Deck 19: Audit Reports on Financial Statements

Question 1

It is management's responsibility to select the accounting policies that are used in the preparation of the financial statements. What is the auditor's responsibility with respect to these accounting policies?

A) approve the accounting policies that are used, so that an opinion can be stated on the fairness of the financial statements
B) evaluate the appropriateness of the accounting policies that are used and of the associated estimates made
C) tell management which accounting policies should be selected so that accurate estimates can be made for year-end adjustments
D) recalculate the estimates that are used for the accounting policies (such as bad debt allowance and warranty expenses)

Answer 1

B

Question 2

The appropriate date for the audit report for a public company is the date on which the

A) client's fiscal year ended.
B) auditor and client entered into a contract.
C) board of directors approved the financial statements.
D) auditor prepares and delivers the report to the client.

Answer 2

C

Question 3

PA firm has been auditing Big Manufacturing Company (BMC) for several years. Last year, BMC converted its inventory and purchasing systems to a new system effective December 31, the date of the year-end. To their horror, the PA firm discovered at the beginning of the current year that there was a cutoff error in the accounts payable system of $25 million dollars LAST YEAR. Neither the client nor the firm had detected that the purchases of December 31 had been omitted from the old computer system transaction processing and had been recorded only in the new computer system, understating last year's expenses. Last year's financial statements have been restated and the error disclosed in the notes to both last year's and this year's financial statements. What type of audit opinion will BMC receive this year?

A) qualified
B) disclaimer
C) adverse
D) unqualified

Answer 3

D

Question 4

The phrase "in our opinion" indicates that

A) the auditor performed the audit on a test basis.
B) the auditor's judgment can be relied upon.
C) the auditor relied on his or her knowledge to perform the audit.
D) there may be some information risk associated with the financial statements.

Question 5

Double dating a report is done when

A) the parent company and its subsidiaries have different year-ends.
B) the auditor finishes his work later than planned.
C) a material event occurs after the date of the auditor's report and affects the period that was audited.
D) a material event occurs after the date of the auditor's report and before the date the report is issued.

Question 6

The scope paragraph of the standard unqualified audit report in the auditor responsibility section states that the audit is designed to

A) discover all errors and/or irregularities.
B) discover material errors and/or irregularities.
C) obtain reasonable assurance of whether the statements are free of material misstatement.
D) conform to a generally accepted financial reporting framework.

Question 7

One of the most controversial parts of the auditor's report is the meaning of the term "presents fairly." What does the auditor's opinion mean when these words are used?

A) The values in the financial statements represent the net realizable values of the assets of the entity.
B) The financial statements are accurate and provide a true and fair representation of the entity's current financial position.
C) The values in the financial statements represent the value of the entity now, if it were liquidated on an open market.
D) The financial statements are fairly presented in accordance with the financial reporting framework described in the opinion paragraph.

Question 8

The use of the term "reasonable assurance" is intended to indicate that an audit cannot be expected to

A) completely eliminate the possibility that a material error or fraud exists.
B) consider or search for minor errors.
C) be compliant with the generally accepted accounting principles for every account.
D) provide assurance of no material errors or irregularities to investors who are using the financial statements for investment decisions.

Question 9

The audit report date is important to users because it indicates the last day

A) of the fiscal period.
B) on which the financial statements may be filed with the provincial securities commission.
C) on which users may institute a lawsuit against either the client or auditor.
D) of the auditor's responsibility for the review of significant events that occurred after the date of the financial statements.

Question 10

In the scope paragraph of the audit report, the use of the term "reasonable assurance" is intended to indicate that

A) no misstatements exist in the financial statements.
B) no material misstatements exist in the statements.
C) there is some possibility that material misstatements still exist in the financial statements.
D) there is a possibility that immaterial misstatements still exist in the financial statements.

