aicpa 2012 audit and assurance

© 2012 by Bisk Education, Inc. All rights reserved. of 44

RECENTLY RELEASED AICPA QUESTIONS AND ANSWERS

In April 2012, the AICPA released fifty multiple-choice questions, two task-based simulations, and one research task related to the AUD section of the CPA Examination. These questions and their unofficial answers are reproduced here as received from the AICPA examiners, along with Bisk Education’s expla- nations. The multiple-choice questions in Problems 1 and 2 were labeled medium and hard, respectively, by the AICPA examiners. The AICPA did not state if these questions ever appeared on any exam; whether they were assigned points or were merely being pretested (and earned no points) if they did appear on an exam; or if they were now obsolete for some reason. These questions are intended only as a study aid and should not be used to predict the content of future exams. It is the AICPA’s policy that released questions will not appear on future exams.

Problem 1 MULTIPLE-CHOICE QUESTIONS

1. An accountant who accepts an engagement to compile a financial projection most likely would make the client aware that the

a. Projection may not be included in a document with audited historical financial statementsb. Accountant’s responsibility to update the projection for future events and circumstances is

limited to one yearc. Projection omits all hypothetical assumptions and presents the most likely future financial

positiond. Engagement does not include an evaluation of the support for the assumptions underlying the

projection (R/12, AUD, #1, 89751)

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

a. Confirmation of accounts receivable from principal customers b. Reconciliation of interest expense with debt outstandingc. Confirmation of bank balancesd. Review of compliance with terms of debt agreements (R/12, AUD, #2, 89752)

3. Which of the following would not be considered an analytical procedure?

a. Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages

b. Developing the current year’s expected net sales based on the sales trend of similar entities within the same industry

c. Projecting a deviation rate by comparing the results of a statistical sample with the actual popu-lation characteristics

d. Estimating the current year’s expected expenses based on the prior year’s expenses and the current year’s budget (R/12, AUD, #3, 89753)

4. A principal auditor decides not to refer to the audit of another CPA who audited a subsidiary of the principal auditor’s client. After making inquiries about the other CPA’s professional reputation and independence, the principal auditor most likely would

a. Document in the engagement letter that the principal auditor assumes no responsibility for the other CPA’s work

b. Obtain written permission from the other CPA to omit the reference in the principal auditor’s report

c. Contact the other CPA and review the audit programs and working papers pertaining to thesubsidiary

d. Add an explanatory paragraph to the auditor’s report indicating that the subsidiary’s financial statements are not material to the consolidated financial statements (R/12, AUD, #4, 89754)


5. In auditing related party transactions, an auditor ordinarily places primary emphasis on

a. The probability that related party transactions will recur b. Confirming the existence of the related partiesc. Verifying the valuation of the related party transactionsd. The adequacy of the disclosure of the related party transactions (R/12, AUD, #5, 89755)

6. The inability to complete which of the following activities most likely would prevent an accountant from accepting and completing an engagement for a review of financial statements performed in accordance with Statements on Standards for Accounting and Review Services?

a. Performing tests of details of major account balances b. Performing inquiries and analytical proceduresc. Obtaining an understanding of internal control to assess control riskd. Having previous experience in the client’s industry (R/12, AUD, #6, 89756)

7. Obtaining an understanding of an internal control involves evaluating the design of the control and determining whether the control has been

a. Authorizedb. Implemented c. Testedd. Monitored (R/12, AUD, #7, 89757)

8. Which of the following procedures most likely would be performed in a review engagement of a nonissuer’s financial statements in accordance with Statements on Standards for Accounting and Review Services?

a. Making inquiries of managementb. Observing a year-end inventory count c. Assessing the internal control systemd. Examining subsequent cash receipts (R/12, AUD, #8, 89758)

9. An auditor should consider which of the following when evaluating the ability of a company to continue as a going concern?

a. Audit feesb. Future assurance servicesc. Management’s plans for disposal of assetsd. A lawsuit for which judgment is not anticipated for 18 months (R/12, AUD, #9, 89759)

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

a. The scope paragraph b. The opinion paragraphc. An explanatory paragraph following the opinion paragraphd. An explanatory paragraph before the opinion paragraph (R/12, AUD, #10, 89760)

11. Which of the following is the best way to compensate for the lack of adequate segregation of duties in a small organization?

a. Disclosing lack of segregation of duties to the external auditors during the annual review b. Replacing personnel every three or four yearsc. Requiring accountants to pass a yearly background checkd. Allowing for greater management oversight of incompatible activities (R/12, AUD, #11, 89761)


12. Which of the following situations most likely represents the highest risk of a misstatement arising from misappropriations of assets?

a. A large number of bearer bonds on handb. A large number of inventory items with low sales pricesc. A large number of transactions processed in a short period of timed. A large number of fixed assets with easily identifiable serial numbers (R/12, AUD, #12, 89762)

13. Which of the following procedures would an auditor most likely perform in the planning stage of an audit?

a. Make a preliminary judgment about materialityb. Confirm a sample of the entity’s accounts payable with known creditorsc. Obtain written representations from management that there are no unrecorded transactions d. Communicate management’s initial selection of accounting policies to the audit committee

(R/12, AUD, #13, 89763)

14. An auditor is required to confirm accounts receivable if the accounts receivable balances are

a. Older than the prior yearb. Material to the financial statements c. Smaller than expectedd. Subject to valuation estimates (R/12, AUD, #14, 89764)

15. Under which of the following circumstances should an auditor consider confirming the terms of a large complex sale?

a. When the assessed level of control risk over the sale is lowb. When the assessed level of detection risk over the sale is highc. When the combined assessed level of inherent and control risk over the sale is moderate d. When the combined assessed level of inherent and control risk over the sale is high

(R/12, AUD, #15, 89765)

16. Of which of the following matters is a management representation letter required to contain specific representations?

a. Length of a material contract with a new customer b. Information concerning fraud by the CFOc. Reason for a significant increase in revenue over the prior yeard. The competency and objectivity of the internal audit department (R/12, AUD, #16, 89766)

17. In which of the following paragraphs of an auditor’s report does an auditor communicate the nature of the engagement and the specific financial statements covered by the audit?

a. Scope paragraph b. Opinion paragraphc. Introductory paragraphd. Explanatory paragraph (R/12, AUD, #17, 89767)

18. The understanding with the client regarding a financial statement audit generally includes which of the following matters?

a. The expected opinion to be issued b. The responsibilities of the auditor c. The contingency fee structured. The preliminary judgment about materiality (R/12, AUD, #18, 89768)


19. Under the Sarbanes-Oxley Act of 2002, exactly how many consecutive years may an audit partner lead an audit for an issuer?

