Chapter Multiple-Choice Questions easy a Auditing standards require that the audit report must be titled and that the title must: a include the word “independent.” b indicate if the auditor is a CPA c indicate if the auditor is a proprietorship, partnership, or incorporated d indicate the type of audit opinion issued Medium a To emphasize the fact that the auditor is independent, a typical addressee of the audit report could be: a b c d Company Controller No No Yes Yes Shareholders Yes No Yes No Board of Directors Yes Yes No No easy b The purpose of the introductory paragraph in the standard unqualified report is: a to identify that the type of opinion issued is unqualified b to identify the financial statements audited and the dates and time periods covered by the report c to indicate the CPA followed applicable audit standards d to indicate all the financial statements are in accordance with GAAP easy d The scope paragraph of the standard unqualified audit report states that the audit is designed to: a discover all errors and/or irregularities b discover material errors and/or irregularities c conform to generally accepted accounting principles d obtain reasonable assurance whether the statements are free of material misstatement easy d The audit report date on a standard unqualified report indicates: a the last day of the fiscal period b the date on which the financial statements were filed with the Securities and Exchange Commission c the last date on which users may institute a lawsuit against either client or auditor d the last day of the auditor’s responsibility for the review of significant events that occurred subsequent to the date of the financial statements easy d As a result of management’s refusal to permit the auditor to physically examine inventory, the auditor has not accumulated sufficient appropriate evidence to conclude whether financial statements are stated in accordance with GAAP The auditor must depart from the unqualified audit report because: a the financial statements have not been prepared in accordance with GAAP b the scope of the audit has been restricted by circumstances beyond either the client’s or auditor’s control c the auditor has lost independence d the scope of the audit has been restricted easy An adverse opinion is issued when the auditor believes: a some parts of the financial statements are materially misstated or misleading /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc d b c d the financial statements would be found to be materially misstated if an investigation were performed the auditor is not independent the overall financial statements are so materially misstated that they not present fairly the financial position or results of operations and cash flows in conformity with GAAP easy c If a misstatement is immaterial to the financial statements of the entity for the current period, but is expected to have a material effect in future periods, it is appropriate to issue a(n): a adverse opinion b qualified opinion c unqualified opinion d disclaimer of opinion (Public) easy c Whenever an auditor issues an audit report for a public company, the auditor can choose to issue a report in which of the following forms? a A combined report on financial statements and internal control over financial reporting b Separate reports on financial statements and internal control over financial reporting c Either a or b d Neither a nor b 10 easy b When determining whether an exception is “highly material,” the extent to which the exception affects different elements of the financial statements must be considered This concept is called: a materiality b pervasiveness c financial analysis d ratio analysis 11 medium d An auditor determines the financial statements include a material departure from GAAP Which type of opinion may be issued? a b c d Disclaimer Yes No Yes No Qualified No Yes No Yes Adverse No No Yes Yes 12 (Public) easy c If an auditor performs an audit of a public company, the scope paragraph should make reference to which standards? a Accounting standards b Generally accepted auditing standards c Standards issued by the PCAOB (U.S.) d Any of the above standards 13 easy b If an auditor performs an audit of a private company, the scope paragraph should make reference to which standards? a Accounting standards b U.S generally accepted auditing standards c Standards issued by the PCAOB (U.S.) d Any of the above standards 14 easy a Examples of unqualified opinions which contain modified wording (without adding an explanatory paragraph) include: a the use of other auditors b material uncertainties c substantial doubt about the audited company (or the entity) continuing as a going concern /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc d lack of consistent application of GAAP 15 GAAP requires that changes in accounting principles be to a: medium c a b c d 16 easy c A CPA may wish to emphasize specific matters regarding the financial statements even though an unqualified opinion will be issued Normally, such explanatory information is: a included in the scope paragraph b included in the opinion paragraph c included in a separate paragraph in the report d included in the introductory paragraph 17 challenging d An auditor who issues a qualified opinion because sufficient appropriate evidence was not obtained should describe the limitations in an explanatory paragraph The auditor should also refer to the limitation in the: more conservative principle principle with equal authoritative support preferable principle principle detailed in a FASB pronouncement Scope paragraph a Yes b No c No d Yes Opinion paragraph No Yes Yes Yes Notes to the financial statements Yes Yes No No 18 medium b When the auditor evaluates the effect of a change in accounting principle, the materiality of the change should be evaluated based on: a the prior years presented b the current year effect of the change c guidelines included in GAAS d the effect on total assets 19 medium b Conditions requiring a departure from an unqualified audit report include all but which of the following? a Management refused to allow the auditor to confirm significant accounts receivable for which there were no alternative procedures performed b Management decided not to allow the auditor to confirm significant accounts receivable, but the auditor obtained sufficient appropriate evidence by examining subsequent cash receipts c The audit partner’s dependent child received a gift of 100 shares of a client’s stock for her birthday from a grandparent