Studocu - Completion of Audit

Answer: B. Considering unusual or unexpected account balances that were not previously identified.

Explanation:

During the overall review stage of the audit, the auditor performs analytical procedures to assess whether the financial statements are consistent with the auditor's understanding of the entity. These procedures help identify unusual fluctuations, unexpected relationships, or account balances that may indicate possible material misstatements requiring further investigation.

1. Analytical procedures used in the overall review stage of the audit generally include

A. Retesting controls that appeared to be ineffective during the assessment of control risk.

B. Considering unusual or unexpected account balances that were not previously identified.

C. Gathering evidence concerning account balances that have not changed from the prior year.

D. Performing tests of transactions to corroborate management's financial statement assertions.

Answer: C. Additional substantive tests of details are required.

Explanation:

When analytical procedures identify unexpected relationships or fluctuations, the auditor should investigate the cause. This often requires performing additional substantive procedures to obtain sufficient appropriate audit evidence and determine whether a material misstatement exists.

overall review stage of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely indicate that

A. The communication with the audit committee should be revised.

B. Irregularities exist among the relevant account balances.

C. Additional substantive tests of details are required.

D. Internal control activities are not operating effectively.

Answer: B. Entity's management.

Explanation:

Under PSA 550, management is responsible for identifying the entity's related parties, accounting for related party transactions, and ensuring that the required disclosures are included in the financial statements. The auditor's responsibility is to obtain sufficient appropriate audit evidence regarding these relationships and transactions.

3. The responsibility for the identification and disclosure of related parties and transactions with such parties rests with the

A. Auditor.

B. Entity's management.

C. Financial Reporting Standards Council (FRSC).

D. Securities and Exchange Commission (SEC).

Answer: C. Both I and II

Explanation:

PSA 550 requires the auditor to review information identifying both the entity's known related parties and the related party transactions. This enables the auditor to assess whether such relationships and transactions have been properly identified, accounted for, and disclosed in the financial statements.

4. The auditor should review information provided by those charged with governance and management identifying I. The names of all known related parties. II. Related party transactions.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Answer: A. Making a loan without scheduled terms for repayment of the funds.

Explanation:

Loans made without normal repayment terms are unusual in arm's-length transactions and may indicate the existence of a related party relationship. Such transactions often occur because of the close relationship between the parties rather than normal commercial considerations.

5. Which of the following events most likely indicates the existence of related parties?

A. Making a loan without scheduled terms for repayment of the funds.

B. Discussing merger terms with a company that is a major competitor.

C. Selling real estate at a price that differs significantly from its book value.

D. Borrowing a large sum of money at a variable rate of interest.

Answer: D. A sale to another corporation with a similar name.

Explanation:

A similar corporate name alone does not establish a related party relationship. A related party relationship is based on factors such as common control, significant influence, key management personnel, or close family relationships—not merely on similarity in names.

6. Which of the following would not necessarily be a related party transaction?

A. A purchase from another corporation that is controlled by the corporation's chief shareholder.

B. A loan from the corporation to a major shareholder.

C. Sale of land to the corporation by the spouse of director.

D. A sale to another corporation with a similar name.

Answer: D. I, II, and III

Explanation:

PSA 550 requires auditors to perform several procedures to identify related parties. Reviewing prior-year working papers helps identify previously known related parties, inquiries of management and those charged with governance may reveal affiliations with other entities, and reviewing minutes of meetings may disclose relationships or transactions with related parties. Therefore, all three procedures are appropriate.

7. Which of the following procedures should be performed by the auditor to determine the completeness of information provided by those charged with governance and management identifying the names of all known related parties? I. Review prior year's working papers for names of known related parties. II. Inquire as to the affiliation of those charged with governance and officers with other entities. III. Review minutes of the meetings of stockholders and those charged with governance.

A. I and II only

B. I and III only

C. I and III only

D. I, II, and III

Answer: B. The audit procedures directed toward identifying related party transactions should include considering whether transactions are occurring but are not being given proper accounting recognition.