Question 11

Management has several responsibilities that are important to the auditor. One of these is that management is responsible for

A) internal controls that prevent material misstatements due to fraud or error.
B) maintaining control of evidence (such as confirmations) until assessed by the auditor.
C) evaluating evidence against acceptable criteria.
D) providing reasonable assurance that the financial statements are fairly stated.

Question 12

According to CAS 700, the standard unqualified report's title should be

A) "Unqualified Report of the Auditor."
B) "Audited Financial Statements."
C) "Auditor's Report."
D) "Independent Auditor's Report."

Question 13

If the balance sheet of a company is dated December 31, 2015, the audit report is dated March 6, 2016, and both are released to the public on March 15, 2016, this indicates that the auditor has searched for material unrecorded transactions and events that occurred up to

A) December 31, 2015.
B) March 6, 2016.
C) March 15, 2016.
D) December 31, 2016.

Question 14

Bianca Jones was engaged to conduct the audit of Smilicor Company (a toy distributor) three months after its year-end date. Bianca was unable to conduct an audit of opening inventory but was able to satisfy herself with respect to the opening balances. She was also able to conduct audit procedures for other opening balances; for example, by observing fixed assets. What type of audit opinion would Smilicor receive?

A) disclaimer
B) adverse
C) qualified
D) unqualified

Question 15

There are five conditions that must be met before an auditor can issue a standard unqualified report. Discuss each of these five conditions.

Question 16

The most common type of audit report contains

A) an adverse opinion.
B) a disclaimer of opinion.
C) a qualified opinion.
D) an unqualified opinion.

Question 17

Under Canadian Auditing Standards, the introductory paragraph of the independent auditor's report indicates that the auditor has audited the balance sheet, the income statement, the cash flow, a summary of accounting policies and notes, and

A) the statements of retained earnings.
B) the statement of changes in equity.
C) management's discussion and analysis letter.
D) the internal controls of the company.

Question 18

The independent auditor's opinion explains how much evidence the auditor collects during the independent audit. How much evidence is collected?

A) sufficient and appropriate evidence to provide a basis for the audit opinion
B) sufficient evidence to state that there are no material errors in the financial statements
C) appropriate evidence to be able to evaluate the exact accuracy of the accounting estimates
D) sufficient and appropriate evidence to conclude the financial statements present a true and fair view of the economic events of the organization

Question 19

The ASPE (Accounting Standards for Private Enterprises) financial reporting framework normally requires the auditor to report using the corresponding figures approach. This means that the auditor reports on

A) the current year's financial statements.
B) both periods under audit: the current and prior year.
C) three years: the current and prior year, and the effects of the prior year.
D) only the ending balances of the general ledger accounts.

Question 20

Clark Kent is a PA partner at the firm of Kent, Lane, and Lang, a limited liability partnership. Kent's firm has just completed the audit of a client with a March 31, 2015, year end. How should the audit report be signed?

A) Clark Kent, PA
B) Kent, Lane, and Lang, LLP
C) Clark Kent, LLP
D) Kent, Lane, and Lang, PAs

Question 21

The dollar amount of some misstatements cannot be accurately measured. If, for example, the client was unwilling to disclose an existing lawsuit, the materiality question the auditor must evaluate in such a situation is

A) what effect will it have on net income.
B) how will it affect management's future decisions.
C) whether it may increase the auditor's exposure to lawsuits.
D) what effect it will have on statement users.

Question 22

Your client is not using either ASPE or IFRS. Instead, it is using current value accounting with no use of historical cost, because your client is in a country with about 50% inflation per year. Local legislation requires that all resident organizations use current value accounting. How do these events affect the independent auditor's report?

A) The auditor would issue a standard unqualified auditor's report.
B) The auditor would use an emphasis of matter paragraph to explain that the financial statements are prepared in accordance with local legislation.
C) The auditor would use an other matter paragraph to explain that the financial statements are prepared in accordance with local legislation.
D) The auditor would state in the opinion paragraph that the financial statements were prepared in accordance with the local legislation.

