Section O Question Sets - 1 & 2

In which of the following circumstances may the auditor issue the standard audit report?

1. Management's refusal to furnish written representations.

2. The principal auditor assumes responsibility for the work of another auditor.

3. The auditor wishes to emphasize a matter regarding the financial statements.

4. The financial statements are affected by a departure from the applicable financial reporting framework.

2 - The principal auditor assumes responsibility for the work of another auditor.

If the principal auditor is able to satisfy himself as to the independence and professional reputation of the other auditor and takes steps he considers appropriate to satisfy himself as to the other auditor's report, he may be able to express an opinion on the financial statements taken as a whole without making reference in his report to the report of the other auditor. If the principal auditor decides to take this position, he should not state in his report that part of the audit was made by another auditor because to do so may cause a reader to misinterpret the degree of responsibility being assumed.

“The auditor wishes to emphasize a matter regarding the financial statements” is incorrect because when the auditor wishes to emphasize a matter in his report, he is — by definition — modifying the report (this should not be construed to mean modification of the opinion).

How does an auditor make the following representations when issuing the auditor's report on comparative financial statements under U.S. auditing standards?

Obtaining evidence that is sufficient and appropriate: Implicitly/Explicitly

Consistent application of accounting principles: Implicitly/Explicitly

Explicitly; Implicitly

Under U.S. auditing standards, the auditor explicitly states in the Auditor's Responsibility paragraph of the opinion: "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion." Consistency is implied in the auditor's report.

How does an auditor of a nonissuer make the following representations when issuing the unmodified audit opinion on comparative financial statements?

Consistent application of accounting principles: Implicitly/Explicitly

Examination of evidence on a test basis: Implicitly/Explicitly

Implicitly; Explicitly

Consistency is implicit in the auditor's report, and will be explicitly mentioned in an emphasis-of-a-matter paragraph ONLY if there are issues with consistency.

"Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements" is included in the Auditor's Responsibilities section.

Which of the following best describes the earliest date for an auditor's report?

1. The date audit documentation was completed.

2. The last day of audit fieldwork.

3. The date the auditor has obtained sufficient appropriate audit evidence to support the opinion.

4. The date all audit procedures have been completed and the audit file has been assembled.

3 - The date the auditor has obtained sufficient appropriate audit evidence to support the opinion.

The auditor's report should be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence to support the opinion.

The auditor's report is required to either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. The objective of such reporting rules is to prevent:

1. Misinterpretations regarding the degree of responsibility that the auditor is assuming.

2. The CPA from expressing different opinions on each of the basic financial statements.

3. Management from reducing its final responsibility for the basic financial statements.

4. The CPA firm from reporting on one basic financial statement and not the others.

1 - Misinterpretations regarding the degree of responsibility that the auditor is assuming.

The objective is to prevent misinterpretation of the degree of responsibility the accountant assumes when his name is associated with financial statements. Thus, a CPA is required to either render an opinion or state that one cannot be rendered.

How are management's responsibility and the auditor's responsibility represented in the auditor's report of a nonissuer?

Management's responsibility: Implicitly/Explicitly

Auditor's responsibility: Implicitly/Explicitly

Explicitly; Explicitly

The responsibility of the auditor and the responsibility of management are stated explicitly in the auditor's report of a nonissuer. There is a Management's Responsibility paragraph and an Auditor's Responsibility paragraph.

Which paragraphs of a nonissuer auditor's report on financial statements under U.S. auditing standards should refer to generally accepted auditing standards (GAAS) and generally accepted accounting principles (GAAP)?

1. GAAS: Basis for Opinion

   GAAP: Opinion

2. GAAS: Opinion

   GAAP: Auditor's Responsibility

3. GAAS: Auditor's Responsibility

   GAAP: Basis for Opinion

4. GAAS: Management's Responsibilities

   GAAP: Basis for Opinion

1 - GAAS: Basis for Opinion

GAAP: Opinion

For nonissuers, GAAS is referred to in the:

• Basis for Opinion

• Auditor's Responsibilities

GAAP is referred to in the:

• Opinion

• Management's Responsibilities

In which of the following situations would the auditor be least likely to issue a report that contains an emphasis of matter paragraph?

1. Correction of a mistake in the application of a generally accepted accounting principle.

2. A change in the method of accounting for specific subsidiaries that comprise the group of companies for which consolidated statements are presented.

3. A change in depreciation methods resulting in immaterial adjustments to future depreciation expense.

4. A change from an accounting principle that is not generally accepted to one that is generally accepted.

3 - A change in depreciation methods resulting in immaterial adjustments to future depreciation expense.

