Chapter 5 Multiple-Choice Questions 1. easy d
While performing services for their clients, professionals have a duty to provide a level of care which is: a. free from judgment errors. b. superior. c. greater than average. d. reasonable.
2. easy b
Auditors who fail to exercise due care in their performance of professional services may be liable for: a. punitive liability. b. breach of contract. c. excess liability. d. criminal charges.
3. easy b
Which of the following may give rise to a business failure? a. An erroneous audit opinion is issued. b. Management may make ill-advised business decisions. c. Auditors may fail to uncover employee fraud. d. Poorly trained auditors may perform a company’s audit.
4. easy b
A(n) _____ failure occurs when an auditor issues an erroneous opinion as the result of an underlying failure to comply with auditing standards. a. business b. audit c. ethics d. process
5. easy a
The standard of due care to which the auditor is expected to adhere is referred to as the: a. prudent person concept. b. common law doctrine. c. due care concept. d. vigilant person concept.
6.
Auditors may be liable to their clients for:
easy a
7. easy b
a. b. c. d.
Punitive damages Yes No Yes No
Compensatory damages Yes No No Yes
Under the laws of agency, partners of a CPA firm may be liable for the work of others on whom they rely. This would not include: a. employees of the CPA firm. b. employees of the audit client. c. other CPA firms engaged to do part of the audit work. d. specialists employed by the CPA firm to provide technical advice on the audit.
Arens/Elder/Beasley
8. easy d
“Absence of reasonable care that can be expected of a person in a set of circumstances” defines: a. pecuniary negligence. b. gross negligence. c. extreme negligence. d. ordinary negligence.
9. easy c
An example of a breach of contract would likely include: a. an auditor’s refusal to return the client’s general ledger book until the client paid last year’s audit fees. b. a bank’s claim that an auditor had a duty to uncover material errors in financial statements that had been relied on in making a loan. c. a CPA firm’s failure to complete an audit on the agreed-upon date because the firm had a backlog of other work which was more lucrative. d. an auditor’s claim that the client staff is unqualified.
10. easy c
Privity of contract exists between: a. auditor and the federal government. b. auditor and third parties. c. auditor and client. d. auditor and client attorney.
11. easy b
Audit contracts (engagement letters): a. may be either oral or written. b. must be written. c. must be written and notarized. d. must be written if the client is regulated by the Securities and Exchange Commission.
12. easy d
An individual who is not party to the contract between a CPA and the client, but who is known by both and is intended to receive certain benefits from the contract is known as: a. a third party. b. a common law inheritor. c. a tort. d. a third-party beneficiary.
13. easy d
Laws that have been developed through court decisions rather than by passage through legislative bodies are: a. statutory laws. b. judicial laws. c. federal laws. d. common laws.
14. easy a
Laws that have been passed through state legislatures are: a. statutory laws. b. judicial laws. c. federal laws. d. common laws.
15. easy d
The assessment against a defendant of the full loss suffered by a plaintiff regardless of other parties’ liability in the wrongdoing is called: a. separate and proportionate liability. b. shared liability. c. unitary liability. d. joint and several liability.
Arens/Elder/Beasley
16. easy c
_____ risk represents the possibility that the auditor concludes after conducting an adequate audit that the financial statements were fairly stated when they were actually misstated. a. Business b. Process c. Audit d. Failure
17. easy a
The assessment against a defendant of that portion of the damage caused by the defendant’s negligence is called: a. separate and proportionate liability. b. joint and several liability. c. shared liability. d. unitary liability.
18. easy a
In third-party suits, which of the auditor’s defenses contends lack of privity of contract? a. Lack of duty. b. Non-negligent performance. c. Contributory negligence. d. Absence of causal connections.
19. easy c
Which of the following auditor’s defenses usually means non-reliance on the financial statements by the user? a. Lack of duty. b. Non-negligent performance. c. Lack of causal connections. d. Contributory negligence.
20. easy a
There are a number of things that the AICPA, representing the profession as a whole, can do to reduce the CPA’s exposure to lawsuits. One of them is to: a. sanction members for improper conduct and performance. b. deal only with clients possessing integrity. c. hire qualified auditors and train and supervise them. d. perform quality audits.
21. easy b
In connection with the audit of financial statements, an independent auditor could be responsible for failure to detect a material fraud if: a. statistical sampling techniques were not used on the audit engagement. b. the auditor planned the audit in a negligent manner. c. accountants performing important parts of the work failed to discover a close relationship between the treasurer and the cashier. d. the fraud was perpetrated by one employee who circumvented the existing internal controls.
22. medium b
Which of the following most accurately describes constructive fraud? a. Absence of reasonable care. b. Lack of slight care. c. Knowledge and intent to deceive. d. Extreme or unusual negligence without the intent to deceive.
23. medium c
Which of the following most accurately describes fraud? a. Absence of reasonable care. b. Lack of slight care. c. Knowledge and intent to deceive. d. Extreme or unusual negligence without the intent to deceive.
24.
Which of the following is an illustration of liability to clients under common law?
Arens/Elder/Beasley
medium a
a. b. c. d.
Client sues auditor for not discovering a theft of assets by an employee. Bank sues auditor for not discovering that borrower’s financial statements are misstated. Combined group of stockholders sue auditor for not discovering materially misstated financial statements. Federal government prosecutes auditor for knowingly issuing an incorrect audit report.
