practitioner must obtain a written assertion from the responsible partybefore a WebTrust seal is granted. The assertion in an engagement to assess processingintegrity should relate to whether system processing is complete, accurate, timely, andauthorized.Answer (D) is incorrect. WebTrust is an assurance service developed under the attestationstandards. Thus, the practitioner must obtain a written assertion from the responsible partybefore a WebTrust seal is granted. The assertion in an engagement to assess processingintegrity should relate to whether system processing is complete, accurate, timely, andauthorized.


The examination report issued under the WebTrust service includes all of the following except

An introductory paragraph indicating the principle or principles of WebTrust beingevaluated.

A.

The CPA’s opinion on the value of the products offered at the web site.B.The CPA’s opinion on the subject matter or management’s assertion on the subjectmatter.

C.

A statement that the examination was made in accordance with the AICPA standards.D.

Answer (A) is incorrect. It is contained within the WebTrust examination report.Answer (B) is correct. The CPA expresses an opinion relating to one or more of thefollowing principles: security, privacy, availability, processing integrity, andconfidentiality.Answer (C) is incorrect. It is contained within the WebTrust examination report.Answer (D) is incorrect. It is contained within the WebTrust examination report.



[14] Gleim #: 1.4.64 -- Source: Publisher, adaptedWhich of the following qualifications is least likely required to provide CPA ElderCare(PrimePlus) services?

Knowledge of geriatric health issues.A.Prior experience.B.Financial management skills.C.Mediation techniques.D.

Answer (A) is incorrect. Knowledge of geriatric health issues are needed to provideElderCare (PrimePlus) services.Answer (B) is correct. Prior experience is not required because ElderCare (PrimePlus)services are relatively new to the CPA market. Personal skills and knowledge of issues arefundamental to providing this service to the elderly.Answer (C) is incorrect. Financial management skills are needed to provide ElderCare(PrimePlus) services.Answer (D) is incorrect. Mediation techniques are needed to provide ElderCare(PrimePlus) services.


One of a CPA firm’s basic objectives is to provide professional services that conform withprofessional standards. Reasonable assurance of achieving this basic objective is providedthrough

A system of quality control.A.A system of peer review.B.Continuing professional education.C.Compliance with generally accepted reporting standards.D.

Answer (A) is correct. A CPA firm must have a system of quality control that ensuresthat its personnel comply with professional standards applicable to its audit andaccounting practice. However, a deficiency in an engagement, by itself, does notnecessarily indicate that the firm’s system of quality control is not sufficient. GAAS applyto individual engagements, and quality control standards apply to the firm’s practice as awhole (AU 161).Answer (B) is incorrect. A system of peer review is a necessary part of the practice-monitoring requirement for AICPA membership.Answer (C) is incorrect. Continuing professional education is but one element of qualitycontrol.Answer (D) is incorrect. Firms must comply with all pronouncements applicable to theservices rendered, not just with the reporting standards.



[16] Gleim #: 1.5.74 -- Source: Publisher, adaptedQuality control policies and procedures should provide the firm with reasonable assurance thatthe system of quality control is relevant, adequate, operating effectively, and complied with inpractice. This statement defines the quality control element of

Planning.A.Supervision.B.Independence, integrity, and objectivity.C.Monitoring.D.

Answer (A) is incorrect. Planning is an aspect of the element of engagementperformance.Answer (B) is incorrect. Supervision is an aspect of the element of engagementperformance.Answer (C) is incorrect. The element of relevant ethical requirements providesreasonable assurance that personnel at all levels remain independent in fact andappearance, perform all professional responsibilities with integrity, and maintainobjectivity in discharging those responsibilities.Answer (D) is correct. The quality control element of monitoring is concerned withproviding reasonable assurance that the system of quality control is relevant, adequate,operating effectively, and complied with in practice. Monitoring involves considering andevaluating the relevance and adequacy of policies and procedures, the appropriateness ofguidance materials and practice aids, the effectiveness of professional development, andthe compliance with policies and procedures.


According to PCAOB quality control standards applying to an audit, the engagement qualityreviewer evaluates

The documentation.A.Only the uncorrected misstatements.B.The audit report but not the internal control report.C.Only the assessment of risks identified by management.D.



Answer (A) is correct. The EQR process in an audit evaluates the significant judgments made.This involves discussions with the engagement partner and other team members and reviewingwhether the documentation supports the conclusions reached and appropriate responses tosignificant risks.Answer (B) is incorrect. The reviewer evaluates corrected and uncorrected identifiedmisstatements and control deficiencies.Answer (C) is incorrect. The reviewer evaluates the statements, the internal control report, andthe audit report.Answer (D) is incorrect. The reviewer evaluates the assessment of, and responses to,significant risks, including those identified by the reviewer.


Within its system of quality control, the objectives of the firm’s policies and procedures relatedto the element of human resources include providing

Technical training that assures proficiency as an auditor.A.Professional education that is required for auditors to perform with due professional care.B.Professional development activities that allow employees to fulfill assignedresponsibilities.

C.

An ongoing evaluation of professional development activities.D.

Answer (A) is incorrect. Policies and procedures should be established to providereasonable assurance that the firm has sufficient personnel with the capabilities,competence, and commitment to ethical principles necessary to perform engagements inaccordance with professional standards and legal/regulatory requirements as well as toissue appropriate reports.Answer (B) is incorrect. Policies and procedures should be established to providereasonable assurance that the firm has sufficient personnel with the capabilities,competence, and commitment to ethical principles necessary to perform engagements inaccordance with professional standards and legal/regulatory requirements as well as toissue appropriate reports.Answer (C) is correct. Policies and procedures should be established to providereasonable assurance that the firm has sufficient personnel with the capabilities,competence, and commitment to ethical principles necessary to perform engagements inaccordance with professional standards and legal/regulatory requirements as well as toissue appropriate reports.Answer (D) is incorrect. Policies and procedures should be established to providereasonable assurance that the firm has sufficient personnel with the capabilities,competence, and commitment to ethical principles necessary to perform engagements inaccordance with professional standards and legal/regulatory requirements as well as toissue appropriate reports.



[19] Gleim #: 1.5.85 -- Source: CPA 1182 A-15In pursuing a CPA firm’s quality control objectives, a CPA firm may maintain recordsindicating which partners or employees of the CPA firm were previously employed by the CPAfirm’s clients. Which quality control element would this be most likely to satisfy?

Professional relationship.A.Engagement performance.B.Relevant ethical requirements.C.Human resources.D.

Answer (A) is incorrect. Professional relationship is not one of the quality controlelements.Answer (B) is incorrect. Engagement performance concerns performance of work inaccordance with professional standards, regulations, and the firm’s quality standards.Answer (C) is correct. CPA firms should avoid situations in which third parties mightquestion the firm’s independence. Thus, they should adhere to the independence standardsestablished by the Code of Professional Conduct, state board of accountancy, state CPAsociety, the SEC, the Sarbanes-Oxley Act, the PCAOB, and any other law or regulation.Answer (D) is incorrect. The quality control element of human resources includes hiring,assignment of personnel, professional development, and advancement activities.

[20] Gleim #: 2.1.1 -- Source: CPA 0605 REG-39

A CPA who is not in public practice is obligated to follow which of the following rules ofconduct?

Independence.A.Integrity and objectivity.B.Contingent fees.C.Commissions.D.

Answer (A) is incorrect. Conduct Rule 101, Independence, applies only to CPAs inpublic practice.Answer (B) is correct. Under Conduct Rule 102, Integrity and Objectivity, all membersmust maintain objectivity and integrity, be free of conflicts of interest, not knowinglymisrepresent facts, and not subordinate his/her judgment to others when performingprofessional services.Answer (C) is incorrect. Conduct Rule 302, Contingent Fees, applies only to CPAs inpublic practice.Answer (D) is incorrect. Conduct Rule 503, Commissions and Referral Fees, applies onlyin part (Referrals) to all members and in part (Commissions) to CPAs in public practice.



[21] Gleim #: 2.2.4 -- Source: CPA 591 A-52The concept of materiality is least important to an auditor when considering the

Adequacy of disclosure of a client’s illegal act.A.Discovery of weaknesses in a client’s internal control.B.Effects of a direct financial interest in the client on the CPA’s independence.C.Decision whether to use positive or negative confirmations of accounts receivable.D.

Answer (A) is incorrect. In considering the effect of an illegal act on the financialstatements and its implications for other aspects of the audit, materiality is important.Answer (B) is incorrect. An auditor who is considering internal control in a financialstatement audit must make materiality judgments.Answer (C) is correct. Independence is impaired if a CPA has any direct financial interestin a client. Whether this direct financial interest is material is irrelevant. The test ofmateriality is applied, however, if the financial interest is indirect.Answer (D) is incorrect. Materiality is one factor considered when deciding betweenpositive or negative confirmations.


Which of the following legal situations would be considered to impair the auditor’sindependence?

An expressed intention by the current management to commence litigation against theauditor alleging deficiencies in audit work for the client, although the auditor considersthat there is only a remote possibility that such a claim will be filed.

A.

Actual litigation by the auditor against the client for an amount not material to the auditoror to the financial statements of the client arising out of disputes as to billings forconsulting services.

B.

Actual litigation by the auditor against the current management alleging managementfraud or deceit.

C.

Actual litigation by the client against the auditor for an amount not material to the auditoror to the financial statements of the client arising out of disputes as to billings for taxservices.

D.



Answer (A) is incorrect. Independence is impaired if the auditor concludes that it is probablethat such a claim will be filed.Answer (B) is incorrect. If the litigation is related to an engagement not requiringindependence, such as consulting services, impairment would not necessarily result unless theamount in controversy is material to one of the litigants.Answer (C) is correct. The following are situations in which actual or threatened litigationimpairs independence: (1) litigation has begun alleging deficient audit work; (2) litigation hasbegun alleging fraud or deceit by current management; and (3) management has expressed anintention to commence litigation alleging deficient audit work, and the auditor concludes that itis probable that such a claim will be filed.Answer (D) is incorrect. If the litigation is related to an engagement not requiringindependence, such as tax services, impairment would not necessarily result unless the amountin controversy is material to one of the litigants.


An audit independence issue might be raised by the auditor’s participation in consultingservices engagements. Which of the following statements is most consistent with theprofession’s attitude toward this issue?

Information obtained as a result of a consulting engagement is confidential to thatengagement and should not influence performance of the attest function.

A.

The decision as to loss of independence must be made by the client based upon the factsof the particular case.

B.

The auditor should not make management decisions for an audit client.C.The auditor who is asked to review management decisions is also competent to makethese decisions and can do so without loss of independence.

D.

Answer (A) is incorrect. The auditor should use all information available.Answer (B) is incorrect. The auditor, not the client, must determine whether (s)he hasbeen put in a position in which independence might be questioned.Answer (C) is correct. A member must evaluate the effect on his/her independence ofperforming nonattest services. The member should take care not to “perform managementfunctions or make management decisions for the attest client.”Answer (D) is incorrect. The auditor may review management decisions and makesuggestions, but (s)he may not actually make those decisions without losingindependence.



[24] Gleim #: 2.2.26 -- Source: Publisher, adaptedWhen is the independence of the CPA auditor of a client company’s financial statements mostlikely to be impaired because of involvement in litigation?

A creditor of the client sues the CPA alleging reliance on materially misstated financialstatements.

A.

An underwriter of securities is a co-defendant with the client and the CPA. It files a cross-claim against the CPA, but the client does not.

B.

Shareholders of the client bring a class action against the client, its management, and theCPA. The CPA files a cross-claim against management alleging fraud.

C.

A director of another client is a co-defendant with the client and the CPA. This personfiles a cross-claim against the CPA.

D.