A change from one generally accepted depreciation method to another generally accepted depreciation method is treated as a change in accounting estimate and receives prospective treatment; but since it results in immaterial adjustments, there is no need to emphasize the change.

When reporting under GAAS, certain statements are required in all auditors’ reports (“explicit”) and others are required only under certain conditions (“implicit”). Which combination that follows correctly describes the auditors’ responsibilities for reporting?

GAAP: Implicit/Explicit

Consistency: Implicit/Explicit

Going concern: Implicit/Explicit

Opinion: Implicit/Explicit

GAAP: Explicit

Consistency: Implicit

Going concern: Explicit

Opinion: Explicit

A CPA's report on audited financial statements under U.S. auditing standards would be inappropriate if it referred to:

1. The CPA's assessment of sampling risk factors.

2. Evaluating the appropriateness of accounting policies used.

3. Management's responsibility for the financial statements.

4. Significant estimates made by management.

1 - The CPA's assessment of sampling risk factors.

The CPA's report on audited financial statements does not include matters related to the auditor's assessment of specific risk factors.

T/F: When an entity will not permit inquiry of outside legal counsel, the auditors' report on the entity's financial statements will ordinarily contain a(n) disclaimer of opinion.

True

In a first audit of a new company the auditor's report will:

1. State that the consistency standard does not apply because the current year is the first year of audit.

2. State that the accounting principles have been applied on a consistent basis.

3. State that accounting principles have been applied consistently during the period.

4. Remain silent with respect to consistency.

4 - Remain silent with respect to consistency.

Consistency is not mentioned in the audit report simply because it is a first audit of a new company. It may be mentioned if the auditor notes a difference, but not because it is a first year client. 

A material change in accounting estimate:

1. Requires a consistency modification in the auditor's report but does not require disclosure in the financial statements.

2. Affects comparability and may require disclosure in a note to the financial statements but does not require a consistency modification in the auditor's report.

3. Involves the acceptability of the generally acceptable accounting principles used.

4. Requires a consistency modification in the auditor's report and disclosure in the financial statements.

2 - Affects comparability and may require disclosure in a note to the financial statements but does not require a consistency modification in the auditor's report.

Which of the following is true regarding the audit report for an issuer?

1. PCAOB standards should not be mentioned at all, although their use is implied in the auditor's report.

2. The report should include references to PCAOB standards and generally accepted accounting principles.

3. Reference should be made to both PCAOB standards and generally accepted auditing standards.

4. Reference may be made to either PCAOB standards or generally accepted auditing standards.

2 - The report should include references to PCAOB standards and generally accepted accounting principles.

An auditor reporting on the audit of financial statements of an issuer should indicate in the Basis for Opinion section that the engagement was conducted in accordance with PCAOB standards, and should refer to GAAP in the Opinion on the Financial Statements section.

March, CPA, is engaged by Monday Corp., a client, to audit the financial statements of Wall Corp., a company that is not March's client. Monday expects to present Wall's audited financial statements with March's auditor's report to 1st Federal Bank to obtain financing in Monday's attempt to purchase Wall. In these circumstances, March's auditor's report would usually be addressed to:

1. 1st Federal Bank.

2. Both Monday Corp. and 1st Federal Bank.

3. Wall Corp., the entity audited by March.

4. Monday Corp., the client that engaged March.

4 - Monday Corp., the client that engaged March.

The auditors should address their report to the entity that engaged them. In this case, Monday Corp. engaged the auditor to perform an acquisition audit and the report should be addressed to Monday.

Which of the following statements is a basic element of the auditor's report under U.S. auditing standards?

1. The financial statements are consistent with those of the prior period.

2. An audit includes evaluating significant estimates made by management.

3. The auditor evaluated the overall internal control.

4. The disclosures provide reasonable assurance that the financial statements are free of material misstatement.

2 - An audit includes evaluating significant estimates made by management.

How does an auditor make the following representations when issuing the standard auditor's report on comparative financial statements?

Consistent Application of Accounting Principles: Implicitly/Explicitly

Examination of Evidence: Implicitly/Explicitly

Implicitly; Explicitly

The consistent application of accounting principles is implicitly (not directly stated) in the audit report. However, the examination of evidence on a test basis is stated directly within the audit report.

How is consistency referred to in a continuing auditor’s standard report on comparative financial statements?

1. Consistency is not explicitly mentioned.

2. Applied on a basis consistent with that of the preceding year.

3. Applied consistently during interim periods.

4. Applied consistently with previous years audited.

1 - Consistency is not explicitly mentioned.

A client decides not to make an auditor's proposed adjustments that collectively are not material, and wants the auditor to issue the report based on the unadjusted numbers. Which of the following statements is correct regarding the financial statement presentation?