a. Four years b. Five years c. Six yearsd. Seven years (R/12, AUD, #19, 89769)

20. A government internal audit function is presumed to be free from organizational independence impairments for reporting internally when the head of the organization

a. Is not accountable to those charged with governanceb. Performs auditing procedures that are consistent with generally accepted accounting principles c. Is a line-manager of the unit under auditd. Is removed from political pressures to conduct audits objectively, without fear of political reprisal

(R/12, AUD, #20 89770)

21. Each of the following is a type of known misstatement, except

a. An inaccuracy in processing datab. The misapplication of accounting principlesc. Differences between management and the auditor’s judgment regarding estimatesd. A difference between the classification of a reported financial statement element and the classi-

fication according to generally accepted accounting principles (R/12, AUD, #21, 89771)

22. An accountant can perform, with preapproval of the audit committee of the board of directors, which of the following non-audit services during the audit of an issuer?

a. Bookkeeping servicesb. Human resource services c. Tax planning servicesd. Internal audit outsourcing services (R/12, AUD, #22, 89772)

23. The controller of a small utility company has interviewed audit firms proposing to perform the annual audit of their employee benefit plan. According to the guidelines of the Department of Labor (DOL), the selected auditor must be

a. The firm that proposes the lowest fee for the work requiredb. Independent for purposes of examining financial information required to be filed annually with

the DOLc. Included on the list of firms approved by the DOLd. Independent of the utility company and not relying on its services (R/12, AUD, #23, 89773)

24. An accountant was asked by a potential client to perform a compilation of its financial statements.The accountant is not familiar with the industry in which the client operates. In this situation, which of the following actions is the accountant most likely to take?

a. Request that management engage an independent industry expert to consult with the accountant b. Accept the engagement and obtain an adequate level of knowledge about the industryc. Decline the engagementd. Postpone accepting the engagement until the accountant has obtained an adequate level of

knowledge about the industry (R/12, AUD, #24, 89774)


25. To compile financial statements of a nonissuer in accordance with Statements on Standards forAccounting and Review Services, an accountant should

a. Identify material misstatements in the financial statements b. Review bank statement reconciliationsc. Make inquiries of significant customers, vendors, and creditorsd. Obtain a general understanding of the client’s business transactions (R/12, AUD, #25, 89775)

Problem 2 MULTIPLE-CHOICE QUESTIONS

26. A CPA firm would best provide itself reasonable assurance of meeting its responsibility to offer professional services that conform with professional standards by

a. Establishing an understanding with each client concerning individual responsibilities in a signed engagement letter

b. Assessing the risk that errors and fraud may cause the financial statements to contain material misstatements

c. Developing specific audit objectives to support management’s assertions that are embodied in the financial statements

d. Maintaining a comprehensive system of quality control that is suitably designed in relation to its organizational structure (R/12, AUD, #26, 89776)

27. An auditor who is unable to form an opinion on a new client’s opening inventory balances may issue an unqualified opinion on the current year’s

a. Income statement onlyb. Statement of cash flows only c. Balance sheet onlyd. Statement of shareholders’ equity only (R/12, AUD, #27, 89777)

28. Which of the following procedures would a CPA most likely perform in the planning phase of a financial statement audit?

a. Make inquiries of the client’s lawyer concerning pending litigation b. Perform cutoff tests of cash receipts and disbursementsc. Compare financial information with nonfinancial operating datad. Recalculate the prior year’s accruals and deferrals (R/12, AUD, #28, 89778)

29. Zag Co. issues financial statements that present financial position and results of operations but Zag omits the related statement of cash flows. Zag would like to engage Brown, CPA, to audit its financial statements without the statement of cash flows although Brown’s access to all of the information underlying the basic financial statements will not be limited. Under these circumstances, Brown most likely would

a. Add an explanatory paragraph to the standard auditor’s report that justifies the reason for the omission

b. Refuse to accept the engagement as proposed because of the client-imposed scope limitation c. Explain to Zag that the omission requires a qualification of the auditor’s opiniond. Prepare the statement of cash flows as an accommodation to Zag and express an unqualified

opinion (R/12, AUD, #29, 89779)

30. Under the ethical standards of the profession, which of the following is a “permitted loan” regardless of the date it was obtained?

a. Home mortgage loan b. Student loanc. Secured automobile loand. Personal loan (R/12, AUD, #30, 89780)


31. In confirming a client’s accounts receivable in prior years, an auditor discovered many differences between recorded account balances and confirmation replies. These differences were resolved and were not misstatements. In defining the sampling unit for the current year’s audit, the auditor most likely would choose

a. Customers with credit balances b. Small account balancesc. Individual overdue balancesd. Individual invoices (R/12, AUD, #31, 89781)

32. An auditor is engaged to report on selected financial data that are included in a client-prepared document containing audited financial statements. Under these circumstances, the report on the selected data should

a. State that the presentation is a comprehensive basis of accounting other than GAAPb. Restrict the use of the report to those specified users within the entityc. Be limited to data derived from the entity’s audited financial statementsd. Indicate that the data are subject to prospective results that may not be achieved

(R/12, AUD, #32, 89782)

33. For which of the following audit tests would an auditor most likely use attribute sampling?

a. Inspecting purchase orders for proper approval by supervisors b. Making an independent estimate of recorded payroll expense c. Determining that all payables are recorded at year endd. Selecting accounts receivable for confirmation of account balances (R/12, AUD, #33, 89783)

34. According to the Code of Professional Conduct of the AICPA, for which type of service may a CPAreceive a contingent fee?

a. Performing an audit of a financial statement b. Performing a review of a financial statementc. Performing an examination of prospective financial informationd. Seeking a private letter ruling (R/12, AUD, #34, 89784)

35. Which of the following controls should prevent an invoice for the purchase of merchandise from being paid twice?

a. The check signer accounts for the numerical sequence of receiving reports used in support of each payment.

b. An individual independent of cash operations prepares a bank reconciliation. c. The check signer reviews and cancels the voucher packets.d. Two check signers are required for all checks over a specified amount.