d Management has determined that fixed assets should be reported in the balance sheet at their replacement values rather than historical costs The auditors not concur 20 medium b The introductory paragraph of the standard audit report states that the financial statements are: a the responsibility of the auditor b the responsibility of management c the joint responsibility of management and the auditor d none of the above 21 medium d The introductory paragraph of the standard audit report states that the financial statements and the opinion expressed about those statements are: a the responsibility of the auditor b the responsibility of management /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc c d the joint responsibility of management and the auditor none of the above 22 medium c The introductory paragraph of the standard audit report states that the auditor is: a responsible for the financial statements and the opinion on them b responsible for the financial statements c responsible for the opinion on the financial statements d jointly responsible for the financial statements with management 23 (Public) medium a PCAOB Auditing Standard No requires the audit of internal control over financial reporting to be integrated with: a the audit of the financial statements b the quarterly review of financial information c the review of annual financial statements d none of the above 24 medium d The audit report indicates that (1) management is responsible for the content of the financial statements and (2) the auditor is responsible for evaluating the appropriateness of the accounting principles chosen by management Which paragraph contains those statements? a Both are in the introductory paragraph b Both are in the scope paragraph c Both are in the opinion paragraph d None of the above are true 25 medium c If the balance sheet of a company is dated December 31, 2009, the audit report is dated February 8, 2010, and both are released on February 15, 2010, this indicates that the auditor has searched for subsequent events that occurred up to: a December 31, 2009 b January 1, 2010 c February 8, 2010 d February 15, 2010 26 (Public) medium b A combined report on financial statements and internal control over financial reporting includes all but which of the following types of paragraphs? a Inherent limitations paragraph b Description paragraph c Opinion paragraph d Each of the above paragraphs is included 27 medium d Whenever an auditor issues a qualified opinion, the implication is that the auditor: a does not know if the financial statements are presented fairly b does not believe the financial statements are presented fairly c believes the financial statements are presented fairly d believes the financial statements are presented fairly “except for” a specific aspect of them 28 medium c The necessity to issue a disclaimer of opinion may arise because of: a a severe limitation on the scope of the audit b a lack of independence between the auditor and client c either a or b d neither a nor b 29 medium b When the auditor determines the financial statements are fairly stated and then determines that the auditor lacks independence, the auditor should issue: a an adverse opinion b a disclaimer of opinion /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc c d either a qualified opinion or an adverse opinion either a qualified opinion or an unqualified opinion with modified wording 30 medium d If the auditor lacks independence, a disclaimer of opinion must be issued: a if the client requests it b only if it is highly material c only if it is material but not highly material d in all cases 31 medium d Misstatements must be compared with some measurement base before a decision can be made about materiality A commonly accepted measurement base includes: a net income b total assets c working capital d all of the above 32 medium When comparing misstatements with a measurement base, the auditor must consider the pervasiveness of the misstatement Of the following examples, the most pervasive misstatement is a(n): a understatement of inventory b understatement of retained earnings caused by a miscalculation of dividends payable c misclassification of notes payable as a long-term liability when it should be current d misclassification of salary expense as a selling expense when it should be allocated equally to both selling and administrative expense a 33 medium b The dollar amount of some misstatements cannot be accurately measured For example, if the client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect on: a net income b users of the financial statements c the auditor’s exposure to lawsuits d management’s future decisions 34 medium d Whenever there is a scope restriction, the appropriate response is to issue a(n): a disclaimer of opinion b adverse opinion c qualified opinion d unqualified report, a qualification of scope and opinion, or a disclaimer, depending on materiality 35 medium a Which of the following is least likely to cause uncertainty about the ability of an entity to continue as a going concern? a A client’s lawsuit against another company which claims the other company has infringed on its patent b Loss of major customers c Significant recurring operating losses d Working capital deficiencies 36 medium d The client has presented all required financial statements with the exception of the statement of cash flows The auditor has completed the audit and is satisfied that all other statements are presented fairly The auditor: a may issue either an unqualified or a qualified opinion b must issue an adverse opinion with “except for” in the opinion paragraph c may issue an unqualified opinion d must issue a qualified opinion with “except for” in the opinion paragraph /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 37 medium d When a disclaimer is issued because the auditor lacks independence: a no report title is included on the report b a one-paragraph audit report is issued c the only reason cited for issuing the disclaimer is the lack of independence d all of the above are correct 38 medium d When a client has not applied GAAP consistently from the prior year to the current year, the auditor does not concur with the appropriateness of the change, and the change in GAAP has a material effect on the financial statements, the auditor should issue a(n): a disclaimer b adverse opinion c unqualified opinion d qualified opinion 39 medium c Which of the following is not a change that affects consistency and, therefore, does not require