Question 1

A client has a large and active investment portfolio that is kept in a bank safe deposit box. If the auditor is unable to count the securities at the balance sheet date, the auditor most likely will:

Accepted Answer

Choice "D" is correct. If the auditor is unable to count the securities at the balance sheet date the auditor should request the client to have the bank seal the safe deposit box until the auditor can count the securities. Choice "A" is incorrect. Bank employees are not present when items are put into or taken from the safety deposit box and do not keep records of safety deposit box contents. They would therefore be unable to provide any information to the auditors. Choice "B" is incorrect. Examining supporting evidence for the transactions occurring during the year is inefficient, as many of the securities purchased during the year may have been sold before the balance sheet date. Counting securities is preferable as it provides direct external evidence of the securities on hand at year-end. Choice "C" is incorrect. Bank employees are not present when items are put into or taken from the safety deposit box and do not keep records of safety deposit box contents. They would therefore be unable to provide any information to the auditors.

Question 2

The scope of an audit is not restricted when an attorney's response to an auditor as a result of a client's letter of audit inquiry limits the response to:

Accepted Answer

Choice "A" is correct. The scope of an audit is not restricted when an attorney's response is limited to matters to which the attorney has given substantive attention in the form of legal representation. The attorney may also limit his or her response to matters that are considered individually or collectively to be material. Choices "B", "C", and "D" are incorrect. The scope of an audit may be restricted when an attorney's response is limited to: 1. An evaluation of the likelihood of an unfavorable outcome of the matter disclosed by the entity. (The attorney's response should also address the nature of the claim, the progress to date, and the intended response.) 2. The attorney's opinion of the entity's historical experience in recent similar litigation. (The attorney's response should address the current situation, which may not parallel historical experience). 3. The probable outcome of asserted claims and pending or threatened litigation. (The attorney's response should also address the nature of the claim, the progress to date, and the intended response, as well as unasserted claims).

Question 3

Which of the following controls would be most effective in assuring that the proper custody of assets in the investing cycle is maintained?

Accepted Answer

Choice "D" is correct. An independent person comparing the contents of the safety deposit box with the recorded balances in the investment subsidiary ledger is an effective control for assuring that the proper custody of assets in the investing cycle is maintained. Choice "A" is incorrect. Direct access to securities in the safety deposit box being limited to only one corporate officer is a weakness in internal control since there is no independent verification of the box's contents. Good internal control generally requires that two or more individuals be present when the safety deposit box is opened. Choice "B" is incorrect. While it is a good idea to have separate employees post investment transactions to the general and subsidiary ledgers (so they can later be reconciled), this control relates to recordkeeping, not to custody. Choice "C" is incorrect. Authorization of the purchase and sale of investments by the board of directors is a good control over the approval of investment transactions but does little to assure that proper custody of assets is maintained.

Question 4

An auditor testing long-term investments would ordinarily use analytical review as the primary audit procedure to ascertain the reasonableness of the:

Accepted Answer

Choice "C" is correct. Analytical review is generally used to ascertain the reasonableness of investment income in relationship to the amount invested. Choice "A" is incorrect. Valuation would be verified using listed prices (NYSE, etc.). Choice "B" is incorrect. Classification of gains or losses would be evaluated based upon appropriate accounting principles. Choice "D" is incorrect. Existence and ownership is generally evaluated by inspection of securities, review of brokerage statements, or confirmation with an outside independent custodian.

Question 5

An auditor's program to examine long-term debt should include steps that require:

Accepted Answer

Choice "A" is correct. Examination of bond trust indentures should be included in audit program of long-term debt to assure that the client was not in violation of any covenants in the indentures. Choice "B" is incorrect. Inspecting the accounts payable subsidiary ledger relates to accounts payable, a current liability. Choice "C" is incorrect. Long-term debt generates interest expense, not interest income. Choice "D" is incorrect. Generally, the existence of the bondholders of debt is not verified.

Question 6

In an audit of contingent liabilities, which of the following procedures would be least effective?