Explanation:

PSA 550 requires auditors to consider whether related party transactions exist but have not been properly identified, recognized, measured, or disclosed in the financial statements. Audit procedures are specifically designed to detect such transactions because they may not be recorded in the same manner as transactions with unrelated parties.

8. Which of the following statements concerning related party transactions is correct?

A. In the absence of evidence to the contrary, related party transactions should be assumed to be outside the ordinary course of business.

B. The audit procedures directed toward identifying related party transactions should include considering whether transactions are occurring but are not being given proper accounting recognition.

C. An auditor should determine whether a particular transaction would have occurred if the parties had not been related.

D. An auditor should substantiate that related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions.

Answer: C. The business structure may be deliberately designed to obscure related party transactions.

Explanation:

Complex organizational structures can be intentionally or unintentionally used to conceal related party relationships and transactions. Understanding each subsidiary's relationship within the group enables the auditor to identify transactions that may otherwise be hidden or inadequately disclosed, as emphasized in PSA 550.

9. An auditor searching for related party transactions should obtain an understanding of each subsidiary's relationship to the total entity because

A. This may permit the audit of intercompany account balances to be performed as of concurrent dates.

B. This may reveal whether particular transactions would have taken place if the parties had not been related.

C. The business structure may be deliberately designed to obscure related party transactions.

Answer: C. Both I and II

Explanation:

Under PSA 560, subsequent events include both: Events occurring between the date of the financial statements and the date of the auditor's report that may require adjustment or disclosure; and Facts discovered after the date of the auditor's report that, had they been known earlier, might have affected the auditor's report. Therefore, both statements correctly describe the scope of subsequent events under PSA 560.

10. As used in PSA 560 "Subsequent Events" refers to the term I. Events occurring between the date of the financial statements and the date of the auditor's report. II. Facts that become known to the auditor after the date of the auditor's report.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Answer: C. The date of the end of the latest period covered by the financial statements.

Explanation:

The date of the financial statements refers to the reporting date or balance sheet date—the end of the latest accounting period covered by the financial statements (e.g., December 31, 20X1). This is the date to which the financial statements relate.

11. Which of the following statements best describes the "date of the financial statements?"

A. The date on which those with the recognized authority assert that they have prepared the entity's complete set of financial statements, including the related notes, and that they have taken responsibility for them.

B. The date that the auditor's report and audited financial statements are made available to third parties.

C. The date of the end of the latest period covered by the financial statements.

D. The date on which the auditor has obtained sufficient appropriate audit evidence on which to base the opinion on the financial statements.

Answer: A. Date of the auditor's report.

Explanation:

PSA 560 requires the auditor to perform audit procedures up to the date of the auditor's report to identify subsequent events that may require adjustment or disclosure in the financial statements. After this date, the auditor has no obligation to actively search for additional events unless specific circumstances arise.

12. The auditor is required to perform procedures designed to obtain sufficient appropriate audit evidence to identify all events that may require adjustment of, or disclosure in, the financial statements up to the

A. Date of the auditor's report.

B. Date of approval of the financial statements.

C. Date the financial statements are issued.

D. Date of the financial statements.

Answer: A. Inquiring as to whether any unusual adjustments were made after the date of the financial statements.

Explanation:

One of the primary procedures under PSA 560 is to inquire of management regarding significant events or unusual accounting adjustments made after the reporting date. Such inquiries help the auditor determine whether events have occurred that require adjustment to or disclosure in the financial statements.

13. Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?

A. Inquiring as to whether any unusual adjustments were made after the date of the financial statements.

B. Confirming a sample of material accounts receivable established after the date of the financial statements.

C. Comparing the financial statements being reported on with those of the prior period.

D. Investigating personnel changes in the accounting department occurring after the date of the financial statements.

Answer: B. Compare the latest available interim financial statements with the financial statements being audited.

Explanation:

Comparing the latest interim financial statements with the audited financial statements is a standard subsequent-events procedure. This comparison helps identify significant changes or unusual trends occurring after the reporting period that may require adjustment or disclosure under PSA 560.