an explanatory paragraph? a Change in accounting principle, such as a change from LIFO to FIFO b Change in reporting entity, such as the inclusion of an additional company in combined financial statements c Change in an estimate, such as a decrease in the life of an asset for depreciation purposes d Correction of errors by changing from non-GAAP to GAAP 40 medium c Items that materially affect the comparability of financial statements generally require disclosure in the footnotes If the client refuses to properly disclose the item, the auditor will most likely issue: a a disclaimer b an unqualified opinion c a qualified opinion d an adverse opinion 41 medium c Auditors sometimes encounter situations in which the outcome of a matter cannot be reasonably estimated at the time the financial statements are issued These matters are referred to as: a inestimable matters b non sequiturs c uncertainties d in-suspense matters 42 medium b When there is uncertainty about a company’s ability to continue as a going concern, the auditor’s concern is the possibility that the client may not be able to continue its operations or meet its obligations for a “reasonable period of time.” For this purpose, a reasonable period of time is considered not to exceed: a six months from the date of the financial statements b one year from the date of the financial statements c six months from the date of the audit report d one year from the date of the audit report 43 medium d When the auditor concludes that there is substantial doubt about the entity’s ability to continue as a going concern, the appropriate audit report would be: a an unqualified opinion with an explanatory paragraph b a disclaimer of opinion c neither a nor b d either a or b 44 medium c An auditor may not issue a qualified opinion when: a a scope limitation prevents the auditor from completing an important audit procedure b the auditor’s report refers to the work of a specialist /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc c d the auditor lacks independence with respect to the audited entity an accounting principle at variance with GAAP is used 45 medium b When a company’s financial statements contain a departure from GAAP with which the auditor concurs, the departure should be explained in: a the scope paragraph b an explanatory paragraph that appears before the opinion paragraph c the opinion paragraph d an explanatory paragraph after the opinion paragraph 46 medium b Which of the following representations does an auditor make explicitly and which implicitly when issuing an unqualified opinion? Conformity Adequacy of with GAAP disclosure a Explicitly Explicitly b Explicitly Implicitly c Implicitly Explicitly d Implicitly Implicitly 47 medium c William Gregory, CPA, is the principal auditor for a multi-national corporation Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation Gregory is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor’s examination With respect to his report on the consolidated financial statements, taken as a whole, Gregory: a must not refer to the examination of the other auditor b must refer to the examination of the other auditor c may refer to the examination of the other auditor d may refer to the examination of the other auditor, in which case Gregory must include in the auditor’s report on the consolidated financial statements a qualified opinion with respect to the examination of the other auditor 48 medium d A company has changed its method of inventory valuation from an unacceptable one to one in conformity with generally accepted accounting principles The auditor’s report on the financial statements of the year of the change should include: a no reference to consistency b a reference to a prior period adjustment in the opinion paragraph c an explanatory paragraph that justifies the change and explains the impact of the change on reported net income d an explanatory paragraph explaining the change 49 (Public) medium a Sarbanes-Oxley requires auditors of a public company to audit a company’s financial statements and attest to management’s report on the effectiveness of internal control over financial reporting What type of assurance does the auditor provide in this report? a Positive assurance on the financial statements and on the effectiveness of internal control over financial reporting b Positive assurance on the financial statements and negative assurance on the effectiveness of internal control over financial reporting c Limited assurance on the financial statements and on the effectiveness of internal control over financial reporting d There is no guidance on what level of assurance to provide 50 medium c Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned that management may be trying to prevent discovery of misstatements In such cases, the auditor will likely issue a: a disclaimer of opinion in all cases b qualification of both scope and opinion in all cases /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc c d disclaimer of opinion whenever materiality is in question qualification of both scope and opinion whenever materiality is in question 51 medium b CPAs issue several types of “special audit reports.” Which of the following circumstances would not require the issuance of a special audit report? a The client’s financial statements are prepared using the cash basis b The client’s financial statements are prepared using the accrual basis c The CPA has been retained to audit only the current assets d The CPA has been retained to review the internal control system, not the financial statements 52 medium b When a qualified or adverse opinion is issued, the qualifying paragraph is inserted: a between the introductory and scope paragraphs b between the scope and opinion paragraphs c after the opinion paragraph, as a fourth paragraph d immediately after the address, as the first paragraph 53 challenging c For the report containing a disclaimer for lack of independence, the disclaimer is in the: a third or opinion paragraph b second or scope paragraph c first and only paragraph d fourth or explanatory paragraph 54 challenging a Which of the following is not a primary category of attestation report? a Compilation report b Review report c Audit report d Special audit report based on a basis of accounting other than GAAP 55 challenging b Most auditors believe that financial statements are “presented fairly” when the statements are in accordance with GAAP, and that it is also necessary to: a determine that they are not in violation of FASB