If the client and auditor agree that a contingent liability resulting from a shareholder lawsuit is reasonably possible and a range of possible damages is
... [Show More] known, what is the most appropriate management action that the auditor would support?
a. Disclose the details of the lawsuit and the possible outcomes in a footnote to the financial statements
b. Include a liability and a charge to income on the financial statements to recognize the contingent liability
c. Neither of the above
Answer: a. Disclose the details of the lawsuit and the possible outcomes in a footnote to the financial statements
If the likelihood is reasonably possible and damages are estimable, the company should disclose the contingency as a footnote to the financial statements.
Auditors generally search for contingent liabilities during the planning phase of the audit.
a. true
b. false
Answer: False
This statement is false. Auditors generally search for contingent liabilities during the final review phase of the audit.
Which of the following is most likely to result in a contingent liability disclosure as a footnote to the financial statements?
a. An accounts payable balance owed by your client to a vendor that is on the verge of bankruptcy
b. An accrual of sales tax throughout the year by a client in the retail industry
c. A civil judgment against your client resulting in a non-appealable damages penalty
d. An impending safety recall following a federal safety regulator's adverse report on a vehicle manufactured by your audit client
Answer: d. An impending safety recall following a federal safety regulator's adverse report on a vehicle manufactured by your audit client
Three of the answers represent known liabilities (they are booked already); the impending safety recall represents an event that is at least reasonably likely (not reasonably estimable). At a minimum, the client should disclose the contingency as a footnote to the financial statements.
If the client and auditor agree that a contingent liability resulting from a shareholder lawsuit is probable and a damage amount is reasonably estimable, what is the most appropriate management action that the auditor would support?
a. Disclose the details of the lawsuit and the possible outcomes in a footnote to the financial statements
b. Include a liability and a charge to income on the financial statements to recognize the contingent liability
c. Neither of the above
Answer: b. Include a liability and a charge to income on the financial statements to recognize the contingent liability
If a liability is probable and the loss is reasonably estimable, GAAP requires the company to recognize the liability in the financial statements.
If an auditor identifies a contingent liability, the client is required to include the liability and associated expense on the financial statements.
a. true
b. false
Answer: False
This statement is false. If a contingent liability is not BOTH probable and reasonably estimable, then the client is not required to include the liability and associated expense on the financial statements.
If the client and auditor agree that a contingent liability resulting from a shareholder lawsuit is remote in its likelihood, what is the most appropriate management action that the auditor would support?
a. Disclose the details of the lawsuit and the possible outcomes in a footnote to the financial statements
b. Include a liability and a charge to income on the financial statements to recognize the contingent liability
c. Neither of the above
Answer: Neither of the above
Contingencies that are deemed remote in likelihood require neither disclosure nor adjustments of the financial statements.
Which of the following audit procedures would be appropriate when searching for contingent liabilities?
a. Sampling sales invoices to determine whether credit sales were properly authorized
b. Reviewing board minutes and other committee meeting minutes
c. Inquiries of management and other key personnel
d. Performing a physical inventory count at year-end
e. Reviewing legal expense accounts and documentation
f. Communication with the client's legal counsel through a letter of inquiry prepared by the client
Answer: Inquiries of management and other key personnel; Reviewing board minutes and other committee meeting minutes; Reviewing legal expense accounts and documentation ; Communication with the client's legal counsel through a letter of inquiry prepared by the client
All but the physical inventory count and sampling of sales invoices are common audit procedures used to identify potential contingent liabilities.
If the client and auditor agree that a contingent liability resulting from a shareholder lawsuit is probable but that the amount of damages is not reasonably estimable, what is the most appropriate management action that the auditor would support?
a. Disclose the details of the lawsuit and the possible outcomes in a footnote to the financial statements
b. Include a liability and a charge to income on the financial statements to recognize the contingent liability
c. Neither of the above
Answer: a. Disclose the details of the lawsuit and the possible outcomes in a footnote to the financial statements
Although a probable likelihood would suggest the need to recognize the liability in the financial statements, the fact that the expected loss is not reasonably estimable leads the client to disclose the liability as a footnote to the financial statements.