25. medium c
Which of the following is an illustration of liability under the federal securities acts? a. Client sues auditor for not discovering a theft of assets by an employee. b. Bank sues auditor for not discovering that borrower’s financial statements are misstated. c. Combined group of stockholders sue auditor for not discovering materially misstated financial statements. d. auditor sues client for not cooperating during engagement.
26. medium c
A third-party beneficiary is one which: a. has failed to establish legal standing before the court. b. does not have privity of contract and is unknown to the contracting parties. c. does not have privity of contract, but is known to the contracting parties and intended to benefit under the contract. d. may establish legal standing before the court after a contract has been consummated.
27. medium c
If the CPA negligently failed to properly prepare and file a client’s tax return, the CPA may be liable for: a. the penalties the client owes the IRS. b. the penalties and interest the client owes. c. the penalties and interest the client owes, plus the tax preparation fee the CPA charged. d. the penalties and interest, the tax preparation fee, and the amount of tax that was underpaid.
28. medium d
Historically, most major lawsuits against CPA firms have dealt with: a. disputes over income tax preparation services. b. disputes arising in the performance of MAS contracts. c. disputes over the accuracy of bookkeeping services. d. audited and unaudited financial statements.
29. medium c
“Privileged communication” between client and auditor is: a. available in all federal courts. b. not available in any court. c. available in several states. d. available for matters involving income taxes only.
30. medium a
Which of the following statements is true?
a. b. c. d.
Arens/Elder/Beasley
Gross negligence may constitute constructive fraud Yes No Yes No
Fraud requires the intent to deceive Yes Yes No No
All fraud should be detected during audit No Yes Yes No
31. medium b
32. medium d
Failure of a party to meet its obligations, thereby causing injury to another party to whom a duty was owed, is: a. breach of contract. b. tort action for negligence. c. constructive fraud. d. fraud. Tort actions against CPAs are more common than breach of contract actions because: a. there are more torts than contracts. b. the burden of proof is on the auditor rather than on the person suing. c. the person suing need prove only negligence. d. the amounts recoverable are normally larger.
33. medium c
The principal issue to be resolved in cases involving alleged negligence is usually: a. the amount of the damages suffered by plaintiff. b. whether to impose punitive damages on defendant. c. the level of care exercised by the CPA. d. whether defendant was involved in fraud.
34. medium c
In the auditing environment, failure to meet auditing standards is often: a. an accepted practice. b. a suggestion of negligence. c. conclusive evidence of negligence. d. tantamount to criminal behavior.
35. medium b
A common way for a CPA firm to demonstrate its lack of duty to perform is by use of a(n): a. expert witness’ testimony. b. audit contract, or engagement letter. c. management representation letter. d. confirmation letter.
36. medium a
The prudent person concept establishes that: a. the CPA firm is not expected to make only perfect judgments. b. an audit in accordance with GAAS is subject to limitations and cannot be relied upon for complete assurance that all errors and irregularities will be found. c. the courts do not require that the auditor become the insurer or guarantor of the accuracy of the statements. d. all CPAs are considered prudent.
37. medium d
To succeed in an action against the auditor, the client must be able to show that: a. the auditor was fraudulent. b. the auditor was grossly negligent. c. there was a written contract. d. there is a close causal connection between the auditor’s behavior and the damages suffered by the client.
38. medium a
A group typically included as “third parties” in common law is:
a. b. c. d.
Arens/Elder/Beasley
Actual and potential stockholders Yes No Yes No
Employees of client Yes No No Yes
39. medium a
The major conclusion of the 1931 Ultramares case was that:
40. medium a
Under common law, a foreseen user would be treated the same as:
a. b. c. d.
a. b. c. d.
ordinary negligence is insufficient for liability to third parties. ordinary negligence is sufficient for liability to third-party beneficiaries. fraud or gross negligence is sufficient for liability to third parties. auditors have no liabilities to third parties.
A primary beneficiary Yes No Yes No
A known third party Yes No No Yes
41. medium b
A broad interpretation of the rights of third-party beneficiaries holds that users that the auditor should have been able to foresee as being likely users of financial statements have the same rights as those with privity of contract. This is known as the concept of: a. foreseen users. b. foreseeable users. c. expected users. d. four-party contracts.
42. medium b
Which of the auditor’s defenses is ordinarily not available when lawsuits are filed by a third party? a. Absence of causal connections. b. Contributory negligence. c. Non-negligent performance. d. Lack of duty.
43. medium c
According to the principle established by the Restatement of Torts case, foreseen users must be members of: a. any potential user group. b. a legally protected class. c. a reasonably limited and identifiable user group. d. a reasonably limited and established user group.
44. medium c
The increased litigation under the federal securities laws has resulted from:
a. b. c. d. 45. medium a
The availability of class-action litigation Yes Yes Yes No
The strict liability standards imposed on CPAs by the securities laws Yes No Yes No
An excess of attorneys Yes No No No
Which of the following statements about the Securities Act of 1933 is not true? a. The amount of the potential recovery is the original purchase price plus punitive damages. b. It deals with the information in registration statements and prospectuses. c. It concerns only the reporting requirements for companies issuing new securities. d. The only parties that can recover from auditors are original purchasers of securities.