statements b examine the substance of transactions and balances for possible misinformation c review the statements using the accounting principles promulgated by the SEC d assure investors that net income reported this year will be exceeded in the future 56 challenging d In which of the following situations would the auditor most likely issue an unqualified report? a The client valued ending inventory by using the replacement cost method b The client valued ending inventory by using the Next-In-First-Out (NIFO) method c The client valued ending inventory at selling price rather than historical cost d The client valued ending inventory by using the First-In-First-Out (FIFO) method, but showed the replacement cost of inventory in the Notes to the Financial Statements 57 challenging d Which of the following statements is true? a The auditor is required to issue a disclaimer of opinion in the event of a material uncertainty b The auditor is required to issue a disclaimer of opinion in the event of a going concern problem c The auditor is required to issue a disclaimer of opinion for a material uncertainty and for a going concern problem d The auditor has the option, but is not required, to issue a disclaimer of opinion for a material uncertainty or for a going concern problem 58 medium a The most common case in which conditions beyond the client’s and auditor’s control cause a scope restriction is an engagement: a agreed upon after the client’s balance sheet date /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc b c d where the client won’t allow the auditor to confirm receivables for fear of offending its customers where the auditor doesn’t have enough staff to satisfactorily audit all of the client’s foreign subsidiaries where the client is going through Chapter 11 bankruptcy 59 challenging d When the auditor cannot perform procedures and the amounts are so material that a disclaimer of opinion rather than a qualified opinion is required, the: a opinion paragraph will state “does not present fairly.” b opinion paragraph will state “presents fairly.” c scope paragraph will be unchanged from the standard unqualified opinion d scope paragraph will be deleted 60 challenging b When misstatements are so material that an adverse opinion is issued, a scope paragraph would be: a qualified b unchanged c deleted d expanded to identify the additional procedures which the auditor performed 61 challenging d When the client fails to make adequate disclosure in the body of the statements or in the related footnotes, it is the responsibility of the auditor to: a inform the reader that disclosure is not adequate, and to issue an adverse opinion b inform the reader that disclosure is not adequate, and to issue a qualified opinion c present the information in the audit report and issue an unqualified or qualified opinion d present the information in the audit report and to issue a qualified or an adverse opinion 62 challenging c The “unqualified report with explanatory paragraph” and the “unqualified report with modified wording”: a arise as a result of an incomplete audit b arise when the financial statements are not “presented fairly.” c meet the criteria of a complete audit with satisfactory results d meet the criteria of a complete audit but with unsatisfactory results 63 medium c Which of the following will not cause the auditor to issue a standard unqualified report with an explanatory paragraph or modified wording? a Emphasis of a matter b Reports involving other auditors c Auditor disagrees with client’s departure from GAAP d Lack of consistent application of GAAP 64 challenging a Which of the following is not one of the principal CPA firm’s alternatives when issuing a report if a different CPA firm performed part of the audit? a Issue a joint report signed by both CPA firms b Make no reference to the other CPA firm in the audit report, and issue the standard unqualified opinion c Make reference to the other auditor in the report by using modified wording (a shared opinion or report) d A qualified opinion or disclaimer, depending on materiality, is required if the principal auditor is not willing to assume any responsibility for the work of the other auditor 65 challenging c Which of the following statements is not true? a A one-paragraph report is generally used when the auditor is not independent b A three-paragraph report ordinarily indicates there are no exceptions in the audit c More than three paragraphs in the report indicates there must be some type of qualification in the audit /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc d An unqualified opinion with an explanation or modified wording would require more than three paragraphs /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 86 medium There are five conditions that must be met before an auditor can issue a standard unqualified report for the audit of a private company Please discuss each of these five conditions Answer: The five conditions that justify issuing a standard unqualified report are:  All statements—balance sheet, income statement, statement of retained earnings, and statement of cash flows—are included in the financial statements  The three general standards of GAAS have been followed in all respects on the engagement  Sufficient appropriate audit evidence has been accumulated and the auditor can conclude that the three fieldwork standards have been followed  The financial statements are presented in accordance with GAAP  There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report 87 medium There are three conditions requiring a departure from an unqualified audit report Discuss each of these three conditions and state the appropriate audit report for each condition Answer: The three conditions requiring a departure from an unqualified report are:  a scope restriction imposed by the client or by circumstances beyond the auditor’s or client’s control which prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP In this condition, the auditor would issue either a qualified scope and opinion report, or a disclaimer of opinion  the financial statements were not prepared in accordance with GAAP In this condition, the auditor would issue a qualified opinion if the GAAP violation were moderately material, or an adverse opinion if the GAAP violation were highly material  the auditor is not independent In this condition, the auditor must issue a disclaimer of opinion /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 88 medium In certain circumstances, an