Which of the following is an auditor least likely to consider a departure from generally accepted accounting principles?

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When financial statements are affected by a material departure from generally accepted?
Which of the following is not a part of the auditors responsibility?
Which of the following would not be an appropriate audit procedure related to the client's physical inventories?
Which of the following best describes the auditor's response to a client's use of statistical sampling techniques to estimate inventory?

(K)

17–25.

Multiple Choice Questions

A material departure from generally accepted accounting principles will result in auditor consideration of:

LO 4

(1)		Whether to issue an adverse opinion rather than a disclaimer of opinion.
(2)		Whether to issue a disclaimer of opinion rather than a qualified opinion.
(3)		Whether to issue an adverse opinion rather than a qualified opinion.
(4)		Nothing, because none of these opinions is applicable to this type of exception.

p. 683

The auditors' report should be dated as of the date the:

LO 1, 2

(1)		Report is delivered to the client.
(2)		Auditors have accumulated sufficient evidence.
(3)		Fiscal period under audit ends.
(4)		Peer review of the working papers is completed.

In an audit report on combined financial statements, reference to the fact that a portion of the audit was performed by a component auditor is:

LO 3

(1)		Not to be construed as a qualification, but rather as a division of responsibility between the two CPA firms.
(2)		Not in accordance with generally accepted auditing standards.
(3)		A qualification that lessens the collective responsibility of both CPA firms.
(4)		An example of a dual opinion requiring the signatures of both auditors.

Assume that the opinion paragraph of an auditors' report begins as follows: “With the explanation given in Note 6, …the financial statements referred to above present fairly…” This is:

LO 1, 2

(1)		An unmodified opinion.
(2)		A disclaimer of opinion.
(3)		An “except for” opinion.
(4)		An improper type of reporting.

The auditors who wish to draw reader attention to a financial statement note disclosure on significant transactions with related parties should disclose this fact in:

LO 3

(1)		An emphasis of matter paragraph to the auditors' report.
(2)		A footnote to the financial statements.
(3)		The body of the financial statements.
(4)		The “summary of significant accounting policies” section of the financial statements.

What type or types of audit opinion are appropriate when financial statements are materially and pervasively misstated?

LO 4

(K)

Which of the following ordinarily involves the addition of an emphasis of matter paragraph to an audit report?

LO 3

(1)		A consistency modification.
(2)		An adverse opinion.
(3)		A qualified opinion.
(4)		Part of the audit has been performed by component auditors.

An audit report for a public client indicates that the audit was performed in accordance with:

LO 2

(1)		Generally accepted auditing standards (United States).
(2)		Standards of the Public Company Accounting Oversight Board (United States).
(3)		Generally accepted accounting principles (United States).
(4)		Generally accepted accounting principles (Public Company Accounting Oversight Board).

An audit report for a public client indicates that the financial statements were prepared in conformity with:

LO 2

(1)		Generally accepted auditing standards (United States).
(2)		Standards of the Public Company Accounting Oversight Board (United States).
(3)		Generally accepted accounting principles (United States).
(4)		Generally accepted accounting principles (Public Company Accounting Oversight Board).

p. 684

When the matter is properly disclosed in the financial statements, the likely result of substantial doubt about the ability of the client to continue as a going concern is the issuance of which of the following audit opinions?

LO 3

(K)

A change in accounting principles that the auditors believe is not justified is likely to result in which of the following types of audit opinions?

LO 4

(K)

Which of the following is least likely to result in inclusion of an emphasis of matter paragraph in an audit report?

LO 3

(1)		The company is a component of a larger business enterprise.
(2)		An unusually important significant event.
(3)		A decision not to confirm accounts receivable.
(4)		A risk or uncertainty.

17–26.

For each of the following brief scenarios, assume that you are reporting on a client's financial statements. Reply as to the type(s) of opinion possible for the scenario. In addition:

LO 3, 4

•		Unless stated otherwise, assume the matter involved is material.
•		If the problem does not state that a misstatement (or possible misstatement) is pervasive, assume that it may or may not be pervasive (thus, the appropriate reply may include two possible reports).
•		Do not read more into the circumstance than what is presented.

Do not consider an auditor discretionary circumstance for modification of the audit report unless the situation explicitly suggests that the auditors wish to emphasize a particular matter. Report Types may be used once, more than once, or not at all.

(K)

p. 685

17–27.