Accepted Answer

Choice "B" is correct. Customer confirmations relate to receivables, and would not be likely to disclose a contingent liability. Choice "A" is incorrect. A standard bank confirmation will most likely identify contingent liabilities because it contains confirmation of discounted drafts and/or guarantees of notes and/or other open letters of credit. Choice "C" is incorrect. Examining professional invoices may disclose a contingent liability. For example, invoices from attorneys may provide information regarding litigation, claims, and assessments. Choice "D" is incorrect. Reviewing the board minutes may identify a contingent liability. For example, the board may discuss contingencies during one of its meetings. Other procedures that may be effective in an audit of contingent liabilities include: Discussing long-term purchase commitments with the purchasing agent. Reviewing long-term leases. Obtaining a client representation letter.

Question 7

In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the:

Accepted Answer

Choice "A" is correct. In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the completeness of recorded investment income. These procedures would probably include a comparison of the recorded investment income with the expected amount (based upon the related interest rate, dividends declared, etc.) and the income balance audited in the prior year. Choice "B" is incorrect. Classification between balance sheet portfolios would most likely be tested by confirming the terms of the investment and making inquiries of management regarding how long they intend to hold the securities. Choice "C" is incorrect. To test the valuation of marketable equity securities an auditor would most likely compare to market quotations (cost method) or examine the audited financial statements of the investee company (equity method). Choice "D" is incorrect. To identify and quantify the existence of unrealized gains and losses in the portfolio, an auditor would examine the trading prices in the Wall Street Journal (or other source) for those long-term investments carried under the cost method. For those carried under the equity method, an auditor would review the audited financial statements of the investee company.

Question 8

Which of the following controls would an entity most likely use in safeguarding against the loss of marketable securities?

Accepted Answer

Choice "A" is correct. The control most likely to be used by an entity in safeguarding against the loss of marketable securities is that an independent trust company that has no direct contact with the employees who have recordkeeping responsibilities, has possession of the securities. For good internal control over the safeguarding of any asset, the individual who has the recordkeeping responsibilities over that asset should never have access to it. Choice "B" is incorrect. Verifying the securities held in the entity's safe would detect that the loss occurred, but it would not prevent the loss. Choice "C" is incorrect. Tracing purchases and sales of marketable securities would verify that the transactions were properly recorded, but would not safeguard against loss. Choice "D" is incorrect. Having one person control the securities in a bank safe-deposit box is a weakness in internal control because that one person can steal the securities. A better system requires that at least two employees have joint control over the securities in a bank safe-deposit box.

Question 9

Under which of the following circumstances would the use of the blank form of confirmations of accounts receivable most likely be preferable to positive confirmations?

Accepted Answer

Choice "A" is correct. If the recipients of confirmations are likely to sign them without devoting proper attention to them, it is possible that a misstatement in the related receivable will not be discovered by the auditor (i.e., when the balance on the confirmation is incorrect and the recipient mistakenly signs it anyway). Use of the blank form of confirmation provides a greater degree of assurance in this situation because it forces the recipient to determine the receivable balance. Choice "B" is incorrect. Inability to verify subsequent cash receipts makes follow-up of unconfirmed accounts more difficult. Since blank forms may result in lower response rates (because they require additional effort), use of the blank form in this situation would be less likely. Choice "C" is incorrect. If few exceptions are expected, it would be acceptable to use positive confirmations. (Blank confirmations may provide a greater degree of assurance, which would be more important if many exceptions were expected.) Choice "D" is incorrect. In low risk situations, it would be acceptable to use positive confirmations. (Blank confirmations may provide a greater degree of assurance, which would be more important in high risk situations.)

