2013 Auditing Aicpa Released Mc Questions and Sims With Explanations

2013 AICPA Newly Released Questions – Auditing

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Following are multiple choice questions and simulations recently released by the

AICPA. These questions were released by the AICPA with letter answers only. Our

editorial board has provided the accompanying explanation.

Please note that the AICPA generally releases questions that it does NOT intend to use

again. These questions and content may or may not be representative of questions you

may see on any upcoming exams.


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AICPA QUESTIONS RATED MODERATE DIFFICULTY 1. CPA-8140 Which of the following types of audit evidence provides the least assurance of reliability?

a. Receivable confirmations received from the client's customers. b. Prenumbered receiving reports completed by the client's employees. c. Prior months' bank statements obtained from the client. d. Municipal property tax bills prepared in the client's name. Solution: Choice "b" is correct. Prenumbered receiving reports completed by the client's employees are considered internal evidence and are the least reliable of the items listed.

Choice "a" is incorrect. Receivable confirmations received from client's customers, which are considered external evidence, are more reliable than internal evidence.

Choice "c" is incorrect. Prior months' bank statements obtained from the client, which are considered external evidence, are more reliable than internal evidence.

Choice "d" is incorrect. Municipal property tax bills prepared in the client's name, which are considered external evidence, are more reliable than internal evidence.


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2. CPA-08141

An auditor is considering whether the omission of the confirmation of investments impairs the auditor's ability to support a previously expressed unmodified opinion. The auditor need not perform this omitted procedure if:

a. The results of alternative procedures that were performed compensate for the omission. b. The auditor's assessed level of detection risk is low. c. The omission is documented in a communication with the audit committee. d. No individual investment is material to the financial statements taken as a whole. Solution: Choice "a" is correct. If other audit procedures compensate for an omitted procedure, the auditor does not need to perform the omitted procedure.

Choice "b" is incorrect. If an auditor's assessed level of detection risk is low, this would provide a further reason to perform the omitted procedure or an alternative procedure to confirm the investment balance.

Choice "c" is incorrect. An auditor would still need to apply the omitted procedure (or alternative procedure) even if the omission is documented in a communication with the audit committee.

Choice "d" is incorrect. An auditor would need to perform the omitted procedure or an alternative procedure, as the aggregate amount of investments may be material to the financial statements taken as a whole.


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3. CPA-08142

Which of the following explanations most likely would satisfy an auditor who questions management about significant debits to accumulated depreciation accounts in the current year?

a. Prior years' depreciation expenses were erroneously understated. b. Current year's depreciation expense was erroneously understated. c. The estimated remaining useful lives of plant assets were revised upward. d. Plant assets were retired during the current year. Solution: Choice "d" is correct. The explanation that plant assets were retired during the year would most likely satisfy an auditor who questions management about significant debits to accumulated depreciation accounts made during the year. The journal entry to retire an asset includes a debit to accumulated depreciation and a credit to the asset account.

Choice "a" is incorrect. If prior years' depreciation expense was erroneously understated, the auditor would expect a debit to retained earnings and a credit to accumulated depreciation for the error correction.

Choice "b" is incorrect. Typically, accumulated depreciation is debited when there is total and permanent impairment, and when an asset is sold, retired, or otherwise disposed of. If the current year's depreciation expense was erroneously understated, this would not typically result in debits to accumulated depreciation. Instead, the auditor would expect smaller amounts credited to accumulated depreciation.

Choice "c" is incorrect. A change in useful life is handled prospectively. An increase in the remaining useful lives of assets would result in smaller amounts of depreciation expense being credited to accumulated depreciation.


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4. CPA-08143

An auditor has substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time because of negative cash flows and working capital deficiencies. Under these circumstances, the auditor would be most concerned about the:

a. Control environment factors that affect the organizational structure. b. Correlation of detection risk and inherent risk. c. Effectiveness of the entity's internal control activities. d. Possible effects on the entity's financial statements. Solution: Choice "d" is correct. If an auditor has substantial doubt about the entity's ability to continue as a going concern, the auditor would be most concerned about the possible effects on the entity's financial statements.

Choice "a" is incorrect. The control environment factors that affect the organizational structure do not directly relate to going concern.

Choice "b" is incorrect. The auditor is concerned about the correlation between detection risk and inherent risk when deciding the nature, extent, and timing of audit procedures.

Choice "c" is incorrect. When the auditor is concerned about an entity's ability to continue as a going concern, the auditor is concerned about the effects on the entity's financial statements and will identify conditions and events that may be indicative of substantive doubt. The effectiveness of internal controls would not typically provide evidence of substantial doubt.


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5. CPA-08144

Subsequent to issuing a report on audited financial statements, a CPA discovers that the accounts receivable confirmation process omitted a number of accounts that are material, in the aggregate. Which of the following actions should the CPA take immediately?

a. Bring the matter to the attention of the board of directors or audit committee. b. Withdraw the auditor's report from those persons currently relying on it. c. Perform alternative procedures to verify account balances. d. Discuss the potential financial statement adjustments with client management. Solution: Choice "c" is correct. If an auditor omits a procedure, the auditor should first determine whether other audit procedures compensate for the omitted audit procedures. If so, no further action is necessary. If other procedures do not compensate for the omitted audit procedure and there are people relying on the report, the auditor should promptly apply the omitted procedure or perform alternative procedures.

Choice "a" is incorrect. The auditor would first need to apply the procedure or alternative procedure to determine the account balance. If the procedure indicated the account was materially misstated, then the auditor would bring the matter to the attention of the board of directors or audit committee.

Choice "b" is incorrect. The auditor would first need to apply the procedure or alternative procedure to determine the account balance. The auditor would withdraw the auditor's report if the client refuses to adjust the financial statements.

Choice "d" is incorrect. The auditor would first need to apply the procedure or alternative procedure to determine the account balance. If adjustments were necessary, the auditor would then talk to the client about the potential adjustments.


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6. CPA-08145

An entity engaged an accountant to review its financial statements in accordance with Statements on Standards for Accounting and Review Services. The accountant determined that the entity maintained its accounts on a comprehensive basis of accounting other than generally accepted accounting principles (GAAP). In this situation, the accountant most likely would have taken which of the following actions?

a. Withdrawn from the engagement because the entity has not been following GAAP. b. Advised management to make the adjustments necessary for the account balances to conform with

GAAP. c. Modified the review report to reflect the fact that the financial statements were presented on another

comprehensive basis of accounting. d. Requested that management justify the use of the other comprehensive basis of accounting in the

management representation letter. Solution: Choice "c" is correct. An accountant asked to review financial statements on a comprehensive basis of accounting other than generally accepted accounting principles should modify the review report to reflect the fact that the financial statements were presented on another comprehensive basis of accounting.