Arens/Elder/Beasley
46. medium b
Under the Securities Act of 1933, the auditor’s responsibility for making sure the financial statements were fairly stated extends to: a. the date of the financial statements. b. the date the registration statement becomes effective. c. the date of the audit report. d. one year beyond the date of the financial statements.
47. medium a
Under the Securities Exchange Act of 1934, which type of organizations is required to submit audited financial statements to the SEC? a. Every company with securities traded on national and over-the-counter exchanges. b. Every corporation. c. Every company issuing new securities. d. Every corporation which is chartered by a state government.
48. medium d
The Securities and Exchange Commission can impose all but which of the following sanctions? a. Suspend a CPA from auditing SEC clients. b. Prohibit a CPA from accepting new SEC clients for a period of time. c. Require a CPA to participate in continuing-education programs and make changes in their practice. d. Revoke a CPA license.
49. medium b
The Foreign Corrupt Practices Act (FCPA) of 1977: a. requires auditors to review and evaluate systems of internal control as a part of an audit. b. requires SEC registrants to maintain a reasonably complete and accurate set of records and an adequate system of internal control. c. requires auditors to review client’s internal control system in a manner which is thorough enough to judge whether client meets the requirements of the FCPA. d. requires auditors to file a report with the SEC if client’s internal control system is inadequate.
50. (SOX) medium a
While the Foreign Corrupt Practices Act of 1977 remains in effect, it has been largely superseded by which of the following? a. The Sarbanes-Oxley Act of 2002. b. The Racketeer Influenced and Corrupt Organization Act. c. The Federal False Statements Statute. d. The Federal Mail Fraud Statute.
51. medium c
Which of the following is not likely a factor in the increase in the number of lawsuits and sizes of awards to plaintiffs related to auditor behavior? a. Increased awareness of auditor responsibilities by users of financial statements. b. CPA firms are more willing to settle lawsuits. c. Difficulty judges and jurors have in understanding legal matters. d. Increased consciousness on the part of the SEC for its responsibility to protect investors.
52. medium b
Historically, one of the leading case of criminal action against CPAs is the: a. 1136 Tenants case. b. United States v. Simon case. c. Escott et al. v. Bar Chris case, aka Bar Chris. d. Ultramares Corporation v. Touche case.
53. medium a
A major purpose of federal securities regulations is to: a. provide sufficient reliable information to the investing public who purchases securities in the marketplace. b. establish the qualifications for accountants who are members of the profession. c. eliminate incompetent attorneys and accountants who participate in the registration of securities to be offered to the public.
Arens/Elder/Beasley
d.
provide a set of uniform standards and tests for accountants, attorneys, and others who practice before the Securities and Exchange Commission.
54. medium c
A CPA is subject to criminal liability if the CPA: a. refuses to turn over requested audit documentation to a client. b. performs an audit in a negligent manner. c. willfully omits a material fact from a set of financial statements. d. willfully breaches a contract with a client.
55. medium c
Which of the following best describes a trend in litigation involving CPAs? a. A CPA cannot render an opinion unless the CPA has audited all affiliates of a company. b. A CPA may not successfully assert that the CPA had no motive to be part of a fraud. c. A CPA may be exposed to criminal as well as civil liability. d. A CPA is primarily responsible for a client’s footnotes filed with the SEC.
56. medium a
Tort actions can be based on which of the following?
a. b. c. d.
Ordinary negligence Yes No Yes No
Gross negligence Yes No No Yes
57. medium b
The preferred defense in third-party suits is: a. lack of duty to perform. b. non-negligent performance. c. absence of causal connection. d. client fraud.
58. challenging a
Which of the following resulted in a federal law passed in 1995 that significantly reduced potential damages in securities-related litigation? a. Private Securities Litigation Reform Act. b. Public Securities Damages and Settlements Act. c. Racketeer Influenced and Corrupt Organization Act. d. U.S. Securities Claims Reform Act.
59. challenging b
The Private Securities Litigation Reform Act of 1995 reduced potential damages in securities-related litigation, but because the act applied only to federal courts, attorneys began taking cases to state courts. Which of the following eliminated this loophole? a. Private Securities Litigation Reform Amendment. b. Securities Litigation Uniform Standards Act of 1998. c. Racketeer Influenced and Corrupt Organization Act. d. U.S. Securities Claims Reform Act.
60. challenging c
One of the changes in auditing procedure which was brought about as a result of the 1136 Tenants case was that auditors were encouraged to begin using: a. letters of representation. b. confirmation letters. c. engagement letters. d. billet doux letters.
61. challenging c
The leading precedent-setting auditing case in third-party liability is: a. Escott et al. v. Bar Chris Construction Corp. b. Hochfelder v. Ernst & Ernst. c. Ultramares Corporation v. Touche. d. United States v. Simon.
Arens/Elder/Beasley
62. challenging d
Under common law, an individual or company that (1) does not have a contract with an auditor, (2) is known by the auditor in advance of the audit, and (3) will use the auditor’s report to make decisions about the client company has: a. no rights unless an auditor is grossly negligent. b. no rights unless an auditor is fraudulent. c. no rights against an auditor. d. the same rights against an auditor as a client.