auditor will issue an unqualified report, but the wording will differ from that of a standard unqualified report Discuss each of the five circumstances when an auditor would issue an unqualified report with an explanatory paragraph or modified wording Answer: An unqualified report with an explanatory paragraph or modified wording is appropriate in the following circumstances:  Lack of consistent application of GAAP When the client has not followed generally accepted accounting principles consistently in the current period in relation to the preceding period, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate  Substantial doubt about continuing as a going concern When an auditor concludes there is substantial doubt about the client’s ability to continue as a going concern, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate The auditor also has the option of issuing a disclaimer of opinion  A departure from GAAP with which the auditor concurs If adherence to GAAP would result in misleading financial statements, an unqualified opinion with an explanatory paragraph is appropriate   89 medium Emphasis of a matter If the auditor wants to emphasize specific matters in the audit report, an explanatory paragraph discussing those matters may be added to an unqualified report Reports involving other auditors When an auditor relies upon a different CPA firm to perform part of the audit, the auditor can indicate that responsibility for the audit is shared with another CPA firm by modifying the wording of an unqualified report An audit report prepared by Garrett and Brown, CPAs, is provided below The audit for the year ended December 31, 2007 was completed on March 1, 2008, and the report was issued to Javlin Corporation, a private company, on March 13, 2008 List any deficiencies in this report Do not rewrite the report We have examined the accompanying financial statements of Dalton Corporation as of December 31, 2007 These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these statements based on our audit We conducted our audit in accordance with generally accepted accounting principles Those principles require that we plan and perform the audit to provide reasonable assurance about whether the financial statements are free of misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements We believe that our audit provides a reasonable basis for our opinion In our opinion, except for the effects of not capitalizing certain lease obligations that should be capitalized in order to conform with generally accepted accounting principles, the financial statements referred to above present accurately the financial position of Jacob Corporation as of December 31, 2007, in conformity with accounting principles generally accepted in the United States of America Garrett and Brown, CPAs March, 2008 /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc Answer: The audit report contains the following deficiencies:  The report title is missing  The report is not addressed to anyone and should be addressed to shareholders or the board of directors  The introductory paragraph should refer to an “audit,” not an “examination.”  The introductory paragraph should list the financial statements that were audited  The introductory paragraph refers to the wrong company  The scope paragraph should state the audit was conducted in accordance with auditing standards generally accepted in the United States of America, not generally accepted accounting principles  “Those principles …” should read “Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.”  The scope paragraph should contain the following phrase: “An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.”      90 medium Following the scope paragraph, there should be an explanatory paragraph that discusses the GAAP violation related to the failure to capitalize certain lease obligations In the opinion paragraph, the auditor should state that the financial statements present fairly…, not present accurately… In the opinion paragraph, the phrase “…in all material respects…” should be included In the opinion paragraph, the phrase “…and the results of its operations and its cash flows for the year then ended…” should be included The audit report should be dated March 13, 2008 Discuss the differences regarding how matters affecting consistency and matters affecting comparability are referred to in the audit report Provide two examples of each type of change Answer: The auditor should disclose a material lack of consistent application of GAAP by adding an explanatory paragraph after the unqualified opinion paragraph The explanatory paragraph should discuss the nature of the change and should refer to the footnote in the financial statements that discusses the change Changes that affect comparability, but not consistency, require no such explanatory paragraph in the audit report, assuming the change is disclosed in the footnotes Examples of changes affecting consistency include changes in accounting principles, changes in reporting entities, and correction of errors involving accounting principles Examples of changes affecting comparability include changes in an estimate, error corrections not involving accounting principles, variations in the format and presentation of financial information, and changes because of substantially different transactions or events /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 91 (Public) medium The following is a portion of an adverse audit report issued for a public company (Note: A separate report was issued on the effectiveness of internal control over financial reporting.) Independent Auditor’s Report To the shareholders of Wallace Corporation We have audited the accompanying balance sheet of Wallace Corporation as of December 31, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audit provides a reasonable basis for our opinion The company has excluded from property and debt in the accompanying balance sheet certain lease obligations that, in our opinion, should be capitalized in order to conform with generally accepted accounting principles If these lease obligations were capitalized, property would be increased by $14,500,000, long-term debt by $13,200,000, and retained earnings by $1,300,000 as of December 31, 2007, and net income and earnings per share would be increased by $1,300,000 and $2.25, respectively, for the year then ended Required: Complete the above adverse audit report by preparing the opinion paragraph Do not date or sign the report Answer: In our