Answer (A) is incorrect. This litigation does not affect independence if the client is notthe plaintiff or is a nominal plaintiff. However, independence may be impaired if the thirdparty (e.g., an insurance company) is also a client of the member, and the risk of amaterial settlement is significant.Answer (B) is incorrect. Cross-claims against the member by an underwriter do notimpair independence if no similar claims are made by the client.Answer (C) is correct. Independence is not necessarily impaired when the CPA is a co-defendant with the client. However, cross-claims filed by the co-defendants against eachother may impair independence. For example, the client may allege that the CPA wasnegligent, or the CPA may allege that the client’s management committed fraud. In thesecircumstances, the interests of the client and the CPA are opposed, and independence maybe impaired.Answer (D) is incorrect. Cross-claims filed against the member by persons who are alsoofficers or directors of other clients do not usually impair independence with respect tothe other clients.

[Fact Pattern #1]A CPA firm was purchased by a public company. The acquirer performs other professional servicesand has banking, insurance, and brokerage subsidiaries. The owners and employees becameemployees of a subsidiary. Also, the previous owners formed a new CPA firm that provides attestservices. It leases employees, offices, and equipment from the parent, which also providesadvertising, billing, and collection services.



[25] Gleim #: 2.2.29 -- Source: Publisher, adapted(Refers to Fact Pattern #1)In the alternative practice structure (APS) of which the new firm is a part, covered members areclosely aligned with other persons and entities. Who is subject to the same independence rulesas covered members?

An indirect superior to whom a direct superior reports.A.Any indirect superior.B.The spouse of an indirect superior.C.An employee leased by the firm from the parent.D.

Answer (A) is incorrect. Less restrictive independence rules apply to indirect superiors(and their spouses, spousal equivalents, and dependents).Answer (B) is incorrect. Less restrictive independence rules apply to indirect superiors(and their spouses, spousal equivalents, and dependents).Answer (C) is incorrect. Less restrictive independence rules apply to indirect superiors(and their spouses, spousal equivalents, and dependents).Answer (D) is correct. The independence rules ordinarily apply in their entirety only tothe persons and entities included in the definition of a covered member: (1) the traditionalfirm (the new firm), (2) its owners, (3) individuals employed or leased by the new firm,and (4) entities controlled by such persons. The independence rules also apply in theirentirety to (1) direct superiors of a partner or manager who is a covered member and (2)entities within the APS subject to significant influence by a direct superior.


Which of the following reports may be issued only by an accountant who is independent of aclient?

Standard report on an examination of a financial forecast.A.Report on consulting services.B.Compilation report on historical financial statements.C.Compilation report on a financial projection.D.



Answer (A) is correct. Conduct Rule 101, Independence, states, “A member in public practiceshall be independent in the performance of professional services as required by standardspromulgated by bodies designated by Council.” Such standards include Statements onStandards for Attestation Engagements, which apply to, among other things, prospectivefinancial statements (forecasts and projections). Thus, Conduct Rule 101 and the SSAEsrequire a practitioner to be independent when performing an examination of a financialforecast.Answer (B) is incorrect. Consulting services engagements do not require independence.Answer (C) is incorrect. Compilation reports on historical financial statements do not requireindependence.Answer (D) is incorrect. Compilation reports on financial projections do not requireindependence.


A violation of the profession’s ethical standards would most likely have occurred when a CPAin public practice

Used a records-retention agency to store the CPA’s working papers and client records.A.Served as an expert witness in a damage suit and received compensation based on theamount awarded to the plaintiff.

B.

Referred life insurance assignments to the CPA’s spouse, who is a life insurance agent.C.Serves on a municipal board of income tax appeals, discloses that status to concernedparties, participates as a board member in a tax appeal involving a client, but does notreceive the client’s consent for such action.

D.

Answer (A) is incorrect. According to an Ethics Ruling, use of a third-party to assist inproviding professional services must be disclosed to the client before confidential clientinformation is disclosed to the provider. The third-party service provider may not be usedif the client objects. But disclosure is not necessary if the services constituteadministrative support (e.g., records storage).Answer (B) is incorrect. The AICPA does not prohibit contingent fees except in certaincases.Answer (C) is incorrect. The benefit (commission) received by the spouse as a result ofthe referral is ascribed to the CPA, but receipt of commissions is permissible in certaincircumstances. The AICPA does not prohibit the acceptance of disclosed commissions forproducts or services supplied by third parties except in certain cases.Answer (D) is correct. Under Interpretation 102-2, if the significant relationship creatinga conflict of interest is disclosed to and consent is obtained from all appropriate parties,Conduct Rule 102 does not prohibit performance of the professional service. Moreover,an Ethics Ruling has determined that service on a governmental body is within theInterpretation. (But disclosure and consent do not eliminate an impairment ofindependence.) The failure to secure the client’s consent therefore means that thearrangement could be viewed as impairing the CPA’s objectivity.




Which of the following acts by a CPA who is not in public practice will most likely beconsidered a violation of the ethical standards of the profession?

Using the CPA designation without disclosing employment status in connection withfinancial statements issued for external use by the CPA’s employer.

A.

A CPA firm indicates on its letterhead that other CPA firms are correspondents ratherthan members of an association.

B.

A member sells a newsletter bearing his/her name.C.Compiling the CPA’s employer’s financial statements and making reference to the CPA’slack of independence.

D.

Answer (A) is correct. A member not in public practice who uses the CPA designation ina manner implying that (s)he is independent of the employer has committed a knowingmisrepresentation of fact in violation of Conduct Rule 102.Answer (B) is incorrect. CPA firms are not allowed to use a firm name indicating anassociation. The public may believe a partnership exists when it does not.Answer (C) is incorrect. A member may sell a newsletter bearing his/her name if themember writes it and ensures that those promoting it do not make statements about theauthor or his/her writings that violate the Conduct Rule on advertising and other forms ofsolicitation.Answer (D) is incorrect. An accountant may compile a nonissuer’s financial statements if(s)he issues the appropriate report. The lack of independence should be disclosed.


According to the standards of the profession, which of the following activities may be requiredin exercising due professional care?

Consulting Obtainingwith Specialty

Experts Accreditation

A. Yes YesB. Yes NoC. No YesD. No No



Answer (A) is incorrect. Due professional care may require additional research or consultationwith others but not specialty accreditation.Answer (B) is correct. A CPA should undertake only those services that (s)he reasonablyexpects to complete with professional competence and should exercise due professional care inperforming those services. Additional research or consultation with others may be necessary togain sufficient competence to complete a service in accordance with professional standards.However, professional standards do not require specialty accreditation, although many CPAschoose to specialize in specific services.Answer (C) is incorrect. Due professional care may require additional research or consultationwith others but not specialty accreditation.Answer (D) is incorrect. Due professional care may require additional research or consultationwith others but not specialty accreditation.


According to the profession’s ethical standards, which of the following events may justify adeparture from a Statement of Financial Accounting Standards?

Evolution ofa New Form

New of BusinessLegislation Transaction

A. No YesB. Yes NoC. Yes YesD. No No

Answer (A) is incorrect. New legislation and the evolution of a new form of businesstransaction may justify departure from a SFAS.Answer (B) is incorrect. New legislation and the evolution of a new form of businesstransaction may justify departure from a SFAS.Answer (C) is correct. In general, strict compliance with accounting principles isrequired. However, Conduct Rule 203 recognizes that, due to unusual circumstances,adhering to GAAP may cause financial statements to be misleading. New legislation andthe evolution of a new form of business transaction are events that may justify departurefrom a SFAS.Answer (D) is incorrect. New legislation and the evolution of a new form of businesstransaction may justify departure from a SFAS.



[31] Gleim #: 2.4.52 -- Source: Publisher, adaptedWhen a CPA is associated with financial statements that do not comply with promulgatedGAAP because the statements would be misleading without the departure, the CPA is notrequired to disclose

The departure.A.The approximate effects of the departure in comparison to the application of GAAP.B.The reason the departure does not have a material effect on the statements.C.The reasons compliance would have been misleading.D.

Answer (A) is incorrect. The CPA is required to disclose the departure.Answer (B) is incorrect. The CPA is required to disclose the approximate effects of thedeparture.Answer (C) is correct. Under Conduct Rule 203, a CPA who performs services thatrequire representations of conformity with promulgated GAAP is required to describe thedeparture, the approximate effects of the departure (if practicable), and the reasonscompliance would have resulted in misleading financial statements. But this requirementapplies only if the effect on the statements or data is material.Answer (D) is incorrect. The CPA is required to disclose the reasons compliance wouldhave been misleading.

[32] Gleim #: 2.5.58 -- Source: CPA 0407 REG-17

Under which of the following circumstances may a CPA charge fees that are contingent uponfinding a specific result?

For an examination of prospective financial statements.A.For an audit or a review if agreed upon by both the CPA and the client.B.For a compilation if a third party will use the financial statement and disclosure is notmade in the report.

C.

If fixed by courts, other public authorities, or in tax matters if based on the results ofjudicial proceedings.

D.



Answer (A) is incorrect. The receipt of contingent fees by a member in public practice isspecifically prohibited when the member performs an examination of prospective financialinformation.Answer (B) is incorrect. The receipt of contingent fees by a member in public practice isspecifically prohibited when the member performs an audit or a review, whether or not theCPA and client agree upon it.Answer (C) is incorrect. The receipt of contingent fees by a member in public practice isspecifically prohibited when the member performs a compilation that will be used by thirdparties, and the report does not disclose the CPA’s lack of independence.Answer (D) is correct. A contingent fee is established as part of an agreement under which theamount of the fee is dependent upon the finding or result. Fees are not deemed to be contingentif fixed by courts or other public authorities, or in tax matters, if they are based on the results ofjudicial proceedings or the finding of governmental agencies.


A member of the AICPA owns an interest in a separate business that performs tax services. Ifthe member does not control the business, who must comply with the Code of ProfessionalConduct?

The entity and the member.A.The other owners.B.The entity’s employees.C.The member only.D.

Answer (A) is incorrect. If the member, individually or with his/her firm or members ofthe firm, lacks control, the entity and the member are not subject to the Code.Answer (B) is incorrect. If the member, individually or with his/her firm or members ofthe firm, lacks control, the other owners are not subject to the Code.Answer (C) is incorrect. If the member, individually or with his/her firm or members ofthe firm, lacks control, the entity’s employees are not subject to the Code.Answer (D) is correct. A member in the practice of public accounting may own aninterest in a separate business that performs the services for which standards areestablished, e.g., if the member, individually or with his/her firm or members of the firm,controls the separate business (as defined by U.S. GAAP), the entity and all its ownersand employees must comply with the Code. Absent such control, the member, but not theseparate business, its other owners, and its employees, would be subject to the Code.



[34] Gleim #: 2.6.77 -- Source: CPA LAW R02-4Which of the following statements is true regarding an accountant’s working papers?

The accountant owns the working papers and generally may disclose them as theaccountant sees fit.

A.

The client owns the working papers, but the accountant has custody of them until theaccountant’s bill is paid in full.

B.

The accountant owns the working papers but generally may not disclose them without theclient’s consent or a court order.

C.

The client owns the working papers, but, in the absence of the accountant’s consent, maynot disclose them without a court order.

D.

Answer (A) is incorrect. The accountant may not disclose client information without theclient’s consent or a court order.Answer (B) is incorrect. The client does not own the accountant’s working papers.Answer (C) is correct. A member’s working papers, including any analyses and schedulesprepared by the client at the request of the member, are the member’s property, not theclient’s. However, under Conduct Rule 301, a member in public practice ordinarily mustnot disclose confidential client information contained in the working papers without theclient’s specific consent. Exceptions to this principle include compliance with a subpoenaor summons or with applicable laws and regulations.Answer (D) is incorrect. The accountant owns the working papers, but may not discloseconfidential information without the client’s permission or a court order.


Which of the following actions by a CPA most likely violates the profession’s ethicalstandards?

Arranging with a financial institution to collect notes issued by a client in payment of feesdue.

A.

Compiling the financial statements of a nonpublic client that employed the CPA’s spouseas a bookkeeper.

B.

Retaining client-provided records after the client has demanded their return.C.Purchasing a segment of an insurance company’s business that performs actuarial servicesfor a nonpublic client’s employee benefit plans.

D.