63. challenging a
The basic legal concept which was affirmed in the 1985 New York case, Credit Alliance, was that: a. the auditor’s defense of privity of contract is still valid against third parties. b. the auditor is liable for ordinary negligence to specifically foreseen third parties. c. the auditor is liable for ordinary negligence to reasonably foreseeable third parties. d. the auditor’s defense of contributory negligence is no longer valid.
64. challenging c
Which of the following statements about the Securities Act of 1933 is not true? a. A third party that purchased securities described in the registration statement may sue the auditor for material misrepresentations or omissions in the audited financial statements. b. A third-party user does not have the burden of proof that he/she relied on the financial statements. c. A third-party user has the burden of proof that the auditor was either negligent or fraudulent in doing the audit. d. A third-party user does not have the burden of proof that the loss was caused by the misleading statements.
65. challenging b
The most significant audit issue that came as a result of the court decision in the Escott et al. v. Bar Chris Construction Corporation case in 1968 was: a. the court’s reaffirmation that the burden of proof was on the plaintiff to prove the auditor was negligent. b. the affirmation of the increased auditor’s responsibility when performing an S-1 review, a review of events subsequent to the balance sheet, for registration statements. c. the increased auditor responsibility when associated with unaudited financial statements. d. the court’s refusal to allow the percentage-of-completion method of accounting for revenues.
66. challenging a
Under the federal securities acts, one significant result occurring directly due to the Escott et al. v. Bar Chris Construction Corporation case was that SAS was changed to require: a. greater emphasis on subsequent events procedures. b. new standards for unaudited statements. c. a broader definition of third-party beneficiaries. d. more companies to file annual reports with the SEC.
67. challenging b
Under the Securities Exchange Act of 1934, most of the litigation against the auditor has been generated because of the auditor’s involvement with the: a. 8-K form. b. 10-K form. c. 10-Q form. d. S-1 form.
68. challenging a
Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934 are often referred to as: a. the antifraud provisions. b. the new issues provisions. c. the full-employment act for accountants. d. the RICO provisions.
Arens/Elder/Beasley
69. challenging c
In a leading securities law and CPA liabilities case, the U.S. Supreme Court ruled in 1976 in Hochfelder v. Ernst & Ernst that before CPAs could be held liable for Rule 10b-5 of the Securities Exchange Act of 1934, what would be required to be shown to the court was the auditor’s: a. ordinary negligence. b. gross negligence. c. knowledge and intent to deceive. d. financial gain at the expense of the plaintiff.
70. challenging d
The similarity that exists in both the United States v. Natelli case (i.e., the National Student Marketing case of 1975), and the ESM Government Securities v. Alexander Grant & Co. case of 1986 is that in each case: a. a partner in a national CPA firm served prison time. b. the partners were punished for the shoddy work of their subordinates. c. a presidential pardon kept them from serving time in prison and allowed them to retain their CPA licenses. d. the auditors were not convicted for failing to discover the problem in year 1, but for failing to disclose the problem when it was discovered in year 2.
71. challenging c
The Securities and Exchange Commission has authority to: a. prescribe specific auditing procedures to detect fraud concerning inventories and accounts receivable of companies engaged in interstate commerce. b. deny lack of privity as a defense in third-party actions for gross negligence against the auditors of public companies. c. determine accounting principles for the purpose of financial reporting by companies offering securities to the public. d. require a change of auditors of governmental entities after a given period of years as a means of ensuring auditor independence.
72. challenging a
The partnership of Booth & Haynes, CPAs, has been engaged to examine the financial statements of Paul, Inc., in connection with the registration of Paul’s securities with the Securities and Exchange Commission. Under these circumstances, which of the following statements is true? a. Booth & Haynes is assuming much greater third-party liability than it assumes on engagements under common law. b. If its examination is not fraudulent, Booth & Haynes may issue an appropriate disclaimer to the financial statements and thereby avoid liability. c. Booth & Haynes must incorporate if they wish to practice before the SEC. d. Booth & Haynes must be a large interstate firm if they wish to practice before the SEC.
73. challenging d
Gregory & Hedrick, a medium-sized CPA firm, employed Elise as a staff accountant. Elise was negligent while auditing several of the firm’s clients. Under these circumstances, which of the following statements is true? a. Elise would have no personal liability for negligence. b. Gregory & Hedrick is not liable for Elise’s negligence because CPAs are generally considered to be independent contractors. c. Gregory & Hedrick would not be liable for Elise’s negligence if Winters disobeyed specific instructions in the performance of the audits. d. Gregory & Hedrick can recover against its insurer on its malpractice policy even if one of the partners was also negligent in reviewing Elise’s work.
74. challenging b
The King Surety Company wrote a general fidelity bond covering thefts of assets by the employees of Wilson, Inc. Thereafter, Cooney, an employee of Wilson, embezzled $17,200 of company funds. When the activities were discovered, King paid Wilson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Wilson’s auditors, Lynch & Merritt, CPAs. Which of the following would be Lynch & Merritt’s best
Arens/Elder/Beasley
defense? a. King is not in privity of contract. b. The shortages were the result of clever forgeries and collusive fraud which would not be detected by an examination made in accordance with generally accepted auditing standards. c. Lynch & Merritt were not guilty either of gross negligence or fraud. d. Lynch & Merritt were not aware of the King-Wilson surety relationship. 75. challenging c
As a consequence of his failure to adhere to generally accepted auditing standards in the course of his examination of the Lamp Corp., Harrison, CPA, did not detect the embezzlement of a material amount of funds by the company’s controller. As a matter of common law, to what extent would Harrison be liable to the Lamp Corp. for losses attributable to the theft? a. He would have no liability, since the ordinary examination cannot be relied upon to detect thefts of assets by employees. b. He would have no liability because privity of contract is lacking. c. He would be liable for losses attributable to his negligence. d. He would be liable only if it could be proven that he was grossly negligent.