14. Which of the following procedures should an auditor ordinarily perform regarding subsequent events?

A. Review the cutoff bank statements for several months after the year-end.

B. Compare the latest available interim financial statements with the financial statements being audited.

C. Send second requests to the client's customers who failed to respond to initial accounts receivable confirmation requests.

D. Communicate material weaknesses in internal control to the client's audit committee.

Answer: B. Auditor's report.

Explanation:

The auditor's responsibility to actively perform procedures for subsequent events extends from the date of the financial statements up to the date of the auditor's report. This period is referred to as the subsequent-events review period under PSA 560.

15. An auditor is concerned with completing various phases of the audit after the balance sheet date. This subsequent period extends to the date of the

A. Delivery of the auditor's report to the client.

B. Auditor's report.

C. Final review of the audit working papers.

D. Public issuance of the financial statements.

Answer: C. The auditor should consider whether the financial statements need amendment, discuss the matter with management, and consider taking actions appropriate in the circumstances.

Explanation:

If the auditor becomes aware of facts after the auditor's report date but before the financial statements are issued, PSA 560 requires the auditor to discuss the matter with management, determine whether the financial statements require amendment, and take appropriate action depending on management's response and the significance of the new information.

16. Which of the following statements best expresses the auditor's responsibility with respect to facts which become known to the auditor after the date of the auditor's report but before the date the financial statements are issued?

A. The auditor should amend the financial statements.

B. If the facts discovered will materially affect the financial statements, the auditor should issue a new report which contains either a qualified opinion or an adverse opinion.

C. The auditor should consider whether the financial statements need amendment, discuss the matter with management, and consider taking actions appropriate in the circumstances.

D. The auditor should withdraw from the engagement.

Answer: D. D. Information, which existed at the report date and may affect the report, comes to the auditor's attention.

Explanation:

After the auditor's report has been issued, the auditor has no continuing responsibility to search for new information. However, if information comes to the auditor's attention that existed at the report date and could have affected the auditor's report had it been known, PSA 560 requires the auditor to consider appropriate actions.

17. After issuing a report, an auditor has no obligation to make continuing inquiries or perform other procedures concerning the audited financial statements, unless

A. Final determinations or resolutions are made of contingencies that had been disclosed in the financial statements.

B. Information about an event that occurred after the date of the auditor's report comes to the auditor's attention.

C. The control environment changes after issuance of the report.

D. Information, which existed at the report date and may affect the report, comes to the auditor's attention.

Answer: C. The discovery of information regarding a contingency that existed before the financial statements were issued.

Explanation:

If information discovered after the auditor's report relates to conditions that already existed before the financial statements were issued, the auditor must determine whether the financial statements and the auditor's report require revision. This is specifically addressed in PSA 560 regarding subsequently discovered facts.

18. Which of the following events occurring after the issuance of an auditor's report most likely would cause the auditor to make further inquiries about the previously issued financial statements?

A. A technological development that could affect the entity's future ability to continue as a going concern.

B. The entity's sale of a subsidiary that accounts for 30% of the entity's consolidated sales.

C. The discovery of information regarding a contingency that existed before the financial statements were issued.

D. The final resolution of a lawsuit disclosed in the notes to the financial statements.

Answer: B. Take no action because the auditor has no obligation to make any further inquiries.

Explanation:

The decision to sell the subsidiary occurred after the auditor's report and did not relate to conditions existing at the report date. Since it is a new event rather than a subsequently discovered fact about prior conditions, PSA 560 does not require the auditor to take further action.

19. After an audit report containing an unqualified opinion on client's financial statements was issued, the client decided to sell the shares of a subsidiary that accounts for 30% of its revenue and 25% of its net income. The auditor should

A. Describe the effects of this subsequently discovered information in a communication with persons known to be relying on the financial statements.

B. Take no action because the auditor has no obligation to make any further inquiries.

C. Determine whether the information is reliable and, if determined to be reliable, request that revised financial statements be issued.

D. Notify the entity that the auditor's report may no longer be associated with the financial statements.

Answer: B. Entity's management.