(R/12, AUD, #35, 89785)

36. A client has capitalizable leases but refuses to capitalize them in the financial statements. Which of the following reporting options does an auditor have if the amounts pervasively distort the financial statements?

a. Qualified opinionb. Unqualified opinion c. Disclaimer opiniond. Adverse opinion (R/12, AUD, #36, 89786)


37. Which of the following items should be included in prospective financial statements issued in an attestation engagement performed in accordance with Statements on Standards for Attestation Engagements?

a. All significant assertions used to prepare the financial statementsb. All significant assumptions used to prepare the financial statements c. Pro forma financial statements for the past two yearsd. Historical financial statements for the past three years (R/12, AUD, #37, 89787)

38. A company employs three accounts payable clerks and one treasurer. Their responsibilities are as follows:

E m ployee Respons i bility Clerk 1 Reviews vendor invoices for proper signature approvalClerk 2 Enters vendor invoices into the accounting system and verifies payment termsClerk 3 Posts entered vendor invoices to the accounts payable ledger for payment and

mails checksTreasurer Reviews the vendor invoices and signs each check

Which of the following would indicate a weakness in the company’s internal control?

a. Clerk 1 opens all of the incoming mail.b. Clerk 2 reconciles the accounts payable ledger with the general ledger monthly. c. Clerk 3 mails the checks and remittances after they have been signed.d. The treasurer uses a stamp for signing checks. (R/12, AUD, #38, 89788)

39. Which of the following management assertions is an auditor most likely testing if the audit objective states that all inventory on hand is reflected in the ending inventory balance?

a. The entity has rights to the inventory. b. Inventory is properly valued.c. Inventory is properly presented in the financial statements.d. Inventory is complete. (R/12, AUD, #39, 89789)

40. Which of the following activities is an accountant not responsible for in review engagements performed in accordance with Statements on Standards for Accounting and Review Services?

a. Performing basic analytical procedures b. Remaining independentc. Developing an understanding of internal controld. Providing any form of assurance (R/12, AUD, #40, 89790)

41. Which of the following items should be included in an auditor’s report for financial statements prepared in conformity with an other comprehensive basis of accounting (OCBOA)?

a. A sentence stating that the auditor is responsible for the financial statements b. A title that includes the word “independent”c. The signature of the company controllerd. A paragraph stating that the audit was conducted in accordance with OCBOA

(R/12, AUD, #41, 89791)

42. Which of the following statements best describes why an auditor would use only substantive procedures to evaluate specific relevant assertions and risks?

a. The relevant internal control components are not well documented.b. The internal auditor already has tested the relevant controls and found them effective. c. Testing the operating effectiveness of the relevant controls would not be efficient.d. The cost of substantive procedures will exceed the cost of testing the relevant controls.

(R/12, AUD, #42, 89792)


43. Which of the following courses of action is the most appropriate if an auditor concludes that there is a high risk of material misstatement?

a. Use smaller, rather than larger, sample sizesb. Perform substantive tests as of an interim date c. Select more effective substantive testsd. Increase of tests of controls (R/12, AUD, #43, 89793)

44. Which of the following procedures would be generally performed when evaluating the accounts receivable balance in an engagement to review financial statements in accordance with Statements on Standards for Accounting and Review Services?

a. Perform a reasonableness test of the balance by computing days’ sales in receivables b. Vouch a sample of subsequent cash receipts from customersc. Confirm individually significant receivable balances with customersd. Review subsequent bank statements for evidence of cash deposits (R/12, AUD, #44, 89794)

45. In which of the following circumstances would a covered member’s independence be impaired with respect to a nonissuer client?

a. The member is designated to serve as guardian of a friend’s children if the need arises, and the friend’s estate, which would be held in trust for the children, holds significant stock ownership in a client entity.

b. The member’s spouse qualifies because of geographical residence to belong to a client’s credit union, and all transactions with the credit union are conducted under normal operating practices.

c. The member owns municipal utility bonds issued by a client, and the bonds are not material to the member’s wealth.

d. The member belongs to a client golf club that requires members to acquire a share of the club’s debt securities. (R/12, AUD, #45, 89795)

46. According to the AICPA Statements on Standards for Attestation Engagements, a public accounting firm should establish quality control policies to provide assurance about which of the following matters related to agreed-upon procedures engagements?

a. Use of the report is not restricted.b. The public accounting firm takes responsibility for the sufficiency of procedures. c. The practitioner is independent from the client and other specified parties.d. The practitioner sets the criteria to be used in the determination of findings.

(R/12, AUD, #46, 89796)

47. A cooling-off period of how many years is required before a member of an issuer’s audit engagement team may begin working for the registrant in a key position?

a. One year b. Two yearsc. Three yearsd. Four years (R/12, AUD, #47, 89797)


48. A CPA is engaged to audit the financial statements of a nonissuer. After the audit begins, the client’s management questions the extent of procedures and objects to the confirmation of certain contracts. The client asks the accountant to change the scope of the engagement from an audit to a review. Under these circumstances, the accountant should do each of the following, except

a. Issue an accountant’s review report with a separate paragraph discussing the change in engagement scope

b. Consider the additional audit effort and cost required to complete the auditc. Evaluate the possibility that financial statement information affected by the limitation on work to

be performed may be incorrect or incompleted. Consider the reason given for the client’s request and assess whether the request is reasonable

(R/12, AUD, #48, 89798)

49. Hart, CPA, is engaged to review the year 2 financial statements of Kell Co., a nonissuer. Pre- viously, Hart audited Kell’s year 1 financial statements and expressed a qualified opinion due to a scope limitation. Hart decides to include a separate paragraph in the year 2 review report because comparative financial statements are being presented for year 2 and year 1. This separate paragraph should indicate the

a. Substantive reasons for the prior-year’s qualified opinionb. Reason for changing the level of service from an audit to a reviewc. Consistency of application of accounting principles between year 2 and year 1d. Restriction on the distribution of the report for internal use only (R/12, AUD, #49, 89799)

50. Which of the following statements is generally correct about the sample size in statistical sampling when testing internal controls?

a. As the population size doubles, the sample size should increase by about 67%. b. The sample size is inversely proportional to the expected error rate.c. There is no relationship between the tolerable error rate and the sample size.d. The population size has little or no effect on the sample size. (R/12, AUD, #50, 89800)


Solution 1 MULTIPLE-CHOICE ANSWERS

1. (d) A compilation is not intended to provide assurance on the prospective financial statements or the assumptions underlying such statements; thus, an accountant who accepts an engagement to compile a financial projection most likely would make the client aware that the engagement does not include an evaluation of the support for the assumptions underlying the projection. Prospective financial statements may be included in a document that also contains audited historical financial statements. The standard report on a compilation of prospective financial statements includes a statement that the practitioner assumes no responsibility to update the report for events and circumstances occurring after the date of the report—it does not extend to one year. A financial forecast, not a projection, omits all hypothetical assumptions and presents the most likely future financial position. (Chapter 31-IV-B; 89751; CSO: I.D.0)

2. (d) A review of compliance with the terms of debt agreements is the audit procedure most likely to assist in the identification of conditions and events that may indicate there could be substantial doubt about an entity’s ability to continue as a going concern. Ordinarily, information that significantly contra- dicts the going concern assumption relates to the entity’s inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations, or similar actions. (Chapter 28-IX-B;89752; CSO: IV.G.0)