Choice "a" is incorrect. An accountant is permitted to review financial statements that are prepared on a comprehensive basis of accounting other than GAAP.

Choice "b" is incorrect. Financial statements are allowed to be prepared using a comprehensive basis of accounting other than generally accepted accounting principles. In order for the financial statements to be considered in appropriate form, the financial statements would need to include:

1. A description of the OCBOA, including a summary of significant accounting policies and description of the primary differences from GAAP.

2. Disclosures similar to those required by GAAP if the financial statements contain items similar to those included in financial statements prepared in accordance with GAAP.

Choice "d" is incorrect. Management does not need to justify the use of the other comprehensive basis of accounting in the management representation letter.


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7. CPA-08146

Which of the following factors should an external auditor obtain updated information about when assessing an internal auditor's competence?

a. The reporting status of the internal auditor within the organization. b. The educational level and professional experiences of the internal auditor. c. Whether policies prohibit the internal auditor from auditing areas where relatives are employed. d. Whether the board of directors, audit committee, or owner-manager oversees employment decisions

related to the internal auditor. Solution: Choice "b" is correct. The educational level and professional experiences of the internal auditor help the external auditor assess an internal auditor's competence.

Choice "a" is incorrect. The reporting status of the internal auditor within the organization helps the external auditor assess an internal auditor's objectivity.

Choice "c" is incorrect. Objectivity is reflected by policies prohibiting the internal auditor from auditing areas where relatives are employed.

Choice "d" is incorrect. Objectivity is reflected by the organization level to which the internal auditor reports, which includes who oversees the employment decisions related to the internal auditor.


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8. CPA-08147

An auditor traces the serial numbers on equipment to a nonissuer's sub-ledger. Which of the following management assertions is supported by this test?

a. Valuation and allocation. b. Completeness. c. Rights and obligations. d. Presentation and disclosure. Solution: Choice "b" is correct. Completeness is the assertion supported by the auditor tracing the serial numbers on equipment (source) to a nonissuer's sub-ledger (book).

Choice "a" is incorrect. Valuation and allocation relate to whether the amounts have been recorded correctly. Reviewing serial numbers on equipment would not provide information about the proper value of the equipment.

Choice "c" is incorrect. Rights and obligations relate to whether the entity holds or controls the rights to the equipment. Inspecting supporting transactions or inspection of contracts would provide evidence of rights and obligations for equipment.

Choice "d" is incorrect. Assertions about presentation and disclosure relate to making sure components of the financial statements are properly presented, described, and disclosed. The auditor would need to review the financial statements, not the serial numbers on equipment, to support the presentation and disclosure assertion.


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9. CPA-08148

Which of the following should a practitioner perform as part of an engagement for agreed-upon procedures in accordance with Statements on Standards for Attestation Engagements?

a. Issue a report on findings based on specified procedures performed. b. Assess whether the procedures meet the needs of the parties. c. Express negative assurance on findings of work performed. d. Report the differences between agreed-upon and audit procedures. Solution: Choice "a" is correct. An agreed-upon procedures engagement is one in which the practitioner is engaged to issue a report of findings based on specific procedures performed.

Choice "b" is incorrect. The sufficiency of the procedures is solely the responsibility of the specified parties, not the practitioner.

Choice "c" is incorrect. The report includes a listing of the procedures performed and the related findings, but does not provide any assurance on these items.

Choice "d" is incorrect. The practitioner does not report on the differences between agreed-upon and audit procedures.


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10. CPA-08149

When the operating effectiveness of a control is not evidenced by written documentation, an auditor should obtain evidence about the control's effectiveness by:

a. Mailing confirmations. b. Inquiry and other procedures such as observation. c. Analytical procedures. d. Recalculating the balance in related accounts. Solution: Choice "b" is correct. Inquiry, observation, inspection, recalculation, and reperformance are procedures used to test operating effectiveness of internal controls.

Choice "a" is incorrect. Mailing confirmations is a substantive procedure, which provides evidence about the dollar balance of an account.

Choice "c" is incorrect. Analytical procedures do not provide evidence about the operating effectiveness of a control. However, analytical procedures may be used in the testing phase of the audit as a substantive procedure to provide evidence about the dollar balance of an account.

Choice "d" is incorrect. Recalculation related to the balance of accounts is a substantive procedure. Recalculation related to a control would help the auditor obtain evidence of the control's effectiveness.


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11. CPA-08150

An auditor is evaluating a client's internal controls. Which of the following situations would be the most difficult internal control issue for an auditor to detect?

a. The accounting staff neglects the control, due to increased transactions to be processed. b. The technology department writes a program that does not properly implement the control, due to a

lack of understanding. c. Two employees, who work in different departments, are circumventing an internal control. d. Someone erroneously disables edit checks in a software program designed to identify control

exceptions. Solution: Choice "c" is correct. Collusion among two employees, who work in different departments, would be the most difficult internal control issue to detect. Choice "a" is incorrect. An auditor would be able to detect whether an accounting staff member neglects the control when testing the operating effectiveness of the control.

Choice "b" is incorrect. An auditor would be able to detect a control that is not properly implemented when testing the design effectiveness of controls.

Choice "d" is incorrect. An auditor would be able to detect if a software program failed to identify control exceptions when testing the operating effectiveness of the control.


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12. CPA-08151

Inherent risk and control risk differ from detection risk in which of the following ways?

a. Inherent risk and control risk are calculated by the client. b. Inherent risk and control risk exist independently of the audit. c. Inherent risk and control risk are controlled by the auditor. d. Inherent risk and control risk exist as a result of the auditor's judgment about materiality. Solution: Choice "b" is correct. Inherent risk and control risk exist independently of the audit and the auditor cannot generally change these risks.

Choice "a" is incorrect. Inherent risk and control risk are not calculated by the client. Inherent risk and control risk are assessed by the auditor.

Choice "c" is incorrect. The auditor can control detection risk, not inherent risk or control risk.

Choice "d" is incorrect. Inherent risk and control risk are assessed based on the entity and its environment, not as a result of the auditor's judgment about materiality.


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13. CPA-08152

Which of the following matters does an auditor usually include in the engagement letter?

a. Arrangements regarding fees and billing. b. Analytical procedures that the auditor plans to perform. c. Indications of negative cash flows from operating activities. d. Identification of working capital deficiencies. Solution: Choice "a" is correct. An engagement letter typically includes information regarding fees and billing.

Choice "b" is incorrect. An engagement letter may include overall audit strategy, but typically would not include specific audit procedures.

Choice "c" is incorrect. Indications of negative cash flows from operating activities would be included in the audit workpapers, but typically would not be included in the engagement letter.