opinion, because of the effects of the matters discussed in the preceding paragraph, the financial statements referred to above not present fairly, in conformity with generally accepted accounting principles, the financial position of Wallace Corporation as of December 31, 2007, or the results of its operations and its cash flows for the year then ended /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 92 medium The following is a portion of a qualified audit report issued for a private company: Independent Auditor’s Report To the shareholders of Tamarak Corporation We have audited the accompanying balance sheet of Tamarak Corporation as of October 31, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit We conducted our audit in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audit provides a reasonable basis for our opinion The company has included in property and debt in the accompanying balance sheet certain lease obligations that, in our opinion, should be expensed in order to conform with generally accepted accounting principles If these lease obligations were capitalized, property would be decreased by $4,000,000, long-term debt by $2,000,000, and retained earnings by $180,000 as of October 31, 2005, and net income and earnings per share would be decreased by $180,000 and $.62, respectively, for the year then ended Required: Complete the above qualified audit report by preparing the opinion paragraph Do not date or sign the report Answer: In our opinion, except for the effects of capitalizing lease obligations, as discussed in the preceding paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of Tamarak Corporation as of October 31, 2007, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 93 (Public) medium The following is a portion of a qualified scope and opinion report due to a scope restriction (Note: A separate report was issued on the effectiveness of internal control over financial reporting.) Independent Auditor’s Report To the shareholders of Fast Times Corporation We have audited the accompanying balance sheet of Fast Times Corporation as of September 30, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit Except as discussed in the following paragraph, we conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audit provides a reasonable basis for our opinion We were unable to obtain audited financial statements supporting the company’s investment in a foreign affiliate stated at $1,040,000, or its equity in earnings of that affiliate of $501,000, which is included in net income, as described in Note 14 to the financial statements Because of the nature of the company’s records, we were unable to satisfy ourselves as to the carrying value of the investment or the equity in its earnings by means of other auditing procedures Required: Complete the above report by preparing the opinion paragraph Do not date or sign the report Answer: In our opinion, except for the effects of such adjustments, if any, as might have been determined to be necessary had we been able to examine evidence regarding the foreign affiliate investment and earnings, the financial statements referred to above present fairly, in all material respects, the financial position of Fast Times Corporation as of September 30, 2007, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 94 medium Your CPA firm has completed the fieldwork for the 2007 audit of Sharp Corporation, a private company with an October year-end You were preparing to draft a standard, unqualified audit report when you discovered that the audit manager on the Sharp engagement owns 10 shares of Sharp’s common stock Prepare the appropriate report Answer: We are not independent with respect to Sharp Corporation, and the accompanying balance sheet as of October 31, 2007, and the related statements of income, retained earnings, and cash flows for the year then ended were not audited by us Accordingly, we not express an opinion on them Note: There is no report title when the auditor issues a disclaimer due to a lack of independence 95 challenging Describe the standard unqualified report to be issued for an audit of a private company Begin by specifying the seven parts of the report, and then discuss the contents of each part Answer: The parts of the standard unqualified report are as follows:  Report title The title must include the word “independent.” Examples of appropriate titles are “independent auditor’s report,” or “report of independent accountant.”  Report address The report is usually addressed to the company’s stockholders or board of directors It should not be addressed to company management  Introductory paragraph There are three important components of the introductory paragraph First, it states that an audit was performed Second, it lists the financial statements that were audited and their dates Third, it states that management is responsible for the financial statements, and that the auditor is responsible for expressing an opinion on those statements based on an audit  Scope paragraph The scope paragraph is a factual statement about what was done during the audit It first states that auditing standards generally accepted in the United States of America were followed by the auditor It then states that an audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement It concludes by stating that the auditor evaluated the appropriateness of the accounting principles used, and estimates made, by management, and of the financial statement disclosures and presentations given  Opinion paragraph This paragraph states the auditor’s opinion concerning whether the financial statements present fairly the client’s financial position and results of its operations and cash flows in conformity with generally accepted accounting principles  Name of CPA firm Typically, the name of the CPA firm, and not the name of an individual auditor, is used  Audit report date The audit report is normally dated as of the last day of fieldwork /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 96 challenging Presented below is an independent auditor’s report for a private company prepared by the firm of Harrington and Perry, LLP Auditor’s Report To the president and management of EPM, Inc We have examined the accompanying balance sheets and statements of income, retained earnings, and cash flows of EPM, Inc., as of December 31, 2007 and 2006 We performed our examination in accordance with auditing standards generally accepted in the United States of America and examined, on a test basis, evidence