76. challenging b
In connection with a public offering of first mortgage bonds by Henson Corp., the bond underwriter has asked Henson’s CPA to furnish him with a comfort letter giving as much assurance as possible relative to Henson’s unaudited financial statements for the three months ended March 31, 2007. The CPA had expressed an unqualified opinion on Henson’s financial statements for the year ended December 31, 2006 and he has performed a limited review of Henson’s financial statements for the three months ended March 31, 2007. Nothing has come to his attention that would indicate that the March 31, 2007 statements are not properly presented. Under these circumstances, the CPA’s response to the underwriter’s request should be to: a. furnish to the underwriters an opinion that the March 31, 2007 statements are fairly presented subject to year-end audit adjustments. b. give negative assurance as to the March 31, 2007 financial statements but disclaim an opinion on these statements. c. inform the underwriters that no comfort letter is possible without an audit of the financial statements for the three months ended March 31, 2007. d. Furnish to the underwriters an adverse opinion covering financial statements for the three months ended March 31, 2007.
Arens/Elder/Beasley
Chapter 6 Multiple-Choice Questions 1. easy a
The objective of the ordinary audit of financial statements is the expression of an opinion on: a. the fairness of the financial statements. b. the accuracy of the financial statements. c. the accuracy of the annual report. d. the balance sheet and income statement.
2. easy c
If the auditor believes that the financial statements are not fairly stated or is unable to reach an conclusion because of insufficient evidence, the auditor: a. should withdraw from the engagement. b. should request an increase in audit fees so that more resources can be used to conduct the audit. c. has the responsibility of notifying financial statement users through the auditor’s report. d. should notify regulators of the circumstances.
3. easy d
Auditors accumulate evidence to: a. defend themselves in the event of a lawsuit. b. justify the conclusions they have otherwise reached. c. satisfy the requirements of the Securities Acts of 1933 and 1934. d. enable them to reach conclusions about the fairness of the financial statements.
4. easy b
The responsibility for adopting sound accounting policies and maintaining adequate internal control rests with the: a. board of directors. b. company management. c. financial statement auditor. d. company’s internal audit department.
5. easy a
The auditor’s best defense when material misstatements are not uncovered is to have conducted the audit: a. in accordance with auditing standards. b. as effectively as reasonably possible. c. in a timely manner. d. only after an adequate investigation of the management team.
6. easy a
If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can: Issue an adverse audit report Issue a qualified audit report a. Yes Yes b. No No c. Yes No d. No Yes
7. easy b
If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can do all but which of the following? a. Issue an adverse audit report. b. Issue a disclaimer of opinion. c. Withdraw from the engagement. d. Issue a qualified audit report.
Arens/Elder/Beasley
8. easy d
Which of the following is not one of the reasons that auditors provide only reasonable assurance on the financial statements? a. The auditor commonly examines a sample, rather than the entire population of transactions. b. Accounting presentations contain complex estimates which involve uncertainty. c. Fraudulently prepared financial statements are often difficult to detect. d. Auditors believe that reasonable assurance is sufficient in the vast majority of cases.
9. (Public) challenging c
In certifying their annual financial statements, the CEO and CFO of a public company certify that the financial statements comply with the requirements of: a. GAAP. b. the Sarbanes-Oxley Act. c. the Securities Exchange Act of 1934. d. GAAS.
10. easy a
Which of the following statements is most correct regarding errors and fraud? a. An error is unintentional, whereas fraud is intentional. b. Frauds occur more often than errors in financial statements. c. Errors are always fraud and frauds are always errors. d. Auditors have more responsibility for finding fraud than errors.
11. (SOX) easy c
Which of the following statements is true of a public company’s financial statements? a. Sarbanes-Oxley requires the CEO only to certify the financial statements. b. Sarbanes-Oxley requires the CFO only to certify the financial statements. c. Sarbanes-Oxley requires the CEO and CFO to certify the financial statements. d. Sarbanes-Oxley neither requires the CEO nor the CFO to certify the financial statements.
12. easy b
Which of the following is not one of the three categories of assertions? a. Assertions about classes of transactions and events for the period under audit b. Assertions about financial statements and correspondence to GAAP c. Assertions about account balances at period end d. Assertions about presentation and disclosure
13. easy d
If a short-term note payable is included in the accounts payable balance on the financial statement, there is a violation of the: a. completeness assertion. b. existence assertion. c. cutoff assertion. d. classification and understandability assertion.
14. easy b
Professional skepticism requires auditors to possess a(n) ______ mind. a. introspective b. questioning c. intelligent d. unbelieving
15. easy c
The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not ________ are detected. a. b. c. d.
Arens/Elder/Beasley
important to the financial statements statistically significant to the financial statements material to the financial statements identified by the client
16. easy c
Fraudulent financial reporting is most likely to be committed by whom? a. Line employees of the company. b. Outside members of the company’s board of directors. c. Company management. d. The company’s auditors.