3. (c) Analytical audit procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. A basic premise underlying the application of analytical audit procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. They are used to assist the auditor in planning the nature, timing, and extent of other auditing procedures; as a substantive test to obtain audit evidence about particular assertions related to account balances or classes of transactions; and as an overall review of the financial information in the final review stage of the audit. All of the answers describe analytical audit procedures performed for these purposes except for projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics. This is an audit sampling procedure. Audit sampling is the application of audit procedures to less than100 percent of the population for the purpose of drawing conclusions about the population based on the results of the sample. (Chapter 24-IV-A; 89753; CSO: III.B.7)

4. (c) Whether or not the principal auditor decides to make reference to the audit of the other auditor, the principal auditor should make inquiries concerning the professional reputation and independence of the other auditor. When the principal auditor decides not to make reference to the audit of the other auditor, i.e., to assume responsibility for the work of the other auditor insofar as that work relates to the principal auditor’s expression of an opinion on the financial statements taken as a whole, the principal auditor should also consider whether to perform one or more of the following procedures: visit the other auditor and discuss the audit procedures followed and results; review the audit programs of the other auditor (in some cases, it may be appropriate to issue instructions to the other auditor as to the scope of his or her audit work); and review the working papers of the other auditor, including the understanding of internal control and the assessment of control risk. Regardless of the principal auditor’s decision (whether or not to refer to the other auditor’s work), the other auditor remains responsible for the performance of his or her own work, and for his or her own report; however this is not a matter ordinarily included in an engagement letter. The principal auditor is not required to obtain permission to omit the reference to the other auditor in the audit report. An explanatory paragraph should not be added to the auditor’s report. If the principal auditor decides not to refer to the audit of another auditor, no reference should be made to the other auditor’s work or report because to do so may cause a reader to misinterpret the degree of responsibility being assumed. (Chapter 28-III-C; 89754; CSO: I.E.1)

5. (d) In auditing related party transactions, an auditor ordinarily places primary emphasis on the adequacy of the disclosure of the related party transactions. (Chapter 24-VIII-C; 89755; CSO: II.I.3)

6. (b) When the accountant is unable to perform the inquiry and analytical procedures necessary to obtain limited assurance that there are no material modifications that should be made to the financial statements in order for them to be in conformity with the applicable financial reporting framework, or the


client does not provide the accountant with a representation letter, the review will be incomplete. A SSARS review does not contemplate obtaining an understanding of the entity’s internal control to assess control risk or for any reason; assessing fraud risk; testing accounting records by obtaining sufficient appropriate audit evidence through inspection, observation, confirmation, or the examination of source documents (for example, cancelled checks or bank images); or other procedures ordinarily performed in an audit. Thus, the review does not include tests of details of major account balances. The accountant should possess an understanding of the industry in which the client operates, including the accounting principles and practices generally used in the industry sufficient to assist the accountant with determining the specific nature, timing, and extent of review procedures to be performed. This requirement does not prevent the accountant from accepting a review engagement for an entity in an industry with which the accountant has no previous experience. It does, however, place upon the accountant a responsibility to obtain the required level of knowledge. (Chapter 31-I-C; 89756; CSO: V.A.2)

7. (b) Obtaining an understanding of an internal control involves evaluating the design of the control and determining whether the control has been implemented. (Chapter 23-II-C; 89757; CSO: III.B.3)

8. (a) Making inquiries of management is the procedure most likely to be performed in a review engagement of a nonissuer’s financial statements in accordance with SSARS. The accountant should perform procedures designed to accumulate review evidence that will provide a reasonable basis for obtaining limited assurance that there are no material modifications that should be made to the financial statements in order for them to be in conformity with the applicable financial reporting framework. Review evidence obtained through the performance of analytical procedures and inquiry will ordinarily provide the accountant with a reasonable basis for obtaining limited assurance; however, the accountant should perform additional procedures if necessary to obtain this limited assurance. (Written representations are also required from management for all financial statements and periods covered by the accountant’s review report.) Observing a year-end inventory count and examining subsequent cash receipts are examples of testing accounting records by obtaining sufficient appropriate audit evidence through inspection, observation, confirmation, or the examination of source documents which are not required for a review. Also, a SSARS review does not contemplate assessing the internal control system. (Chapter 31-I-C;89758; CSO: V.B.6)

9. (c) An auditor should consider management’s plans for disposal of assets when evaluating the ability of a company to continue as a going concern. Other examples the auditor should consider are the adequacy of support regarding plans to obtain additional financing by restructuring debt or borrowing money; reduce or delay expenditures; and/or to increase ownership equity. When evaluating management’s plans, the auditor should identify those elements that are particularly significant to overcoming the adverse effects of the conditions and events and should plan and perform auditing procedures to obtain audit evidence about them. The auditor should consider whether it is likely the adverse effects will be mitigated for a reasonable period of time and that such plans can be effectively implemented. The fear of losing audit fees or future assurance service engagements (if the client does go bankrupt) should not be a consideration in whether to issue a “going-concern opinion”. The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited. Thus, a lawsuit for which judgment is not anticipated for 18 months would not be relevant. Editor note: This question may have been released / dropped by the examiners due to the difference in the period an auditor is required to consider going concern issues according to U.S. auditing standards vs. International Standards of Auditing (ISA). ISA require a period of at least, but not limited to, 12 months, from the date of the financial statements. The period is extended if management’s plan extends beyond 12 months and can be extended by the auditor when there is knowledge of events or conditions (beyond the period covered by management’s plan) that may cast significant doubt about the entity’s ability to continue as a going concern. (Chapter 28-IX-D; 89759; CSO: IV.G.0)

10. (c) When there has been a change in an accounting principle or in the method of its application that has a material effect on the comparability of the company’s financial statements, the auditor should refer to the change in an explanatory paragraph of the report following the opinion paragraph (if the auditor determines it has been handled appropriately). This is not a qualification of the auditor’s opinion.