Choice "d" is incorrect. Identification of working capital deficiencies would be included in the audit workpapers, but typically would not be included in the engagement letter.


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14. CPA-08153

Which of the following is an important consideration when deciding the nature of tests to use in a financial statement audit?

a. Tests of details typically provide a low level of assurance. b. Analytical procedures are an inefficient means of obtaining assurance. c. The procedures to be applied on a particular engagement are a matter of the auditor's professional

judgment. d. The use of tests of controls should be considered without regard to the level of assurance required. Solution: Choice "c" is correct. The nature of tests to be applied on a particular engagement is a matter of the auditor's professional judgment.

Choice "a" is incorrect. The level of assurance provided by test of details varies based on the nature, extent and timing of audit procedure.

Choice "b" is incorrect. Analytical procedures can be very efficient in obtaining assurance, especially when potential misstatements are not apparent from an examination of detailed evidence or when such detail is unavailable.

Choice "d" is incorrect. The use of test of controls should be considered when deciding the level of assurance required and the nature of tests to be used. For example, if test of controls indicate that controls are not operating effectively, this will result in a lower detection risk. As the acceptable level of detection risk decreases, the assurance provided from substantive procedures should increase. In this case, the auditor may change the nature of substantive tests from a less effective to more effective procedure.


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15. CPA-08154

Which of the following procedures would an auditor most likely complete to test the existence assertion of property, plant, and equipment?

a. Obtaining a listing of all current-year additions, vouching significant additions to original invoices, and determining that they have been placed in service.

b. Obtaining a detailed fixed-asset register and ensuring items are appropriately capitalized. c. Obtaining a listing of current-year additions and verifying that items are recorded in the proper period. d. Obtaining a detailed fixed-asset register and ensuring depreciation methods are applied consistently. Solution: Choice "a" is correct. Existence is verified by vouching from the records and statements back to the supporting documents. Therefore, to test the existence assertion of property, plant, and equipment, an auditor most likely would obtain a listing of all current-year additions (records), vouching significant additions to original invoices (source), and determining that they have been placed in service (source).

Choice "b" is incorrect. An auditor would typically review the related repair and maintenance expense accounts in order to locate items that should have been capitalized.

Choice "c" is incorrect. Obtaining a listing of current-year additions and verifying that items are recorded in the proper period is typically used to test the cutoff assertion.

Choice "d" is incorrect. Obtaining a detailed fixed-asset register and ensuring depreciation methods are applied consistently is typically used to test the valuation, allocation, and accuracy assertion.


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16. CPA-08155

Which of the following is correct regarding a compilation of financial statements engagement in accordance with Statement on Standards for Accounting and Review Services?

a. If the accountant's independence is impaired, a qualified opinion must be issued. b. The accountant may not base the report on information obtained from prior engagements with the

same client. c. The accountant is not required to make inquiries nor perform procedures to corroborate the

information provided by the client. d. The accountant should perform analytical procedures to financial data. Solution: Choice "c" is correct. An accountant is not required to make inquiries nor perform procedures to corroborate the information provided by the client in a compilation engagement. These procedures are required in an audit engagement.

Choice "a" is incorrect. Independence is not required in a compilation engagement nor is an opinion rendered in a compilation engagement.

Choice "b" is incorrect. An accountant may base the report on information obtained from prior engagements. For example, knowledge gained from prior engagements may make the accountant aware that the information supplied by the entity is incorrect, incomplete, or otherwise unsatisfactory.

Choice "d" is incorrect. An accountant should perform analytical procedures related to financial data in a review or audit. Performing analytical procedures is not required in a compilation.


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17. CPA-08156

What is the primary objective of the fraud brainstorming session?

a. Determine audit risk and materiality. b. Identify whether analytical procedures should be applied to the revenue accounts. c. Assess the potential for material misstatement due to fraud. d. Determine whether the planned procedures in the audit program will satisfy the general audit

objectives. Solution: Choice "c" is correct. The primary objective of the fraud brainstorming session is to assess the potential for material misstatement due to fraud.

Choice "a" is incorrect. While audit risk and materiality may be discussed at the fraud brainstorming session, this is not the primary objective of the session.

Choice "b" is incorrect. The fraud discussion may include a discussion of procedures to test the revenue accounts, however, this is not the primary objective of the fraud discussion.

Choice "d" is incorrect. The focus of the fraud brainstorming discussion typically would not be about whether the planned procedures in the audit program satisfy the general audit objectives.


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18. CPA-08157

While performing an audit of the financial statements of a company for the year ended December 31, Year 1, the auditor notes that the company's sales increased substantially in December, Year 1, with a corresponding decrease in January, Year 2. In assessing the risk of fraudulent financial reporting or misappropriation of assets, what should be the auditor's initial indication about the potential for fraud in sales revenue?

a. There is a broad indication of misappropriation of assets. b. There is an indication of theft of the entity's assets. c. There is an indication of embezzling cash receipts. d. There is a broad indication of financial reporting fraud. Solution: Choice "d" is correct. Misstatements arising from fraudulent financial reporting are intentional misstatements or omissions of amounts or disclosures in financial statements designed to deceive financial statement users where the effect causes the financial statements not to be presented, in all material respects, in conformity with GAAP.

A substantial increase in sales in December, Year 1, with a corresponding decrease in January, Year 2, is a broad indication of financial reporting fraud. The auditor should obtain additional information and evidence regarding the significant increase and corresponding decrease in sales.

Choice "a" is incorrect. There is a broad indication of financial reporting fraud, not misappropriation of assets. Misappropriation of assets involves the theft of an entity's assets.

Choice "b" is incorrect. There is no indication of theft of the entity's assets.

Choice "c" is incorrect. Embezzling cash receipts is an example of misappropriation of assets. There is no indication of misappropriation of assets.


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19. CPA-08158

According to the Sarbanes-Oxley Act of 2002, which of the following non-audit services can be provided by a registered public accounting firm to the client contemporaneously with the audit when preapproval is granted by audit committee action?

a. Internal audit outsourcing services. b. Tax services. c. Actuarial services related to the audit. d. Advice on financial information system design. Solution: Choice "b" is correct. Tax services may be provided by a registered public accounting firm to the client contemporaneously with the audit when preapproval is granted by audit committee action.

Choice "a" is incorrect. The Sarbanes-Oxley Act of 2002 specifically prohibits a registered accounting firm from providing internal audit outsourcing services during an audit.

Choice "c" is incorrect. The Sarbanes-Oxley Act of 2002 specifically prohibits a registered accounting firm from providing actuarial services related to the audit contemporaneously with the audit.

Choice "d" is incorrect. The Sarbanes-Oxley Act of 2002 specifically prohibits a registered accounting firm from providing advice on financial information system design during an audit.