17. easy c
Which of the following would most likely be deemed a direct-effect illegal act? a. Violation of federal employment laws. b. Violation of federal environmental regulations. c. Violation of federal income tax laws. d. Violation of civil rights laws.
18. easy a
The concept of reasonable assurance indicates that the auditor is: a. not an insurer of the correctness of the financial statements. b. not responsible for the fairness of the financial statements. c. responsible only for issuing an opinion on the financial statements. d. responsible for finding all misstatements.
19. easy a
Tests of details of balances are specific procedures intended to: a. test for monetary errors in the financial statements. b. prove that the accounts with material balances are classified correctly. c. prove that the trial balance is in balance. d. identify the details of the internal control system.
20. easy c
Which of the following is the auditor least likely to do when aware of an illegal act? a. Discuss the matter with the client’s legal counsel. b. Obtain evidence about the potential effect of the illegal act on the financial statements. c. Contact the local law enforcement officials regarding potential criminal wrongdoing. d. Consider the impact of the illegal act on the relationship with the company’s management.
21. medium c
The auditor gives an audit opinion on the fair presentation of the financial statements and associates his or her name with it when, on the basis of adequate evidence, the auditor concludes that the financial statements are unlikely to mislead: a. investors. b. management. c. a prudent user. d. the reader.
22. medium b
The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to: a. the auditor. b. management. c. both management and the auditor equally. d. management for the statements and the auditor for the notes.
23. medium a
When engaged to audit the financial statements, it is acceptable for the auditor to draft:
a. b. c. d. 24. medium a
The client’s financial statements Yes No Yes No
The footnotes to the client’s financial statements Yes No No Yes
The auditor has considerable responsibility for notifying users as to whether or not the statements are properly stated. This imposes upon the auditor a duty to: a. provide reasonable assurance that material misstatements will be detected.
Arens/Elder/Beasley
b. c. d.
be a guarantor of the fairness in the statements. be equally responsible with management for the preparation of the financial statements. be an insurer of the fairness in the statements.
25. easy b
“The auditor should not assume that management is dishonest, but the possibility of dishonesty must be considered.” This is an example of: a. unprofessional behavior. b. an attitude of professional skepticism. c. due diligence. d. a rule in the AICPA’s Code of Professional Conduct.
26. medium d
If the auditor were responsible for making certain that all of management’s assertions in the financial statements were absolutely correct: a. bankruptcies could no longer occur. b. bankruptcies would be reduced to a very small number. c. audits would be much easier to complete. d. audits would not be economically feasible.
27. medium d
The auditor’s best defense when existing material misstatements in the financial statements are not uncovered in the audit is: a. the audit was conducted in accordance with generally accepted accounting principles. b. the financial statements are the client’s responsibility. c. the client is guilty of contributory negligence. d. the client is guilty of fraudulent misrepresentation.
28. medium a
Fraudulent financial reporting is often called: a. management fraud. b. theft of assets. c. defalcation. d. embezzlement.
29. challenging c
Which of the following statements is usually true? a. It is easier for the auditor to uncover fraud than errors. b. It is easier for the auditor to uncover indirect-effect illegal acts than fraud. c. The auditor’s responsibility for detecting direct-effect illegal acts is similar to the responsibility to detect fraud. d. The auditor’s responsibility for detecting indirect-effect illegal acts is similar to the responsibility to detect fraud.
30. medium c
Auditing standards make _____ distinction(s) between the auditor’s responsibilities for searching for errors and fraud. a. little b. a significant c. no d. various
31. medium b
In comparing management fraud with employee fraud, the auditor’s risk of failing to discover the fraud is: a. greater for management fraud because managers are inherently more deceptive than employees. b. greater for management fraud because of management’s ability to override existing internal controls. c. greater for employee fraud because of the higher crime rate among blue collar workers. d. greater for employee fraud because of the larger number of employees in the organization.
32.
Which of the following statements is correct with respect to the auditor’s responsibilities
Arens/Elder/Beasley
medium a
relative to the detection of indirect-effect illegal acts? a. The auditor has no responsibility for searching for indirect-effect illegal acts. b. The auditor has the same responsibility for searching for indirect-effect illegal acts as any other potential misstatement that may occur. c. Auditors have responsibility for searching for any illegal act, whether direct-effect or indirect-effect. d. Discovery of indirect-effect illegal acts is usually easier than discovery of fraud.
33. medium c
When comparing the auditor’s responsibility for detecting employee fraud and for detecting errors, the profession has placed the responsibility: a. more on discovering errors than employee fraud. b. more on discovering employee fraud than errors. c. equally on discovering either one. d. on the senior auditor for detecting errors and on the manager for detecting employee fraud.
34. medium a
If several employees collude to falsify documents, the chance a normal audit would uncover such acts is: a. very low. b. very high. c. zero. d. none of the above.
35. medium d
When planning the audit, if the auditor has no reason to believe that illegal acts exist, the auditor should: a. include audit procedures which have a strong probability of detecting illegal acts. b. still include some audit procedures designed specifically to uncover illegalities. c. ignore the issue. d. make inquiries of management regarding their policies for detecting and preventing illegal acts and regarding their knowledge of violations, and then rely on normal audit procedures to detect errors, irregularities, and illegalities.