Assume that an uncontrolled wildfire destroys a large stockyard of lumber, equipment, and a significant number of partially-built tract homes for a homebuilder client five weeks after year-end but prior to the company issuing its annual financial statements. Assuming the damages are material to the financial statements, what type of event is described and what is the most appropriate course of action?
a. Type I Subsequent Event; Adjust the financial statements to reflect the losses
b. Type II Subsequent Event; Adjust the financial statements to reflect the losses
c. Type I Subsequent Event; Disclose the damage and losses, but do not adjust the financial statements
d. Type II Subsequent Event; Disclose the damage and losses, but do not adjust the financial statements
e. This is not considered a subsequent event for the current period
Answer: d. Type II Subsequent Event; Disclose the damage and losses, but do not adjust the financial statements
Because the event was not predicted and occurred after year end (but before the financial statements were issued), it is a Type II event requiring disclosure rather than an adjustment to the financial statements. In the event that the event was pervasively material, the client may choose to include pro forma financial statements (i.e., reflecting the losses) in addition to the GAAP-compliant statements (i.e., do not reflect the losses).
A subsequent event occurs after year-end but prior to the client's issuance of the financial statements.
a. true
b. false
a. true
Type I subsequent events require an adjustment to the financial statements to reflect the effects of the event.
a. true
b. false
a. true
The auditor has a responsibility to actively search for subsequent events up until the client issues the financial statements.
a. true
b. false
Answer: False
This statement is false. The auditor's responsibility to actively search for subsequent events extends until the auditor's report date (i.e., end of work). Between the auditor's report date and the issue date on the financial statements, the auditor passively searches for subsequent events.
Three weeks prior to the end of the fiscal year, an uncontrolled wildfire destroys a large stockyard of lumber, equipment, and a significant number of partially-built tract homes for a homebuilder client. Because of a lull in new home construction, the homebuilder was already struggling to earn a profit and pay its bills. The builder does not have fire insurance to cover the losses incurred. Is this a subsequent event? If so, is it a Type I or Type II event?
a. Type I Subsequent Event
b. Type II Subsequent Event
c. Not a subsequent event
Answer: c. Not a subsequent event
Because the event occurs prior to the end of the fiscal year, this is not considered a subsequent event. The effects of the event should be appropriately reflected in the financial statements.
If your audit client experiences a material Type I subsequent event, which of the following is the most appropriate for informing investors of the effects of that event?
a. Adjust the year-end audited financial statements
b. Do not adjust the year-end audited financial statements, but include a set of pro-forma financial statements showing the effects of the event
Answer: a. Adjust the year-end audited financial statements
Type I subsequent events should be reflected in the financial statements. As such, an adjustment to the financial statements is required to reflect the changes.
Type II subsequent events require an adjustment to the financial statements to reflect the effects of the event.
a. true
b. false
Answer: False
This statement is false. Type II subsequent events require disclosure (i.e., footnote discussion accompanying the financial statements) rather than an adjustment to the actual financial statements.
As part of your audit, you review the client's disclosures for contingencies. One contingent liability related to a patent infringement lawsuit with a reasonable possibility of a loss within a known range has been disclosed in the footnotes. After you have completed your audit work, but prior to your client issuing its financial statements, the client informs you of an adverse judgment in the patent infringement lawsuit. The decision cannot be appealed, and the damages have been determined. Because the client has already included a discussion of this lawsuit in a footnote, what other actions - if any - are required?
a. Adjust the financial statements to include a loss and associated liability
b. No additional action is necessary; the event is already disclosed in the footnotes
c. Revise the footnote disclosure to indicate the loss is probable and the damage amount is known
Answer: a. Adjust the financial statements to include a loss and associated liability
Because this was a known issue leading to an event occurring after the end of the period (but before the financial statements were issued), this is a Type I Subsequent Event. The liability and associated expense should be recorded on the financial statements.