The paragraph should identify the nature of the change and make reference to the note in the financial statements that discusses the change in detail. (Chapter 28-I-B; 89760; CSO: IV.J.1)

11. (d) The best way to compensate for the lack of adequate segregation of duties in a small organization is to allow for greater management oversight of incompatible activities because it is the more con- stant control and a practical solution. Disclosing lack of segregation of duties to the external auditors during the annual review would not be effective because it could occur after the fact, moreover, establishing and maintaining effective internal control is the responsibility of management, not the auditors. Replacing personnel every three or four years is not effective because, again, it could occur after the fact, not to mention it is so draconian it could actually motivate some individuals to commit a crime if they became aware of the policy. An issue discovered during a yearly background check of accountants is not as effective because it could also occur after the fact. (Chapter 23-II-A; 89761; CSO: II.F.5)

12. (a) A large number of bearer bonds on hand most likely represents the highest risk of a misstatement arising from misappropriations of assets. Certain characteristics or circumstances may increase the susceptibility of assets to misappropriation, for example, large amounts of cash on hand or processed; inventory items that are small in size, of high value, or in high demand; easily convertible assets, such as bearer bonds, diamonds or computer chips; or fixed assets that are small in size, marketable, or lacking observable identification of ownership. A large number of inventory items with low sales prices or a large number of fixed assets with easily identifiable serial numbers would not be as attractive to a thief as bearer bonds. A large number of transactions processed in a short period of time is not a fraud risk factor. (Chapter 22-V-B; 89762; CSO: II.C.4)

13. (a) An auditor would most likely make a preliminary judgment about materiality in the planning stage of an audit. Audit risk and materiality affect the application of generally accepted auditing standards; thus, they need to be considered together during the planning of an audit in designing the nature, timing, and extent of audit procedures and later, in evaluating the results of those procedures. The confirmation of a sample of the entity’s accounts payable with known creditors is an example of an audit procedure that is not usually done unless evidence is uncovered that warrants it, so it would be unlikely to be performed early in the audit. The written representations from management should be made as of the date of the auditor’s report because the auditor is concerned with events occurring through the date of the report that may require adjustment to or disclosure in the financial statements; thus, this would not be obtained during the planning stage. The communication of management’s initial selection of accounting policies (the auditor’s views about qualitative aspects of the entity’s significant accounting practices, including accounting policies, accounting estimates, and financial statement disclosures) to the audit committee is an example of a required communication of a significant finding from the audit; thus, it is also unlikely to be communicated during the planning stage. (Chapter 22-II-F; 89763; CSO: II.A.0)

14. (b) An auditor is required to confirm accounts receivable if the accounts receivable balances are material to the financial statements. Confirmation of accounts receivable is a generally accepted auditing procedure. It is generally presumed that evidence obtained from third parties will provide the auditor with higher-quality audit evidence than is typically available from within the entity. Thus, there is a presumption that the auditor will request the confirmation of accounts receivable during an audit unless one of the following is true: accounts receivable are immaterial to the financial statements; the use of confirmations would be ineffective; or the auditor’s combined assessed level of inherent and control risk is low, and the assessed level, in conjunction with the evidence expected to be provided by analytical procedures or other substantive tests of details, is sufficient to reduce audit risk to an acceptably low level for the applicable financial statement assertions. (In many situations, both confirmation of accounts receivable and other substantive tests of details are necessary to reduce audit risk to an acceptably low level for the applicable financial statement assertions.) An auditor who has not requested confirmations in the examination of accounts receivable should document how he or she overcame this presumption. (Chapter 25- III-B; 89764; CSO: III.B.8)

15. (d) Unusual or complex transactions may be associated with high levels of inherent risk and control risk. If the combined assessed level of inherent and control risk over the occurrence of revenue related to a large complex sale is high, the auditor should consider confirming the terms of that sale. (Chapter 25-III-B; 89765; CSO: III.B.8)


16. (b) A management representation letter is required to contain specific representations about information concerning fraud by the CFO. (The specific representations should relate to knowledge of fraud or suspected fraud affecting the entity involving management; employees who have significant roles in internal control; or others where the fraud could have a material effect on the financial statements.) The other items are not appropriate for inclusion in the letter. (Chapter 24-III-B; 89766; CSO: III.B.19)

17. (c) An auditor communicates the nature of the engagement and the specific financial statements covered by the audit in the introductory paragraph of the audit report: We have audited the accompa- nying balance sheet of X Company as of December 31, 20XX, and the related statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. Editor note: The examiners may have released / dropped this question because the scope paragraph also contains information about the nature of the engagement; however, it does not list the financial statements. (Chapter 28-III-B; 89767; CSO: IV.J.1)

18. (b) The understanding with the client regarding a financial statement audit generally includes the responsibilities of the auditor. The other items are not appropriate for inclusion in the required engagement letter which documents the understanding. (Chapter 22-I-B; 89768; CSO: I.D.0)

19. (b) Under the Sarbanes-Oxley Act of 2002, the lead audit or coordinating partner and the reviewing partner must rotate off the audit every five years. (Chapter 32-VII-B; 89769; CSO: VI.A.6)

20. (d) A government internal audit function is presumed to be free from organizational independence impairments for reporting internally when the head of the organization is removed from political pressures to conduct audits objectively, without fear of political reprisal. (Chapter 29-I-B; 89770; CSO: VI.A.4)

21. (c) Known misstatements are specific misstatements identified during the audit arising from the incorrect selection or misapplication of accounting principles or misstatements of facts identified, including, for example, those arising from mistakes in gathering or processing data and the overlooking or misinterpretation of facts. A difference between management and the auditor’s judgment regarding [accounting] estimates is a likely misstatement. The other instance of a likely misstatement is a misstatement that the auditor considers likely to exist based on an extrapolation from audit evidence obtained, for example, the amount obtained by projecting known misstatements identified in an audit sample to the entire population from which the sample was drawn. (Chapter 22-II-C; 89771; CSO: IV.E.0)

22. (c) Tax planning services is an acceptable non-audit service that an accountant can perform, with preapproval of the audit committee of the board of directors, during the audit of an issuer. (Chapter32-I-C; 89772; CSO: VI.A.6)

23. (b) According to the guidelines of the Department of Labor (DOL), the selected auditor performing the annual audit of the company’s employee benefit plan must be independent for purposes of examining financial information required to be filed annually with the DOL. The selected auditor may be a customer of the utility company, does not have to be on any approved list of firms, and does not have to be the lowest fee bidder for the work required. (Chapter 32-I-C; 89773; CSO: VI.A.5)

24. (b) When an accountant is asked to compile financial statements and the accountant is not familiar with the client’s industry, the accountant most likely will accept the engagement and obtain an adequate level of knowledge about the industry. The requirement that the accountant possess a level of knowledge of the industry in which the client operates does not prevent the accountant from accepting a compilation engagement for an entity in an industry with which the accountant has no previous experience. It does, however, place upon the accountant a responsibility to obtain the required level of knowledge. Thus, the accountant is not required to decline or even postpone accepting the engagement. If the accountant decides to obtain the knowledge by consulting with an industry expert, the accountant, not management, should engage the expert. (Chapter 31-I-B; 89774; CSO: V.B.1)