Question 23

The primary concern in measuring materiality when a client has failed to follow an acceptable financial reporting framework is usually

A) the total dollar error in the accounts involved, compared with some acceptable base.
B) measurability of the dollar error.
C) the nature of the item in error.
D) whether it can materially affect some future period.

Question 24

The "unqualified report with explanatory paragraph" or the "unqualified report with modified wording"

A) arise as a result of an incomplete audit.
B) arise when the financial statements are not quite "presented fairly."
C) meet the criteria of a complete audit with satisfactory results but further explanation is required.
D) meet the criteria of a complete audit but with unsatisfactory results.

Question 25

Fractal Software Limited has acquired a 100% subsidiary in Malaysia that produces keyboards and other types of computer hardware. Fractal is refusing to consolidate its financial statements, as this would increase the debt to equity ratio to the point that Fractal would violate its debt agreement, although it would benefit the current ratio with a sizeable increase in inventory. Instead, Fractal would like to record the investment in the Malaysian subsidiary at cost. What type of effect does the non-consolidation have upon the financial statements?

A) material and isolated
B) material
C) material and pervasive
D) immaterial

Question 26

Your client is a large financial institution in Canada. Canadian regulators require that financial statements for such institutions have an audit report that provides an opinion on the consistency of accounting policies. How do these events affect the independent auditor's report?

A) The auditor would add an other matter paragraph titled "Report on Other Legal and Regulatory Requirements."
B) The auditor would add an emphasis of matter paragraph titled "Report on Other Legal and Regulatory Requirements."
C) The auditor would use a standard unqualified auditor's report.
D) The auditor would state in the opinion paragraph that the financial statements were prepared in accordance with the legislation for financial institutions.

Question 27

When a misstatement in the financial statements exists but is unlikely to affect the decisions of a reasonable user, it would be appropriate to issue

A) an unqualified opinion.
B) a qualified opinion.
C) a disclaimer of opinion.
D) an adverse opinion.

Question 28

A misstatement in the financial statements can be considered material if

A) it overshadows the financial statements as a whole.
B) knowledge of the misstatement would affect the decision of a reasonable user of the statements.
C) it affects more than one account on the statements.
D) it affects only one account on the statements.

Question 29

A deviation from the standard unqualified report will cause knowledgeable users of financial statements to recognize that the

A) auditor intends to communicate additional or limiting information.
B) financial statements contain a material error.
C) financial statements contain an error.
D) Canadian Auditing Standards were not followed.

Question 30

Publicly listed organizations and those using IFRS (International Financial Reporting Standards) must have audit reports that use the comparative financial statements approach. This means that the auditor reports on

A) the current year's financial statements.
B) both periods under audit, the current and prior year.
C) three years, the current and prior year, and the effects of the prior year.
D) only the ending balances of the general ledger accounts.

Question 31

Your client has experienced a major data breach with lawsuits and fines pending of significant and uncertain amounts. These events are disclosed in the client's financial statements and are clearly explained in the notes. How do these events affect the independent auditor's report?

A) The auditor would use a standard unqualified auditor's report.
B) The auditor would use an emphasis of matter paragraph titled "Data Breach" to highlight the events.
C) The auditor would use an "other matters" paragraph titled "Data Breach" to highlight the amounts.
D) The auditor would use a qualified audit opinion due to the size of the uncertainty.

Question 32

Explain four different variations that could occur in unqualified audit reports. For each variation, state how the auditor's report is affected and provide an example.

Question 33

Your client has two sets of financial statements. One set is in compliance with IFRS, while the other set is in compliance with local tax legislation and will be used only with the tax returns. How do these events affect the independent auditor's report?

A) The auditor would use an unqualified audit report for both financial statements, with an emphasis of matter paragraph that describes to readers the nature of the other set of financial statements.
B) The auditor would use a standard unqualified auditor's report for both financial statements, labeling the auditor's report "for IFRS only" and "for tax purposes only."
C) The auditor would use an unqualified audit report for both financial statements, with an other matter paragraph that describes to readers the nature of the other set of financial statements.
D) The auditor would use a qualified audit report, as the client may not have two different sets of financial statements.