Question 10

In testing for unrecorded retirements of equipment, an auditor most likely would:

Accepted Answer

Choice "A" is correct. Tracing (old) equipment recorded in the books to the actual equipment during a plant tour is a control which tests for unrecorded retirements. Choice "B" is incorrect. Determining which assets are fully depreciated does not tell you which ones are retired, as fully depreciated assets may continue to be used. Choice "C" is incorrect. Selecting items from the plant tour and then tracing them to the equipment subsidiary ledger will provide evidence that all equipment is recorded. It will not detect whether recorded equipment has been retired. (This step is backwards.) Choice "D" is incorrect. Scanning the general journal for unusual equipment additions and excessive debits to repairs and maintenance expense provides evidence regarding fixed asset additions, not retirements.

Question 11

Which of the following is not an audit procedure that the independent auditor would perform concerning litigation, claims, and assessments?

Accepted Answer

Choice "B" is correct. The independent auditor would not confirm directly with the client's lawyer that all claims have been recorded in the financial statements. Management has the responsibility to include all claims in the financial statements, not the lawyers. The purpose of a legal letter is to obtain outside corroboration of the information furnished by management concerning litigation, claims, and assessments. Choice "A" is incorrect. The auditor should obtain assurance from management that it has disclosed all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed. Choice "C" is incorrect. The auditor should inquire of and discuss with management the controls adopted for identifying, evaluating, and accounting for litigation, claims, and assessments. Choice "D" is incorrect. The auditor should obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.

Question 12

Which of the following controls most likely would give the greatest assurance that securities held as investments are safeguarded?

Accepted Answer

Choice "D" is correct. Requiring the signatures and presence of two designated officials in order to gain access to securities is an internal control that provides assurance regarding the safeguarding of securities. Choice "A" is incorrect. Having no access to securities between the year-end and the date of the auditor's security count would assure that no securities are added or taken away before the auditor counts them, but it would not ensure that securities are safeguarded for the entire year. Choice "B" is incorrect. Proceeds from the sale of investments should be received by an employee who does not have access to securities, but this control does not prevent the theft of investments that are not sold. Choice "C" is incorrect. Requiring authorization from a member of the board of directors before execution assures that investment purchases are approved and consistent with the financial philosophy of the organization (level of financial risk that the company is willing to accept), but this approval does not provide assurance that the assets will be safeguarded.

Question 13

The negative request form of accounts receivable confirmation is useful particularly when the:

Accepted Answer

Choice "A" is correct. The negative request form of accounts receivable confirmation is useful particularly when: -the assessed level of control risk relating to receivables is low (if control risk is high, then positive confirmation requests would probably be sent), -there are many small balances (which would make it difficult to keep the number of positive confirmations to a reasonably low level), and -consideration of the confirmation by the recipient is likely (since the auditor is relying on the customers' consideration as the sole basis of support for the confirmation). Choices "B", "C", and "D" are incorrect, based on the above Explanation.

Question 14

To establish the existence and ownership of a long-term investment in the common stock of a publiclytraded company, an auditor ordinarily performs a security count or:

Accepted Answer

Choice "B" is correct. Auditors obtain a confirmation (safekeeping list) indicating the number of shares of stocks held by an outside independent custodian. Choice "A" is incorrect. Even a good system of internal control does not necessarily provide sufficient evidence of existence and ownership. Choice "C" is incorrect. Verifying the market price doesn't provide evidence regarding ownership or existence. Choice "D" is incorrect. Confirmations are generally sent to the independent custodian, not to the issuing company.

Question 15

An auditor's plan to examine long-term debt most likely would include steps that require:

Accepted Answer

Choice "B" is correct. An auditor's plan to examine long-term debt most likely would include steps that require correlating interest expense recorded for the period with outstanding debt. This is an analytical procedure that would provide evidence regarding the reasonableness of the interest expense balance. Choice "A" is incorrect. This question was released prior to the issuance of FAS 107, which requires disclosure of the fair values of financial instruments. Accordingly, the auditor now needs to audit the year-end market values of long-term debt. Choice "a" is still not the best answer, however, since the auditor would not need to compare the carrying amount to the year-end market value. (Both values are shown, as FAS 107 does not require that debt securities be written down to (a lower) market value.) Choice "C" is incorrect. Generally, the existence of the holders of the debt is not verified. Choice "D" is incorrect. Inspecting the accounts payable subsidiary ledger would be included in the audit of accounts payable, not long-term debt.