Which of the following audit procedures would be most helpful for identifying subsequent events?
a. Accounts receivable confirmations
b. Performing a physical inventory count
c. Reviewing minutes from board of directors meetings
d. Bank confirmations of cash
(note legal and official record meeting)
c. Reviewing minutes from board of directors meetings
Auditors are never responsible for subsequent events that occur after the date of the auditor's report.
a. true
b. false
b. false
Assume the auditor is performing a December 31st year-end audit. The auditor actively searches for subsequent events while performing his fieldwork, he issues the auditor's report on March 15th, and the financial statements are released to the public on March 19th. If an event occurs and is brought to the auditor's attention on March 20th, what is the auditor's responsibility with respect to the December 31st financial statements?
a. The auditor should require management to revise the financial statements.
b. The auditor should go back and dual date the auditor's report.
c. The auditor is not responsible for revising the issued auditor's report.
c. The auditor is not responsible for revising the issued auditor's report.
Auditing standards require that the auditor "perform audit procedures designed to obtain sufficient appropriate audit evidence that all subsequent events that require adjustment of, or disclosure in, the financial statements have been identified."
a. true
b. false
a. true
What term refers to the practice wherein auditors issue their report with one date marking the end of their fieldwork and planned procedures and a separate, later date referring to a subsequent event they were made aware of after completing their work?
a. Restating the opinion
b. Revised reporting
c. Dual dating
d. Multi-dating
c. dual dating
The auditor has a responsibility to actively search for subsequent events up until the date when the financial statements are released to the public.
a. true
b. false
b. false
Which of the following is NOT an example of an audit procedure for identifying subsequent events?
a. Obtaining an understanding of the client's procedures for identifying subsequent events
b. Inquiries with management
c. testing client's controls
d. Reading the client's latest interim financial statements, if any
c. testing client's controls
From an investor's perspective, a for-profit company operating on a continual basis is assumed ________ a going concern.
a. not to be
b. to be
Answer: b. to be
The term "going concern" relates to an entity's ability to continue operating in future periods. Unless evidence indicates otherwise, most companies are assumed to be going concerns.
Remember going concern is good; not bad like the word concern suggests
Which of the following is NOT a likely consequence of a company receiving an adverse going concern opinion as part of the auditor's report?
a. Inability to obtain additional financing
b. Increase in interest rates on future loans
c. Less favorable credit terms for inventory and materials purchases
d. Credit rating downgrade
e. Receiving a "sell" rating from stock analysts
f. All of the above are likely consequences of receiving an adverse going concern opinion
Answer: f. All of the above are likely consequences of receiving an adverse going concern opinion
Each response is a likely result of receiving an adverse going concern opinion.
Three weeks prior to the end of the fiscal year, an uncontrolled wildfire destroys a large stockyard of lumber, equipment, and a significant number of partially-built tract homes for a homebuilder client. Because of a lull in new home construction, the homebuilder was already struggling to earn a profit and pay its bills. The builder does not have fire insurance to cover the losses incurred. If this were your audit client, which of the following issues would you be most concerned about relating to this event?
a. Contingent liabilities
b. Subsequent events
c. Going concern issues
d. All of the above
Answer: b. Going concern issues
This is not a subsequent event, and no contingent liability exists. Because the client's ability to continue as a financially viable entity is in doubt, the going concern assumption is challenged.
Generally speaking, a for-profit company would not want to be labeled as a "going concern."
a. true
b. false
Answer: False
The term "going concern" relates to an entity's ability to continue operating in future periods. Unless evidence indicates otherwise, most companies are assumed to be going concerns.
Analytical procedures can be an effective audit procedure for identifying evidence if a substantial doubt exists about a company's ability to continue as a going concern.
a. true
b. false
Answer: True
This is a true statement.
If the auditor determines that substantial doubt exists about the client's ability to continue as a going concern, standards require that the auditor obtain information about what?
a. The client's legal counsel and their prediction of whether the company will go bankrupt
b. The client's customer base and the likelihood of future sales
c. Management's plans to mitigate or overcome the negative conditions that are casting doubt on the company's status as a going concern
d. Other audit engagement possibilities
Answer: c. Management's plans to mitigate or overcome the negative conditions that are casting doubt on the company's status as a going concern
AU 570.02 indicates that the auditor "should obtain information about management's plans that are intended to mitigate the adverse effects of such conditions or events."