Explanation:

PSA 570 clearly states that management is responsible for assessing the entity's ability to continue as a going concern. The auditor's responsibility is to evaluate the appropriateness of management's assessment and determine whether adequate disclosures have been made regarding any material uncertainties.

20. PSA 570 (Going Concern) states that a fundamental principle in the preparation of financial statements is the going concern assumption. Under this assumption, an entity is ordinarily viewed as continuing in business for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to laws and regulations. The responsibility to make an assessment of an entity's ability to continue as a going concern rests with the

A. Auditor

B. Entity's management.

C. Securities and Exchange Commission (SEC).

D. Entity's creditors.

Answer: C. The auditor's responsibility is to consider the appropriateness of management's use of the going concern assumption and consider whether there are material uncertainties about the entity's ability to continue as a going concern that need to be disclosed in the financial statements.

Explanation:

Under PSA 570, the auditor's responsibility is to evaluate whether management's use of the going concern basis of accounting is appropriate and whether any material uncertainties exist that require disclosure in the financial statements. The auditor does not make the assessment for management or guarantee the entity's future viability.

21. Which of the following statements best describes the auditor's responsibility concerning the appropriateness of the going concern assumption in the preparation of the financial statements?

A. The auditor's responsibility is to make a specific assessment of the entity's ability to continue as a going concern.

B. The auditor's responsibility is to predict future events or conditions that may cause the entity to cease to continue as a going concern.

C. The auditor's responsibility is to consider the appropriateness of management's use of the going concern assumption and consider whether there are material uncertainties about the entity's ability to continue as a going concern that need to be disclosed in the financial statements.

D. The auditor's responsibility is to give a guarantee in the audit report that the entity has the ability to continue as a going concern.

Answer: A. Cash flows from operating activities are negative.

Explanation:

Negative operating cash flows are a significant financial indicator that an entity may not be generating enough cash to sustain its operations. PSA 570 identifies recurring operating losses and negative cash flows as conditions that may cast significant doubt on an entity's ability to continue as a going concern.

22. Which of the following conditions or events most likely would cause an auditor to have substantial doubt about an entity's ability to continue as a going concern?

A. Cash flows from operating activities are negative.

B. Stock dividends replace annual cash dividends.

C. Significant related party transactions are pervasive.

D. Research and development projects are postponed.

Answer: A. Confirming with third parties the details of arrangements to maintain financial support.

Explanation:

When management intends to rely on financial support from third parties, the auditor should obtain evidence that such support actually exists. Confirming these arrangements provides evidence regarding the entity's ability to continue operating and is specifically relevant to evaluating going concern under PSA 570.

23. Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?

A. Confirming with third parties the details of arrangements to maintain financial support.

B. Comparing the entity's depreciation and asset capitalization policies to other entities in the industry.

C. Reconciling the cash balance per books with the cutoff bank statement and the bank confirmation.

D. Inspecting title documents to verify whether any assets are pledged as collateral.

Answer: B. Usual trade credit from suppliers is denied.

Explanation:

The inability to obtain normal trade credit indicates that suppliers have lost confidence in the entity's ability to pay its obligations. PSA 570 recognizes the loss of normal trade credit as a significant indicator of possible going concern problems.

24. Which of the following conditions or events most likely would cause an auditor to have substantial doubt about an entity's ability to continue as a going concern?

A. Restrictions on the disposal of principal assets are present.

B. Usual trade credit from suppliers is denied.

C. Significant related party transactions are pervasive.

D. Arrearages in principal stock dividends are paid.

Answer: D. Review of compliance with terms of debt agreements.

Explanation:

Reviewing compliance with debt covenants helps the auditor determine whether the entity has defaulted or is at risk of defaulting on loan agreements. Debt covenant violations may result in loans becoming immediately payable and are important indicators of potential going concern issues.

25. Which of the following audit procedures would most likely assist an auditor in identifying conditions and events that may indicate there could be substantial doubt about an entity's ability to continue as going concern?

A. Confirmation of bank balances.

B. Confirmation of accounts receivable from major customers.

C. Reconciliation of interest expense with debt outstanding.

D. Review of compliance with terms of debt agreements.

Answer: A. Postpone expenditures for research and development projects.