Question 16

When auditing prepaid insurance, an auditor discovers that the original insurance policy on plant equipment is not available for inspection. The policy's absence most likely indicates the possibility of a (an):

Accepted Answer

Choice "C" is correct. If an auditor discovers that the original insurance policy on plant equipment is not available for inspection, this most likely indicates that there is a lien on the plant equipment, since the original policy would likely be in the possession of the lien holder. Choices "A", "B", and "D" are incorrect. The absence of the original policy does not necessarily indicate that there is an insurance premium due but not recorded, that there is a deficiency in the coinsurance provision, or that insurance expense is understated, since the policy must be reviewed before any of these conclusions can be drawn.

Question 17

Which of the following combinations of procedures would an auditor most likely perform to obtain evidence about fixed asset additions?

Accepted Answer

Choice "A" is correct. In order to obtain evidence about fixed asset additions, an auditor would most likely inspect documents (e.g., purchase invoices) and physically examine the new assets. Choice "B" is incorrect. Recomputing calculations might provide evidence about depreciation, and obtaining management representations might provide evidence about commitments with respect to fixed assets, but neither procedure provides specific evidence about fixed asset additions. Choice "C" is incorrect. Observing operating activities and comparing balances to prior years might provide evidence that depreciation expense was properly recorded, but does not provide evidence supporting additions. Choice "D" is incorrect. Inquiry alone is not as persuasive as direct personal observation.

Question 18

An auditor should request that an audit client send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide:

Accepted Answer

Choice "D" is correct. The primary reason for an auditor to request that the audit client send a letter of inquiry to its attorneys is to provide corroboration of the information furnished by management concerning litigation, claims and assessments. Choice "A" is incorrect. The letter of inquiry is used to corroborate information furnished by management. The likelihood of loss contingencies occurring is only one item addressed in this correspondence, but it is not the primary purpose of the request. Choice "B" is incorrect. The description of litigation, claims and assessments that have a reasonable possibility of unfavorable outcomes should be provided by management, not the attorneys. Choice "C" is incorrect. The attorneys do not give an appraisal of management's controls adopted for identifying and evaluating legal matters.

Question 19

In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified?

Accepted Answer

Choice "D" is correct. The use of negative confirmations most likely would be justified when there are a small number of accounts that may be in dispute and the accounts receivable balance arises from sales to many customers with small balances (e.g., utility consumer customers). Choice "A" is incorrect. Positive (not negative) confirmations should be used when a substantial number of accounts are expected to be in dispute, or if the accounts receivable balance is comprised of accounts from a few major customers. Choice "B" is incorrect. Positive (not negative) confirmations should be used when a substantial number of accounts are expected to be in dispute. Choice "C" is incorrect. Positive (not negative) confirmations should be used when the accounts receivable balance is comprised of accounts from a few major customers.

Question 20

An auditor ordinarily sends a standard confirmation request to all banks with which the client has done business during the year under audit, regardless of the year-end balance. A purpose of this procedure is to:

Accepted Answer

Choice "D" is correct. The standard confirmation request seeks information on contingent liabilities and security agreements in addition to information related to deposit account balances. Choice "A" is incorrect. The standard confirmation request does not provide all of the data necessary to prepare a "proof of cash" (i.e., bank reconciliation), since it only confirms the balances at the end of a period, and does not provided information about the activity during the period under audit. Such information is necessary to perform a bank reconciliation and would be provided in a bank statement. Choice "B" is incorrect. A request for a cut-off statement, and not the standard bank confirmation form, is used to obtain a cut-off bank statement and related checks. Choice "C" is incorrect. The bank cut-off statement, not the standard confirmation request, is used to detect kiting activities that may not otherwise be discovered.

Exam 1: CPA Auditing and Attestation Exam