Answer (A) is incorrect. A CPA may make arrangements with a bank to collect notes issuedby a client in payment of fees.Answer (B) is incorrect. The independence of a member is impaired by a spouse’s job as abookkeeper if the spouse approves transactions, prepares source documents, determines journalentries, etc. However, a compilation does not require independence. Thus, preparing financialstatements based on the trial balance does not impair independence.Answer (C) is correct. Retention of client-provided records after demand is made for them bythe client is an act discreditable to the profession and a violation of Conduct Rule 501. Even ifthe state in which a member practices grants a lien on certain records, this ethical standard isapplicable.Answer (D) is incorrect. An appraisal, valuation, or actuarial service impairs independence ifthe results are material to the financial statements and significant subjectivity is involved. Forexample, a valuation for a business combination, but not an actuarial valuation for a pension orother postemployment liability, usually involves significant subjectivity. Furthermore,appraisal, valuation, and actuarial services not performed for financial statement purposes donot impair independence if the other requirements of Rule 101 are satisfied.


Which of the following violates the AICPA’s Code of Professional Conduct?

A member not in public practice is a bank controller who is designated as a CPA on bankstationery and in bank advertisements listing officers of the bank.

A.

A member contracts with a service entity to maintain a client’s computer hardware andcharges the client a higher servicing fee than that charged to the member by the serviceprovider.

B.

A partner in a CPA firm is elected to public office. After her withdrawal from the firm,the remaining partners continue to use a firm name that includes her name.

C.

A member shares offices with another member. Their joint letterhead implies that apartnership exists when each member is in fact practicing individually.

D.

Answer (A) is incorrect. The bank controller’s use of the CPA title is permitted.Answer (B) is incorrect. The profit on the resale is not a commission. Resale of productsto clients is permitted.Answer (C) is incorrect. The name of a past owner may be included in the firm name of asuccessor organization.Answer (D) is correct. Two CPAs who are in fact not in partnership should not use aletterhead showing both names. Such a representation is misleading. Furthermore, somecourts have held that such an arrangement may be a de facto partnership, and theindividual CPAs may be liable for the obligations of the de facto partnership and of the defacto partners.



[37] Gleim #: 2.6.89 -- Source: CPA 1177 A-37Richard, CPA, performs compilation services for Norton Corporation, a nonpublic entity. Thecompilation reports issued by Richard disclose lack of independence and are not used by thirdparties. Richard has accepted a commission from a software company for recommending itsproducts to Norton. The commission agreement was disclosed to Norton. Richard also refersNorton to Cruz, CPA, who is more competent with respect to engagements involving theindustry in which Norton operates. Cruz performs an audit of Norton’s financial statements andsubsequently remits to Richard a portion of the fee collected. The referral fee agreement waslikewise disclosed to Norton. Richard accepts the fee. Who, if anyone, has violated the Code ofProfessional Conduct?

Only Richard.A.Both Richard and Cruz.B.Only Cruz.C.Neither Richard nor Cruz.D.

Answer (A) is incorrect. Richard has not violated the Code.Answer (B) is incorrect. Neither Richard nor Cruz has violated the Code.Answer (C) is incorrect. Cruz has not violated the Code.Answer (D) is correct. A commission is “compensation, except a referral fee, forrecommending or referring any product or service to be supplied by another person” (FTCOrder dated August 3, 1990). Conduct Rule 503 prohibits receipt of a disclosedcommission only if the CPA performs for the client an audit, a review, a compilationwhen the report will be used by third parties and the report does not disclose the CPA’sindependence, or an examination of prospective financial information. A referral fee is“compensation for recommending or referring any service of a CPA to any person” (FTCOrder cited above). Conduct Rule 503 permits referral fees if they are disclosed to theclient. Consequently, Richard has not violated Conduct Rule 503 by accepting either thedisclosed commission or the disclosed referral fee. Cruz has not violated the Code bypaying the disclosed referral fee.


According to SEC independence regulations,

All audit partners must rotate every 5 years.A.Preapproval of accountants’ services may be in accord with detailed policies andprocedures rather than explicit.

B.

The issuer must disclose only those fees paid to the accountant for audit work.C.No partner may sell nonaudit services to the client during the audit.D.



Answer (A) is incorrect. The lead and concurring (reviewing) audit partners must rotate every5 years, with a 5-year time-out period. Other audit partners must rotate every 7 years, with a 2-year time-out.Answer (B) is correct. Audit committees ordinarily must preapprove the services performed byaccountants (permissible nonaudit services and all audit, review, and attest engagements).Approval must be either explicit or in accordance with detailed policies and procedures. Ifapproval is based on detailed policies and procedures, the audit committee must be informed,and no delegation of its authority to management is allowed.Answer (C) is incorrect. An issuer must disclose in its proxy statement or annual filing feespaid to the accountant segregated into four categories: (1) audit, (2) audit-related, (3) tax, and(4) all other.Answer (D) is incorrect. An accountant is not independent if, during the audit and the periodof the engagement, any audit partner (excluding specialty partners such as tax partners) earnsor receives compensation for selling services (excluding audit, review, or attest services) to theclient.


According to the PCAOB, an accounting firm’s independence is least likely to be impaired ifthe firm

Provides a service to the audit client for a contingent fee.A.Receives a commission from the audit client.B.Has an audit client that employs a former firm professional.C.Provides tax services to a person in a financial reporting oversight role at the audit client.D.

Answer (A) is incorrect. A firm is not independent of its client if the firm, or anyaffiliate, during the audit and engagement period, provides any service or product to theclient for a contingent fee or a commission, or receives from the client a contingent fee orcommission.Answer (B) is incorrect. A firm is not independent of its client if the firm, or any affiliate,during the audit and engagement period, provides any service or product to the client for acontingent fee or a commission, or receives from the client a contingent fee orcommission.Answer (C) is correct. Firm independence is impaired by a client’s employment of aformer firm professional that could adversely affect the audit unless safeguards areestablished. Pre-â€‹change safeguards include removal from the audit of those negotiatingwith the client, and post-â€‹change safeguards include possibly modifying the audit plan.Answer (D) is incorrect. A registered public accounting firm is not independent of itsaudit client if the firm, or any affiliate, during the professional engagement periodprovides any tax service to a person in a financial reporting oversight role at the auditclient.



[40] Gleim #: 2.7.92 -- Source: Publisher, adaptedAccording to the PCAOB, an accounting firm is most likely to be independent of its audit clientif

A reasonable investor would conclude that it is not objective and impartial.A.The firm’s audit professional is responsible for internal control over financial reporting.B.The firm’s audit professional implemented the client’s internal control over financialreporting.

C.

The firm recommended an aggressive tax position to the client that is more likely than notto be legally allowed.

D.

Answer (A) is incorrect. An auditor is not independent if (s)he is not, or a reasonableinvestor would conclude that (s)he is not, able to be objective and impartial.Answer (B) is incorrect. Guiding principles regarding independence include whether theauditor assumes a management role or audits his/her own work. Thus, an auditor is notindependent if, for example, the auditor is responsible for internal control over financialreporting or had designed or implemented it.Answer (C) is incorrect. Designing or implementing internal control over financialreporting impairs independence.Answer (D) is correct. A firm is not independent of its audit client if, during the audit andengagement period, it provides any nonaudit service related to marketing, planning, orexpressing an opinion in favor of the tax treatment of aggressive tax position transactionsfor the purpose of tax avoidance. However, this Rule does not apply if the tax treatment isat least more likely than not to be allowable under tax law.

[41] Gleim #: 3.1.2 -- Source: CPA 0410-4B

Which of the following conditions most likely would pose the greatest risk in accepting a newaudit engagement?

Staff will need to be rescheduled to cover this new client.A.There will be a client-imposed scope limitation.B.The firm will have to hire a specialist in one audit area.C.The client’s financial reporting system has been in place for 10 years.D.



Answer (A) is incorrect. New clients will often require rescheduling of staff to conduct theaudit.Answer (B) is correct. A client-imposed scope limitation suggests that management will not becompletely forthcoming with all necessary evidence to support the auditor’s opinion. This issuemay raise doubts about the integrity of management.Answer (C) is incorrect. Recognizing the need for the expertise of a specialist in oneparticular area prior to acceptance of a client does not create a significant risk to the auditor.Answer (D) is incorrect. Although the system may be dated, it may still meet the needs of theorganization and be able to provide the evidence necessary to complete the audit.


Early appointment of the auditor enables preliminary work to be performed by the auditor. Thisbenefits the client because it permits the audit to be performed in

A more efficient manner.A.A more thorough manner.B.Accordance with quality control standards.C.Accordance with generally accepted auditing standards.D.

Answer (A) is correct. Early appointment of the auditor is advantageous to both theauditor and the client. Early appointment aids the auditor in planning the work, especiallythat to be done before the end of the year. The client benefits from more efficientscheduling of the audit and an early completion of the work after the end of the fiscalyear.Answer (B) is incorrect. Thoroughness is directly related to the requirement to collectsufficient appropriate evidence, not to the time of appointment.Answer (C) is incorrect. Adherence to quality control standards is necessary regardless ofthe time of appointment.Answer (D) is incorrect. Adherence to GAAS is necessary regardless of the time ofappointment.



[43] Gleim #: 3.1.21 -- Source: Publisher, adaptedOrdinarily, the predecessor auditor permits the auditor to review the predecessor’s auditdocumentation relating to

Balance SheetContingencies Accounts

A. Yes YesB. Yes NoC. No YesD. No No

Answer (A) is correct. AU 315 indicates that the auditor is required to communicate withthe predecessor auditor before accepting the engagement, and the audit documentation ofthe predecessor should normally be made available to the auditor with the client’spermission. Audit documentation records the audit procedures applied, tests performed,information obtained, and conclusions reached. Thus, AU 315 states that the auditorordinarily may review audit documentation related to planning, internal control, auditresults, and other matters of continuing accounting and auditing significance, such as theanalysis of balance sheet accounts, and those relating to contingencies.Answer (B) is incorrect. The audit documentation of the predecessor should normally bemade available to the auditor and may include analyses relating to contingencies andbalance sheet accounts.Answer (C) is incorrect. The audit documentation of the predecessor should normally bemade available to the auditor and may include analyses relating to contingencies andbalance sheet accounts.Answer (D) is incorrect. The audit documentation of the predecessor should normally bemade available to the auditor and may include analyses relating to contingencies andbalance sheet accounts.


Which of the following factors most likely would cause an auditor to question the integrity ofmanagement?

Management has an aggressive attitude toward financial reporting and meeting profitgoals.

A.

Audit tests detect material fraud that was known to management, but not disclosed to theauditor.

B.

Managerial decisions are dominated by one person who is also a stockholder.C.Weaknesses in internal control reported to the audit committee are not corrected bymanagement.

D.



Answer (A) is incorrect. Most managers have an aggressive attitude toward meeting profitgoals and this alone does not indicate that management lacks integrity.Answer (B) is correct. As part of a typical audit, the auditors will acquire a writtenrepresentation letter from management stating that management has no knowledge of existingfraud. However, if the auditor performs tests and detects material fraud known to management,the auditor would have strong reason to question the integrity of management. In addition, theauditor should question the validity of all information provided by management and determinewhether an audit can be completed.Answer (C) is incorrect. Domination of decision-making alone does not imply lack ofintegrity.Answer (D) is incorrect. Failure to immediately correct internal control problems by itselfdoes not indicate a lack of integrity by management.


A document in an auditor’s audit documentation includes the following statement: “Our auditis subject to the inherent risk that material errors and fraud, including defalcations, if they exist,will not be detected. However, we will inform you of fraud that comes to our attention, unless itis inconsequential.” The above passage is most likely from a(n)

Comfort letter.A.Engagement letter.B.Letter of audit inquiry.C.Representation letter.D.

Answer (A) is incorrect. A comfort letter expresses a conclusion on whether auditedfinancial statements and schedules included in the registration statement comply as toform in all material respects with the rules adopted by the SEC.Answer (B) is correct. The audit scope, limitations, expectations, and fees for services areusually set forth in the engagement letter. The engagement letter would disclaim liabilityfor detecting fraud but disclose it if discovered.Answer (C) is incorrect. A letter of audit inquiry is confirmation from the client’s legalcounsel to corroborate assertions made by management regarding litigation.Answer (D) is incorrect. A representation letter is management’s acknowledgement ofresponsibility for the assertions made in the financial statements.