Question 34

ProForce Inc. is facing a large lawsuit from its employees. The contingency is significant and may lead to a going concern issue if ProForce is found guilty. ProForce took the adequate measures, as prescribed by IFRS (International Financial Reporting Standards), to account, disclose, and present the contingency in the financial statements. The auditor should

A) add an emphasis of matter paragraph after the opinion paragraph.
B) issue a standard unqualified report.
C) issue a qualified report.
D) deny an audit opinion.

Question 35

When a material uncertainty exists, the auditor must

A) disclose it in the audit report.
B) first determine the materiality of the item and whether adequate disclosure is included in the financial statements.
C) issue a disclaimer of opinion.
D) issue a qualified opinion.

Question 36

Discuss how materiality affects audit reporting decisions.

Question 37

A company has changed its method of inventory valuation from an unacceptable one to one that complies with ASPE (Accounting Standards for Private Enterprises). The auditor's report on the financial statements of the year of the change should include

A) no reference to the item assuming that the change has been properly disclosed.
B) a reference to a change in accounting principles in the opinion paragraph.
C) an explanatory paragraph explaining the change.
D) a justification for making the change and the impact of the change on reported net income.

Question 38

Beem & Lord, a PA firm, audited the financial statements of Frazer Inc. Since this was a first time audit, Beem & Lord did not audit the comparative financial statements, as this was done by the previous auditor. Beem & Lord should expand their report to include an explanation in

A) the scope paragraph.
B) the management responsibility paragraph.
C) the opinion paragraph.
D) a paragraph following the opinion paragraph.

Question 39

Analyze the "Auditor Responsibility Section" of the standard Independent Auditor's Report. Explain the intended purpose of the sentences in this section.

Question 40

When determining whether an exception is highly material, the extent to which the exception affects different parts of the financial statements must be considered. This is referred to as

A) materiality.
B) pervasiveness.
C) financial analysis.
D) ratio analysis.

Question 41

The auditor has set materiality at XYZ Company of $50 000 based upon a percentage of net assets. The company currently has a small profit (only $3500). Which of the following items would the auditor most likely consider to be material and request an account balance adjustment?

A) a misclassification between accounts receivable and accounts payable of $10 000
B) incorrect allocation of a note payable to current rather than long term
C) poor wording in a note to the financial statements, making it a bit difficult to understand
D) an understatement of depreciation expense, which would increase depreciation by $5000

Question 42

The primary auditor who relies on a secondary auditor

A) is responsible for any deficiencies in the secondary auditor's work.
B) will mention the name of the secondary auditor if he or she decides that an unqualified opinion is appropriate.
C) will never mention the name of the secondary auditor in his or her report even if the report is qualified.
D) has no responsibility for checking the work of the secondary auditor.

Question 43

The auditor would most likely issue a disclaimer of opinion because of

A) the client's failure to present supplementary information.
B) inadequate disclosure of material information.
C) a client-imposed scope limitation.
D) the qualification of an opinion by the other auditor of a subsidiary where there is a division of responsibility.

Question 44

As a result of management's refusal to permit the auditor to physically examine inventory, the auditor has not accumulated sufficient evidence to conclude whether financial statements are stated in accordance with ASPE (Accounting Standards for Private Enterprises). 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 by the client.

Question 45

If a misstatement is immaterial relative to the financial statements of the entity for the current period and is not expected to have a material effect in future periods, it is appropriate to issue

A) an unqualified opinion.
B) a qualified opinion.
C) an adverse opinion.
D) a disclaimer of opinion.

Question 46

If inventory is the largest balance on the financial statements, a large misstatement would be so material that the auditor should issue

A) an unqualified opinion.
B) a qualified opinion.
C) an adverse opinion.
D) a disclaimer of opinion.