According to recent research, the number of going concern issues disclosed by auditors has been steadily increasing over the past decade.
a. true
b. false
Answer: False
This statement is false. The number of adverse going concern opinions disclosed by auditors has steadily declined over the past decade. (to avoid lawsuits; has too much impact on their investors and company)
The auditor is required to provide the same level of assurance for management's disclosure and analysis (MD&A) as for the financial statements.
a. true
b. false
Answer: False
Although the auditor reviews the MD&A section to ensure statements made by management are generally consistent with the audited information, the auditor does not provide the same level of assurance for MD&A as he does for the financial statements.
Auditing standards explicitly require that the auditor obtain _________ , _________ evidence as a basis for forming his or her opinion.
a. accurate; reliable
b. sufficient; appropriate
c. confirming; reliable
d. relevant; disconfirming
Answer: b. sufficient; appropriate
Standards require auditors to obtain sufficient, appropriate evidence to support their opinion.
Which of the following qualitative characteristics about an identified misstatement would cause the auditor the greatest concern?
a. A known misstatement based on a detected transposition error
b. A likely misstatement involving a difference of management/auditor opinions on a sophisticated estimation process
c. An unintentional overstatement of sales revenue
d. An intentional understatement of operating expenses
Answer: d. An intentional understatement of operating expenses
Intentional misstatements should cause auditors serious concern because they may be indicative of a systematic problem within the organization.
Whose responsibility is it to ensure that the financial statements comply with the FASB's prescribed standards for presentation and disclosure?
a. Management
b. The auditor
Answer: a. Management
Management is ultimately responsible for the content and presentation of the financial statements.
According to auditing standards, the auditor must review evidence that is both consistent and inconsistent with management's assertions.
a. true
b. false
Answer: True
This statement is true.
Auditing standards require that auditors employ analytical procedures at which of the following stages? (check all that apply)
a. Planning phase (i.e., risk assessment activities)
b. Fieldwork (i.e., substantive testing)
c. Review phase (i.e., final review activities)
d. Analytical procedures are required to be used during all three phases
Answer: Planning phase (i.e., risk assessment activities); Review phase (i.e., final review activities)
Auditing standards require auditors to employ analytical procedures during the Planning and Review phases of the audit. Although many auditors use analytical procedures during the Fieldwork phase, it is not required.
At which stages of an engagement are auditors required to consider fraud risk?
a. Planning phase
b. Fieldwork phase
c. Review phase
d. All of the above
Answer: All of the above
Auditors are required to consider fraud throughout all phases of the audit.
If the auditor determines that substantial doubt exists about the entity's ability to continue as a going concern, to whom does the auditor have a responsibility to share his concerns?
a. The auditor is required to discuss this issue with both management and the audit committee
b. The auditor is only required to discuss this issue to the audit committee
c. The auditor is only required to discuss this issue with management
Answer: a. The auditor is required to discuss this issue with both management and the audit committee
The auditor is required to discuss/report his concerns to both management and the audit committee.
For publicly-traded companies, which of the following is charged with overseeing the auditor's role in the financial reporting process?
a. The internal audit function
b. The audit committee
c. Human resources
d. Management
Answer: b. The audit committee
The independent audit committee of the board of directors is charged with overseeing the auditor's role in the financial reporting process.
The auditor's required communications with the audit committee must be completed prior to issuing the auditor's opinion.
a. true
b. false
Answer: True
This statement is true.
The auditor is not required to report critical accounting estimates made by management to the independent audit committee.
a. true
b. false
Answer: False
The auditor is required to report critical accounting estimates made by management to the audit committee.
The auditor is required to communicate to management any instances where the auditor or management sought help from a specialist consultant.
a. true
b. false
Answer: True
This statement is true.
Facts that become known to the auditor after the auditor's report has been issued that, had they been known previously, may have caused the auditor to revise his report are known as subsequently discovered facts.
a. true
b. false
Answer: True
This statement is true.