[46] Gleim #: 3.1.32 -- Source: CPA 0407 AUD-11An auditor’s engagement letter most likely would include a statement that

Lists potential significant deficiencies in internal control discovered during the prior-year’s audit.

A.

Explains the analytical procedures that the auditor expects to apply.B.Describes the auditor’s responsibility to evaluate going-concern issues.C.Limits the auditor’s responsibility to detect errors and fraud.D.

Answer (A) is incorrect. The engagement letter does not disclose significant deficienciesin internal control discovered during the prior-year’s audit.Answer (B) is incorrect. The auditor need only include the nature of the services to beperformed. Analytical procedures will be documented in the planning stage of theengagement.Answer (C) is incorrect. While it is assumed that the auditor has a responsibility toevaluate going-concern issues, such a matter is not normally explicitly described in theengagement letter.Answer (D) is correct. The engagement letter establishes a written understanding with theentity regarding the services to be performed. The understanding should usually describethe nature and limitations of the services to be performed; describe the report theaccountant expects to render; state that the engagement cannot be relied upon to discloseerrors, fraud, or illegal acts; and state that any errors, fraud, or illegal acts discovered willbe reported to those charged with governance.


In designing written audit plans, an auditor should establish specific audit objectives that relateprimarily to the

Timing of audit procedures.A.Cost-benefit of gathering evidence.B.Selected audit techniques.C.Financial statement assertions.D.

Answer (A) is incorrect. Timing is important in meeting the objectives of the audit butdoes not relate to the audit objectives themselves.Answer (B) is incorrect. The cost-benefit of gathering evidence is important to theauditor but is not the primary objective.Answer (C) is incorrect. Audit objectives determine the specific audit techniques.Answer (D) is correct. Most audit work consists of obtaining and evaluating evidenceabout relevant financial statement assertions, which are management representationsembodied in financial statement components.



[48] Gleim #: 3.2.46 -- Source: CPA 1194 A-4The senior auditor responsible for coordinating the field work usually schedules a pre-auditconference with the audit team primarily to

Give guidance to the staff regarding both technical and personnel aspects of the audit.A.Discuss staff suggestions concerning the establishment and maintenance of time budgets.B.Establish the need for using the work of specialists and internal auditors.C.Provide an opportunity to document staff disagreements regarding technical issues.D.

Answer (A) is correct. A pre-audit conference is useful to provide guidance to the staffregarding such technical issues as the expected use of client personnel and theexpectations of the audit team.Answer (B) is incorrect. Time budgets are prepared by supervisors based on the estimatesof the time necessary to complete the tasks.Answer (C) is incorrect. The determination of the need for specialists and the use ofinternal auditors is made by supervisors, not the staff.Answer (D) is incorrect. Disagreements regarding technical issues do not normally ariseprior to the audit.


The audit work performed by each assistant should be reviewed to determine whether it wasadequately performed and to evaluate whether the

Audit procedures performed are approved in the professional standards.A.Audit has been performed by persons having adequate technical training and proficiencyas auditors.

B.

Auditor’s system of quality control has been maintained at a high level.C.Results are consistent with the conclusions to be presented in the auditor’s report.D.

Answer (A) is incorrect. Determination of whether the procedures are in accordance withGAAS is necessary in the planning stage.Answer (B) is incorrect. The selection of assistants having adequate technical trainingand proficiency concerns planning, not supervision.Answer (C) is incorrect. The review of the audit work of each assistant is only a part ofquality control.Answer (D) is correct. The first standard of field work requires assistants to be properlysupervised. Thus, the work performed by each assistant, including the auditdocumentation, should be reviewed to determine whether it was adequately performedand documented and to evaluate the results, relative to the conclusions to be presented inthe auditor’s report (AU 311).



[50] Gleim #: 3.2.63 -- Source: CPA 0706 A-07Prior to commencing field work, an auditor usually discusses the general audit strategy with theclient’s management. Which of the following details do management and the auditor usuallyagree upon at this time?

The specific matters to be included in the communication with the audit committee.A.The minimum amount of misstatements that may be considered to be material.B.The schedules and analyses that the client’s staff should prepare.C.The effects that inadequate controls may have over the safeguarding of assets.D.

Answer (A) is incorrect. The specific matters to be included in the communication withthe audit committee are determined by the results of the audit.Answer (B) is incorrect. The minimum amount of misstatements that may be consideredto be material is a professional judgment of the auditor, not a matter to be agreed uponwith management.Answer (C) is correct. Audit planning procedures may include coordinating the assistanceof entity personnel in data preparation (AU 311).Answer (D) is incorrect. The effects that inadequate controls may have over thesafeguarding of assets is a professional judgment of the auditor, not a matter to be agreedupon with management.


The risk that an auditor’s procedures will lead to the conclusion that a material misstatementdoes not exist in an account balance when, in fact, such misstatement does exist is

Audit risk.A.Inherent risk.B.Control risk.C.Detection risk.D.

Answer (A) is incorrect. Audit risk includes inherent risk and control risk, which are notaffected by the auditor’s procedures.Answer (B) is incorrect. Inherent risk is the susceptibility of an assertion to materialmisstatement in the absence of related controls.Answer (C) is incorrect. Control risk is the risk that a material misstatement will not beprevented or detected by internal control.Answer (D) is correct. Detection risk is the risk that the auditor will not detect a materialmisstatement that exists in a relevant assertion. It is affected by the auditor’s proceduresand can be changed at his/her discretion.



[52] Gleim #: 3.3.69 -- Source: CPA 591 A-26The acceptable level of detection risk is inversely related to the

Assurance provided by substantive procedures.A.Risk of misapplying auditing procedures.B.Preliminary judgment about materiality levels.C.Risk of failing to discover material misstatements.D.

Answer (A) is correct. An auditor considers internal control to assess control risk. (S)healso assesses inherent risk. The greater (lower) the assessed levels of control risk andinherent risk, the lower (greater) the acceptable level of detection risk. Hence, therelationship between performing substantive procedures and detection risk is inverse.Answer (B) is incorrect. The risk of misapplying auditing procedures is related to theauditor’s training and experience.Answer (C) is incorrect. Preliminary judgments about materiality are used by the auditorto determine the acceptable level of audit risk. Detection risk is just one component ofaudit risk.Answer (D) is incorrect. The acceptable level of detection risk is an inverse function ofthe assessments of control risk and inherent risk.

[53] Gleim #: 3.3.72 -- Source: CPA AUD R97-11

Holding other planning considerations equal, a decrease in the amount of misstatements in aclass of transactions that an auditor could tolerate most likely would cause the auditor to

Apply the planned substantive tests prior to the balance sheet date.A.Perform the planned auditing procedures closer to the balance sheet date.B.Increase the assessed level of control risk for relevant financial statement assertions.C.Decrease the extent of auditing procedures to be applied to the class of transactions.D.

Answer (A) is incorrect. Applying tests at interim dates reduces the assurance provided.Answer (B) is correct. A decrease in the acceptable level of detection risk or in theamount considered material will result in the auditor’s modifying the audit plan to obtaingreater assurance from substantive testing by (1) selecting a more effective auditprocedure, (2) applying procedures nearer to year-end, or (3) increasing the extent ofparticular tests. Tolerable misstatement should not exceed the auditor’s judgments aboutmateriality, so its decrease is a reduction in materiality that requires greater assurancefrom substantive testing.Answer (C) is incorrect. Control risk is assessed based on consideration of the client’scontrols.Answer (D) is incorrect. Decreasing the extent of auditing procedures reduces theireffectiveness and the assurance provided.



[54] Gleim #: 3.3.77 -- Source: CPA 1189 A-59Which of the following factors is most important concerning an auditor’s responsibility forconsidering fraud?

The susceptibility of the accounting records to intentional manipulations, alterations, andthe misapplication of accounting principles.

A.

The assessment of whether accounting estimates result from unintentional bias orintentional attempts to misstate the financial statements.

B.

The possibility that the misappropriation of assets may indicate the existence of illegalacts.

C.

The risk that the financial statements are not fairly presented in all material respects, inconformity with GAAP.

D.

Answer (A) is incorrect. The susceptibility of the accounting records to fraud is but oneof the many factors that must be considered in identifying, assessing, and responding tothe risks of material misstatement due to fraud.Answer (B) is incorrect. Whether unreasonable accounting estimates result fromunintentional bias or intentional attempts to misstate the financial statements is but one ofthe many factors that must be considered in identifying, assessing, and responding to therisks of material misstatement due to fraud.Answer (C) is incorrect. The possibility that management fraud, defalcations, and themisappropriation of assets may indicate the existence of illegal acts is but one of the manyfactors that must be considered in identifying, assessing, and responding to the risks ofmaterial misstatement due to fraud.Answer (D) is correct. The auditor has a responsibility to plan and perform the audit toobtain reasonable assurance about whether the financial statements are free of materialmisstatement, whether caused by error or fraud (AU 110). Thus, the consideration offraud should be logically integrated into the overall audit process in a manner consistentwith other pronouncements, e.g., those on planning and supervision, audit risk andmateriality, and internal control. This consideration entails (1) understanding fraud, (2)discussing fraud risks with members of the engagement team, (3) obtaining informationneeded to identify fraud risks, (4) identifying those risks, (5) assessing fraud risks, (6)responding to the assessments, (7) evaluating evidence at the end of the audit, (8) makingappropriate communications about fraud, and (9) documenting the consideration.



[55] Gleim #: 3.3.83 -- Source: CPA 0407 AUD-03After testing a client’s internal control activities, an auditor discovers a number of significantdeficiencies in the operation of a client’s internal controls. Under these circumstances, theauditor most likely would

Issue a disclaimer of opinion about the internal controls as part of the auditor’s report.A.Increase the assessment of control risk and increase the extent of substantive tests.B.Issue a qualified opinion of this finding as part of the auditor’s report.C.Withdraw from the audit because the internal controls are ineffective.D.

Answer (A) is incorrect. A disclaimer of opinion is not appropriate. During this stage ofthe audit, the auditor is assessing risk and has not yet performed substantive tests.Answer (B) is correct. When an auditor discovers significant deficiencies, there is ahigher risk that internal control will not prevent or detect on a timely basis a materialmisstatement that could occur in an assertion, which increases the assessment of controlrisk. When control risk is increased, the auditor places less reliance on tests of controlsand more reliance on substantive tests.Answer (C) is incorrect. A qualified opinion is not appropriate. During this stage of theaudit, the auditor is assessing risk and has not yet performed substantive tests.Answer (D) is incorrect. The auditor is not required to withdraw from an audit wheninternal controls are ineffective.


An auditor assesses control risk because it

Is relevant to the auditor’s understanding of the control environment.A.Provides assurance that the auditor’s materiality levels are appropriate.B.Indicates to the auditor where inherent risk may be the greatest.C.Affects the level of detection risk that the auditor may accept.D.

Answer (A) is incorrect. The understanding of the control environment provides evidencefor assessing control risk.Answer (B) is incorrect. Materiality levels are based upon auditor judgment.Answer (C) is incorrect. Inherent risk is independent of internal control.Answer (D) is correct. Control risk and inherent risk are components of the risk ofmaterial misstatement (RMM). The auditor determines the appropriate level of detectionrisk based on the assessment of RMM and an acceptable level of audit risk.



[57] Gleim #: 3.4.93 -- Source: CPA 1194 A-6To obtain an understanding of a continuing client in planning an audit, an auditor most likelywould

Perform tests of details of transactions and balances.A.Read internal audit reports.B.Read specialized industry journals.C.Reevaluate the risks of material misstatement.D.