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20. CPA-08159

Which of the following situations would not impair objectivity, integrity, or independence with respect to an audit client?

a. An auditor takes the client's audit committee to Las Vegas for the weekend. b. An out-of-town client takes the audit engagement team out to dinner at a renowned local restaurant. c. An auditor provides client management with box seats for the season at a major league baseball

franchise. d. A client takes the audit engagement team on a two-day ski trip after the audit team worked for two

consecutive weekends. Solution: Choice "b" is correct. Objectivity, integrity, or independence would not be impaired if a client takes the audit engagement team out to dinner at a renowned local restaurant. Of the choices, this appears to be the most reasonable based on the circumstance, and clearly insignificant to the recipient.

Objectivity or integrity is considered impaired if a member offers or accepts gifts or entertainment to or from a client, unless the gift or entertainment is reasonable in the circumstances. Relevant facts and circumstances would include, but are not limited to:

• The nature of the gift or entertainment.

• The occasion giving rise to the gift or entertainment.

• The cost or value of the gift or entertainment.

Independence would be considered to be impaired if the member's firm or member on the attest engagement or in a position to influence the attest engagement accepts a gift from an attest client, if the value is clearly more than a token gift.

Choice "a" is incorrect. Objectivity, integrity, and independence appear to be impaired if an auditor takes the client's audit committee to Las Vegas for the weekend.

Choice "c" is incorrect. Objectivity, integrity, and independence appear to be impaired if an auditor provides client management with box seats for the season at a major league baseball franchise.

Choice "d" is incorrect. Objectivity, integrity, and independence appear to be impaired if a client takes the audit engagement team on a two-day ski trip after the audit team worked for two consecutive weekends.


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21. CPA-08160

When a PCAOB auditing standard indicates that an auditor "could" perform a specific procedure, how should the auditor decide whether and how to perform the procedure?

a. By comparing the PCAOB standard with related AICPA auditing standards. b. By exercising professional judgment in the circumstances. c. By soliciting input from the issuer's audit committee. d. By evaluating whether the audit is likely to be subject to inspection by the PCAOB. Solution: Choice "b" is correct. The words "may," "might," and "could" describe actions and procedures that auditors have a responsibility to consider. Matters described in this fashion require the auditor's attention and understanding. How and whether the auditor implements these matters in the audit will depend on the exercise of professional judgment in the circumstances consistent with the objectives of the standard.

Choice "a" is incorrect. "Could" does not mean that the auditor should compare the PCAOB standard with the related AICPA standards.

Choice "c" is incorrect. The auditor should not solicit input from the issuer's audit committee, as audit procedure decisions need to be made by the auditor.

Choice "d" is incorrect. Whether the audit is likely to be subject to inspection by the PCAOB should not be a factor on the auditor's decision to perform a procedure.


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22. CPA-08161

While performing certain non-audit services for an insurance company, a professional accountant is asked to recommend the appropriate accounting treatment for a weather hedge transaction. The accountant has worked with financial hedges but has no experience with weather hedges. Which of the following actions by the accountant would be in compliance with the IFAC Code of Ethics for Professional Accountants?

a. Agree to recommend the appropriate accounting treatment after performing sufficient research on weather hedges.

b. Refuse to conduct the research and make a recommendation, because of insufficient experience. c. Refuse to conduct the research and make a recommendation, because of a conflict of interest. d. Agree with the accounting treatment recommended by the company's hedge fund trader. Solution: Choice "a" is correct. The accountant may agree to recommend the appropriate accounting treatment after performing sufficient research on weather hedges.

Choice "b" is incorrect. An accountant may make a recommendation after performing research, even if the accountant does not have previous experience with weather hedge transactions.

Choice "c" is incorrect. An accountant should not make a recommendation until sufficient research has been obtained on weather hedge transactions. This situation does not appear to be a conflict of interest.

Choice "d" is incorrect. The accountant is responsible for gaining the required level of knowledge on hedge transactions. The recommendation may or may not agree with the accounting treatment recommended by the company's hedge fund trader.


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23. CPA-08162

According to the SEC, members of an issuer's audit committee may not:

a. Establish procedures for employees to anonymously report fraud. b. Be responsible for the compensation of any registered public accounting firm employed by the

registrant to provide an audit report. c. Accept any consulting, advisory, or other compensatory fee from the registrant for services other than

as a member of the board. d. Engage independent counsel as deemed necessary to carry out their duties. Solution: Choice "c" is correct. According to the SEC, members of an issuer's audit committee may not accept any consulting, advisory, or other compensatory fee from the registrant for services other than as a member of the board.

Choice "a" is incorrect. Members of an issuer's audit committee may establish procedures for employees to anonymously report fraud.

Choice "b" is incorrect. Members of an issuer's audit committee are typically responsible for the compensation of the public accounting firm employed by the registrant to provide an audit report.

Choice "d" is incorrect. Members of an issuer's audit committee may engage independent counsel as deemed necessary to carry out their duties.


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24. CPA-08163

Which of the following would not be included in an accountant's documentation of a compilation of a client's financial statements?

a. Discussion with the client regarding the proper presentation of gross cash flows for investment purchases.

b. An engagement letter. c. A memo to the CFO about a potentially significant fraud revealed during compilation procedures. d. A review of the segregation of duties in the cash disbursement process. Solution: Choice "d" is correct. Documentation provides the support that the accountant compiled with SSARS when performing the compilation engagement. SSARS does not require internal control procedures, such as review of segregation of duties, to be performed in a compilation engagement.

Choice "a" is incorrect. Significant issues, such as discussing with the client the proper presentation of investment purchases, which relate to the financial statements should be included in the documentation of a compilation.

Choice "b" is incorrect. An engagement letter should be included in the documentation of a compilation.

Choice "c" is incorrect. Written communications with management regarding fraud that came to the accountant's attention during a compilation should be included in the documentation of a compilation.


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25. CPA-08164

If requested to perform a compilation engagement for a nonissuer in which an accountant has an immaterial direct financial interest, the accountant is:

a. Independent because the financial interest in the nonissuer is immaterial. b. Not independent and, therefore, may not be associated with the financial statements. c. Not independent and, therefore, may not issue a compilation report. d. Not independent and, therefore, may issue a compilation report, but may not issue a review report. Solution: Choice "d" is correct. An accountant who has a direct financial interest, no matter how small, is considered to not be independent. Independence is not required for a compilation engagement since no assurance is given. However, a review engagement provides limited assurance, and therefore requires independence. Consequently, a review report may not be issued when the accountant is not independent.

Choice "a" is incorrect. An accountant who has any direct financial interest, even if immaterial, is considered to not be independent.