25. (d) To compile financial statements of a nonissuer in accordance with SSARS, an accountant should obtain a general understanding of the client’s business transactions in order to compile financial statements that are appropriate in form for an entity operating in that industry. The accountant is not required to make inquiries or perform other procedures to verify, corroborate, or review information sup- plied by the entity. Thus, reviewing bank reconciliations or making inquiries of significant customers, vendors, and creditors is not required. Nor is the accountant compiling financial statements required to identify material misstatements in the financial statements. A compilation is a service, the objective of which is to assist management in presenting financial information in the form of financial statements without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements in order for the statements to be in conformity with the applicable financial reporting framework. Editor note: Before submission, the accountant should read the financial statements and consider whether such financial statements appear to be appropriate in form and free from obvious material errors. In this context, the term error refers to mistakes in the preparation of financial statements, including arithmetical or clerical mistakes, and mistakes in the application of accounting principles, including inadequate disclosure. This is a much narrower requirement than identifying material misstatements in the financial statements. (Chapter 31-I-B; 89775; CSO: V.B.1)

Solution 2 MULTIPLE-CHOICE ANSWERS

26. (d) The best way a CPA firm could best provide reasonable assurance of meeting its responsibility to offer professional services that conform with professional standards is by maintaining a comprehensive system of quality control that is suitably designed in relation to its organizational structure. (Chapter 21-IV-A; 89776; CSO: I.B.1)

27. (c) An auditor who is unable to form an opinion on a new client’s opening inventory balances may issue an unqualified opinion on the current year’s balance sheet only. When an auditor of a new client cannot become satisfied with the accuracy of opening inventory balances, this scope limitation affects the income, retained earnings, and cash flow statements, but not the balance sheet. (This is because cost of goods sold cannot be verified.) Thus, an unqualified opinion could be issued on the balance sheet and a disclaimer of opinion should be issued on the other financial statements. (Chapter 28-I-D; 89777; CSO: IV.J.1)

28. (c) During the planning phase of a financial statement audit a CPA would most likely compare financial information with nonfinancial operating data. This is an example of an analytical procedure. Analytical procedures are required during the planning phase. The latest date of the period coved by the lawyer’s response to an auditor’s inquiries should be as close as possible to the date of the auditor’s report, thus it is not likely these inquiries would be made during the planning phase. Cutoff tests of cash receipts and disbursements as well as the recalculation of the prior year’s accruals and deferrals are procedures performed during the gathering-evidence phase of the audit rather than the planning phase. (Chapter 24-IV-A; 89778; CSO: II.D.2)

29. (c) The auditor (Brown) is not required to prepare a basic financial statement and include it in the report if the company’s management declines to present the statement. In the case of the omission of a cash flow statement, a qualified opinion would be appropriate, with an explanatory paragraph added preceding the opinion paragraph. In accordance with a firm’s system of quality control regarding the accep- tance and continuance of client relationships and specific engagements, specifically those policies in place to minimize the risk of misunderstandings regarding the nature, scope, and limitations of the services to be performed, the auditor should explain to the client (Zag) that the omission requires a qualification of the auditor’s opinion. (Chapter 28-IV-A; 89779; CSO: I.D.0)

30. (c) A car loan that is collateralized by the vehicle is a permitted loan which will not impair independence, regardless of the date it was obtained. (Chapter 32-I-C; 89780; CSO: VI.A.1)


31. (d) When planning samples for tests of controls, the auditor will consider the relationship of the sample to the objective of the test of controls as well as the characteristics of the population. Confirma- tion replies relate directly to items appearing on individual invoices. (Chapter 26-I-F; 89781; CSO: III.B.8)

32. (c) When an auditor is engaged to report on selected financial data that are included in a client- prepared document containing audited financial statements, the report on the selected data should be limited to data derived from [and relates directly to] the [underlying accounting and other records used to prepare] the entity’s audited financial statements. None of the other answers are required report elements. Note that the question stipulates that the selected financial data is in a document containing the financial statements. The auditor may consider restricting the use of a separate report on supplementary information to the appropriate specified parties to avoid potential misinterpretation or misunderstanding of the supplementary information that is not presented with the financial statements. Editor note: When the entity presents the supplementary information with the financial statements, the auditor should report on the supplementary information in either an explanatory paragraph following the opinion paragraph in the auditor’s report on the financial statements or in a separate report. When the audited financial statements are not presented with the supplementary information, the auditor should report on the supplementary information in a separate report. In this case, the report should include a reference to the report on the financial statements, the date of that report, the nature of the opinion expressed on the financial statements, and any report modifications. (Chapter 30-I-A; 89782; CSO: IV.H.0)

33. (a) Attribute sampling is used to test the effectiveness of internal control procedures. For example, the auditor may be concerned with estimating the percentage of purchase orders that do not have proper authorization. Variable sampling is utilized when testing details of transactions and account balances. (Chapter 26-III-A; 89783; CSO: III.B.6)

34. (d) In some cases, contingent fees in certain tax matters are permitted. A contingent fee would be permitted when a member represents a client in an examination by a revenue agent of the client’s tax return, or when a member represents a client with obtaining a private letter ruling. (Chapter 32-III-B;89784; CSO: VI.I.1)

35. (c) If the check signer reviews and cancels the voucher packets that should prevent an invoice from being paid twice. All of the other answers are valid controls, but not for the purpose of preventing an invoice from being paid twice. (Chapter 23-VII-E; 89785; CSO: II.F.5)

36. (d) If a client has capitalizable leases but refuses to capitalize them in the financial statements and the amounts pervasively distort the financial statements, the auditor should issue an adverse opinion. Such an opinion is expressed when the financial statements taken as a whole are not presented fairly in conformity with generally accepted accounting principles. The auditor could issue an “except for” qualified opinion if the effect was material, but not pervasive. (Chapter 28-IV-B; 89786; CSO: IV.J.1)

37. (b) [A summary of] all significant assumptions used to prepare the financial statements should be included in prospective financial statements issued in an attestation engagement performed in accordance with SSAE. The summary of significant assumptions is essential to the reader’s understanding of prospective financial statements. Accordingly, the practitioner should not compile or perform an agreed- upon procedures engagement on prospective financial statements that exclude disclosure of the summary of significant assumptions. In an examination engagement if the presentation departs from the presentation guidelines because it fails to disclose assumptions that appear to be significant, the practitioner should express an adverse opinion. The other answers are not required to be included. (Chapter 31-IV-B; 89787; CSO: IV.J.7)

38. (c) The mailing of the checks and remittances by clerk 3 after they have been signed indicates a weakness in the company’s internal control due to improper segregation of duties. Incompatible functions place a person in the position to both perpetrate and conceal errors or fraud in the normal course of their duties. Therefore, a well designed plan of organization separates the duties of authorization, record keeping, and custody of assets. Clerk 3 has duties that encompass both custody of assets and record keeping. Signed checks should be independently mailed directly after signing without being returned to persons


involved in the invoice processing, check preparation, or recording functions. (Chapter 23-VII-E; 89788; CSO: II.F.5)