Answer (A) is incorrect. Tests of details are used to collect sufficient, appropriate auditevidence to support the opinion.Answer (B) is correct. The auditor performs risk assessment procedures to obtain theunderstanding of the entity and its environment, including its internal control. Theseinclude, for example, reading (1) internal audit reports, (2) interim statements, (3)quarterly reports, and (4) minutes of board meetings.Answer (C) is incorrect. Reading specialized industry journals would provideinformation about the industry, but not necessarily about the specific client.Answer (D) is incorrect. The auditor reevaluates the RMMs after updating theunderstanding of a continuing client.


The objective of performing analytical procedures in planning an audit is to identify theexistence of

Unusual transactions and events.A.Illegal acts that went undetected because of internal control weaknesses.B.Related party transactions.C.Recorded transactions that were not properly authorized.D.

Answer (A) is correct. The objective of analytical procedures “is to identify such thingsas the existence of unusual transactions and events, and amounts, ratios, and trends thatmight indicate matters that have financial statement and audit planning ramifications”(AU 329).Answer (B) is incorrect. The objective of performing analytical procedures to plan theaudit is to identify areas of specific risk, not specific illegal acts.Answer (C) is incorrect. Although the auditor should evaluate disclosures about relatedparty transactions, analytical procedures performed to plan the audit do not necessarilydetect such transactions.Answer (D) is incorrect. Tests of controls are necessary to determine whethertransactions were properly authorized.



[59] Gleim #: 3.5.108 -- Source: CPA AUD R97-3Which of the following nonfinancial information would an auditor most likely consider inperforming analytical procedures during the planning phase of an audit?

Turnover of personnel in the accounting department.A.Objectivity of audit committee members.B.Square footage of selling space.C.Management’s plans to repurchase stock.D.

Answer (A) is incorrect. Turnover of personnel in the accounting department is not ameasure related to analytical procedures.Answer (B) is incorrect. Objectivity of audit committee members is not a measure relatedto analytical procedures.Answer (C) is correct. AU 329 states, “Although analytical procedures used in planningthe audit often use only financial data, sometimes relevant nonfinancial information isconsidered as well. For example, number of employees, square footage of selling space,volume of goods produced, and similar information may contribute to accomplishing thepurpose of the procedures.”Answer (D) is incorrect. Management’s plans to repurchase stock is not a measure relatedto analytical procedures.


An auditor’s analytical procedures performed during the overall review stage indicated that theclient’s accounts receivable had doubled since the end of the prior year. However, theallowance for doubtful accounts as a percentage of accounts receivable remained about thesame. Which of the following client explanations most likely would satisfy the auditor?

The client liberalized its credit standards in the current year and sold much moremerchandise to customers with poor credit ratings.

A.

Twice as many accounts receivable were written off in the prior year as in the currentyear.

B.

A greater percentage of accounts receivable were currently listed in the “more than 90days overdue” category than in the prior year.

C.

The client opened a second retail outlet in the current year and its credit salesapproximately equaled the older, established outlet.

D.



Answer (A) is incorrect. An increase in credit sales to less creditworthy customers wouldincrease the proportion of doubtful accounts.Answer (B) is incorrect. This explanation suggests a lower percentage of doubtful accounts,not a constant percentage.Answer (C) is incorrect. The dating of accounts receivable would not affect the percentagerelationship of the allowance to total accounts receivable.Answer (D) is correct. Analytical procedures should be applied to some extent in the finalstage of the audit as a review. A basic premise of analytical procedures is that plausiblerelationships among data may reasonably be expected to exist and continue in the absence ofknown conditions to the contrary. The only reasonable explanation proposed by the client tosatisfy the auditor is the opening of a second retail outlet with sales approximating theestablished outlet. It is plausible that a doubling of capacity while selling to similarlycreditworthy customers might have resulted in a doubling of receivables without a change inthe proportion of doubtful accounts.


Which of the following items tend to be the most predictable for purposes of analyticalprocedures applied as substantive tests?

Relationships involving balance sheet accounts.A.Transactions subject to management discretion.B.Relationships involving income statement accounts.C.Data subject to audit testing in the prior year.D.

Answer (A) is incorrect. Relationships involving balance sheet accounts tend to be lesspredictable. Balance sheet accounts represent amounts at a moment in time.Answer (B) is incorrect. Transactions subject to management discretion are oftenunpredictable.Answer (C) is correct. According to AU 329, relationships involving income statementaccounts tend to be more predictable than relationships involving only balance sheetaccounts because income statement accounts represent transactions over a period of time,whereas balance sheet accounts represent amounts at a moment in time.Answer (D) is incorrect. Data subject to audit testing in the prior year may not reflectchanged conditions.



[62] Gleim #: 3.5.125 -- Source: CPA 1187 A-33One reason the independent auditor applies analytical procedures with regard to the client’soperations is to identify

Material weaknesses in internal control.A.Unusual transactions.B.Noncompliance with prescribed control activities.C.Improper separation of accounting and other financial duties.D.

Answer (A) is incorrect. Material weaknesses in internal control would be discoveredduring the auditor’s consideration of the client’s internal control.Answer (B) is correct. Analytical procedures are evaluations of financial informationmade by a study and comparison of the relationships among data. The premise is thatcertain relationships prevail in the absence of known conditions to the contrary. Analyticalprocedures identify such things as the existence of unusual transactions and events andamounts, ratios, and trends that might indicate matters that have financial statement andaudit planning ramifications (AU 329). These matters may then be examined andinvestigated by the auditor.Answer (C) is incorrect. Noncompliance with prescribed control activities would bediscovered during the auditor’s consideration of the client’s internal control.Answer (D) is incorrect. Improper separation of accounting and other financial dutieswould be discovered during the auditor’s consideration of the client’s internal control.


An auditor testing long-term investments would ordinarily use analytical procedures toascertain the reasonableness of the

Existence of unrealized gains or losses in the portfolio.A.Completeness of recorded investment income.B.Classification between current and non-current portfolios.C.Valuation of marketable equity securities.D.



Answer (A) is incorrect. Unrealized gains or losses are dependent on the market values ofspecific securities and cannot be calculated based on plausible relationships among the data.Answer (B) is correct. The auditor may develop expectations regarding the completenessassertion for recorded investment income from stocks by using dividend records published bystandard investment advisory services to recompute dividends received. Interest income frombond investments can be calculated from interest rates and payment dates noted on thecertificates. Income from equity-based investments can be estimated from audited financialstatements of the investees. Thus, applying an expected rate of return to the net investmentamount may be an effective means of estimating total investment income.Answer (C) is incorrect. The classification depends on management’s objectives regarding thespecific investments, not relationships among the data.Answer (D) is incorrect. Valuation is a function of cost and market values.


A not-for-profit organization published a monthly magazine that had 15,000 subscribers onJanuary 1. The number of subscribers increased steadily throughout the year and at December31 there were 16,200 subscribers. The annual magazine subscription cost was $10 on January 1and was increased to $12 for new members on April 1. An auditor would expect that thereceipts from subscriptions for the year ended December 31 would be approximately

$194,400.A.$179,400.B.$164,400.C.$163,800.D.

Answer (A) is incorrect. Assuming that all subscribers paid the $12 rate results in$194,400 ($12 × 16,200).Answer (B) is incorrect. Assuming that all new subscribers paid the $12 rate and that theold subscribers paid an $11 rate results in $179,400 [($12 × 1,200) + ($11 × 15,000)].Answer (C) is incorrect. Assuming that all 1,200 new subscribers paid the $12 rateresults in $164,400 [$150,000 + ($12 × 1,200)].Answer (D) is correct. If all original and new subscribers paid $10 up to April 1, and newsubscribers after April 1 paid $12, the total receipts would be $163,800, assuming 100new subscribers per month [(16,200 – 15,000) ÷ 12].

Number Rate Revenue

Original subscribers 15,000 $10 $150,000New until April 1 (1/4 × 1,200) 300 10 3,000New after April 1 (3/4 × 1,200) 900 12 10,800

Total expected $163,800




An auditor’s analytical procedures most likely would be facilitated if the entity

Segregates obsolete inventory before the physical inventory count.A.Uses a standard cost system that produces variance reports.B.Corrects material weaknesses in internal control before the beginning of the audit.C.Develops its data from sources solely within the entity.D.

Answer (A) is incorrect. The segregation of obsolete inventory before physical countsassures that an accurate count of salable inventory can be achieved.Answer (B) is correct. A comparison of anticipated results, such as budgets or forecastsprepared by management, with actual results is an analytical procedure. Thus, the use ofstandard costs and variance analysis facilitates the application of analytical procedures.Answer (C) is incorrect. The correction of material weaknesses is more likely to improvethe reliability of the data examined in next year’s audit.Answer (D) is incorrect. Sources of information external to the organization are assumedto be more reliable.


An auditor most likely will apply analytical procedures in the overall review stage of an audit to

Enhance the auditor’s understanding of subsequent events.A.Identify auditing procedures omitted by the staff accountants.B.Determine whether additional audit evidence may be needed.C.Evaluate the effectiveness of the internal control activities.D.

Answer (A) is incorrect. Analytical procedures do not apply to subsequent events. Anauditor’s subsequent events procedures include cutoff tests, reading interim statements,and inquiry of those responsible for accounting matters.Answer (B) is incorrect. Analytical procedures are based on the existence of plausiblerelationships among data. Thus, they cannot determine whether audit work has beenomitted.Answer (C) is correct. Analytical procedures should be performed in the final reviewstage of the audit. They assist in assessing the conclusions reached and in evaluating theoverall financial presentation. When analytical procedures have unexpected results, theauditor should investigate the causes. Thus, additional tests of details and otherprocedures should be performed to gather additional evidence (AU 329).Answer (D) is incorrect. Analytical procedures are not tests of controls.



[67] Gleim #: 3.6.156 -- Source: CPA 594 A-11Because of the risk of material misstatement due to fraud, an audit of financial statements inaccordance with generally accepted auditing standards should be planned and performed withan attitude of

Objective judgment.A.Independent integrity.B.Professional skepticism.C.Impartial conservatism.D.

Answer (A) is incorrect. Although objective judgment is a quality appropriate forpractitioners, it is not required to be applied specifically in an audit.Answer (B) is incorrect. Although independent integrity is a quality appropriate forpractitioners, it is not required to be applied specifically in an audit.Answer (C) is correct. Due professional care requires the auditor to exercise professionalskepticism. Professional skepticism is an attitude that includes a questioning mind andcritical assessment of audit evidence. Regardless of past experience with the entity orbelief in management’s honesty, the audit should be conducted with (1) an awareness thata material misstatement due to fraud may exist and (2) ongoing questioning of whetherthe evidence suggests that such fraud has occurred (AU 316).Answer (D) is incorrect. Although impartial conservatism is a quality appropriate forpractitioners, it is not required to be applied specifically in an audit.


In every audit, the members of the audit team should discuss the potential for materialmisstatement due to errors or fraud. This discussion

Must include all members of the audit team.A.Includes brainstorming about how assets can be misappropriated.B.Must be deferred until the auditor begins information-gathering procedures.C.Normally excludes consideration of how fraud might be concealed.D.



Answer (A) is incorrect. Professional judgment should be exercised to determine the teammembers included.Answer (B) is correct. Key engagement personnel should discuss the risk of both errors andfraud. The discussion should emphasize professional skepticism and continual alertness topotential errors or fraud. The discussion may occur before or during information gathering, andcommunication should be ongoing. The discussion should include (1) brainstorming aboutfactors that might create the conditions for errors or fraud, (2) how and where the statementsmight be misappropriated, (3) how assets might be misappropriated or financial reportsmisstated, (4) how fraud could be concealed, and (5) how the auditors might respond to the riskof material misstatement.Answer (C) is incorrect. The discussion may be prior to or during gathering information toidentify fraud risks.Answer (D) is incorrect. How fraud might be concealed is one topic covered when teammembers exchange ideas (brainstorm) about fraud.


Which of the following circumstances most likely would cause an auditor to consider whethermaterial misstatements exist in an entity’s financial statements?

Management places little emphasis on meeting earnings projections.A.The board of directors makes all major financing decisions.B.Significant deficiencies and material weaknesses previously communicated tomanagement are not corrected.

C.