Explanation:

Postponing discretionary expenditures, such as research and development, is a practical cost-reduction strategy that can conserve cash and improve short-term liquidity. PSA 570 recognizes plans to reduce or delay expenditures as possible mitigating factors when evaluating going concern.

26. Harold, CPA, believes there is substantial doubt about the ability of Jersamtan Co. to continue as a going concern for a reasonable period of time. In evaluating Jersamtan's plans for dealing with the adverse effects of future conditions and events, Harold most likely would consider, as a mitigating factor, Jersamtan's plans to

A. Postpone expenditures for research and development projects.

B. Purchase production facilities currently being leased from a related party.

C. Strengthen internal controls over cash disbursements.

D. Discuss with lenders the terms of all debt and loan agreements.

Answer: C. Negotiate reductions in required dividends being paid on preferred stock.

Explanation:

Negotiating reductions in required dividend payments decreases cash outflows and helps preserve working capital. Such financing-related plans are considered potential mitigating factors when evaluating an entity's ability to continue as a going concern.

27. Harry, CPA, believes there is substantial doubt about the ability of Tansamjer Corp. to continue as a going concern for a reasonable period of time. In evaluating Tansamjer's plans for dealing with the adverse effects of future conditions and events, Harry most likely would consider, as a mitigating factor, Tansamjer's plans to

A. Purchase equipment and production facilities currently being leased.

B. Accumulate treasury stock at prices favorable to Tansamjer's historic price range.

C. Negotiate reductions in required dividends being paid on preferred stock.

D. Accelerate research and development projects related to future products.

Answer: A. Consider the adequacy of disclosure about the client's possible inability to continue as a going concern.

Explanation:

When substantial doubt exists, the auditor's primary responsibility is to evaluate whether management has adequately disclosed the material uncertainty in the financial statements. If the disclosure is adequate, the auditor may issue an unmodified opinion with an appropriate section (or emphasis, depending on the applicable reporting framework and standards). If the disclosure is inadequate, the opinion may need to be modified.

28. When an auditor concludes that there is substantial doubt about a continuing audit client's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to

A. Consider the adequacy of disclosure about the client's possible inability to continue as a going concern.

B. Issue a qualified or adverse opinion, depending upon materiality, due to the possible effects on the financial statements.

C. Report to the client's audit committee that management's accounting estimates may need to be adjusted.

D. Reissue the prior year's auditor's report and add an emphasis of matter paragraph that specifically refers to "substantial doubt" and "going concern."

Answer: C. Both I and II

Explanation:

PSA 580 requires the auditor to obtain written representations from management confirming that it has fulfilled its responsibility for preparing and fairly presenting the financial statements and that it has provided the auditor with all relevant information, records, and unrestricted access necessary to perform the audit.

29. Under PSA 580 (Written Representations), the auditor is required to obtain audit evidence that management I. Has fulfilled its responsibility for the fair presentation of the financial statements in accordance with applicable financial reporting framework. II. Has provided the auditor with all relevant information and access as agreed in the terms of the audit engagement.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Answer: D. As near as practicable to, but not after the date of the auditor's report on the financial statements.

Explanation:

Under PSA 580, the written representation letter should be dated as close as possible to the auditor's report because it covers all matters relevant up to that date. It must not be dated after the auditor's report.

30. The date of the written representation shall be

A. After the date of the auditor's report.

B. After the date of approval of the entity's financial statements.

C. Before the entity's financial statements are issued.

D. As near as practicable to, but not after the date of the auditor's report on the financial statements.

Answer: A. The possibility of a misunderstanding concerning management's responsibility for the financial statements.

Explanation:

The management representation letter formally acknowledges management's responsibilities for preparing and fairly presenting the financial statements and providing complete information to the auditor. This reduces misunderstandings regarding management's responsibilities but does not replace other audit evidence.