Question 47

The auditor's report of the Samcorp Company indicates that the auditor is unable to form an opinion on whether the financial statements of the company are fairly presented due to scope restrictions and unavailable and incomplete records. The auditor's report

A) is unqualified.
B) is qualified.
C) is adverse.
D) is a disclaimer of opinion.

Question 48

Three of the following conditions would, by themselves, require the auditor to issue a report other than an unqualified report. Which condition would permit a standard unqualified report?

A) The financial statements show a significant net loss for each of the last three years, including the current fiscal period.
B) The financial statements have not been prepared in accordance with an acceptable financial reporting framework and are misleading.
C) The auditor is not independent during the fiscal period under audit.
D) The scope of the auditor's examination has been restricted, although the cause of the restriction was not the client's fault.

Question 49

The least severe type of report for disclosing departures from an unqualified report is the

A) adverse opinion.
B) disclaimer of opinion.
C) qualified opinion.
D) report on unaudited financial statements.

Question 50

When the auditor knows that the financial statements may be misleading because they were not prepared in accordance with an acceptable financial reporting framework, he or she must issue

A) a qualified opinion.
B) an adverse opinion.
C) a disclaimer of opinion.
D) a qualified or an adverse opinion, depending on the materiality of the item in question.

Question 51

The auditor's report of the Huge Mega Company indicates that the financial statements are fairly presented except for the goodwill balance, which does not comply with International Financial Reporting Standards. The auditor's report is

A) unqualified.
B) unqualified with an explanatory paragraph.
C) qualified.
D) adverse.

Question 52

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 everything, with the exception of the missing statement, is presented fairly. As a result, the auditor would likely issue

A) a qualified opinion.
B) an unqualified opinion.
C) a disclaimer of opinion.
D) either an unqualified or qualified opinion.

Question 53

When a misstatement in the financial statements would affect a user's decision but the overall statements are still fairly stated, it would be appropriate to issue

A) an unqualified opinion.
B) a qualified opinion.
C) an adverse opinion.
D) a disclaimer of opinion.

Question 54

The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor's report that may be necessary and give reasons. State your assumptions.

A) Queen Lake Construction Ltd. uses an aggressive revenue recognition policy under the percentage of completion method for long-term construction contracts. Your review of this year's contracts indicates that several projects look as if they will be high in revenue for the first two years and then have negligible earnings for the next three years.
B) Maple Manufacturing Limited constructs furniture out of maple wood. The furniture is prized for its durability and craftsmanship. Last year, the company received a letter from a government agency advising that it had been found that Maple's factory was located on contaminated land that leached hazardous chemicals into the air. This was a preliminary letter stating that a full investigation into the health effects was underway. Management has stated that everything is okay and the investigation was terminated. However, the lawyer refused to sign the legal letter with respect to several lawsuits with regarding employee claims for long-term disability due to a nervous disorder that affected employees' ability to work. Neither the investigation nor the lawsuits are disclosed in the notes to the financial statements.

Question 55

When Dussault & Montgomery relies on Groves & Padden, another PA firm, to audit the Quebec subsidiaries of one of their audit clients, Dussault & Montgomery should

A) assess Groves & Padden's professional qualifications.
B) ask Groves & Padden to also sign the auditor's report.
C) send one of their auditors to Quebec to supervise the work being done by Groves & Padden.
D) issue a qualified opinion for the financial information pertaining to the Quebec subsidiaries.

Question 56

An adverse opinion is issued when the auditor believes

A) some parts of the financial statements are materially misstated or misleading.
B) the financial statements will be found to be misleading or misstated, if an adequate investigation is performed.
C) the overall financial statements are so materially misstated or misleading as a whole that they do not present fairly the financial position or results of operations and changes in financial position.
D) the audit firm is not independent.