Transactions selected for testing are not supported by proper documentation.D.

Answer (A) is incorrect. If management places increased emphasis on meeting earningsprojections, the likelihood for misstatement increases.Answer (B) is incorrect. The board’s involvement in decision making reduces thelikelihood of material misstatements.Answer (C) is incorrect. Management should evaluate the cost and benefits of correctionsin deciding whether to correct control deficiencies.Answer (D) is correct. The planned scope of audit procedures should be reconsideredwhen conditions differ adversely from expectations. When transactions chosen for testinglack proper documentation or authorization, the likelihood of misstatement increases.



[70] Gleim #: 3.6.165 -- Source: CPA 590 A-55Disclosure of fraud to parties other than a client’s senior management and its audit committeeordinarily is not part of an auditor’s responsibility. However, to which of the following outsideparties may a duty to disclose fraud exist?

To the SEC To a Successor To a GovernmentalWhen the Auditor When Agency from Which

Client Reports the Successor the Clientan Auditor Makes Appropriate Receives Financial

Change Inquiries Assistance

A. Yes Yes NoB. Yes No YesC. No Yes YesD. Yes Yes Yes

Answer (A) is incorrect. An auditor responds to a government agency in accordance withthe requirements of audits of recipients of government funds.Answer (B) is incorrect. A predecessor auditor responds to inquiries by the auditor if theclient gives its specific permission.Answer (C) is incorrect. An auditor responds to the SEC when the entity reports anauditor change on Form 8-K.Answer (D) is correct. According to AU 316, a duty of disclosure to parties other than theclient may exist when the entity reports an auditor change to the SEC on Form 8-K, andthe fraud (or risk factors) is a reportable event or a source or disagreement. An auditormust also respond in accordance with the requirements for governmental audits, forexample, those imposed by Government Auditing Standards. Under AU 315, apredecessor auditor must respond to inquiries by the auditor if the client gives its specificpermission.


Which of the following statements best describes an auditor’s responsibility to detect errors andfraud?

An auditor should design an audit to provide reasonable assurance of detecting errors andfraud that are material to the financial statements.

A.

An auditor is responsible to detect material errors, but has no responsibility to detect fraudthat is concealed through employee collusion or management override of internal control.

B.

An auditor has no responsibility to detect errors and fraud unless analytical procedures ortests of transactions identify conditions causing a reasonably prudent auditor to suspectthat the financial statements were materially misstated.

C.

An auditor has no responsibility to detect errors and fraud because an auditor is not aninsurer and an audit does not constitute a guarantee.

D.



Answer (A) is correct. The auditor has a responsibility to plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of material misstatement,whether caused by error or fraud (AU 110). Thus, the consideration of fraud should belogically integrated into the overall audit process in a manner consistent with otherpronouncements, e.g., those on planning and supervision, audit risk and materiality, andinternal control. This consideration entails (1) understanding fraud, (2) discussing fraud riskswith members of the engagement team, (3) obtaining information needed to identify fraudrisks, (4) identifying those risks, (5) assessing fraud risks, (6) responding to the assessments,(7) evaluating evidence at the end of the audit, (8) making appropriate communications aboutfraud, and (9) documenting the consideration.Answer (B) is incorrect. The auditor provides reasonable assurance of detecting materialerrors and fraud in the financial statements.Answer (C) is incorrect. The auditor provides reasonable assurance of detecting materialerrors and fraud in the financial statements.Answer (D) is incorrect. The auditor provides reasonable assurance of detecting materialerrors and fraud in the financial statements.


The independent auditor’s plan for an audit in accordance with GAAS is influenced by thepossibility of material misstatements. The auditor will therefore conduct the audit

With an attitude of professional skepticism.A.On the assumption that management is dishonest.B.On the assumption of the unquestioned honesty of management.C.With the attitude that all evidence in support of assertions must be conclusive.D.

Answer (A) is correct. Due professional care requires the auditor to exercise professionalskepticism. Professional skepticism is an attitude that includes a questioning mind andcritical assessment of audit evidence. Regardless of past experience with the entity orbelief in management’s honesty, the audit should be conducted with (1) an awareness thata material misstatement due to fraud may exist and (2) ongoing questioning of whetherthe evidence suggests that such fraud has occurred (AU 316).Answer (B) is incorrect. The auditor does not assume that management is dishonest.Answer (C) is incorrect. The auditor does not assume the unquestioned honesty ofmanagement.Answer (D) is incorrect. Requiring conclusive rather than persuasive evidence tocorroborate all of management’s assertions is impracticable.



[73] Gleim #: 3.6.174 -- Source: CPA 1188 A-9Which of the following circumstances would most likely cause an auditor to suspect that fraudexists in a client’s financial statements?

Property and equipment are usually sold at a loss before being fully depreciated.A.Significantly fewer responses to confirmation requests are received than expected.B.Monthly bank reconciliations usually include several in-transit items.C.Clerical errors are listed on an computer-generated exception report.D.

Answer (A) is incorrect. Sale at a loss before being fully depreciated suggests that thedepreciation method is inadequate.Answer (B) is correct. If a condition or circumstance differs adversely from the auditor’sexpectation, the auditor needs to consider the reason for such a difference. An example ofsuch a condition is that confirmation requests disclose significant differences or yieldfewer responses than expected (AU 316).Answer (C) is incorrect. In-transit items are normal.Answer (D) is incorrect. A listing of errors is an effective internal control procedure.


Which of the following characteristics most likely would heighten an auditor’s concern aboutthe risk of intentional manipulation of financial statements?

Turnover of senior accounting personnel is low.A.Insiders recently purchased additional shares of the entity’s stock.B.Management places substantial emphasis on meeting earnings projections.C.The rate of change in the entity’s industry is slow.D.

Answer (A) is incorrect. Low turnover of senior accounting personnel suggests a lowerrisk of manipulation.Answer (B) is incorrect. The purchase of an entity’s stock by employees and managementis not unusual.Answer (C) is correct. The auditor should evaluate whether management may bemotivated to engage in fraudulent financial reporting. Specific indicators of suchmotivation are that

Management compensation is based on unduly aggressive financial goals.1.There is excessive interest in increasing stock price or earning trends throughaggressive accounting practices.

2.

Managers have made commitments to analysts’ or other users’ unrealistic forecasts.3.Inappropriate means minimizing taxable earnings have been used.4.

Answer (D) is incorrect. A slow rate of change in an entity’s industry suggests a lowerrisk of manipulation.



[75] Gleim #: 3.6.189 -- Source: Publisher, adaptedAn auditor’s response to the assessment of the risks of material misstatement due to fraud takesvarious forms. A response with an overall effect on the conduct of the audit is to

Change the nature of auditing procedures.A.Consider whether management’s applications of accounting principles indicates a bias.B.Change the timing or extent of auditing procedures.C.Perform a retrospective review of significant accounting estimates.D.

Answer (A) is incorrect. Responses involving changes in the nature of auditingprocedures address specifically identified fraud risks.Answer (B) is correct. The responses to the assessment of fraud risks should reflect acritical evaluation of the audit evidence. These responses may take three forms: thosehaving an overall effect on the audit; those involving changes in the nature, timing, andextent of audit procedures performed in response to specific fraud risks; and those thatfurther address management override. One overall effect of a judgment about heightenedfraud risk is to assign more experienced personnel or individuals with specialized skills orto increase supervision. A second overall effect is to consider the selection and applicationof accounting principles, especially those involving subjective measurements andcomplex transactions, and whether they indicate a collective bias. Another overall effect isto make unpredictable choices of audit procedures.Answer (C) is incorrect. Responses involving changes in the timing and extent ofauditing procedures address specifically identified fraud risks.Answer (D) is incorrect. An auditor performs a retrospective review of significantaccounting estimates in the prior year’s statements to determine whether management’srelevant judgments and assumptions reflect a bias. This review is a response that furtheraddresses management override of controls.


Which of the following circumstances most likely would cause an auditor to suspect that thereare material misstatements in an entity’s financial statements?

Senior financial management participates in the selection of accounting principles and thedetermination of significant estimates.

A.

Supporting accounting records and files that should be readily available are not producedpromptly when requested.

B.

Related party transactions take place in the ordinary course of business with an entity thatis audited by another CPA firm.

C.

Senior management has an excessive interest in upgrading the entity’s informationtechnology capabilities.

D.



Answer (A) is incorrect. Participation of senior financial management suggests properoversight.Answer (B) is correct. An auditor should assess fraud risk throughout the audit. Conditionsobserved during field work that may change or support the assessment include difficult orunusual relationship with management, for example, denial of access to records, unusual delaysin providing requested information, and unwillingness to facilitate access to computer files(AU 316).Answer (C) is incorrect. Significant related-party transactions not in the ordinary course ofbusiness or with entities not audited or audited by another accounting firm representopportunities for fraudulent reporting.Answer (D) is incorrect. A management antifraud program should include implementing andmaintaining effective controls over IT-generated information.


Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc. What assurance doesJones provide that direct-effect illegal acts that are material to XYZ’s financial statements andillegal acts that have a material but indirect effect on the financial statements will be detected?

Direct-Effect Indirect-EffectIllegal Acts Illegal Acts

A. Reasonable NoneB. Reasonable ReasonableC. Limited NoneD. Limited Reasonable

Answer (A) is correct. The auditor has the same responsibility for detectingmisstatements arising from illegal acts that have a direct and material effect on thefinancial statements as for material errors and fraud. Thus, the auditor should plan andperform the audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement caused by illegal acts having direct and material effects.However, because of the nature of illegal acts that have an indirect effect, an audit inaccordance with GAAS provides no assurance that such illegal acts will be detected orthat any resulting contingent liabilities will be disclosed (AU 317).Answer (B) is incorrect. The auditor provides reasonable assurance regarding direct-effect illegal acts but no assurance regarding indirect-effect illegal acts.Answer (C) is incorrect. The auditor provides reasonable assurance regarding direct-effect illegal acts but no assurance regarding indirect-effect illegal acts.Answer (D) is incorrect. The auditor provides reasonable assurance regarding direct-effect illegal acts but no assurance regarding indirect-effect illegal acts.



[78] Gleim #: 3.7.201 -- Source: CPA AUD R00-6An auditor who discovers that a client’s employees paid small bribes to municipal officialsmost likely would withdraw from the engagement if

The payments violated the client’s policies regarding the prevention of illegal acts.A.The client receives financial assistance from a federal government agency.B.Documentation that is necessary to prove that the bribes were paid does not exist.C.Management fails to take the appropriate remedial action.D.

Answer (A) is incorrect. A violation of client policies regarding illegal acts by personneldoes not necessitate a withdrawal from the engagement as long as management takes theproper remedial action proposed by the auditors.Answer (B) is incorrect. In some cases, auditors may need to report fraud and illegal actsto appropriate officials, oversight bodies, or funding organizations, but this duty is not initself a basis for withdrawal when illegal acts have been detected.Answer (C) is incorrect. If the auditor lacks sufficient information, the auditor usuallydisclaims an opinion. The auditor should then withdraw if the client refuses to accept theauditor’s modified report.Answer (D) is correct. When the auditor concludes that an illegal act has or is likely tohave occurred, (s)he should discuss the matter with the appropriate level of managementand request that any necessary remedial actions be taken. If the alleged illegal act has amaterial effect on the financial statements or the client does not take the remedial actionthat the auditor considers necessary, the auditor should express a qualified or adverseopinion, depending on the level of materiality, or withdraw from the engagement.


An auditor of a manufacturer would most likely question whether that client has committedillegal acts if the client has

Failed to file a tax return.A.Been an annual donor to a local political candidate.B.Failed to correct material weaknesses in internal control that were reported after the prioryear’s audit.

C.

Disclosed several subsequent events involving foreign operations in the notes to thefinancial statements.

D.



Answer (A) is correct. Some examples of information raising questions about possible illegalacts are unauthorized or improperly recorded transactions, a governmental investigation,violations reported by regulators, large payments for unspecified services to consultants,excessive commissions or fees, unusual cash payments, unexplained payments to governmentofficials or employees, and failure to file tax returns or pay governmental duties or similar fees.Answer (B) is incorrect. Donations to local candidates are permissible.Answer (C) is incorrect. Failure to correct material weaknesses may be based on cost-benefitconsiderations.Answer (D) is incorrect. Disclosure of subsequent events is customary.


