Question 1

Which of the following factors most likely would cause a CPA not to accept a new audit engagement?

Accepted Answer

Choice "A" is correct. A direct letter of inquiry to the entity's legal counsel is required, and a client's refusal to permit such inquiry generally will result in a disclaimer of opinion. It is unlikely that a CPA would accept a new audit engagement under such circumstances. Choice "B" is incorrect. Inability to review the predecessor auditor's working papers would not cause a CPA to decline a new audit engagement. The CPA would simply need to perform an appropriate level of work to substantiate the opening financial statement balances. Choice "C" is incorrect. The CPA need not have an understanding of the prospective client's operations and industry before accepting a new audit engagement. Such an understanding may be obtained after acceptance, during the planning phase of the engagement. Choice "D" is incorrect. Indications that management has not investigated employees in key positions before hiring them is a fraud risk factor that the auditor would need to consider in planning the audit, but it would not cause the CPA to decline the engagement.

Question 2

Which of the following statements extracted from a client's lawyer's letter concerning litigation, claims, and assessments most likely would cause the auditor to request clarification?

Accepted Answer

Choice "A" is correct. The lawyer's comment that the plaintiff "will have problems establishing any liability" is vague…it does not provide an evaluation of the likelihood of an unfavorable outcome. Does "will have problems" mean a loss is probable, reasonably possible, or remote? The auditor would likely want to request clarification to ensure that the situation has been properly accounted for and disclosed. Choice "B" is incorrect. When a lawyer asserts that a contingent liability is improbable ("remote chance"), it is unlikely that the auditor would require further clarification. Choice "C" is incorrect. When a lawyer asserts that a contingent liability is improbable ("without merit"), it is unlikely that the auditor would require further clarification. Choice "D" is incorrect. When a lawyer asserts that a contingent liability is improbable ("able to defend this action successfully"), it is unlikely that the auditor would require further clarification.

Question 3

An auditor ordinarily uses a working trial balance resembling the financial statements without footnotes, but containing columns for:

Accepted Answer

Choice "A" is correct. An auditor's working trial balance generally contains columns for reclassifications and adjustments. Choice "B" is incorrect. Reconciliations and tickmarks are included within audit documentation, but would not necessarily be shown in columns on the working trial balance. Choice "C" is incorrect. Accruals and deferrals are included within audit documentation, but would not necessarily be shown in columns on the working trial balance. Choice "D" is incorrect. Expense and revenue summaries are included within audit documentation, but would not necessarily be shown in columns on the working trial balance.

Question 4

If a client will not permit inquiry of outside legal counsel, the auditor's report ordinarily will contain a(an):

Accepted Answer

Choice "B" is correct. A client's refusal to permit inquiry of outside legal counsel is a significant scope limitation that generally will result in a disclaimer of opinion. Choice "A" is incorrect. Adverse opinions are used when there are very material departures from GAAP, which is not the case here. Choice "C" is incorrect. A client's refusal to permit inquiry of outside legal counsel is a significant scope limitation that generally will result in a disclaimer of opinion. An unqualified opinion with a separate explanatory paragraph would not be sufficient to address this situation. Choice "D" is incorrect. A client's refusal to permit inquiry of outside legal counsel is a significant scope limitation that generally will result in a disclaimer of opinion. A qualified opinion would not be sufficient to address this situation.

Question 5

In evaluating an entity's accounting estimates, one of the auditor's objectives is to determine whether the estimates are:

Accepted Answer

Choice "D" is correct. The auditor has four responsibilities with respect to evaluating estimates: to assess management's practices, to verify that all material estimates have been developed, to determine that accounting estimates are reasonable, and to ensure that accounting estimates are properly recorded and disclosed. Choice "A" is incorrect. With respect to accounting estimates, the auditor would only be concerned with the entity's control environment in terms of assessing management's policies and practices. It might be the case that the control environment is less than satisfactory, but as long as management has taken this into account, and has properly developed, presented, and disclosed all material estimates, the poor control environment is irrelevant. Choice "B" is incorrect. The auditor is concerned with making sure that management has properly developed, presented, and disclosed all material estimates. Whether or not those estimates are consistent with industry guidelines is not a concern, as long as the estimates are reasonable in the circumstances. Choice "C" is incorrect. Estimates need not be based on verifiable objective assumptions. In fact, many estimates are subjective, and can be susceptible to misstatement. The auditor should evaluate whether management has properly developed, presented, and disclosed all material estimates.