Question 57

Your client, Huge Telephone Company (HTC), has encountered troubled times, due to deregulation. There is competition for local telephone business and long distance telephone business. The high speed lines for internet access provided via the telephone network have not been selling as well as expected. A new quirk is that many large cities are going to provide free wireless services by installing wireless transmitters on telephone poles, and is only offering to pay a pittance for the use of the telephone poles. HTC has been able to retain reasonable profits by cutting staff to a bare minimum and outsourcing many services.
However, due to several labour contracts and federal legislation that will increase services, you have doubts about the ability of the company to renew a major bond issue this coming year.
Required:
How does the above information affect the audit report?

Question 58

There are two conditions requiring a departure from an unqualified audit report. Discuss each of these conditions and state the appropriate audit report for each condition.

Question 59

The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor's report that may be necessary and give reasons. State your assumptions.

A) During 2015, your client was sued by a customer who had a serious car accident as a result of scrap metal that had been dumped in the parking lot. The customer drove over the scrap metal, which became embedded in the tires of her vehicle. The tires blew and the car went out of control on a major highway. The amount in dispute is $400 000, with estimated legal bills of about $20 000. The client does not wish to disclose the suit in the financial statements.
B) During the current year, your client leased a large amount of equipment. As the lease qualifies as a capital lease, the equipment has been recorded as an asset, with the corresponding liabilities recorded on the financial statements. The implicit interest rate in the lease is 7 percent. The annual payments due over the terms of the lease have been disclosed in the notes to the financial statements.

Question 60

Dussault & Montgomery, the auditors of Greenwich Corp., relied on Groves & Padden, another PA firm, to audit the Quebec subsidiaries of Greenwich. The responsibility for the opinion to issue on the financial statements is the responsibility of

A) Greenwich Corp.
B) Dussault & Montgomery.
C) Groves & Padden.
D) Dussault & Montgomery and Groves & Padden.

Question 61

Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned about the possibility that management is trying to prevent discovery of misstated information. In such cases, which type of report should be issued?

A) a disclaimer of opinion in all cases
B) a qualification of both scope and opinion in all cases
C) a disclaimer of opinion whenever materiality is in question
D) a qualification of both scope and opinion whenever materiality is in question

Question 62

The new IAASB Auditors report, is effective for audits and will be mandatory for listed companies for audits with year ending

A) 31 December 2017.
B) 31 December 2016.
C) 31 December 2015.
D) 31 December 2014.

Question 63

Julia is in the process of auditing the legal liability section of the financial statements. The controller indicated that he did not want her to contact their external lawyers and he is refusing to grant her access to the detail of the legal expense for the year and any legal invoices. What should Julia do in this situation? Indicate the steps she should take.

Question 64

Both disclaimers of opinion and adverse opinions are used

A) only when the condition is highly material and pervasive.
B) whether the condition is material or not.
C) regardless of the auditor's independence.
D) regardless of the client's choice of accounting method.

Question 65

The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor's report that may be necessary, and give reasons. State your assumptions.

A) Rosebud Ltd. is a construction company that builds and repairs greenhouses for nurseries. An architect does the design and three different small construction companies are used to build the greenhouses. You are concerned that some of the projects that span the April year-end may result in material losses, even though income has been reported in the coming year. Management has refused permission for you to enter construction sites, as they feel that the construction sites will be dangerous and they do not want to be exposed to such liability.
B) Save Our Trees is a charitable organization devoted to maintaining national woodland and green space. Fundraising is handled primarily by means of electronic mail and door-to-door canvassing by volunteers. Canvassing volunteers provide receipts at the door using prenumbered receipts. Donors who give money by email are sent receipts by email.

Question 66

Mafah Distribution Limited has requested that the audited financial statements be completed by January 5, five days after the December 31 year-end. This means that the auditor will be unable to verify subsequent payments on accounts receivable and will be unable to determine whether accounts payable have been set up correctly. What type of audit report should Mafah receive if the auditor is unable to use alternative procedures for these two audit areas?

A) disclaimer
B) adverse
C) qualified
D) unqualified

Question 67

What level of assurance is provided by the auditor in an audit engagement?

A) high, but not absolute, level of assurance
B) positive level of assurance
C) moderate assurance
D) high level of assurance