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Chapter 14 Audit Reports

Audit Reports MULTIPLE CHOICE: 1.

An auditor would issue an adverse opinion if a. The audit was begun by other independent auditors who withdrew from the engagement. b. A qualified opinion cannot be given because the auditor lacks independence. c. The restriction on the scope of the audit was significant. d. The statements taken as a whole do not fairly present the financial condition and results of operations of the company. ANSWER:

2.

An audit report contains the following paragraph: "Because of the inadequacies in the company's accounting records during the year ended June 30, 2003, it was not practicable to extend our auditing procedures to the extent necessary to enable us to obtain certain evidential matter as it relates to classification of certain items in the consolidated statements of operations." This paragraph most likely describes a. A material departure from GAAP requiring a qualified audit opinion. b. An uncertainty that should not lead to a qualified opinion. c. A matter that the auditor wishes to emphasize and that does not lead to a qualified audit opinion. d. A material scope restriction requiring a qualification of the audit opinion. ANSWER:

3.

D

D

A limitation on the scope of the auditor's examination sufficient to preclude an unqualified opinion will always result when management a. Asks the auditor to report on the balance sheet and not on the other basic financial statements. b. Refuses to permit its lawyer to respond to the letter of audit inquiry. c. Discloses material related party transactions in the footnotes to the financial statements. d. Knows that confirmation of accounts receivable is not feasible.

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Chapter 14 Audit Reports

ANSWER: 4.

The auditor issued a qualified opinion covering the financial statements of Client A for the year ended December 31, 2002. The reason for the qualification was a departure from GAAP. In presenting comparative statements for the years ended December 31, 2002 nd 2003, the client revised the 2002 financial statements to correct the previous departure from GAAP. The auditor's 2003 report on the 12/31/02 and 12/31/03 comparative financial statements will a. Express a qualified opinion on the 2002 financial statements and an unqualified opinion on the 2003 statements. b. Express unqualified opinions on both the 2002 and 2003 financial statements. c. Retain the qualified opinion covering the 2002 statements, but add an explanatory paragraph describing the correction of the prior departure from GAAP. d. Render qualified audit opinions for both 2002 and 2003 financial statements given the 2003 carryover effect of the 2002 error. ANSWER:

5.

B

When financial statements are presented that are not in conformity with generally accepted accounting principles, an auditor may issue a(an) "Except for" Disclaimer opinion of an opinion a. Yes No b. Yes Yes c. No Yes d. No No ANSWER:

6.

B

A

Under which of the following circumstances would a disclaimer of opinion not be appropriate? a. The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances. b. The auditor is unable to determine the amounts associated with illegal acts committed by the client's management. c. The financial statements fail to contain adequate disclosure concerning related party transactions.

Chapter 14 Audit Reports d.

The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry.

ANSWER: 7.

A

An auditor's report would be designated as a special report when it is issued in connection with financial statements that are a. For an interim period and are subjected to a limited review. b. Unaudited and are prepared from a client's accounting records. c. Prepared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles. d. Purported to be in accordance with generally accepted accounting principles but do not include a presentation of the Statement of Cash Flows. ANSWER:

9.

C

An auditor may reasonably issue an "except for" qualified opinion for Inadequate Scope disclosure limitation a. Yes Yes b. Yes No c. No Yes d. No No ANSWER:

8.

233

C

A limitation on the scope of an auditor's examination sufficient to preclude an unqualified opinion will usually result when management a. Presents financial statements that are prepared in accordance with the cash receipts and disbursements basis of accounting. b. States that the financial statements are not intended to be presented in conformity with generally accepted accounting principles. c. Does not make the minutes of the Board of Directors' meetings available to the auditor. d. Asks the auditor to report on the balance sheet and not on the other basic financial statements. ANSWER:

C

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10.

Chapter 14 Audit Reports

When there is a significant change in accounting principle, an auditor's report should refer to the lack of consistency in a. The scope paragraph. b. An explanatory paragraph between the second paragraph and the opinion paragraph. c. The opinion paragraph. d. An explanatory paragraph following the opinion paragraph. ANSWER:

11.

Which of the following subsequent events will be least likely to result in an adjustment to the financial statements? a. Culmination of events affecting the realization value of accounts receivable owned as of the balance sheet date. b. Culmination of events affecting the realization of inventories owned as of the balance sheet date. c. Material changes in the settlement of liabilities which were estimated as of the balance sheet date. d. Material changes in the quoted market prices of listed investment securities since the balance sheet date. ANSWER:

12.

D

Soon after Boyd's audit report was issued, Boyd learned of certain related party transactions that occurred during the year under audit. These transactions were not disclosed in the notes to the financial statements. Boyd should a. Plan to audit the transactions during the next engagement. b. Recall all copies of the audited financial statements. c. Determine whether the lack of disclosure would affect the auditor's report. d. Ask the client to disclose the transactions in subsequent interim statements. ANSWER:

13.