Question 6

"In connection with an audit of our financial statements, management has prepared, and furnished to our auditors a description and evaluation of certain contingencies." The foregoing passage most likely is from a(an):

Accepted Answer

Choice "A" is correct. Legal counsel is best able to corroborate the description and evaluation of contingencies provided by management. Choice "B" is incorrect. The management representation letter serves to confirm, in writing, representations provided to the auditor. It does not include a statement indicating that management has prepared and furnished a list of contingencies. Choice "C" is incorrect. The audit committee would not communicate to the auditor regarding the list of contingencies prepared by management. Choice "D" is incorrect. It would be inappropriate to indicate in the footnotes whether specific information was provided by management to the auditor.

Question 7

Tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management's assertion regarding:

Accepted Answer

Choice "B" is correct. Cutoff tests are designed to determine whether transactions have been recorded in the proper period. Tests to detect credit sales made before the end of the year that have been (improperly) recorded in the subsequent year provide assurance about both cutoff and completeness (i.e., whether all current year sales have been properly included). Choice "A" is incorrect. Cutoff tests do not determine whether the components of the financial statements are properly presented, described and disclosed (classification). Choice "C" is incorrect. The cutoff testing described is designed to identify sales recorded in the subsequent year that more properly belong in the current year. This relates to the timing of the entry, not to its accuracy. Choice "D" is incorrect. To test existence, the auditor would need to start with sales that were recorded in the current year, not those recorded in the subsequent year.

Question 8

A client's lawyer is unable to form a conclusion about the likelihood of an unfavorable outcome of pending litigation because of inherent uncertainties. If the litigation's effect on the client's financial statements could be material but it is properly disclosed in the financial statements, the auditor most likely would:

Accepted Answer

Choice "D" is correct. A lawyer may be unable to respond concerning the likelihood of an unfavorable outcome of litigation, claims, and assessments or the amount or range of potential loss, because of inherent uncertainties. Even if the effect of the matter on the financial statements could be material, if it is properly disclosed (and supported by available evidence), the auditor will ordinarily issue an unqualified opinion without any modification. Choice "A" is incorrect. The inability to form an opinion on the amount or range of potential loss would generally not be classified as a scope limitation resulting in a qualification. Choice "B" is incorrect. The auditor should consider withdrawing from the engagement only if the lawyer withholds information per the client's request. Given the fact pattern, there is no need for the auditor to withdraw from the engagement. Choice "C" is incorrect. The inability to form an opinion on the amount or range of potential loss would generally not be classified as a scope limitation resulting in a disclaimer of opinion.

Question 9

After determining that a related party transaction has, in fact, occurred, an auditor should:

Accepted Answer

Choice "C" is correct. After identifying the occurrence of a related party transaction, the auditor should apply the procedures considered necessary to obtain satisfaction concerning the purpose and nature of the transaction and its effect on the financial statements. Choice "A" is incorrect. While an extra paragraph may be added to emphasize a matter, there is no requirement that related party transactions be disclosed via explanatory language added to the auditor's report. Choice "B" is incorrect. Analytical procedures are generally not effective in the identification of related party transactions. Choice "D" is incorrect. It will generally not be possible to substantiate representations that the transaction was consummated on terms equivalent to those that would have prevailed in an arm's-length transaction.