31. A purpose of a management representation letter is to reduce

A. The possibility of a misunderstanding concerning management's responsibility for the financial statements.

B. The scope of an auditor's procedures concerning related party transactions and subsequent events.

C. Audit risk to an aggregate level of misstatement that could be considered material.

D. An auditor's responsibility to detect material misstatements only to the extent that the letter is relied on.

Answer: B. Obtain certain written representations from management.

Explanation:

PSA 580 requires auditors to obtain written representations from management in every audit engagement. These representations are mandatory audit evidence and complement, but do not replace, other audit procedures.

32. When an audit is made in accordance with generally accepted auditing standards, the auditor should always

A. Observe the taking of physical inventory on the balance sheet date.

B. Obtain certain written representations from management.

C. Employ analytical procedures as substantive tests to obtain evidence about specific assertions related to account balances.

D. Document the understanding of the client's internal control and the basis for all conclusions about the assessed level of control risk for financial statement assertions.

Answer: D. Complement, but do not replace, substantive tests designed to support the assertion.

Explanation:

Written representations are necessary audit evidence, but PSA 580 emphasizes that they cannot substitute for other audit evidence. They supplement substantive procedures and other audit work performed by the auditor.

33. When considering the use of management's written representations as audit evidence about the completeness assertion, an auditor should understand that such representations

A. Constitute sufficient appropriate audit evidence to support the assertion when considered in combination with a sufficiently low assessed level of control risk.

B. Are not part of the audit evidence considered to support the assertion.

C. Replace a low assessed level of control risk as audit evidence to support the assertion.

D. Complement, but do not replace, substantive tests designed to support the assertion.

Answer: B. Auditor.

Explanation:

The representation letter is prepared by management and addressed to the auditor. It serves as written confirmation of management's representations made during the audit and becomes part of the audit evidence.

34. The written representations shall be in the form of a representation letter addressed to the

A. Entity's management.

B. Auditor.

C. Entity's chief executive officer.

D. Entity's chief financial officer.

Answer: B. Chief executive officer and the chief financial officer.

Explanation:

PSA 580 requires written representations to be signed by those members of management with overall responsibility for the financial statements, typically the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO).

35. A written representation from a client's management that, among other matters, acknowledges responsibility for the fair presentation of financial statements, should normally be signed by the

A. Chief financial officer and the chair of the board of directors.

B. Chief executive officer and the chief financial officer.

C. Chief executive officer, the chair of the board of directors, and the client's lawyer.

D. Chair of the audit committee of the board of directors.

Answer: B. Sufficient appropriate audit evidence has been made available to permit the expression of an unqualified opinion.

Explanation:

Management's representation letter confirms facts and representations within management's knowledge and responsibility, such as the completeness of information provided and responsibility for the financial statements. Whether sufficient appropriate audit evidence exists to support an unqualified opinion is the auditor's professional judgment, not management's representation.

36. The following statements are ordinarily included in a management representation letter, except

A. The completeness and availability of minutes of stockholders' and directors' meetings.

B. Sufficient appropriate audit evidence has been made available to permit the expression of an unqualified opinion.

C. There have been no irregularities involving management or employees who have a significant role in internal control or that could have a material effect on the financial statements.

D. The financial statements are free of material misstatements, including omissions.

Answer: B. Client's management.

Explanation:

Under PSA 501, management is primarily responsible for identifying, accounting for, and disclosing all litigation, claims, and assessments affecting the financial statements. The auditor obtains this information initially from management and then corroborates it with other audit procedures, such as legal inquiry letters.

37. The primary source of information to be reported about litigation, claims, and assessments is the

A. Independent auditor.

B. Client's management.

C. Court records.

D. Client's lawyer.

Answer: A. Confirm directly with the client's lawyer that all claims have been recorded in the financial statements.

Explanation:

The auditor does not ask the client's external lawyer to confirm that all claims have been recorded in the financial statements. The lawyer's role is to provide information about existing or potential litigation, while management is responsible for recording and disclosing such matters in the financial statements.

38. Which of the following procedures is least likely to be performed by the auditor to identify litigation and claims involving the entity which may result in a material misstatement of the financial statements?