D

C

Under which of the following circumstances would a disclaimer of opinion not be appropriate? a. The financial statements fail to contain adequate disclosure concerning related party transactions. b. The client refuses to permit its attorney to furnish

Chapter 14 Audit Reports

c. d.

information requested in a letter of audit inquiry. The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances. The auditor is unable to determine the amounts associated with illegal acts committed by the client's management.

ANSWER: 14.

D

Management of Blue Company has decided not to account for a material transaction in accordance with the provisions of an FASB Standard. In setting forth its reasons in a note to the financial statements, management has clearly demonstrated that due to unusual circumstances the financial statements presented in accordance with the FASB Standard would be misleading. The auditor's report should include an explanatory separate paragraph and contain a(an) a. Adverse opinion. b. Unqualified opinion. c. "Except for" qualified opinion. d. "Subject to" qualified opinion. ANSWER:

16.

A

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 "Except for" of opinion qualified opinion a. Yes Yes b. No No c. No Yes d. Yes No ANSWER:

15.

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B

In the "management discussion and analysis" contained in the 2002 annual report of Dermicile Corporation, management stated that total sales were $4.95 billion and net profit was $500 million. The audited sales and net profit, however, were $3.8 billion and $450 million respectively. The financial statements, contained in the annual report, reflected the audited figures and the CPA planned to issue an unqualified opinion. Upon noting the inconsistencies

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Chapter 14 Audit Reports between the MD&A and the audited financial statements, however, the CPA should a. Refer to the inconsistency in the audit report and issue a qualified audit opinion. b. Issue an unqualified opinion without an explanatory paragraph, because the MD&A is not covered in the audit report. c. Issue an unqualified audit opinion with an explanatory paragraph describing the inconsistency. d. Render an adverse opinion on the basis that management had intentionally misrepresented reported sales and net profit. ANSWER:

17.

When the audited financial statements of the prior year are presented together with those of the current year, the continuing auditor's report should cover a. Both years. b. Only the current year. c. Only the current year, but the prior year's report should be presented. d. Only the current year, but the prior year's report should be referred to. ANSWER:

18.

A

If the auditor believes that financial statements which are prepared on a comprehensive basis of accounting other than generally accepted accounting principles are not suitably titled, the auditor should a. Modify the auditor's report to disclose any reservations. b. Consider the effects of the titles on the financial statements taken as a whole. c. Issue a disclaimer of opinion. d. Add a footnote to the financial statements which explains alternative terminology. ANSWER:

19.

C

A

Morgan, CPA, is the principal auditor for a multi-national corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Morgan is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's examination. With respect to

Chapter 14 Audit Reports

237

Morgan's report on the consolidated financial statements, taken as a whole, Morgan a. Must not refer to the examination of the other auditor. b. Must refer to the examination of the other auditor. c. May refer to the examination of the other auditor. d. May refer to the examination of the other auditor, in which case Morgan must include in the auditor's report on the consolidated financial statements a qualified opinion with respect to the examination of the other auditor. ANSWER: 20.

A post-audit review, conducted by another audit partner, discovered that the audit team had failed to examine or confirm securities held in safekeeping. The amounts involved were material in relation to reported net assets. The unqualified audit report, along with the audited financial statements, had been released two months earlier. Based on this information, the audit team should a. Request the client for permission to examine or confirm the securities. b. Notify persons known to be relying on the audit report that the report can no longer be relied upon. c. Draft a revised audit report containing an opinion qualified for a scope restriction. d. Ignore the finding inasmuch as the financial statements and audit report have already been released. ANSWER:

21.

A

The auditor's report should be dated as of the date on which the a. Report is delivered to the client. b. Field work is completed. c. Fiscal period under audit ends. d. Review of the working papers is complete. ANSWER:

22.

C

B

After issuing the audit report, the auditor may become aware of information that would have affected the audit report had it been known at the time. Given discovery of such information, the auditor must take appropriate action. Which of the following actions would be considered inappropriate under these circumstances?

238

Chapter 14 Audit Reports a. b. c.

d.

Determine whether the information is reliable and whether the facts existed at the date of the audit report. Request the client to disclose, to financial statement users, the newly discovered facts and their impact on the financial statements. If the client refuses to inform third parties, the auditor should notify the board of directors and regulatory agencies having jurisdiction over the client that the auditors' report can no longer be relied upon. Draft a revised audit report expressing a qualified or adverse opinion, depending on the materiality of the effect, and transmit the report to the stockholders.

ANSWER: 23.