Question 10

An auditor's purpose in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to obtain evidence concerning management's assertions about:

Accepted Answer

Choice "B" is correct. An auditor's purpose in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to obtain evidence concerning management's assertions about understandability and classification (i.e., classification of the note as current or noncurrent). Choice "A" is incorrect. Occurrence relates to whether recorded transactions have actually occurred during the given period. Since the renewal took place subsequent to year-end, the auditor would not be concerned about how the transaction was actually recorded until the next reporting period. Choice "C" is incorrect. Completeness relates to whether all transactions occurring in the period have been recorded. Since the renewal took place subsequent to year-end, it is not relevant to the completeness assertion for the year under audit. Choice "D" is incorrect. Valuation and accuracy pertains to the fair disclosure of financial and other information at appropriate amounts. The renewal of a note payable shortly after year-end generally would not affect its valuation or its accuracy.

Question 11

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

Accepted Answer

Choice "C" is correct. Compensating balance arrangements may be maintained by or for related parties. Choice "A" is incorrect. Performing tests of controls concerning the segregation of duties relates to the allocation of responsibilities among company employees; related party transactions typically relate to transactions with affiliates, owners, or management. Choice "B" is incorrect. Evaluating the reasonableness of management's accounting estimates would not provide any evidence of transactions with affiliates, owners, or management. Choice "D" is incorrect. Related party transactions are more likely to be nonrecurring than recurring.

Question 12

Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

Accepted Answer

Choice "D" is correct. Auditors try to identify predictable relationships when using analytical review procedures. Payroll expense is predictable because it is based on objective information (number of employees and pay rates). It can generally be computed directly by the auditor. Choices "A", "B", and "C" are incorrect. These account balances are less predictable because they are affected by other factors. Payable and receivable balances can be affected by cash payments or receipts; advertising expense is subject to management discretion.

Question 13

In evaluating the reasonableness of an entity's accounting estimates, an auditor normally would be concerned about assumptions that are:

Accepted Answer

Choice "A" is correct. An auditor would be concerned about assumptions that are susceptible to bias because it is more likely that estimates based on such assumptions will be misstated. Choice "B" is incorrect. The auditor would not normally be concerned about assumptions that are consistent with prior periods, as estimates based on such assumptions are less likely to be misstated. Choice "C" is incorrect. The auditor would not normally be concerned about assumptions that are insensitive to variation, as estimates based on such assumptions are less likely to be misstated. Choice "D" is incorrect. The auditor would not normally be concerned about assumptions that are similar to industry guidelines, as estimates based on such assumptions are less likely to be misstated.

Question 14

Inquiries of warehouse personnel concerning possible obsolete or slow-moving inventory items provide assurance about management's assertion of:

Accepted Answer

Choice "D" is correct. Inquiries of warehouse personnel concerning possible obsolete or slow-moving inventory items provide assurance about management's assertion of valuation (i.e., has inventory been properly recorded at lower of cost or market?). Choice "A" is incorrect. Inquiries regarding obsolete or slow-moving inventory items provide little assurance regarding whether all transactions have been properly included (completeness). Choice "B" is incorrect. Inquiries regarding obsolete or slow-moving inventory items provide little assurance regarding whether all recorded transactions are real (existence). Choice "C" is incorrect. Inquiries regarding obsolete or slow-moving inventory items provide little assurance regarding whether all transactions are properly presented, described, and disclosed.

Question 15

The refusal of a client's attorney to provide information requested in an inquiry letter generally is considered:

Accepted Answer

Choice "B" is correct. A lawyer's refusal to furnish the information requested in an inquiry letter would be a limitation on the scope of the audit sufficient to preclude an unqualified opinion. Choice "A" is incorrect. An adverse opinion states that the financial statements do not present fairly the financial position or the results of operations or cash flows in conformity with generally accepted accounting principles. A lawyer's refusal to furnish the information requested in an inquiry letter does not necessarily mean that the financial statements are not fairly presented in conformity with GAAP. Choice "C" is incorrect. A lawyer's refusal to furnish the information requested in an inquiry letter is not a reason to withdraw from the engagement, as long as the lawyer's refusal is not based on the client's request. Choice "D" is incorrect. A lawyer's refusal to furnish the information requested in an inquiry letter is not considered to be a significant deficiency in internal control.