What assurance does the auditor provide that errors, fraud, and direct-effect illegal acts that arematerial to the financial statements will be detected?

Direct-EffectErrors Fraud Illegal Acts

A. Limited Negative LimitedB. Limited Limited ReasonableC. Reasonable Limited LimitedD. Reasonable Reasonable Reasonable

Answer (A) is incorrect. The auditor provides reasonable assurance that the financialstatements are free of material misstatements caused by errors, fraud, and direct-effectillegal acts.Answer (B) is incorrect. The auditor provides reasonable assurance that the financialstatements are free of material misstatements caused by errors, fraud, and direct-effectillegal acts.Answer (C) is incorrect. The auditor provides reasonable assurance that the financialstatements are free of material misstatements caused by errors, fraud, and direct-effectillegal acts.Answer (D) is correct. The auditor’s responsibility for detection of illegal acts havingdirect and material effects and of material errors and fraud is to design the audit to providereasonable assurance of detection.



[81] Gleim #: 3.7.210 -- Source: CPA 1187 A-28The most likely reason the audit cannot reasonably be expected to bring all illegal acts by theclient to the auditor’s attention is that

Illegal acts are perpetrated by management override of the information andcommunication component of internal control.

A.

Illegal acts by clients often relate to operating aspects rather than accounting aspects.B.The information and communication component of the client’s internal control may be soeffective that the auditor performs only minimal substantive testing.

C.

Illegal acts may be perpetrated by the only person in the client’s organization with accessto both assets and the accounting records.

D.

Answer (A) is incorrect. Many illegal acts are not subject to internal control; e.g.,violations of insider trading rules may result from transactions that are recordedappropriately. Thus, no override of controls will be involved.Answer (B) is correct. AU 317 states that some illegal acts, such as violations of tax law,have a direct and material effect on the financial statements. Other illegal acts, such asviolations of environmental protection laws, relate more to an entity’s operating aspectsthan to its financial and accounting aspects, and their financial statement effect is indirect.An audit in accordance with GAAS usually does not include audit procedures specificallydesigned to detect illegal acts that have such indirect effects. Thus, no assurance isprovided that such illegal acts will be detected or that resulting contingent liabilities willbe disclosed. However, an audit should be designed to provide reasonable assurance thatillegal acts having a direct and material effect on the financial statements will be detected.Answer (C) is incorrect. Illegal acts may involve matters outside the information andcommunication component, so even extensive substantive tests would not detect them.Answer (D) is incorrect. Illegal acts may not involve manipulation of records.


An auditor who finds that the client has committed an illegal act would be most likely towithdraw from the engagement when the

Illegal act affects the auditor’s ability to rely on management representations.A.Illegal act has material financial statement implications.B.Illegal act has received widespread publicity.C.Auditor cannot reasonably estimate the effect of the illegal act on the financial statements.D.



Answer (A) is correct. The auditor should consider the implications of an illegal act in relationto the other representations of management. If the disposition of the illegal act is questionable(whether or not the act is material), the auditor may have to withdraw, owing to a lack ofconfidence in client management. If management cannot be trusted in this matter, seriousdoubts arise about their other representations. The auditor must also consider the possibleeffects of continuing the association with the client (AU 317).Answer (B) is incorrect. The materiality of the act is less important than the considerationgiven to it by management.Answer (C) is incorrect. The amount of publicity is not relevant.Answer (D) is incorrect. The auditor might qualify the opinion or issue a disclaimer ratherthan withdraw.


If the auditor considers an illegal act to be sufficiently serious to warrant withdrawing from theengagement, the auditor would likely

Notify all parties who may rely upon the company’s financial statements of the company’sillegal act.

A.

Consult with legal counsel as to what other action, if any, should be taken.B.Return all incriminating evidence and working papers to the client’s audit committee forfollow-up.

C.

Contact the successor auditor to make the successor aware of the possible consequencesof relying on management’s representations.

D.

Answer (A) is incorrect. Notifying others is the responsibility of management.Answer (B) is correct. According to AU 317, the auditor should consider consulting legalcounsel in these circumstances. Such consultation may be necessary in determining theeffects of continued association with the client or whether the auditor may have a duty tonotify parties outside the client that overrides his/her duty of confidentiality to the client.Answer (C) is incorrect. The auditor has no responsibility to return all incriminatingevidence and working papers to the client’s audit committee for follow-up.Answer (D) is incorrect. The successor auditor, with client approval, has the burden ofinitiating communication with the predecessor.



[84] Gleim #: 3.7.214 -- Source: CPA 1194 A-12During the annual audit of Ajax Corp., an issuer, Jones, CPA, a continuing auditor, determinedthat illegal political contributions had been made during each of the past 7 years, including theyear under audit. Jones notified the board of directors about the illegal contributions, but theyrefused to take any action because the amounts involved were immaterial to the financialstatements. Jones should reconsider the intended degree of reliance to be placed on the

Letter of audit inquiry to the client’s attorney.A.Prior years’ audit programs.B.Management representation letter.C.Preliminary judgment about materiality levels.D.

Answer (A) is incorrect. The letter of audit inquiry to the client’s attorney will beresponded to by the client’s attorney, not the client.Answer (B) is incorrect. The prior years’ audit program will not be relied upon in thecurrent audit.Answer (C) is correct. The auditor should consider the implications of an illegal act inrelation to other aspects of the audit, particularly the reliability of representations ofmanagement (AU 317). Management’s representations are documented by the auditor inthe management representation letter.Answer (D) is incorrect. The results of the acts have been judged immaterial to thefinancial statements and no reconsideration is necessary.


Which of the following relatively small misstatements most likely could have a material effecton an entity’s financial statements?

An illegal payment to a foreign official that was not recorded.A.A piece of obsolete office equipment that was not retired.B.A petty cash fund disbursement that was not properly authorized.C.An uncollectible account receivable that was not written off.D.



Answer (A) is correct. The auditor’s response to detected illegal acts is to consider the effectson the financial statements and the implications for other aspects of the audit. The reliability ofmanagement’s representations is particularly important. Failure to record an illegal paymentcreates doubt regarding management’s integrity and therefore its other representations andassertions in the financial statements.Answer (B) is incorrect. Failure to retire obsolete equipment does not necessarily indicatefraud.Answer (C) is incorrect. The petty cash fund is typically not supervised by an individual withsignificant authority. Thus, the improper authorization of immaterial amounts would not bedeemed to have a material effect.Answer (D) is incorrect. Failure to write off an uncollectible account does not necessarilyindicate fraud.


Which of the following information discovered during an audit most likely would raise aquestion concerning possible illegal acts?

Related party transactions, although properly disclosed, were pervasive during the year.A.The entity prepared several large checks payable to cash during the year.B.Material internal control weaknesses previously reported to management were notcorrected.

C.

The entity was a campaign contributor to several local political candidates during the year.D.

Answer (A) is incorrect. Related party transactions are common in many entities.Answer (B) is correct. Some examples of information raising questions about possibleillegal acts are unauthorized or improperly recorded transactions, a governmentalinvestigation, violations reported by regulators, large payments for unspecified services toconsultants, excessive commissions or fees, unusual cash payments or checks payable tocash, unexplained payments to government officials or employees, and failure to file taxreturns or pay governmental duties or similar fees.Answer (C) is incorrect. Failure to correct material weaknesses may be based on cost andbenefit considerations.Answer (D) is incorrect. Donations to local candidates are permissible.



[87] Gleim #: 4.1.8 -- Source: CPA 590 A-28Miller Retailing, Inc. maintains a staff of three full-time internal auditors. If the work of theinternal auditors is relevant to the audit, it is efficient to consider how that work may affect theaudit, and the internal auditors are found to be competent and objective, the independentauditor most likely will

Nevertheless need to make direct tests of assertions about material financial statementamounts for which the risk of material misstatement is high.

A.

Decrease the extent of the tests of controls needed to restrict detection risk to theacceptable level.

B.

Increase the extent of the procedures needed to reduce control risk to an acceptable level.C.Not evaluate and test the work performed by the internal auditors.D.

Answer (A) is correct. The auditor has the sole reporting responsibility and makes alljudgments about matters affecting the report. When amounts are material and the risk ofmaterial misstatement or the subjectivity of the evaluation of the evidence is high, theconsideration of the internal auditors’ work cannot alone reduce audit risk to anacceptable level. Thus, direct testing of those assertions by the auditor cannot beeliminated (AU 322).Answer (B) is incorrect. The auditor performs substantive tests, not tests of controls, torestrict detection risk to the acceptable level.Answer (C) is incorrect. Control risk can be assessed but not restricted by the auditor.Answer (D) is incorrect. The auditor should evaluate the quality and effectiveness of thework of the internal auditors that significantly affects the nature, timing, and extent of theaudit procedures.


In connection with the audit of financial statements by an independent auditor, the clientsuggests that members of the internal audit staff be used to minimize audit costs. For which ofthe following tasks may the independent auditor most appropriately request direct assistancefrom the internal audit staff?

Selection of accounts receivable for confirmation, based upon the internal auditor’sjudgment as to how many accounts and which accounts will provide sufficient coverage.

A.

Preparation of schedules for negative accounts receivable responses.B.Assessment of control risk for internal controls relevant to accounts receivable and sales.C.Determination of the adequacy of the allowance for doubtful accounts.D.



Answer (A) is incorrect. Selection of accounts receivable for confirmation is an activityrequiring a judgment that may only be made by the independent auditor.Answer (B) is correct. Internal auditors may provide direct assistance in performing bothsubstantive tests and tests of controls provided that the auditor assesses their competence andobjectivity; supervises, reviews, evaluates, and tests their work; and makes all judgmentsregarding matters that affect the report on the financial statements. Preparing schedules fornegative accounts receivable responses is a clerical activity related to a substantive test that aninternal auditor may perform under the supervision of the independent auditor.Answer (C) is incorrect. Assessment of control risk is an activity requiring a judgment thatmay only be made by the independent auditor.Answer (D) is incorrect. Determination of the adequacy of the allowance for doubtfulaccounts is an activity requiring a judgment that may only be made by the independent auditor.


In using the work of a specialist, an auditor referred to the specialist’s findings in the auditor’sreport. This would be an appropriate reporting practice if the

Auditor is not familiar with the professional certification, personal reputation, orparticular competence of the specialist.

A.

Auditor, as a result of the specialist’s findings, adds an explanatory paragraphemphasizing a matter regarding the financial statements.

B.

Specialist understands the auditor’s corroborative use of the specialist’s findings inrelation to the assertions in the financial statements.

C.

Auditor, as a result of the specialist’s findings, decides to indicate a division ofresponsibility with the specialist.

D.

Answer (A) is incorrect. The auditor is required to evaluate the professionalqualifications of the specialist.Answer (B) is correct. An auditor ordinarily should not refer to the work or findings of aspecialist. However, the auditor may, as a result of the report or findings of the specialist,decide to add explanatory language to his/her standard report or depart from anunqualified opinion. The specialist may be identified if the auditor believes the referencewill facilitate an understanding of the reason for the explanatory paragraph or thedeparture from the unqualified opinion (AU 336). Emphasizing a matter is a basis foradding an explanatory paragraph that may justify referring to a specialist.Answer (C) is incorrect. The specialist’s awareness of the use of his/her work isindependent of the decision to refer to the specialist.Answer (D) is incorrect. A division of responsibility with the specialist is inappropriate.



[90] Gleim #: 4.2.26 -- Source: CPA 1195 A-54Which of the following statements is true concerning an auditor’s use of the work of aspecialist?

The auditor need not obtain an understanding of the methods and assumptions used by thespecialist.

A.

The auditor may not use the work of a specialist in matters material to the fairpresentation of the financial statements.

B.

The reasonableness of the specialist’s assumptions and their applications are strictly theauditor’s responsibility.