Choice "b" is incorrect. A compilation engagement permits an accountant to be associated with the financial statements even if the accountant lacks independence.

Choice "c" is incorrect. An accountant who is not independent of the entity may compile financial statements for such an entity and issue a compilation report. This is permitted as long as the accountant discloses their lack of independence in the report.


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AICPA QUESTIONS RATED HARD DIFFICULTY 26. CPA-08165

When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, the auditor should:

a. Not refer to the change in the auditor's report. b. Refer to the note in the financial statements that discusses the change. c. Refer to the change in an emphasis-of-matter paragraph. d. Explicitly state whether the change conforms with GAAP. Solution: Choice "a" is correct. If the change in accounting principles has an immaterial effect on the comparability of financial statements, no revision to the audit report is necessary.

Choice "b" is incorrect. The auditor's report would not need to be modified when the effect of the change on comparability is immaterial, therefore, the auditor does not need to refer to the note in the financial statements that discusses the change.

Choice "c" is incorrect. A change in accounting principles, which has a material effect on the comparability of financial statements, would refer to the change in an emphasis-of-matter paragraph.

Choice "d" is incorrect. The auditor does not need to explicitly state whether the change conforms with GAAP because the effect of the change is immaterial. The auditor's standard report implies that the auditor is satisfied that the comparability of financial statements between periods has not been materially affected by changes in accounting principles, and that such principles have been consistently applied between or among periods because either (a) no change in accounting principles has occurred, or (b) there has been a change in accounting principles or in the method of their application, but the effect of the change on the comparability of the financial statements is not material.


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27. CPA-08166

An entity prepares its financial statements on its income tax basis. A description of how that basis differs from GAAP should be included in the:

a. Notes to the financial statements. b. Auditor's engagement letter. c. Management representation letter. d. Introductory paragraph of the auditor's report. Solution: Choice "a" is correct. A description of how the income tax basis differs from GAAP should be included in the notes to the financial statements.

Choice "b" is incorrect. The auditor's engagement letter may discuss that the financial statements are prepared on the income tax basis. However, it is unlikely that the engagement letter would include a description of how that basis differs from GAAP.

Choice "c" is incorrect. The management representation letter would likely include management's acknowledgement of their responsibility for the fair presentation of the financial statements in accordance with the applicable financial reporting framework. However, it is unlikely that the management representation letter would include a description of how that basis differs from GAAP.

Choice "d" is incorrect. The introductory paragraph of the auditor's report identifies the financial statements audited, but does not include a description of how the other comprehensive basis of accounting differs from GAAP.


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28. CPA-08167

When an accountant compiles projected financial statements, the accountant's report should include a separate paragraph that:

a. Disclaims any form of assurance on the historical financial statements. b. Expresses limited assurance that the results will be within the projected range. c. Describes the limitations on the usefulness of the projection. d. Evaluates the hypothetical assumptions used to prepare the projection. Solution: Choice "c" is correct. A compilation of a financial projection report describes the limitations on the usefulness of the projection by including a caveat that the prospective results may not be achieved.

Choice "a" is incorrect. A compilation of a financial projection report disclaims any assurance on the projected, not historical, financial statements.

Choice "b" is incorrect. No assurance is provided in a compilation of projected financial statements.

Choice "d" is incorrect. An examination, not a compilation, of a financial projection evaluates the hypothetical assumptions used to prepare the projection.


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29. CPA-08168

Which of the following would be considered an analytical procedure?

a. Testing purchasing, shipping, and receiving cutoff activities. b. Comparing inventory balances to recent sales activities. c. Projecting the deviation rate of a statistical sample to the population. d. Reconciling physical counts to perpetual records and general ledger balances. Solution: Choice "b" is correct. Comparing relationships among data, such as inventory balances to recent sales activities, represents an analytical procedure.

Choice "a" is incorrect. Testing purchasing, shipping, and receiving cutoff activities represents a test of details procedure.

Choice "c" is incorrect. Projecting the deviation rate of a statistical sample to the population is used to evaluate sample results.

Choice "d" is incorrect. Reconciling physical counts to perpetual records and general ledger balances represents a test of details procedure.


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30. CPA-08169

Which of the following statements should be included in a practitioner's report on the application of agreed-upon procedures?

a. A statement that the practitioner performed an examination of prospective financial statements. b. A statement of scope limitation that will qualify the practitioner's opinion. c. A statement referring to standards established by the AICPA. d. A statement of negative assurance based on procedures performed. Solution: Choice "c" is correct. A statement referring to standards established by the AICPA should be included in a practitioner's report on the application of agreed-upon procedures.

Choice "a" is incorrect. Agreed-upon procedure reports state that the practitioner did not conduct an examination of the subject matter.

Choice "b" is incorrect. No opinion is rendered in an agreed-upon procedure engagement. An opinion is rendered in an examination or audit engagement.

Choice "d" is incorrect. Agreed-upon procedure engagements do not provide any assurance.


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31. CPA-08170

Which of the following documents the procedures that are applied and the conclusions reached in an audit engagement?

a. Management representation letter. b. Audit guide. c. Auditor's report. d. Working papers. Solution: Choice "d" is correct. Working papers should include the procedures that are applied and the conclusions reached in an audit engagement.

Choice "a" is incorrect. The management representation letter is where the client asserts that all material matters have been adequately disclosed to the auditor.

Choice "b" is incorrect. The accounting firm may have an overall audit guide on how to perform an audit, but it would not have the conclusions related to a specific audit.

Choice "c" is incorrect. An auditor's report does not list the specific procedures used in an audit engagement.


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32. CPA-08171

When reviewing the financial statements of a nonissuer in accordance with Statements on Standards for Accounting and Review Services, an accountant's procedures should include:

a. Obtaining an understanding of internal control. b. Assessing fraud risk. c. Applying substantive tests of transactions. d. Inquiring into actions taken at meetings of the Board of Directors. Solution: Choice "d" is correct. An inquiry within the organization, such as actions taken at meetings of the Board of Directors, is a procedure performed in a review. Choice "a" is incorrect. Reviews in accordance with SSARS do not require an accountant to obtain an understanding of internal control.

Choice "b" is incorrect. Assessing fraud risk is included as a procedure in an audit and is not required as part of a review.

Choice "c" is incorrect. Applying substantive tests of transactions is an audit procedure and is not required as part of a review.


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33. CPA-08172

Which of the following rules of the AICPA Code of Professional Conduct must be observed even by a member who is not in public practice?

a. Independence in Fact and Appearance. b. Integrity and Objectivity. c. Professional Competence. d. Compliance with Standards. Solution: Choice "b" is correct. An AICPA member who is not in public practice must follow Integrity and Objectivity (Rule 102). Note that an AICPA member who is not in public practice must also follow Discreditable Acts (Rule 501).