36. medium
When the auditor has reason to believe an illegal act has occurred, the auditor should: a. inquire of management only at one level below those likely to be involved with the illegality. b. begin communication with the FASB in accordance with PCAOB regulations. c. consider accumulating additional evidence to determine if there is actually an illegal act. d. withdraw from the engagement.
c
37. medium b
When the auditor knows that an illegal act has occurred, the auditor must: a. report it to the proper governmental authorities. b. consider the effects on the financial statements, including the adequacy of disclosure. c. withdraw from the engagement. d. issue an adverse opinion.
38. (Public) medium c
If an auditor uncovers an illegal act at a public company, the auditor must notify: a. local law enforcement officials. b. the Public Company Accounting Oversight Board. c. the Securities and Exchange Commission. d. all of the above.
39. medium a
Why does the auditor divide the financial statements into smaller segments? a. Using the cycle approach makes the audit more manageable. b. Most accounts have few relationships with others and so it is more efficient to break the financial statements into smaller pieces. c. The cycle approach is used because auditing standards require it. d. All of the above are correct.
Arens/Elder/Beasley
40. medium b
Why does the auditor divide the financial statements into segments around the financial statement cycles? a. Most auditors are trained to audit cycles as opposed to entire financial statements. b. The approach aids in the assignment of tasks to different members of the audit team. c. The cycle approach is required by auditing standards. d. The cycle approach allows the auditor to detect indirect-effect illegal acts.
41. medium a
The most important general ledger account included in and affecting several cycles is the: a. cash account. b. inventory account. c. income tax expense and liability accounts. d. retained earnings account.
42. medium a
Management assertions are: a. implied or expressed representations about accounts, transactions, and disclosures in the financial statements. b. stated in the footnotes to the financial statements. c. explicitly expressed representations about the financial statements. d. provided to the auditor in the assertions letter, but are not disclosed on the financial statements.
43. medium a
Which of the following statements is true? a. Audit objectives follow and are closely related to management assertions. b. Management’s assertions follow and are closely related to the audit objectives. c. The auditor’s primary responsibility is to find and disclose fraudulent management assertions. d. Assertions about presentation and disclosure deal with whether the accounts have been included in the financial statements at appropriate amounts.
44. medium b
Which of the following statements is true regarding the distinction between general audit objectives and specific audit objectives for each account balance? a. The specific audit objectives are applicable to every account balance on the financial statements. b. The general audit objectives are applicable to every account balance on the financial statements. c. The general audit objectives are stated in terms tailored to the engagement. d. For any given class of transactions, usually only one audit objective must be met to conclude the transactions are properly recorded..
45. medium c
Which of the following statements about the existence and completeness assertions is not true? a. The existence and completeness assertions emphasize different audit concerns. b. Existence deals with overstatements and completeness deals with understatements. c. Existence deals with understatements and completeness deals with overstatements. d. The completeness assertion deals with unrecorded transactions.
46. medium b
The occurrence assertion applies to _______. a. presentation and disclosure matters b. classes of transactions and events during the period c. account balances d. proper classification of income statement accounts
47. medium b
Which of the following management assertions is not associated with transaction-related audit objectives? a. Occurrence b. Classification and understandability
Arens/Elder/Beasley
c. d.
Accuracy Completeness
48. medium d
Which of the following statements is not true? a. Balance-related audit objectives are applied to account balances. b. Transaction-related audit objectives are applied to classes of transactions. c. Balance-related audit objectives are applied to the ending balance in balance sheet accounts. d. Balance-related audit objectives are applied to both beginning and ending balances in balance sheet accounts.
49. medium b
In testing for cutoff, the objective is to determine: a. whether all of the current period’s transactions are recorded. b. whether transactions are recorded in the correct accounting period. c. the proper cutoff between capitalizing and expensing expenditures. d. the proper cutoff between disclosing items in footnotes or in account balances.
50. medium b
The detail tie-in objective is not concerned that the details in the account balance: a. agree with related subsidiary ledger amounts. b. are properly disclosed in accordance with GAAP. c. foot to the total in the account balance. d. agree with the total in the general ledger.
51. medium b
The detail tie-in is part of the_______ assertion for account balances. a. classification b. valuation and allocation c. rights and obligations d. completeness
52. medium a
Which of the following is not a proper match of a transaction-related audit objective and management assertion? a. Accuracy and cutoff. b. Classification and classification. c. Posting and summarization with accuracy. d. Occurrence and occurrence.
53. medium d
Which of the following statements is not correct? a. There are many ways an auditor can accumulate evidence to meet overall audit objectives. b. Sufficient appropriate evidence must be accumulated to meet the auditor’s professional responsibility. c. It is appropriate to minimize the cost of accumulating evidence. d. Gathering evidence and minimizing costs are equally important considerations that affect the approach the auditor selects.
54. medium a
Two overriding considerations affect the many ways an auditor can accumulate evidence: 1. Sufficient appropriate evidence must be accumulated to meet the auditor’s professional responsibility. 2. Cost of accumulating evidence should be minimized. In evaluating these considerations: a. the first is more important than the second. b. the second is more important than the first. c. they are equally important. d. it is impossible to prioritize them.