Use the following to provide the type of audit report the auditors generally should issue in the situations presented below:

LO 3, 4

1.		Unmodified—standard.
2.		Unmodified—with an emphasis of matter paragraph.
3.		Qualified.
4.		Adverse.
5.		Disclaimer

Situation:

a.		Client-imposed restrictions significantly limit the scope of the auditors' procedures, and they are unable to obtain sufficient appropriate audit evidence. The possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.
b.		The auditors decide not to make reference to the report of a component auditor that audited a portion of group financial statements.
c.		The auditors believe that the financial statements have been presented in conformity with generally accepted accounting principles in all respects, except that a loss contingency that should be disclosed through a note to the financial statements is not included. While they consider this a material omission, they do not believe that it pervasively affects the financial statements.
d.		The client has changed from LIFO to FIFO for inventory valuation purposes; the auditors concur with this change. The effect is considered material to the financial statements, although inventory is not a large part of total assets.
e.		The client has changed from LIFO to FIFO for inventory valuation purposes; the auditors do not concur with this change. The effect is considered material and pervasive.

17–28.

Auditors report on the consistency of application of accounting principles. Assume that the following list describes changes that have a material effect on a client's financial statements for the current year.

LO 3

(1)		A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction contracts.
(2)		A change in the estimated service lives of previously recorded plant assets based on newly acquired information.
(3)		Correction of a mathematical error in inventory pricing made in a prior period.
(4)		A change from direct costing to full absorption costing for inventory valuation.
(5)		A change from deferring and amortizing preproduction costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits.
(6)		A change to including the employer's share of FICA taxes as “Retirement benefits” on the income statement. This information was previously included with “Other taxes.”
(7)		A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing.

Required:

For each of the above situations, state whether the audit report should include an emphasis of matter paragraph on consistency.

17–29.

Items 1 through 5 present various independent factual situations an auditor might encounter in conducting an audit. For each situation, assume:

•		The auditor is independent.
•		The auditor previously expressed an unmodified opinion on the prior year's financial statements.
•		Only single-year (not comparative) statements are presented for the current year.
•		The conditions for an unmodified opinion exist unless contradicted in the factual situations.
•		The conditions stated in the factual situations are material.
•		No report modifications are to be made except in response to the factual situation.

1.		In auditing the long-term investments account, an auditor is unable to obtain audited financial statements for an investee located in a foreign country. The auditor concludes that sufficient appropriate audit evidence regarding this investment cannot be obtained.
p. 686 2.		Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. However, the financial statement disclosures concerning these matters are adequate. The auditor has decided not to issue a disclaimer of opinion.
3.		A group auditor decides to take responsibility for the work of a component CPA who audited a wholly owned subsidiary of the entity and issued an unmodified opinion. The total assets and revenues of the subsidiary represent 17 percent and 18 percent, respectively, of the total assets and revenues of the entity being audited.
4.		An entity changes its depreciation method for production equipment from straight-line to a units-of-production method based on hours of utilization. The auditor concurs with the change, although it has a material effect on the comparability of the entity's financial statements.
5.		An entity discloses certain lease obligations in the notes to the financial statements. The auditor believes that the failure to capitalize these leases is a departure from generally accepted accounting principles and, although the possible effects on the financial statements of the misstatements is material, they could not be pervasive.

Required:

List A represents the types of opinions the auditor ordinarily would issue and List B represents the report modifications (if any) that would be necessary. Select as the best answer for each situation (items 1 through 6) the type of opinion and alterations, if any, the auditor would normally select. Replies may be selected once, more than once, or not at all.

(AICPA, adapted)

(K)

17–30.

For each of the following brief scenarios, assume that you are reporting on a client's financial statements. Reply as to the type(s) of opinion (per below) possible for the scenario. In addition:

•		Unless stated otherwise, assume the matter involved is material. If the problem doesn't tell you whether a misstatement pervasively misstates the financial statements or doesn't list a characteristic that indicates pervasiveness, two reports may be possible (i.e., replies 6 to 9).
•		Do not read more into the circumstances than what is presented.
•		Do not consider an auditor discretionary circumstance for modification of the audit report unless the situation explicitly suggests that the auditor wishes to emphasize a particular matter.

Types of Opinion

1.		Unmodified—standard.
2.		Unmodified with an emphasis of matter paragraph.
3.		Qualified.
4.		Adverse.
5.		Disclaimer.
6.		Unmodified with an emphasis of matter paragraph or disclaimer.
7.		Qualified or adverse.
8.		Qualified or disclaimer.
9.		Adverse or disclaimer.
10.		Other.