Choice "a" is incorrect. Independence in Fact and Appearance applies to a member in public practice.

Choice "c" is incorrect. Professional Competence applies to a member in public practice.

Choice "d" is incorrect. Compliance with standards applies to a member in public practice who performs auditing, review, compilation, management consulting, tax, or other professional services.


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34. CPA-08173

A practitioner is engaged to express an opinion on management's assertion that the square footage of a warehouse offered for sale is 150,000 square feet. The practitioner should refer to which of the following sources for professional guidance?

a. Statements on Auditing Standards. b. Statements on Standards for Attestation Engagements. c. Statements on Standards for Accounting and Review Services. d. Statements on Standards for Consulting Services. Solution: Choice "b" is correct. The practitioner should refer to Statements on Standards for Attestation Engagements for an attestation engagement. In an attest service, the practitioner is engaged to issue a report on subject matter or on an assertion about the subject matter (in this case, the square footage of the warehouse), that is the responsibility of another party (in this case, management).

Choice "a" is incorrect. Statements on Auditing Standards apply to audits of financial statements.

Choice "c" is incorrect. SSARS provide standards with respect to compilations and reviews of financial statements. SSARS also apply to engagements in which the accountant is engaged to compile or issue a compilation report on specified elements, accounts, or items of a nonissuer's financial statements, or on pro forma financial information of a nonissuer.

Choice "d" is incorrect. Statements on Standards for Consulting Services apply to consulting services. In a consulting service, the practitioner develops the findings, conclusions, and recommendations presented.


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35. CPA-08174

Which of the following would a successor auditor ask the predecessor auditor to provide after accepting an audit engagement?

a. Disagreements between the predecessor auditor and management as to significant accounting policies and principles.

b. The predecessor auditor's understanding of the reasons for the change of auditors. c. Facts known to the predecessor auditor that might bear on the integrity of management. d. Matters that may facilitate the evaluation of financial reporting consistency between the current and

prior years. Solution: Choice "d" is correct. Matters that may facilitate the evaluation of financial reporting consistency between the current and prior years should be discussed after accepting an audit engagement.

Choice "a" is incorrect. Disagreements between the predecessor auditor and management as to significant accounting policies and principles should be discussed prior to accepting an audit engagement.

Choice "b" is incorrect. The predecessor auditor's understanding of the reasons for the change of auditors should be discussed prior to accepting an audit engagement.

Choice "c" is incorrect. Information regarding the integrity of management should be discussed prior to accepting an audit engagement.


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36. CPA-08175

Which of the following procedures should a user auditor include in the audit plan to create the most efficient audit when an audit client uses a service organization for several processes?

a. Review the service auditor's report on controls placed in operation. b. Review the service auditor's report and outline the accounting system in a memo to the working

papers. c. Audit the service organization's controls, assess risk, and prepare the audit plan. d. Audit the service organization's controls to test the work of the service auditor. Solution: Choice "a" is correct. Reviewing the service auditor's report on controls placed in operation would be the most efficient procedure when an audit client uses a service organization for several processes.

Choice "b" is incorrect. Although the user auditor may review the service auditor's report and outline the accounting system in a memo to the working papers, this would not be as efficient as just reviewing the service auditor's report.

Choice "c" is incorrect. Although the user auditor may contact the service organization to request to audit the service organization's controls, this would not be as efficient as reviewing the service auditor's report.

Choice "d" is incorrect. While the user auditor may supplement his or her understanding of the service auditor's procedures and conclusions by discussing with the service auditor the scope and results of the service auditor's work, this would not be as efficient as just reviewing the service auditor's report.


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37. CPA-08176

Which of the following is a management assertion regarding account balances at the period end?

a. Transactions and events that have been recorded have occurred and pertain to the entity. b. Transactions and events have been recorded in the proper accounts. c. The entity holds or controls the rights to assets, and liabilities are obligations of the entity. d. Amounts and other data related to transactions and events have been recorded appropriately. Solution: Choice "c" is correct. "The entity holds or controls the rights to assets" and "liabilities are obligations of the entity" are management assertions that relate to the rights and obligation assertion about account balances at period end.

Choice "a" is incorrect. Transactions and events that have been recorded have occurred and pertain to the entity are statements that relate to the existence and occurrence assertion about transactions and events. Choice "b" is incorrect. The statement "transactions and events have been recorded in the proper accounts" relates to the understandability and classification assertion about transactions and events. Choice "d" is incorrect. Amounts and other data related to transactions and events have been recorded appropriately is a statement that relates to the valuation, allocation and accuracy assertion about transactions and events.


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38. CPA-08177

While performing interim audit procedures of accounts receivable, numerous unexpected errors are found resulting in a change of risk assessment. Which of the following audit responses would be most appropriate?

a. Move detailed analytical procedures from year end to interim. b. Increase the dollar threshold of vouching customer invoices. c. Send negative accounts receivable confirmations instead of positive accounts receivable

confirmations. d. Use more experienced audit team members to perform year-end testing. Solution: Choice "d" is correct. Numerous unexpected errors would result in an increase in the assessment of risk. An increase in risk of material misstatement would result in a decrease in detection risk, which means the assurance provided from substantive procedures should increase. Performing testing at year-end as well as utilizing more experienced audit team members to perform those tests would be an appropriate response.

Choice "a" is incorrect. Moving procedures from year-end to interim results in less assurance and would be an incorrect response to an increase in assessment of risk.

Choice "b" is incorrect. Numerous unexpected errors may result in the auditor decreasing the dollar threshold of vouching customer invoices.

Choice "c" is incorrect. The auditor should respond by obtaining more assurance from substantive procedures. Negative confirmations provide less assurance than positive confirmations.


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39. CPA-08178

Which of the following types of risk increases when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date?

a. Inherent. b. Control. c. Detection. d. Sampling. Solution: Choice "c" is correct. Detection risk increases when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date.

Choice "a" is incorrect. Inherent risk exists independently of the audit.

Choice "b" is incorrect. Control risk exists independently of the audit.

Choice "d" is incorrect. Sampling risk arises from the possibility that, when a tests of controls or a substantive test is restricted to a sample, the auditor's conclusions may be different from the conclusions that would have been reached had the test been applied to all items in the account balance or class of transactions.


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40. CPA-08179

Which of the following matters relating to an entity's operations would an auditor most likely consider as an inherent risk factor in planning an audit?

a. The entity's fiscal year ends on June 30. b. The entity enters into derivative transactions as hedges. c. The entity's financial statements are generated at an outside service center. d. The entity's financial data are available only in computer-readable form. Solution: Choice "b" is correct. The auditor would most likely consider derivative transactions as an inherent risk factor. Derivative transactions entered into as hedges may result in an increased assessment of inherent risk. For example, derivatives entered into as hedges may involve complex calculations and/or may be based on accounting estimates that are subject to significant measurement uncertainty.