55. medium
If the auditor has obtained a reasonable level of assurance about the fair presentation of the financial statements through understanding internal control, assessing control risk, testing
Arens/Elder/Beasley
b
controls, and analytical procedures, then the auditor: a. can issue an unqualified opinion. b. can significantly reduce other substantive tests. c. can write the engagement letter. d. needs to perform additional tests of controls so that the assurance level can be increased.
56. medium d
After the auditor has completed all audit procedures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This is a highly subjective process that relies heavily on: a. generally accepted auditing standards. b. the AICPA’s Code of Professional Conduct. c. generally accepted accounting principles. d. the auditor’s professional judgment.
57. medium c
Which of the following combinations is correct? a. Existence relates to whether the amounts in accounts are understated. b. Occurrence relates to whether balances exist. c. Existence relates to whether amounts included exist. d. Occurrence relates to whether the amounts in accounts occurred in the proper year.
58. medium b
If an auditor conducted an audit in accordance with auditing standards, which of the following would the auditor likely detect? a. Unrecorded transactions. b. Incorrect postings of recorded transactions. c. Counterfeit signatures on paid checks. d. Fraud involving collusion.
59. medium a
Which of the following statements best describes the auditor’s responsibility with respect to illegal acts that do not have a material effect on the client’s financial statements? a. Generally, the auditor is under no obligation to notify parties other than personnel within the client’s organization. b. Generally, the auditor is under an obligation to inform the PCAOB. c. Generally, the auditor is obligated to disclose the relevant facts in the auditor’s report. d. Generally, the auditor is expected to compel the client to adhere to requirements of the Foreign Corrupt Practices Act.
60. medium c
Which of the following statements best describes the auditor’s responsibility regarding the detection of fraud? a. The auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance of audit procedures specifically described in the engagement letter. b. The auditor must extend auditing procedures to actively search for evidence of fraud in all situations. c. The auditor must extend auditing procedures to actively search for evidence of fraud where the examination indicates that fraud may exist. d. The auditor is responsible for the failure to detect fraud only when an unqualified opinion is issued.
61. medium b
The essence of the attest function is to: a. assure the consistent application of correct accounting procedures. b. determine whether the client’s financial statements are fairly stated. c. examine individual transactions so that the auditor may certify as to their validity. d. detect collusion and fraud.
62. medium
The primary difference between an audit of the balance sheet and an audit of the income statement is that the audit of the income statement deals with the verification of:
Arens/Elder/Beasley
a
a. b. c. d.
63. challenging c
The auditor’s evaluation of the likelihood of material employee fraud is normally done initially as a part of: a. tests of controls. b. tests of transactions. c. understanding the entity’s internal control. d. the assessment of whether to accept the audit engagement.
64. challenging c
When using the cycle approach to segmenting the audit, the reason for treating capital acquisition and repayment separately from the acquisition of goods and services is that: a. the transactions are related to financing a company rather than to its operations. b. most capital acquisition and repayment cycle accounts involve few transactions, but each is often highly material and therefore should be audited extensively. c. both a and b are correct. d. neither a nor b is correct.
65. challenging c
Illegal acts are defined in SAS 54 (AU217) as: a. violations of laws or government regulations. b. violations of laws or government regulations other than errors. c. violations of laws or government regulations other than fraud. d. violations of law which would result in the arrest of the perpetrator.
66. challenging b
Most illegal acts affect the financial statements: a. directly. b. only indirectly. c. both directly and indirectly. d. materially if direct; immaterially if indirect.
67. challenging a
With respect to the detection of illegal acts, auditing standards state that the auditor provides: a. no assurance that they will be detected. b. the same reasonable assurance provided for other items. c. assurance that they will be detected, if material. d. assurance that they will be detected, if highly material.
68. challenging d
In describing the cycle approach to segmenting an audit, which of the following statements is not true? a. All general ledger accounts and journals are included at least once. b. Some journals and general ledger accounts are included in more than one cycle. c. The “capital acquisition and repayment” cycle is closely related to the “acquisition of goods and services and payment” cycle. d. The “inventory and warehousing” cycle may be audited at any time during the engagement since it is unrelated to the other cycles.
69. challenging c
Which of the following journals would be included most often in the various audit cycles? a. Cash receipts journal. b. Cash disbursements journal. c. General journal. d. Sales journal.
70. challenging d
Transaction cycles begin and end: a. at the beginning and end of the fiscal period. b. each start of the annual audit.
Arens/Elder/Beasley
transactions. authorizations. costs. cutoffs.
c. d.
at January 1 and December 31. at the origin and final disposition of the company.
71. challenging a
After general audit objectives are understood, specific audit objectives for each account balance on the financial statements can be developed. Which of the following statements is true? a. There should be at least one specific objective for each relevant general objective. b. There will be only one specific objective for each relevant general objective. c. There will be many specific objectives developed for each relevant general objective. d. There must be one specific objective for each general objective.
72. challenging a
An auditor should recognize that the application of auditing procedures may produce evidence indicating the possibility of errors or fraud and therefore should: a. plan and perform the engagement with an attitude of professional skepticism. b. not rely on internal controls that are designed to prevent or detect errors or fraud. c. design audit tests to detect unrecorded transactions. d. extend the work to audit most recorded transactions and records of an entity.
Arens/Elder/Beasley