39. (d) If the audit objective states that all inventory on hand is reflected in the ending inventory balance an auditor is most likely testing the management assertion of completeness (inventory is complete): all assets, liabilities, and equity interests that should have been recorded have been recorded. Two of the other answers also are included in the category of assertions for account balances: the entity has rights to the inventory relates to the assertion of rights and obligations: the entity holds or controls the rights to assets, and liabilities are the obligations of the entity. The inventory is properly valued relates to the assertion of valuation and allocation: assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are recorded appropriately. The inventory is properly presented in the financial statements relates to the assertion of classification and understandability: financial information is appropriately presented and described and disclosures are clearly expressed. This assertion is included in the category of presentation and disclosure. Chapter 25-III-C; 89789; CSO: II.H.1)

40. (c) An accountant is not responsible for developing an understanding of internal control in review engagements performed in accordance with SSARS. A review does require the CPA to perform analytical procedures and remain independent. The objective of a review is to provide limited assurance. (Chapter 31-I-C; 89790; CSO: V.A.1)

41. (b) A title that includes the word “independent” should be included in an auditor’s report for financial statements prepared in conformity with an OCBOA. A statement that management, not the auditor, is responsible for the financial statements should be included. The manual or printed signature of the auditor’s firm, not the signature of the company controller, is required. A paragraph that states that the audit was conducted in accordance with generally accepted auditing standards, not with OCBOA, should also be included. (Chapter 30-II-B; 89791; CSO: IV.J.9)

42. (c) In some cases, the auditor may determine that performing only substantive procedures is appropriate to evaluate specific relevant assertions and risks. In those circumstances, the auditor may exclude the effect of controls from the relevant risk assessment. This may be because the auditor’s risk assessment procedures have not identified any effective controls relevant to the assertion or because testing the operating effectiveness of controls would be not be efficient. However, the auditor needs to be satisfied that performing only substantive procedures for the relevant assertions would be effective in reducing detection risk to an acceptably low level. (A combined audit approach using both tests of the operating effectiveness of controls and substantive procedures is often most effective.) The quality of the documentation of the internal control components would not be a factor in the auditor’s determination to use only substantive procedures. Because the auditor has the ultimate responsibility to express an opinion on the financial statements, judgments about assessments of inherent and control risks, the materiality of misstatements, the sufficiency of tests performed, the evaluation of significant accounting estimates, and other matters affecting the auditor’s report should always be those of the auditor. The auditor may consider cost / benefit in the determination of an appropriate audit procedure; however, in this case, there is no information about a benefit, the answer only states nonsensically that the proposed action is more expensive. (Chapter 22-VII-B; 89792; CSO: III.B.1)

43. (c) When an auditor concludes that there is a high risk of material misstatement (RMM) the most appropriate course of action is to select more effective substantive tests. The auditor’s selection of audit procedures is based on the RMM. The higher the auditor’s assessment of risk, the more reliable and relevant is the audit evidence sought by the auditor from substantive procedures. When there is a high RMM, the auditor is more likely to use larger, rather than smaller, sample sizes. The higher the RMM, the more likely it is that the auditor may decide it is more effective to perform substantive procedures nearer to, or at, the period end rather than at an earlier date, or to perform audit procedures unannounced or at unpredictable times. The auditor should increase the extent of tests of controls the more the auditor relies on the operating effectiveness of controls in the assessment of risk. This reliance on controls by the auditor is due to an expectation of a low, not high, RMM because the auditor believes the entity has effective controls. (Chapter 22-VII-B; 89793; CSO: III.A.1)


44. (a) Performing a reasonableness test of the balance by computing days’ sales in receivables would generally be performed when evaluating the accounts receivable balance in an engagement to review financial statements in accordance with SSARS. This is an example of an analytical procedure. Analytical procedures along with inquires will ordinarily provide the accountant with a reasonable basis for obtaining limited assurance which is the objective of a review. The other answers are examples of procedures ordinarily performed during an audit, not a review. A review according to SSARS does not contemplate obtaining an understanding of the entity’s internal control; assessing fraud risk; testing accounting records by obtaining sufficient appropriate audit evidence through inspection, observation, confirmation, or the examination of source documents (for example, cancelled checks or bank images); or other procedures ordinarily performed in an audit. (Chapter 31-I-C.; 89794; CSO: V.B.4)

45. (c) Independence is impaired if the member has a direct or material indirect financial interest in the client. A direct financial interest will impair independence even if it is immaterial. (Chapter 32-I-C;89795; CSO: VI.I.1)

46. (c) According to SSAE, a CPA may perform an agreed-upon procedures attest engagement provided that the CPA is independent. As a consequence of the role of the specified parties in agreeing upon the procedures performed, a practitioner’s report on such engagements should clearly indicate that its use is restricted to those specified parties. The specified parties, not the public accounting firm, are required to take responsibility for the sufficiency of the agreed-upon procedures [for their purposes]. The criteria to be used in the determination of findings are agreed upon between the CPA (practitioner) and the specified parties, not set by the CPA. (Chapter 31-IV-A; 89796; CSO: I.B.1)

47. (a) A cooling-off period of one year is required before a member of an issuers audit engagement team may begin working for the registrant in a key position. (Chapter 32-I-C; 89797; CSO: VI.A.6.)

48. (a ) If the accountant concludes that there is reasonable justification to change the engagement and if he or she complies with the standards applicable to a review engagement, the accountant should issue an appropriate review report. The report should not include reference to the original engagement; any audit procedures that may have been performed; or scope limitations that resulted in the changed engagement. (Chapter 31-I-C; 89798; CSO: V.A.4)

49. (a) The separate paragraph should indicate the substantive reasons for the prior-year’s qualified opinion. When the current-period financial statements of a nonissuer have been compiled or reviewed and those of the prior period have been audited, the accountant should issue an appropriate compilation or review report on the current-period financial statements and either the report on the prior period should be reissued or the report on the current period should include, as a separate paragraph, an appropriate description of the responsibility assumed for the financial statements of the prior period. In the latter case, the separate paragraph should indicate that the financial statements of the prior period were audited previously; the date of the previous report; the type of opinion expressed previously; if the opinion was other than unqualified, the substantive reasons; and that no auditing procedures were performed after the date of the previous report. (Chapter 31-II-E; 89799; CSO: V.C.2)

50. (d) When a sample is small in relation to the population, the population size has little or no effect on the determination of an appropriate sample size. (Chapter 26-III-C; 89800; CSO: III.B.6)


Solution 3-1 SIMULATION ANSWER: Internal Control Reporting

Situation Response

1. The client did not furnish adequate evidence for the auditor to evaluate the internal controls over inventory. All other evidence was provided.