Question 16

The accounts receivable turnover ratio increased significantly over a two-year period. This trend could indicate that:

Accepted Answer

Choice "C" is correct. The accounts receivable turnover ratio is calculated as sales / receivables. More aggressive collection policies will result in a decrease in the receivables balance, which in turn causes the turnover ratio to increase. Choice "A" is incorrect. A deterioration in the aging of receivables implies a greater receivables balance, which would cause the turnover ratio to decline. Choice "B" is incorrect. Elimination of the company's discount policy would increase both the sales figure and the receivables balance. The net effect on the turnover ratio would depend upon the proportionate impact of each increase. Choice "D" is incorrect. A decline in sales would cause a decrease in both sales and receivables. The net effect on the turnover ratio would depend upon the proportionate impact of each decrease.

Question 17

The audit documentation that makes up the current file most likely would include a copy of the:

Accepted Answer

Choice "A" is correct. The audit documentation that makes up the current file most likely would include a copy of the bank reconciliation. Choice "B" is incorrect. The audit documentation that makes up the permanent file would include a copy of the pension plan contract. Choice "C" is incorrect. The audit documentation that makes up the permanent file would include a copy of the articles of incorporation. Choice "D" is incorrect. The audit documentation that makes up the permanent file would include a flowchart of the internal control.

Question 18

Which of the following procedures would an auditor ordinarily perform first in evaluating management's accounting estimates for reasonableness?

Accepted Answer

Choice "D" is correct. In evaluating the reasonableness of an accounting estimate, the auditor should first obtain an understanding of how management developed its estimate. Choice "A" is incorrect. After first obtaining an understanding of how management developed its estimate, the auditor should use one or a combination of the following approaches: a) review and test the process used by management to develop the estimate, b) develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate, or c) review subsequent events. Choice "B" is incorrect. After having first obtained an understanding of how management developed its estimate, the auditor should consider testing management's process by assessing the appropriateness of the key factors or assumptions used in preparing the estimate. Choice "C" is incorrect. After first obtaining an understanding of how management developed its estimate, the auditor should use one or a combination of the following approaches: a) review and test the process used by management to develop the estimate, b) develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate, or c) review subsequent events.

Question 19

Which of the following procedures most likely would assist an auditor in determining whether management has identified all accounting estimates that could be material to the financial statements?

Accepted Answer

Choice "D" is correct. The auditor should inquire of management concerning pending or threatened litigation, and should obtain a letter from the client's lawyer to corroborate this information. Included in this letter is either an identification of the omission of any pending or threatened litigation, claims, and assessments, or a statement that the list of such matters (as provided by management) is complete. Choice "A" is incorrect. Accounting estimates generally are not associated with the existence of related party transactions. Choice "B" is incorrect. Evaluating deviations from historical patterns assists an auditor in determining if a recorded estimate is reasonable, but it does not provide assurance that management has identified all material accounting estimates. Choice "C" is incorrect. Accounting estimates generally are not associated with the existence of inventories at locations outside the entity.

Question 20

In evaluating the reasonableness of an accounting estimate, an auditor most likely would concentrate on key factors and assumptions that are:

Accepted Answer

Choice "D" is correct. In evaluating the reasonableness of an estimate, an auditor would normally concentrate on key factors and assumptions that are (1) significant to the accounting estimate, (2) sensitive to variations, (3) deviations from historical patterns, or (4) subjective and susceptible to misstatements and bias. Choice "A" is incorrect. The auditor need not concentrate on key factors or assumptions that are consistent with those of prior periods, since estimates based on such assumptions are less likely to be misstated. Choice "B" is incorrect. The auditor need not concentrate on key factors or assumptions that are similar to industry guidelines, since estimates based on such assumptions are less likely to be misstated. Choice "C" is incorrect. The auditor need not focus on factors that are objective and not susceptible to bias, since estimates based on such assumptions are less likely to be misstated.

Exam 1: CPA Auditing and Attestation Exam