If management fails to take appropriate steps to inform third parties of subsequently discovered facts that cause a material adjustment of the financial statements, what should the auditor do?
a. Inform management that the auditor will take steps to inform third parties
b. Do nothing; management is the only one who can inform third parties
Answer: a. Inform management that the auditor will take steps to inform third parties
If management does not take appropriate steps to inform third parties, the auditor should inform the client that he will take necessary steps to inform those parties of the material changes to the financial statements and revisions to the auditor's report.
If subsequently discovered facts cause management to make adjustments to the financial statements to which the auditor has already opined, should the auditor revise her opinion?
a. Yes; revise the opinion to include a discussion of the subsequently discovered facts, management's changes to the financial statements, and any changes in the auditor's opinion.
b. No; the issued opinion remains and cannot be adjusted.
Answer: a. Yes; revise the opinion to include a discussion of the subsequently discovered facts, management's changes to the financial statements, and any changes in the auditor's opinion..
Facts that become known to the auditor after the auditor's report has been issued that, had they been known previously, may have caused the auditor to revise his report are known as subsequent events.
a. true
b. false
Answer: False
Subsequent events are events that occur after year end but prior to the issuance of the auditor's report. Subsequently discovered facts refer to information discovered after the auditor's report has been issued.
Who has the primary responsibility to inform third parties if subsequently discovered facts compel management to revise the financial statements in a material manner?
a. The SEC
b. Management
c. The auditor
d. The audit committee
Answer: b. Management
Management has the primary responsibility for the financial statements and for informing known users of the financial statements regarding any material changes the occur after the statements have been issued.
Auditing standards require that each audit engagement be reviewed to ensure the quality and appropriateness of the audit process and the auditor's opinion.
a. true
b. false
Answer: True
This is a true statement.
Given the need for a quality control reviewer to be knowledgeable about the client and industry, best practices suggest that an engagement partner who rotated off of the engagement under review last year is an ideal quality control candidate.
a. true
b. false
Answer: False
A quality control member cannot have been a member of the audit team being reviewed during the previous two years.
Which of the following is not one of the tasks completed during a quality control review of an audit engagement?
a. Review assessments of and judgments related to materiality
b. Determine whether audit documentation is clear and sufficient
c. Determine whether information has been communicated to the appropriate parties
d. Determine the appropriate opinion and issue the auditor's report
Answer: d. Determine the appropriate opinion and issue the auditor's report
The quality control reviewer does not assume the responsibility of the original audit team. It is the original audit team's responsibility to select an appropriate opinion and to issue the auditor's report.
Auditing standards require that one out of every five audit engagements be reviewed to ensure the quality and appropriateness of the audit process and the auditor's opinion.
a. true
b. false
Answer: False
Auditing standards require that a quality control review be performed for each audit engagement.
The audit engagement quality control review process focuses on each of the following except...
a. Judgments and risk assessments made during the planning phase
b. Assessments of and judgments related to materiality
c. Determining whether sufficient appropriate evidence was collected to support the auditor's opinion
d. Determine the firm's independence and whether appropriate steps were taken to ensure independence throughout the engagement
e. All of the above are focused on in the engagement quality control review
Answer: e. All of the above are focused on in the engagement quality control review
Each of the items listed is a focus of the quality control review.
If an auditor discovers an omitted audit procedure after the financial statements have been issued, but determines that additional compensating procedures were performed and sufficient appropriate audit evidence was obtained through those procedures, he may conclude that the omitted procedure does not impair his ability to continue to support the audit opinion.
a. true
b. false
Answer: True
This statement is true.
When an auditor discovers an omitted audit procedure after the financial statements has been issued, he should first...
a. perform the omitted audit procedure
b. consider the effect of the omitted procedure on his ability to continue to support the audit opinion
c. withdraw the audit report and announce to the public that they should not rely on the financial statements
d. revise the audit report
Answer: b. consider the effect of the omitted procedure on his ability to continue to support the audit opinion
When he has discovered an omitted audit procedure, the auditor should first consider the effect of the omitted procedure on his ability to continue to support the audit opinion.
Omitted audit procedures are those audit procedures that were not performed because the auditor felt they were not necessary.
a. true
b. false
Answer: False
This is false.
Omitted audit procedures - are those procedures which were considered necessary, but ultimately were not performed. [Show Less]