A. Confirm directly with the client's lawyer that all claims have been recorded in the financial statements.

B. Make appropriate inquiries of management including obtaining representations.

C. Examine legal expense accounts.

D. Use any information regarding the entity's business including information obtained from discussions with any in-house legal department.

Answer: C. Corroboration of the information furnished by management about litigation, claims, and assessments.

Explanation:

The letter of inquiry to the client's legal counsel is intended to corroborate management's representations regarding litigation, claims, and assessments. This independent confirmation provides additional audit evidence about the existence and status of legal matters affecting the financial statements.

39. The primary reason an auditor requests that letters of inquiry be sent to a client's attorneys is to provide the auditor with

A. A description and evaluation of litigation, claims, and assessments that existed at the balance sheet date.

B. The attorneys' opinions of the client's historical experiences in recent similar litigation.

C. Corroboration of the information furnished by management about litigation, claims, and assessments.

D. The probable outcome of asserted claims and pending or threatened litigation.

B. Prepared by management and sent by the auditor.

Explanation:

The letter of audit inquiry is prepared by management because it authorizes the entity's legal counsel to communicate confidential information regarding litigation, claims, and assessments. The auditor then sends the letter directly to the lawyer and requests that the lawyer respond directly to the auditor. This process provides the auditor with independent audit evidence while preserving the client's attorney-client privilege.

40. The letter of audit inquiry should be

A. Prepared and sent by the auditor.

B. Prepared by management and sent by the auditor.

C. Prepared and sent by management.

D. Prepared by the auditor and sent by management.

A. Jurisdiction in which the matter will be resolved.

Explanation:

For audit purposes, the auditor is primarily concerned with whether litigation exists, the likelihood of loss, and the period to which the matter relates. The legal jurisdiction where the case will be heard is generally not relevant to determining the financial statement effect of the litigation.

41. An auditor should obtain evidence relevant to all of the following factors concerning third-party litigation against a client except the

A. Jurisdiction in which the matter will be resolved.

B. Existence of a situation indicating an uncertainty as to the possible loss.

C. Probability of an unfavorable outcome.

D. Period in which the underlying cause for legal action occurred.

C. Considered to be a scope limitation.

Explanation:

If the client's lawyer refuses to provide information that the auditor considers necessary, the auditor may be unable to obtain sufficient appropriate audit evidence. This constitutes a scope limitation and may require a qualified opinion or disclaimer of opinion, depending on its significance.

42. The refusal of a client's lawyer to provide a representation on the legality of a particular act committed by the client is ordinarily

A. Proper grounds to withdraw from the engagement.

B. Insufficient reason to modify the auditor's report because of the lawyer's obligation of confidentiality.

C. Considered to be a scope limitation.

D. Sufficient reason to issue a "subject to" opinion.

D. A qualified opinion or a disclaimer of opinion.

Explanation:

If management refuses to allow communication with legal counsel, the auditor cannot obtain sufficient appropriate audit evidence regarding litigation and claims. This creates a scope limitation that may require either a qualified opinion or a disclaimer of opinion, depending on the materiality and pervasiveness of the limitation.

43. Management's refusal to give the auditor permission to communicate with the entity's legal counsel is most likely to lead to

A. An adverse opinion.

B. A qualified opinion or an adverse opinion.

C. An unqualified opinion.

D. A qualified opinion or a disclaimer of opinion.

A. "I believe that the action can be settled for less than the damages claimed."

Explanation:

This statement is too imprecise for audit purposes. Although it suggests that the damages may 

44. 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?

A. "I believe that the action can be settled for less than the damages claimed."

B. "I believe that the company will be able to defend this action successfully."

C. "I believe that the plaintiff's case against the company is without merit."

D. "I believe that the possible liability to the company is nominal in amount."

B. Date of the auditor's report.

Explanation:

Under PSA 501 and PSA 560, the auditor is responsible for obtaining sufficient appropriate audit evidence regarding litigation, claims, and assessments up

45. The auditor should consider the status of legal matters up to the

A. Balance sheet date.

B. Date of the auditor's report.

C. Date of approval of the financial statements.

D. Date of issuance of the financial statements.