I. Issue a disclaimer of opinion

2. The auditors examined the client’s internal controls over cash receipts and concluded that they are operating exactly as designed. How- ever, the design of the controls does not include control procedures to prevent misstatements and the potential omission of cash receipts.

C. Determine if the control deficiency is a materialweakness by obtaining further evidence

3. The auditors concluded that the ineffectiveness of the design of controls over accounts payable and cash disbursements represents a material weakness in internal control even though the financial statements are not materially misstated.

E. Express an adverse opinion on the internalcontrols

4. Management has not provided assurance that there are no material weaknesses in controls. Subsequent tests revealed no material weaknesses.

F. Express an unqualified opinion on the internalcontrols

5. The auditor’s prior-year report on internal control included an adverse opinion. The client has since modified internal controls. No material weaknesses were found in the current year.

F. Express an unqualified opinion on the internalcontrols

1. I. Issue a disclaimer of opinion(89883)

The auditor can express an opinion on the company’s internal control over financial reporting only if the auditor has been able to apply the procedures necessary in the circumstances. A scope limitation requires the auditor to disclaim an opinion or withdraw from the engagement. A disclaimer of opinion states that the auditor does not express an opinion on the effectiveness of internal control over financial reporting. The auditor should communicate, in writing, to management and the audit committee that the audit of internal control over financial reporting cannot be satisfactorily completed.

2. C. Determine if the control deficiency is a material weakness by obtaining further evidence

The auditor must evaluate the severity of each identified control deficiency to determine whether the defi- ciencies, individually or in combination, are material weaknesses as of the date of management’s assessment.

3. E. Express an adverse opinion on the internal controls

A material weakness in internal control over financial reporting may exist even when financial statements are not materially misstated. If one or more material weaknesses exist, the company’s internal control over financial reporting cannot be considered effective. Under these circumstances, the auditor must express an adverse opinion on the company’s internal control over financial reporting, unless there is a restriction on the scope of the engagement. The auditor should determine the effect the adverse opinion

on internal control has on the opinion on the financial statements. Additionally, the auditor should disclose whether the opinion on the financial statements was affected by the adverse opinion on internal control over financial reporting. The auditor must communicate, in writing, to management and the audit committee all material weaknesses identified during the audit. The written communication should be made prior to the issuance of the auditor’s report on internal control over financial reporting.

4. F. Express an unqualified opinion on the internal controls

The auditor is required to express an opinion directly on the company’s internal control over financial reporting rather than opining on management’s assessment. Thus, even though management did not provide assurance that there were no material weaknesses in controls, the problem stated that tests revealed no material weaknesses. Editor note: The problem stated that management has not provided assurance that there are no material weaknesses. Apparently the examiners did not intend for this to be interpreted as a failure to obtain written representations from management which would constitute a scope limitation. A scope limitation should result in the auditor’s withdrawal or issuance of a disclaimer of opinion. Apparently, the examiners also did not intend for this to be interpreted as a situation in which elements of management’s annual report on internal control are incomplete or improperly presented which would require the auditor to modify the audit report by adding an explanatory paragraph. Perhaps this issue is why the examiners released / dropped this simulation.

5. F. Express an unqualified opinion on the internal controls

No material weaknesses were found in the current year, thus the auditor can express an unqualified opinion.

Solution 3-2 SIMULATION ANSWER: Bank Reconciliation

Issues Potential Issues

1. Issue #1 D. Reconciliation was not reviewed in a timelymanner

2. Issue #2 K. Reconciliation was not agreed to bank state-ment balance at the appropriate date

3. Issue #3 O. Reconciliation contains stale checks

4. Issue #4 F. Reconciliation has unsubstantiated unrecordeditems

5. Issue #5 G. Reconciliation contains aged items that shouldhave been added to the bank balance

6. Issue #6 B. Reconciliation balance was not properly agreedto the December 31 general ledger balance

1. D. Reconciliation was not reviewed in a timely manner(89884)

The year-end close was expected to be completed on January 6, year 3, yet the reconciliation was not reviewed until March 2, year 3.

2. K. Reconciliation was not agreed to bank statement balance at the appropriate date

The reconciliation should have been agreed to the bank statement balance as of December 31, year 2, not to the balance as of January 3, year 3 per Note A.

3. O. Reconciliation contains stale checks

Outstanding checks should have recent dates. Stale-dated checks should be resolved by attempting to contact the payee and then taking the appropriate action.

4. F. Reconciliation has unsubstantiated unrecorded items

The bank reconciliation should identify unrecorded items. They should be researched and resolved.

5. G. Reconciliation contains aged items that should have been added to the bank balance

The deposit dated 10/25/year 2 should have been received by the bank on the date of the deposit or very soon thereafter. This should have already been investigated, resolved, and hopefully included in the bank balance.

6. B. Reconciliation balance was not properly agreed to the December 31 general ledger balance

Per Note B, the balance was incorrectly agreed to the January 1, year 3 general ledger balance instead of the December 31, year 2 balance.

Solution 3-3 SIMULATION ANSWER: Research

AU § 508 69 (89885)

.69 If, in an updated report, the opinion is different from the opinion previously expressed on the financial statements of a prior period, the auditor should disclose all the substantive reasons for the different opinion in a separate explanatory paragraph(s) preceding the opinion paragraph of his or her report. The explanatory paragraph(s) should disclose (a) the date of the auditor’s previous report, (b) the type of opinion previously expressed, (c) the circumstances or events that caused the auditor to express a different opinion, and (d) that the auditor’s updated opinion on the financial statements of the prior period is different from his or her previous opinion on those statements. The following is an example of an explanatory paragraph that may be appropriate when an auditor issues an updated report on the financial statements of a prior period that contains an opinion different from the opinion previously expressed:

Independent Auditor’s Report

[Same first and second paragraphs as the standard report]

In our report dated March 1, 20X2, we expressed an opinion that the 20X1 financial statements did not fairly present financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America because of two departures from such principles: (1) the Company carried its property, plant, and equipment at appraisal values, and provided for deprecia- tion on the basis of such values, and (2) the Company did not provide for deferred income taxes with respect to differences between income for financial reporting purposes and taxable income. As described in Note X, the Company has changed its method of accounting for these items and restated its 20X1 financial statements to conform with accounting principles generally accepted in the United States of America. Accordingly, our present opinion on the 20X1 financial statements, as presented herein, is different from that expressed in our previous report.

In our opinion, the financial statements referred to above, present fairly, in all material respects, the financial position of X Company as of December 31, 20X2 and 20X1, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

aicpa 2012 audit and assurance

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