supporting the accounting principles used and estimates made by management In our opinion, the financial statements referred to above accurately present the financial position of EPM, Inc., in conformity with generally accepted accounting principles Harrington and Perry, LLP December 31, 2007 Other information: EPM, Inc., is a for-profit corporation and publishes comparative financial statements for distribution to shareholders, potential investors, and the general public The client has a calendar year-end For the most recent audit, the auditor completed all significant fieldwork on March 5, 2008 and issued the audit report on March 16, 2008 During 2007, EPM changed its method of depreciating long-term assets and properly reflected the effect of the change in the current year’s financial statements, restated the prior year’s financial statements, and properly discussed the change in a footnote (Note 4) to those statements The auditors are satisfied that the change was preferable Required: Consider all the facts given and rewrite the complete auditor’s report, including report title, address, body of report, name of firm, and audit report date /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc Answer: Independent Auditor’s Report To the shareholders of EPM, Inc We have audited the accompanying balance sheets of EPM, Inc., as of December 31, 2007 and 2006, and the related statements of income, retained earnings, and cash flows for the years then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audits We conducted our audits in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audits provide a reasonable basis for our opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of EPM, Inc., as of December 31, 2007 and 2006, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles As discussed in Note to the financial statements, EPM, Inc., changed its method of computing depreciation in 2007 Harrington and Perry, LLP March 5, 2008 /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 97 challenging On April 14, 2008, your CPA firm completed the fieldwork for the audit of O’Malley Corporation’s financial statements for the year ended December 31, 2007 O’Malley is a privately held company Last year, your firm expressed an unqualified opinion on O’Malley’s 2006 financial statements Barrett and O’Connor, CPAs, performed the audit of the December 31, 2007 and 2006 financial statements of Tom’s Supply Company, a consolidated subsidiary of O’Malley’s Barrett and O’Connor completed the fieldwork on February 25, 2008, and issued its unqualified opinion on Tom’s Supply Company on March 2, 2008 Tom’s statements reflect total assets of $950,000 and $900,000 as of December 31, 2007 and 2006, respectively, and revenues of $1,845,000 and $1,650,000 for the years then ended During your audit, you obtained the following information which does not appear in the footnotes to O’Malley’s 2007 financial statements: During 2007, O’Malley changed its method of valuing inventory from the First-In-FirstOut method to the Last-In-First-Out method O’Malley’s management believes the change provides a better matching of revenues and expenses, with which you concur The change reduced ending inventory in 2007 by $248,000 and net income by $129,000 The effect of the change on 2007 is considered material, but not highly material The effect of the change on prior years is immaterial Required: Prepare the shared audit report to accompany O’Malley’s 2007-2006 comparative financial statements Include the report title, address, body, date, and your signature /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc Answer: Independent Auditor’s Report To the Board of Directors of O’Malley Corporation: We have audited the accompanying consolidated balance sheets of O’Malley Corporation as of December 31, 2007 and 2006 and the related consolidated statements of income, retained earnings, and cash flows for the years then ended These financial statements are the responsibility of the company’s management Our responsibility is to express an opinion on these financial statements based on our audit We did not audit the financial statements of Tom’s Supply Company, a consolidated subsidiary, which statements reflect total assets of $950,000 and $900,000 as of December 31, 2007 and 2006, respectively, and total revenues of $1,845,000 and $1,650,000 for the years then ended Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Tom’s Supply Company, is based solely on the report of the other auditors We conducted our audits in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audits and the report of other auditors provide a reasonable basis for our opinion During the year, O’Malley changed its method of valuing inventory from the first-in, firstout method to the last-in, first-out method This change was made because management believes the change provides a better matching of revenues and expenses The change reduced inventory at December 31, 2007, by $248,000 and net income for 2007 by $129,000 The effect of the change on prior years is immaterial In our opinion, disclosure of this change is required to conform with generally accepted accounting principles In our opinion, based on our audits and the report of other auditors, except for not disclosing the change in inventory valuation methods discussed in the preceding paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of O’Malley Corporation as of December 31, 2007 and 2006, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles April 14, 2008 (Name of student’s CPA firm) Other Objective Answer Format Questions /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 98 medium Assume you are the partner in charge of the 2007 audit of Becker Corporation, a private company The audit report has not yet been prepared In each independent situation following (1-8), indicate the appropriate action (a-g) to be taken The possible actions are as follows: a b c d e f g f g Issue a standard unqualified report Qualify both the scope and opinion paragraphs Qualify the opinion paragraph Issue an unqualified opinion with an explanatory paragraph Issue an unqualified opinion with modified wording (no explanatory paragraph) Issue an adverse opinion Disclaim an opinion The situations are as follows: Becker Corporation carries its property, plant, and equipment accounts at current market values Current market values exceed historical cost by a highly material amount, and the effects are pervasive throughout the financial statements Management of Becker