C.

The work of a specialist who has a contractual relationship with the client may beacceptable under certain circumstances.

D.

Answer (A) is incorrect. The auditor should obtain an understanding of the methods orassumptions used to determine whether the findings are suitable for corroborativepurposes.Answer (B) is incorrect. The auditor may use the work of a specialist in helping to collectsufficient appropriate evidence.Answer (C) is incorrect. Although the auditor should evaluate the assumptions and theirusefulness for the auditor’s purpose, the reasonableness of the specialist’s assumptionsand their application is the responsibility of the specialist.Answer (D) is correct. A related specialist may be acceptable, but the auditor shouldassess the risk of impairment of objectivity. If the specialist’s objectivity may beimpaired, the auditor performs additional audit procedures regarding his/her assumptions,methods, and findings to determine whether the findings are reasonable.


In using the work of a specialist, an understanding should exist among the auditor, the client,and the specialist as to the nature of the specialist’s work. The documentation of thisunderstanding should cover

A statement that the specialist assumes no responsibility to update the specialist’s reportfor future events or circumstances.

A.

The conditions under which a division of responsibility may be necessary.B.The specialist’s understanding of the auditor’s corroborative use of the specialist’sfindings.

C.

The auditor’s disclaimer as to whether the specialist’s findings corroborate therepresentations in the financial statements.

D.



Answer (A) is incorrect. The understanding need not contain a disclaimer about thespecialist’s responsibility to update the report.Answer (B) is incorrect. The auditor may in some cases refer to a specialist but may not divideresponsibility with him/her.Answer (C) is correct. The understanding should be documented and should cover (1) theobjectives and scope of the work, (2) the specialist’s representations as to his/her relationshipto the client, (3) the methods or assumptions to be used, and (4) a comparison with those usedin the preceding period. It also should cover the (1) specialist’s understanding of the auditor’scorroborative use of the findings in relation to the assertions in the financial statements and (2)the form and content of the specialist’s report that would enable the auditor to evaluate thespecialist’s work (AU 336).Answer (D) is incorrect. The understanding need not contain a disclaimer about whether thefindings corroborate the representations.


In which of the following instances would it be appropriate for the auditor to refer to the workof an appraiser in the auditor’s report?

An unqualified opinion is expressed and no explanatory paragraph is added, but theauditor wishes to disclose the use of a specialist.

A.

A qualified opinion is expressed because of a matter unrelated to the work of theappraiser.

B.

An adverse opinion is expressed based on a difference of opinion between the client andthe outside appraiser as to the value of certain assets.

C.

A disclaimer of opinion is expressed owing to a scope limitation imposed on the auditorby the appraiser.

D.

Answer (A) is incorrect. The auditor should not refer to a specialist when an unqualifiedopinion is expressed unless an explanatory paragraph is added. This is only done incertain circumstances.Answer (B) is incorrect. The qualification must be related to the work of the specialist.Answer (C) is correct. If there is a material difference between the specialist’s findingsand the representations in the statements, the auditor should apply additional procedures,possibly including obtaining the opinion of another specialist. If the auditor concludes thatthe client’s representations are not in conformity with GAAP, a qualified or adverseopinion should be expressed. Reference to and identification of the specialist may bemade in the report if understanding of the reason for the modification will be facilitated(AU 336).Answer (D) is incorrect. It is unlikely that an appraiser could impose a scope limitationon the auditor. The auditor could simply consult another appraiser.



[93] Gleim #: 4.2.38 -- Source: CPA 0409 AUD-39Which of the following statements is correct concerning an auditor’s use of the work of anactuary in assessing a client’s pension obligations?

The auditor is required to understand the objectives and scope of the actuary’s work.A.The reasonableness of the actuary’s assumptions is strictly the auditor’s responsibility.B.The client is required to consent to the auditor’s use of the actuary’s work.C.If the actuary has a relationship with the client, the auditor may not use the actuary’swork.

D.

Answer (A) is correct. AU 336 notes that the auditor should obtain an understanding ofthe methods and assumptions used to determine whether the findings are suitable forcorroborative purposes. The auditor should consider whether the specialist’s findingssupport the assertions and should test the accounting data provided by the client to thespecialist.Answer (B) is incorrect. Although the auditor must evaluate the assumptions and theirusefulness for the auditor’s purpose, the reasonableness of the specialist’s assumptionsand their application is the responsibility of the specialist.Answer (C) is incorrect. The auditor, client, and specialist should have an understandingof the nature of the work to be performed by the specialist. However, the client need notconsent to the use of a specialist.Answer (D) is incorrect. When using a specialist, the auditor should become satisfiedabout the qualifications and reputation of the specialist. The auditor should attempt toobtain a specialist who is unrelated to the client. However, circumstances may permitusing the work of a specialist who has a relationship with the client.


Which of the following procedures most likely could assist an auditor in identifying related-party transactions?

Performing tests of controls concerning the segregation of duties.A.Evaluating the reasonableness of management’s accounting estimates.B.Reviewing confirmations of compensating balance arrangements.C.Scanning the accounting records for recurring transactions.D.



Answer (A) is incorrect. Testing segregation of duties of entity personnel is unlikely toidentify related-party transactions.Answer (B) is incorrect. Evaluating the reasonableness of accounting estimates has littlerelevance to related-party transactions. The auditor should concentrate on transactions of a kindthat tend to be entered into with related parties.Answer (C) is correct. The auditor performs procedures to identify material transactions thatmay be indicative of previously undetermined relationships. These procedures includereviewing confirmations of compensating balance arrangements for indications that balancesare or were maintained for or by related parties (AU 334).Answer (D) is incorrect. Scanning the accounting records for recurring transactions are not bytheir nature indicative of related-party transactions.


Which of the following events least likely would indicate the existence of related partytransactions?

Making a loan with no scheduled date for the funds to be repaid.A.Exchanging property for the benefit of a principal stockholder.B.Borrowing funds at an interest rate significantly below prevailing market rates.C.Writing off obsolete inventory to net realizable value just before year end.D.

Answer (A) is incorrect. A loan with no scheduled date for the funds to be repaid canindicate the existence of related party transactions.Answer (B) is incorrect. The exchange of property for the benefit of a principalstockholder would possibly indicate the existence of related party transactions.Answer (C) is incorrect. Borrowing funds at an interest rate significantly belowprevailing market rates is a possible indicator of the existence of related party transactionsAnswer (D) is correct. The following suggest possible related party transactions: (1)exchanging property for similar property in a nonmonetary transaction, (2) borrowing orlending at rates significantly above or below market rates, (3) selling realty at a pricematerially different from its appraised value, and (4) making loans with no scheduledrepayment terms (AU 334).


Which of the following events most likely indicates the existence of related parties?

Borrowing a large sum of money at a variable rate of interest.A.Selling real estate at a price that differs significantly from its carrying amount.B.Making a loan without scheduled terms for repayment of the funds.C.Discussing merger terms with a company that is a major competitor.D.



Answer (A) is incorrect. Large sums of money are often borrowed at fluctuating interest rates,especially when the debt is long term.Answer (B) is incorrect. Real estate’s fair value is often significantly different from itscarrying amount.Answer (C) is correct. The following suggest possible related party transactions: (1)exchanging property for similar property in a nonmonetary transaction, (2) borrowing orlending at rates significantly above or below market rates, (3) selling realty at a price materiallydifferent from its appraised value, and (4) making loans with no scheduled repayment terms(AU 334).Answer (D) is incorrect. Discussing merger terms indicates only that the parties may berelated in the future.


Which of the following would not necessarily be a related party transaction?

A sale to another corporation with a similar name.A.A purchase from another corporation that is controlled by the corporation’s chiefshareholder.

B.

Loan from the corporation to a major shareholder.C.Sale of land to the corporation by the spouse of a director.D.

Answer (A) is correct. Principal owners, management, and members of their immediatefamilies are parties related to the enterprise. Other parties with which the enterprise maydeal are related if one party can control or significantly influence the management oroperating policies of the other to the extent that one of the parties might be preventedfrom fully pursuing its own interests. A corporation that merely has the same name is notnecessarily related.Answer (B) is incorrect. A purchase from another corporation that is controlled by thecorporation’s chief shareholder is a related party transaction.Answer (C) is incorrect. A loan from the corporation to a major shareholder is a relatedparty transaction.Answer (D) is incorrect. A sale of land to the corporation by the spouse of a director is arelated party transaction.


The existence of a related party transaction may be indicated when another entity

Sells real estate to the corporation at a price that is comparable to its appraised value.A.Absorbs expenses of the corporation.B.Borrows from the corporation at a rate of interest equal to the current market rate.C.Lends to the corporation at a rate of interest equal to the current market rate.D.



Answer (A) is incorrect. Selling real estate to the corporation at a price that is comparable toits appraised value is an arm’s-length transaction between unrelated parties.Answer (B) is correct. Typical related party transactions include interest-free or low interestloans, real estate sales at prices different from appraisal values, nonmonetary exchanges ofsimilar property, and loans with no scheduled terms (AU 334). Thus, when another entityabsorbs the interest cost for a loan or otherwise provides an advantage that would not becharacteristic of an arm’s-length transaction, the existence of related parties may be indicated.Answer (C) is incorrect. Borrowing from the corporation at a rate of interest equal to thecurrent market rate is an arm’s-length transaction between unrelated parties.Answer (D) is incorrect. Lending to the corporation at a rate of interest equal to the currentmarket rate is an arm’s-length transaction between unrelated parties.


An auditor concludes that a substantive auditing procedure considered necessary during theprior year’s audit was omitted and there are persons currently relying on the auditor’s report.The auditor most likely would promptly apply the omitted procedure if

Control risk was assessed at a high level for the relevant financial statement assertions.A.The auditor’s audit documentation will be subject to post-issuance review in connectionwith a peer review program.

B.

The results of other procedures that were applied tend to compensate for the one omitted.C.The omission of the procedure impairs the auditor’s present ability to support thepreviously expressed opinion.

D.

Answer (A) is incorrect. Assessing control risk at a high level does not requireperformance of the omitted procedure if the evidence gathered by other procedures(whether or not tests of controls were performed) permits support of the previouslyexpressed opinion.Answer (B) is incorrect. The review of audit documentation in connection with a peerreview program does not affect the evidence-gathering process. The auditor’s attentionshould be on obtaining sufficient appropriate evidence, not on whether his/her decision issubject to review.Answer (C) is incorrect. If the results of other procedures that were applied tend tocompensate for the one omitted, the auditor is more likely not to apply the omittedprocedure.Answer (D) is correct. If the auditor determines that the omission impairs his/her currentability to support the opinion and (s)he believes persons are currently relying or are likelyto rely on the report, the auditor should promptly undertake to apply the omittedprocedure or alternative procedures that would provide a satisfactory basis for the opinion(AU 390).



[100] Gleim #: 4.5.78 -- Source: CPA 586 A-8After issuance of the auditor’s report, the auditor has no obligation to make any furtherinquiries with respect to audited financial statements covered by that report unless

A final resolution of a contingency that had been properly disclosed in the financialstatement notes is made.

A.

A development occurs that may affect the client’s ability to continue as a going concern.B.An investigation of the auditor’s practice by a peer review committee ensues.C.New information is discovered concerning undisclosed related party transactions of thepreviously audited period.

D.

Answer (A) is incorrect. AU 561 does not apply to resolution of a contingency that hadbeen properly disclosed in the notes of the financial statements.Answer (B) is incorrect. The auditor will have no obligation if the development occurredafter the report date.Answer (C) is incorrect. A peer review does not itself affect the financial statements.However, discovery of an omitted procedure may lead to further inquiries (AU 390).Answer (D) is correct. After issuing the report, the auditor has no obligation to make anyfurther or continuing inquiry or to perform any other auditing procedures with respect tothe audited financial statements unless new information that may affect the report comesto the auditor’s attention. If investigation reveals that the information is reliable and thatthe facts existed at the date of the report, the auditor should take steps to prevent relianceon the report (AU 561).



Documents

Audit Class Units 1-4