Choice "a" is incorrect. The entity's fiscal year end would not be considered an inherent risk.

Choice "c" is incorrect. The complexity of the entity's computer operations, including the use of an outside service center, would be considered when evaluating control (not inherent) risk.

Choice "d" is incorrect. The auditor would consider the availability of data, such as the financial data is only available in computer-readable form, when evaluating control (not inherent) risk.


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41. CPA-08180

Which of the following is a factor in the control environment?

a. Segregation of duties. b. Information processing. c. Performance reviews. d. Management's philosophy and operating style. Solution: Choice "d" is correct. The COSO framework for internal control consists of five interrelated components. Management's philosophy and operating style is a factor in the control environment. The control environment sets the tone of the organization and originates with management and those charged with governance.

Choice "a" is incorrect. Segregation of duties is a factor of control activities. Control activities is another component of the COSO framework, and consists of control policies and procedures.

Choice "b" is incorrect. Information processing is a factor of information and communication.

Choice "c" is incorrect. Performance reviews is a factor of control activities.


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42. CPA-08181

Which of the following statements about audit sampling risks is correct for a nonissuer?

a. Nonsampling risk arises from the possibility that, when a substantive test is restricted to a sample, conclusions might be different than if the auditor had tested each item in the population.

b. Nonsampling risk can arise because an auditor failed to recognize misstatements. c. Sampling risk is derived from the uncertainty in applying audit procedures to specific risks. d. Sampling risk includes the possibility of selecting audit procedures that are not appropriate to achieve

the specific objective. Solution: Choice "b" is correct. Nonsampling risk includes all aspects of audit risk that are not due to sampling. It is always present and cannot be measured; the auditor can only attempt to reduce this risk to a very low level through adequate planning and supervision of the audit and quality control of all firm practices. Nonsampling risk can arise because an auditor failed to recognize misstatements in documents examined.

Choice "a" is incorrect. Sampling risk, not nonsampling risk, arises from the possibility that, when a substantive test is restricted to a sample, conclusions might be different than if the auditor had tested each item in the population. Choice "c" is incorrect. Audit risk, not sampling risk, refers to uncertainty in applying audit procedures to specific risks.

Choice "d" is incorrect. Nonsampling risk, not sampling risk, includes the possibility of selecting audit procedures that are not appropriate to achieve the specific objective.


44

43. CPA-08182

An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports which of the following?

a. The planned level of control risk. b. Management's assertions that internal controls exist and are operating efficiently. c. The effectiveness of internal controls. d. The planned level of assurance at the relevant assertion level. Solution: Choice "d" is correct. An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports the planned level of assurance at the relevant assertion level.

Choice "a" is incorrect. Test of controls, not test of details, would support the planned level of control risk.

Choice "b" is incorrect. Test of controls, not test of details, would help evaluate management's assertions that internal controls exist and are operating effectively.

Choice "c" is incorrect. The objective of tests of controls is to evaluate whether a control operated effectively.


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44. CPA-08183

Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of:

a. A substantive response. b. Further audit procedures. c. Tests of controls. d. An overall response. Solution: Choice "d" is correct. Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of an overall response.

Choice "a" is incorrect. "Substantive response" is not a term used in the audit literature. The terms used are "overall response," "response to risks at the relevant assertion level," and "response to significant risks." The auditor develops these responses to the assessed risks of material misstatement.

Choice "b" is incorrect. Performing further audit procedures include tests of the operating effectiveness of controls and/or substantive procedures. Increasing supervision is neither a test of operating effectiveness of controls nor a substantive procedure.

Choice "c" is incorrect. Tests of controls are used to evaluate the operating effectiveness of internal controls in preventing or detecting material misstatements. Providing more supervision is not a test of controls.


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45. CPA-08184

The Public Company Accounting Oversight Board was established by which of the following?

a. The Financial Accounting Standards Board. b. The American Institute of Certified Public Accountants. c. The Sarbanes-Oxley Act of 2002. d. The International Accounting Standards Board. Solution: Choice "c" is correct. The Public Company Accounting Oversight Board was established by the Sarbanes-Oxley Act of 2002.

Choices "a", "b", and "d" are incorrect per the explanation above.


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46. CPA-08185

Which of the following applies to an accountant conducting a review of interim financial information?

a. The accountant must indicate in the report those circumstances in which generally accepted accounting principles have not been consistently observed in the current period in relation to the preceding period.

b. The accountant must express an opinion on the financial statements taken as a whole. c. The accountant must maintain independence in mental attitude in all matters relating to the

engagement. d. The accountant must obtain sufficient appropriate evidence by performing procedures to afford a

reasonable basis for an opinion. Solution: Choice "c" is correct. An accountant must maintain independence in mental attitude in all matters relating to the engagement in a review.

Choice "a" is incorrect. Inconsistencies in the application of accounting principles do not require modification of the review report as long as the financial statements include adequate disclosure. However, at the accountant's discretion, a separate paragraph of the report may be used to discuss the inconsistency.

Choice "b" is incorrect. An accountant must express an opinion on the financial statements taken as a whole in an audit, not a review.

Choice "d" is incorrect. An accountant must obtain sufficient appropriate evidence by performing procedures to afford a reasonable basis for an opinion in an audit, not a review.


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47. CPA-08186

Which of the following circumstances would be inappropriate for the auditor to communicate to those charged with governance?

a. A material misstatement was noted by the auditor and corrected by management. b. No significant deficiencies in internal control exist that would affect the financial statements. c. The auditor is requesting representations regarding the financial statements from management. d. Management has consulted with other accountants about accounting and auditing matters during the

period under audit. Solution: Choice "b" is correct. The auditor may not report the absence of significant deficiencies to those charged with governance or management.

Choice "a" is incorrect. It is appropriate for the auditor to communicate to those charged with governance a material misstatement noted by the auditor and corrected by management.

Choice "c" is incorrect. The auditor's request that management provide representations regarding the financial statements is an appropriate communication from the auditor to those charged with governance.

Choice "d" is incorrect. Management's consultation with other accountants about accounting and auditing matters during the period under audit is an appropriate communication for the auditor to make to those charged with governance.