Corporation refuses to allow you to observe, or make, any counts of inventory The recorded book value of inventory is highly material /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc a You were unable to confirm accounts receivable with Becker’s customers However, because of detailed sales and cash receipts records, you were able to perform reliable alternative audit procedures g One week before the end of fieldwork, you discover that the audit manager on the Becker engagement owns a material amount of Becker’s common stock e You relied upon another CPA firm to perform part of the audit Although you were the principal auditor, the other firm audited a material portion of the financial statements You wish to refer to (but not name) the other firm in your report d or g You have substantial doubt about Becker’s ability to continue as a going concern d Becker Corporation changed its method of computing depreciation in 2007 You concur with the change and the change is properly disclosed in the financial statement footnotes c Ten days after the balance sheet date, one of Becker’s buildings was destroyed by a fire Becker refuses to disclose this information in a footnote to the financial statements, but you believe disclosure is required to conform with GAAP The amount of the uninsured loss was material, but not highly material 99 (Public) easy b Audit reports issued for financial statements of a public company should refer to generally accepted auditing standards in the scope paragraph a True b False 100 easy a Audit reports issued for financial statements of a private company should refer to generally accepted auditing standards in the scope paragraph a True b False 101 easy a If an audit client has not consistently observed accounting principles in the current period in relation to the preceding period, the auditor should normally issue an unqualified report with an explanatory paragraph which explains the nature of the change a True b False 102 easy b A qualified report is issued when all auditing conditions have been met, no significant misstatements have been discovered, and it is the auditor’s opinion that the financial statements are fairly stated in accordance with GAAP a True b False 103 easy b The audit report is normally addressed to the company’s president or chief executive officer a True b False /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 104 easy a The phrase “generally accepted accounting principles” can be found in the opinion paragraph of a standard unqualified report a True b False 105 (Public) medium b Auditors of public company financial statements must issue separate reports on internal control over financial reporting a True b False 106 medium b Changes in an estimate, such as a change in the estimated useful life of an asset for depreciation purposes, affect consistency but not comparability, and therefore require an explanatory paragraph in the audit report a True b False 107 medium b When an auditor decides that adherence to GAAP would result in misleading financial statements, the auditor has no choice but to issue a qualified audit report a True b False 108 (Public) medium b The phrase “auditing standards generally accepted in the United States of America” can be found in the opinion paragraph of a standard, unqualified audit report for a public company a True b False 109 medium b Auditors should issue a disclaimer of opinion when there is a highly material scope restriction caused by the client a True b False 110 medium a Whenever an auditor issues a qualified report, he or she must use the term “except for” in the opinion paragraph a True b False 111 medium b Whenever an auditor issues a qualified report, he or she must use the term “subject to” in the opinion paragraph a True b False 112 medium b Whenever an auditor discovers a highly material GAAP violation in the financial statements that the client refuses to correct, the auditor should issue a disclaimer of opinion a True b False 113 medium b When there is a scope limitation in an audit, the audit report will be unqualified, qualified scope and opinion, or adverse, depending on the materiality of the scope limitation a True b False /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc 114 medium b Changes in reporting entities, such as the inclusion of an additional company in combined financial statements, affect comparability but not consistency, and therefore not require an explanatory paragraph in the audit report a True b False 115 medium b When a qualified opinion is issued, an explanatory paragraph is added immediately after the opinion paragraph to explain the nature of the qualification that affects the opinion a True b False 116 medium a If an audit client has not consistently applied accounting principles, and the auditor does not concur with the appropriateness of the change, either an unqualified, a qualified, or an adverse opinion should be issued, depending on the materiality level involved a True b False 117 medium a When an auditor relies upon a different CPA firm to perform part of the audit and chooses to issue a shared opinion, the wording of the report should be modified in all three paragraphs a True b False 118 medium b An auditor should issue a qualified opinion with an explanatory paragraph whenever there is a material uncertainty affecting the financial statements a True b False 119 medium b The phrase “The audit is designed to obtain reasonable assurance about whether the statements are free of material misstatements” is included in the introductory paragraph of an audit report a True b False 120 challenging b If an auditor is not independent and the auditor knows that the company has not followed GAAP, the auditor should immediately disclaim an opinion and not mention the departure from GAAP in the audit report a True b False /storage1/vhost/convert.123doc.vn/data_temp/document/cey1519786350-267443515197863508605/cey1519786350.doc ... increased by $14,500,000, long-term debt by $13,200,000, and retained earnings by $1,300,000 as of December 31, 2007, and net income and earnings per share would be increased by $1,300,000 and $2.25,... decreased by $4,000,000, long-term debt by $2,000,000, and retained earnings by $180,000 as of October 31, 2005, and net income and earnings per share would be decreased by $180,000 and $.62,... should make reference to which standards? a Accounting standards b Generally accepted auditing standards c Standards issued by the PCAOB (U.S.) d Any of the above standards 13 easy b If an auditor