Which of the following best describes the auditor's responsibility for "other information" included in the annual report to stockholders which contains financial statements and the auditor's report? a. The auditor has no obligation to read the "other information." b. The auditor has no obligation to corroborate the "other information," but should read the "other information" to determine whether it is materially inconsistent with the financial statements. c. The auditor should extend the examination to the extent necessary to verify the "other information." d. The auditor must modify the auditor's report to state that the "other information is unaudited" or "not covered by the auditor's report." ANSWER:

24.

D

B

When an auditor conducts an examination in accordance with generally accepted auditing standards and concludes that the financial statements are fairly presented in accordance with a comprehensive basis of accounting other than generally accepted accounting principles such as the cash basis of accounting, the auditor should issue a a. Disclaimer of opinion. b. Review report. c. Qualified opinion. d. Special report. ANSWER:

D

Chapter 14 Audit Reports 25.

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In which of the following circumstances would an auditor be most likely to express an adverse opinion? a. The statements are not in conformity with the FASB Statements regarding the capitalization of leases. b. Information comes to the auditor's attention that raises substantial doubt about the entity's ability to continue in existence. c. The chief executive officer refuses the auditor access to minutes of board of directors' meetings. d. Control tests show that the entity's internal control is so poor that the financial records cannot be relied upon. ANSWER:

A

26.

Under which of the following circumstances would an unqualified audit opinion, followed by an explanatory paragraph, not be appropriate? a. The auditor wishes to emphasize that the client has entered into material transactions with related parties. The substance of the related party transactions is properly disclosed in the audited financial statements. b. The client has completed material transactions with related parties and the auditor is unable to persuade management to properly reflect the economic substance of the transactions in the financial statements. c. The client has used a method of revenue recognition that is at variance with promulgated accounting standards. The auditor, however, agrees with the departure on the basis that use of the promulgated standard would make the financial statements materially misleading. d. The auditor believes that substantial doubt exists concerning the ability of the client to continue as a going concern. ANSWER: 27.

B

Doe, an independent auditor, was engaged to perform an examination of the financial statements of Ally Incorporated one month after its fiscal year had ended. Although the inventory count was not observed by Doe, and accounts receivable were not confirmed by direct communication with debtors, Doe was able to gain satisfaction by applying

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Chapter 14 Audit Reports alternative auditing procedures. Doe's auditor's report will probably contain a. A standard unqualified opinion. b. An unqualified opinion and an explanatory middle paragraph. c. Either a qualified opinion or a disclaimer of opinion. d. An "except for" qualification. ANSWER:

28.

The adverse effects of events causing an auditor to believe there is substantial doubt about an entity's ability to continue as a going concern would most likely be mitigated by evidence relating to the a. Ability to expand operations into new product lines in the future. b. Feasibility of plans to purchase leased equipment at less than market value. c. Marketability of assets that management plans to sell. d. Committed arrangements to convert preferred stock to long-term debt. ANSWER:

29.

A

C

Comparative financial statements include the financial statements of a prior period which were examined by a predecessor auditor whose report is not presented. If the predecessor auditor's report was qualified, the successor auditor must a. Obtain written approval from the predecessor auditor to include the prior year's financial statements. b. Issue a standard comparative audit report indicating the division of responsibility. c. Express an opinion on the current year statements alone and make no reference to the prior year statements. d. Disclose the reasons for any qualification in the predecessor auditor's opinion. ANSWER:

D

30. When reporting on financial statements prepared on a comprehensive basis of accounting other than generally accepted accounting principles, the independent auditor should include in the report a paragraph that a. States that the financial statements are not intended to be in conformity with generally accepted accounting principles.

Chapter 14 Audit Reports b. c. d.

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States that the financial statements are not intended to have been examined in accordance with generally accepted auditing standards. Refers to the authoritative pronouncements that explain the comprehensive basis of accounting being used. Justifies the comprehensive basis of accounting being used.

ANSWER:

A

31.

After an audit report containing an unqualified opinion on a non-public client's financial statements was issued, the client decided to sell the shares of a subsidiary that accounts for 30% of its revenue and 25% of its net income. The auditor should a. Determine whether the information is reliable and, if determined to be reliable, request that revised financial statements be issued. b. Notify the entity that the auditor's report may no longer be associated with the financial statements. c. Describe the effects of this subsequently discovered information in a communication with persons known to be relying on the financial statements. d. Take no action because the auditor has no obligation to make any further inquiries. ANSWER: D

32.

An audit report contained the following wording: "In our opinion, except for the omission of the segment information referred to in the preceding paragraph..." This excerpt was taken from a(n) a. Unqualified audit opinion with an explanatory paragraph added to emphasize a matter. b. Unqualified audit opinion with an explanatory paragraph added to describe a material uncertainty. c. Audit opinion qualified due to a departure fr...