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48. CPA-08187

An auditor may provide an issuer client any of the following non-audit services without impairing independence and without obtaining the preapproval of the audit committee, except:

a. Non-audit services with revenues in aggregate of less than 5% of the total revenues paid by the issuer to the auditor during the fiscal year in which the non-audit services are provided.

b. Non-audit services that were promptly brought to the attention of, and approved by, the audit committee prior to the completion of the audit.

c. Non-audit services to perform financial information systems design and implementation. d. Services that the issuer did not recognize as non-audit services at the time of the engagement. Solution: Choice "c" is correct. Financial information systems design and implementation to an attestation client would impair independence. In addition, all non-audit services, except those that fall under the de minimis exception, need to be preapproved by the audit committee.

Note to Students: This question implies that there are three unique situations in which the auditor may provide an issuer client non-audit services without impairing independence and without obtaining the preapproval of the audit committee. However, Regulation S-X provides that all three conditions must be met. The incorrect answers in this question are ALL required in order to satisfy the exception.


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49. CPA-08188

An accountant compiles the financial statements of a nonissuer and issues the standard compilation report. Although not specifically stated in this report, it is implied that:

a. The accountant has not audited or reviewed the financial statements. b. Substantially all disclosures required by GAAP are included in the financial statements. c. The financial statements should not be used to obtain credit. d. The compilation is limited to presenting information that is the representation of management. Solution: Choice "b" is correct. A standard compilation report implies that substantially all disclosures required by GAAP are included in the financial statements.

Choice "a" is incorrect. The standard compilation report explicitly states that the accountant has not reviewed or audited the financial statements.

Choice "c" is incorrect. The financial statements may be used to obtain credit if a standard compilation report is issued.

Choice "d" is incorrect. The standard compilation report addresses this by stating, "Management is responsible for the preparation and fair presentation of the financial statements..."


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50. CPA-08189

According to the Sarbanes-Oxley Act of 2002, what is the maximum number of years an audit partner can perform audit services for an issuer before the auditor rotation is required?

a. 2 years. b. 3 years. c. 4 years. d. 5 years. Solution: Choice "d" is correct. The lead (or coordinating) audit partner or the reviewing audit partner must rotate off the audit every five years. Note: The Sarbanes-Oxley Act of 2002 addresses the partner rotation for the lead audit partner and the concurring partner. On the other hand, SEC Standards reference both the maximum number of years a lead or concurring partner may perform audit services (5 years) and the maximum number of years other audit partners may perform audit services before audit rotation is required (7 years).

Choices "a", "b", and "c" are incorrect. The number of years for these answer choices does not match the SOX audit requirement for audit partner rotation.

AUDIT Released by AICPA

2013

Task 527_01

Selection list

SOLUTION AND EXPLANATION:

1.

Account balance—A/R

Assertion—Completeness

Procedure—Trace sales invoice and shipping documents just before year-end to customer account transactions

The completeness assertion is tested by going from the supporting documents to the financial statement records. An auditor may test accounts receivable for completeness by tracing sales invoices (source) and shipping documents (source) just before year-end to customer account transactions (accounting records).

Note: Reviewing confirmation of accounts receivable balances does not provide evidence of completeness (i.e., customers may not report understatement errors).

2.

Account balance—Inventory

Assertion—Valuation and allocation

Procedure—Examine invoices from suppliers

An auditor would examine invoices from suppliers to make sure that inventory is valued at the correct amount.

#3.

Account balance—Fixed assets

Assertion—Rights and obligations

Procedure—Vouch fixed asset acquisitions to purchase invoices

An auditor would examine invoices related to fixed assets acquired during the year to confirm ownership of fixed assets.

4.

Account balance—Accounts payable

Assertion—Completeness

Procedure—Examine invoices paid subsequent to year-end and trace to subsidiary ledger

Completeness is tested by going from the supporting documents to the financial statement records. When testing completeness of accounts payable, the auditor is looking for items that should have been recorded at the balance sheet date, but were not. Therefore, an auditor can test accounts payable for completeness by examining invoices paid subsequent to year-end (support) to the subsidiary ledger (accounting records).

5.

Account balance—Cash

Assertion—Existence

Procedure—Agree cash balance per bank reconciliation to year-end bank statement

Existence is tested by going from the financial statements records to the supporting documents. An auditor can test existence of cash by agreeing the cash balance per bank reconciliation (per accounting records) to year-end bank statement (source document).

Task 1921_01

Selection List


Days' sales in accounts receivable

Sales managers are recording fraudulent sales to receive larger commissions.

The formula for "Days sales in accounts receivable" is:

Average net receivables x (365 / Net credit sales)

The ratio increased in Year 2 as compared in Year 1. This ratio indicates the average number of days required to collect accounts receivable increased. An increase in average net receivables would result in an increase in the ratio. If sales managers are recording fraudulent sales this would result in a larger amount of accounts receivables as fictitious customers do not pay their account receivables balance.

Inventory turnover

Due to an economic downturn, buyers have shifted to economy cars.

The formula for inventory turnover is:

Cost of goods sold / Average inventory

The ratio decreased in Year 2 as compared to Year 1. This can result from a decrease in cost of goods sold and/or an increase in average inventory. If buyers have shifted to economy cars this means that fewer luxury cars are being sold in Year 2, resulting in a lower cost of goods sold as well as an increase in average inventory. (The journal entry when inventory is sold is a debit to cost of goods sold and a credit to inventory.)

Debt to equity

In Year 2, the company made a required principal payment on its long-term debt.

The formula for debt to equity is:

Total liabilities / Common shareholders' equity

The ratio decreased in Year 2 as compared to Year 1. This can result due to a decrease in total liabilities and/or an increase in common shareholders' equity. If the company made a required payment on long-term debt this would decrease total liabilities. Note that an increase in dividends to shareholders or a buyback of stock would decrease shareholders' equity.

Return on assets

Due to an economic downturn, buyers have shifted to economy cars.

The formula for return on assets is:

(Net income / Net sales ) * (Net sales/ Average total assets)

or

Net income / Average total assets

The ratio decreased in Year 2 as compared to Year 1. This may result from a decrease in net income and/or an increase in average total assets. If buyers have shifted to buying economy cars instead of luxury cars this would result in a decrease in net income as a result of lower sales. Also, average total assets may have increased as a result of higher inventory levels.

Net fixed assets to equity

In Year 2, the company reclassified its international production factories to held for sale.

The formula for net fixed assets to equity is:

Net fixed assets / Equity

The ratio decreased in Year 2 as compared to Year 1. This can result due to a decrease in net fixed assets and/or an increase in equity. If the company reclassified its international production facilities to held for sale, this would result in a decrease in net fixed assets because long-lived assets classified as held for sale are presented separately from other assets. (Items held for sale get their own individual line item on the balance sheet.)

Note that there would be no change in assets when a company removed fully depreciated machinery from its books.

Task 3837_01


Source of answer for this question:

ET 54.03

Keyword: Integrity

Documents

2013 Auditing Aicpa Released Mc Questions and Sims With Explanations