1. The financial statements do not conform with generally accepted accounting principles (GAAP).

2. The financial statements are free from material misstatement, but disclosure of the proposed adjustments is required in the notes to the financial statements.

3. The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements.

4. The financial statements contain unadjusted misstatements that should result in a qualified opinion.

3 - The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements.

An unmodified opinion states that the financial statements are presented fairly, in all material respects. Since the collective effect of the proposed adjustments is immaterial, an unmodified opinion should be expressed. In addition, footnote disclosure of proposed immaterial adjustments is not required.

Digit Co., a nonissuer, uses the FIFO method of costing for its international subsidiary's inventory and LIFO for its domestic inventory. Under these circumstances, the auditor's report on Digit's financial statements should express an:

1. Adverse opinion.

2. Opinion qualified because of a departure from GAAP.

3. Opinion qualified because of a lack of consistency.

4. Unmodified opinion.

4 - Unmodified opinion.

GAAP allows a company to use different methods for costing different inventories as long as the methods are disclosed. Thus, the audit report would be unmodified; there is no departure from GAAP.

When there is a significant change in accounting principle, an auditor's report should refer to the lack of consistency in:

1. In the Management's Responsibility paragraph.

2. An emphasis-of-matter paragraph.

3. The Basis for Opinion paragraph.

4. The Opinion paragraph.

2 - An emphasis-of-matter paragraph.

When there is a significant change in accounting principle, the auditor's report should refer to the lack of consistency in an emphasis-of-matter paragraph following the Opinion paragraph. The emphasis-of-matter paragraph should identify the change and refer to the note in the FS that discusses the change in detail. The auditor's concurrence with the change in GAAP is implicit, unless he or she takes exception.

When there has been a change in accounting principle that materially affects the comparability of the nonissuer's comparative financial statements presented and the auditor concurs with the change, the auditor should:

Concur explicitly with the change: Yes/No

Issue an "except for" qualified opinion: Yes/No

Refer to the change in an emphasis-of-matter paragraph: Yes/No

No; No; Yes

When a change in accounting principle materially affects the comparability of the comparative FS, the auditor should refer to the change in an emphasis-of-matter paragraph following the unmodified opinion paragraph.

Which one of the following would require a consistency modification in the auditor's report? (Select all that apply)

1. Changing the salvage value of an asset.

2. Changing from consolidating a wholly-owned subsidiary to carrying it on the equity basis.

3. Division of the consolidated subsidiary into two subsidiaries which are both consolidated.

4. Changing the presentation of prepaid insurance from inclusion in "other assets" to disclosing it as a separate line item.

2 & 3

The following are examples of a change in the reporting entity, that is NOT a result of a transaction or event, that may materially affect consistency:

a. presenting consolidated or combined financial statements in place of financial statements of individual entities.

b. changing specific subsidiaries that make up the group of entities for which consolidated financial statements are presented.

c. changing the entities included in combined financial statements.

Both, division of the consolidated subsidiary into two subsidiaries which are both consolidated, and changing from consolidating a wholly-owned subsidiary to carrying it on the equity basis are examples of changes in the reporting entity, that is NOT a result of a transaction or event, that may materially affect consistency as they represent examples, b. and and c., respectively. Since a change in the reporting entity is a special type of change in accounting principle, the consistency standard is applicable. Since the consistency standard is applicable, a modification in the auditor's report is necessary.

Changing the salvage value of an asset is a change in estimate, that is handled prospectively. Changing the presentation of prepaid insurance from inclusion in "other assets" to disclosing it as a separate line item is a reclassification and reclassifications are strictly not considered consistency issues.

For which of the following events would an auditor issue a report that omits any reference to consistency?

1. A change in the method of accounting for inventories.

2. Management's lack of reasonable justification for a change in accounting principle.

3. A change in the useful life used to calculate the provision for depreciation expense.

4. A change from an accounting principle that is not generally accepted to one that is generally accepted.

3 - A change in the useful life used to calculate the provision for depreciation expense.

A change in accounting estimate, such as a change in the useful life of a depreciable asset, is accounted for prospectively and does not affect the comparability of financial statements between periods. Because the auditor's unmodified opinion implies that consistency exists, no modification to the report is necessary.

If a client makes a change in accounting estimate that is inseparable from the effect of a related change in accounting principle, this material event should be accounted for as a change in:

1. Principle and the auditor would include an emphasis-of-matter paragraph.

2. Estimate and the auditor would not modify the report.

3. Principle and the auditor would not modify the report.

4. Estimate and the auditor would include an emphasis-of-matter paragraph.

1 - Principle and the auditor would include an emphasis-of-matter paragraph.

Which of the following is true?

1. The auditor may issue an unmodified opinion when a material departure from GAAP exists.

2. When an auditor includes a paragraph after the opinion paragraph emphasizing a significant related party transaction, the opinion would be considered a qualified opinion.

3. When a material accounting change has been properly accounted for and disclosed, the auditor may not issue an unmodified opinion.

4. If an auditor believes there is substantial doubt about an entity's ability to continue as a going concern, and management has properly disclosed the situation, the auditor may not issue an unmodified opinion.

1 - The auditor may issue an unmodified opinion when a material departure from GAAP exists.

Although this situation is unusual, if a departure from GAAP is justified, the auditor may issue an unmodified opinion with an emphasis-of-matter paragraph.

An entity changed from the straight-line method to the declining balance method of depreciation for all newly acquired assets. This change has no material effect on the current year's financial statements, but is reasonably certain to have a substantial effect in later years. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a(an):

1. Emphasis-of-matter paragraph.

2. Unmodified opinion.

3. "Except for" qualified opinion.

4. Consistency modification.

2 - Unmodified opinion.

If an accounting change has no material effect on the financial statements in the current year, but a material future effect, the auditor must ensure that the change is disclosed in the footnotes whenever the financial statements of the change period are presented, but does not have to recognize the change in the current year's audit report.

When an entity changes its method of accounting for income taxes, which has a material effect on comparability, the auditor should refer to the change in an emphasis-of-matter paragraph added to the auditor's report. This paragraph should identify the nature of the change and:

1. Refer to the financial statement note that discusses the change in detail.

2. Explain why the change is justified under generally accepted accounting principles.

3. State the auditor's explicit concurrence with or opposition to the change.

4. Describe the cumulative effect of the change on the audited financial statements.

1 - Refer to the financial statement note that discusses the change in detail.

In which of the following circumstances would an auditor most likely add an emphasis-of-matter paragraph to the report while not affecting the auditor's unmodified opinion?

1. Certain transactions cannot be tested because of management's records retention policy.

2. The auditor is asked to report on the balance sheet, but not on the other basic financial statements.

3. Management's estimates of the effects of future events are unreasonable.

4. There is substantial doubt about the entity's ability to continue as a going concern.

4 - There is substantial doubt about the entity's ability to continue as a going concern.

For a particular entity's financial statements to be presented fairly in conformity with the applicable financial reporting framework, it is not required that the principles selected:

1. Reflect transactions in a manner that presents the financial statements within a range of acceptable limits.

2. Be applied on a basis consistent with those followed in the prior year.

3. Present information in the financial statements that is classified and summarized in a reasonable manner.

4. Be appropriate in the circumstances for the particular entity.

2 - Be applied on a basis consistent with those followed in the prior year.

For a particular entity's financial statements to be presented fairly in accordance with the applicable financial reporting framework, it is not required that the principles selected be applied on a basis consistent with those followed in the prior year, merely that any changes in accounting principle be properly accounted for and disclosed.

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. If the entity's disclosures concerning this matter are adequate, the audit report may include a(an):

Disclaimer of opinion: Yes/No

"Except for" qualified opinion: Yes/No

Yes; No

If an auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern and that the entity's disclosures are adequate, then the audit report may be either: Unmodified (Unqualified) with emphasis-of-matter (explanatory) paragraph, or Disclaimed. Generally, an unmodified (unqualified) opinion is issued, but the auditor is not prohibited from choosing to issue a disclaimer.

In which of the following should an auditor's report for a nonissuer refer to the lack of consistency when there is a change in accounting principle that is significant?

1. An other matter paragraph.

2. An emphasis of matter paragraph.

3. Management responsibility paragraph.

4. The opinion paragraph.

2 - An emphasis of matter paragraph.

An auditor most likely would express an unmodified opinion and would not add emphasis-of-matter or other-matter paragraphs to the report if the auditor:

1. Concurs with the entity's change in its method of computing depreciation.

2. Believes that there is a probable likelihood of a material loss resulting from an uncertainty that is sufficiently supported and disclosed.

3. Discovers that supplementary information required by FASB has been omitted.

4. Wishes to emphasize that the entity had significant transactions with related parties.

2 - Believes that there is a probable likelihood of a material loss resulting from an uncertainty that is sufficiently supported and disclosed.

It is not appropriate to refer a reader of an auditor's report to a financial statement footnote for details concerning:

1. The results of confirmation of receivables.

2. The pro forma effects of a business combination.

3. Sale of a discontinued operation.

4. Subsequent events.

1 - The results of confirmation of receivables.