p. 687

1.		A company has not followed generally accepted accounting principles in the recording of its leases.
2.		A company has not followed generally accepted accounting principles in the recording of its leases. The amounts involved are immaterial.
3.		A company valued its inventory at current replacement cost. Although the auditor believes that the inventory costs do approximate replacement costs, these costs do not approximate any GAAP inventory valuation method.
4.		A client changed its depreciation method for production equipment from the straight-line method to the units-of-production method based on hours of utilization. The auditor concurs with the change.
5.		A client changed its depreciation method for production equipment from the straight-line to a units-of-production method based on hours of utilization. The auditor does not concur with the change.
6.		A client changed the depreciable life of certain assets from 10 years to 12 years. The auditor concurs with the change.
7.		A client changed the depreciable life of certain assets from 10 years to 12 years. The auditor does not concur with the change. Confined to fixed assets and accumulated depreciation, the misstatements involved are not considered pervasive.
8.		A client changed from the method it uses to calculate postemployment benefits from one acceptable method to another. The effect of the change is immaterial this year, but is expected to be material in the future.
9.		A client changed the salvage value of certain assets from 5 percent to 10 percent of original cost. The auditor concurs with the change.
10.		A client uses the specific identification method of accounting for valuable items in inventory, and LIFO for less valuable items. The auditor concurs that this is a reasonable practice.
11.		Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the situation.
12.		Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements do not adequately disclose the substantial doubt situation, and the auditor believes the omission fundamentally affects the users' understanding of the financial statements.
13.		An auditor reporting on group financial statements decides to take responsibility for the work of a component auditor who audited a 70 percent owned subsidiary and issued an unmodified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited.
14.		An auditor reporting on group financial statements decides not to take responsibility for the work of a component auditor who audited a 70 percent owned subsidiary and issued an unqualified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited.
15.		An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. She is unable to apply other procedures to determine whether ending inventory and related information are properly stated.
16.		An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. However, she was able to apply other procedures and determined that ending inventory and related information are properly stated.
17.		An auditor discovered that a client made illegal political payoffs to a candidate for president of the United States. The auditor was unable to determine the amounts associated with the payoffs because of the client's inadequate record-retention policies. The client has added a note to the financial statements to describe the illegal payments and has stated that the amounts of the payments are not determinable.
18.		An auditor discovered that a client made illegal political payoffs to a candidate for president of the United States. The auditor was unable to determine the amounts associated with the payoffs because of the client's inadequate record-retention policies. Although there is no likelihood that the financial statements are pervasively misstated, they may be materially misstated. The client refuses to disclose the payoffs in a note to the financial statements.
19.		In auditing the long-term investments account of a new client, an auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, but the amount is not estimable. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail.
20.		In auditing the long-term investments account of a new client, an auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, and this amount is reasonably estimable as $2,000,000. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail and includes the $2,000,000 estimate in that note.
p. 688 21.		A client is issuing two years of comparative financial statements. The first year was audited by another auditor who is not being asked to reissue her audit report. (Reply as to the successor auditors' report.)
22.		A client is issuing two years of comparative financial statements. The first year was audited by another auditor who is being asked to reissue her audit report. (Reply as to the successor auditors' report.)
23.		A client's financial statements follow GAAP, but the auditor wishes to emphasize in his audit report a significant related party transaction that is adequately described in the notes to the financial statements.
24.		A client's financial statements follow GAAP except that they do not include a note on a significant related party transaction.

17–31.

Last year, Johnson & Barkley, CPAs, audited the consolidated financial statements of Jordan Company (a nonpublic company) for the year ended December 31, 20X0, and expressed a standard unmodified report.

Johnson & Barkley also audited Jordan's this year's financial statements—for the year ended December 31, 20X1. These consolidated financial statements are being presented on a comparative basis with those of the prior year, and an unmodified opinion is being expressed. Smith, the engagement supervisor, instructed Abler, an assistant on the engagement, to draft the auditors' report. In drafting the report below, Abler considered the following:

•		Jordan changed its method of accounting for inventory from LIFO to FIFO in 20X1.
•		Larkin & Lake, CPAs, audited the financial statements of BX, Inc., a consolidated subsidiary of Jordan, for the year ended December 31, 20X1. The subsidiary's financial statements reflected total assets and revenues of 2 percent and 3 percent, respectively, of the consolidated totals. Larkin & Lake expressed an unmodified opinion and furnished Johnson & Barkley with a copy of the auditors' report. Johnson & Barkley has decided to assume responsibility for the work of Larkin & Lake insofar as it relates to the expression of an opinion on the consolidated financial statements taken as a whole and has applied the necessary audit procedures.
•		Jordan is a defendant in a lawsuit alleging patent infringement. This is adequately disclosed in the notes to Jordan's financial statements, but no provision for liability has been recorded because the ultimate outcome of the litigation cannot presently be determined.

Abler drafted the following audit report:

Auditors' Report

We have audited the accompanying consolidated financial statements of Jordan Company and its subsidiaries, which comprise the consolidated balance sheets as of December 31, 20X1 and 20X0, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended, and the related notes to the financial statements.

Auditors' Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors' judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

p. 689

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Emphasis of Matter

As discussed in Note 2 to the consolidated financial statements, the Company adopted the first-in-first-out method of inventory valuation in 20X1. Our opinion is not modified with respect to this matter.

Opinion

In our opinion, the consolidated financial statements referred to here present fairly, in all material respects, the financial position of Jordan Company and its subsidiaries as of December 31, 20X1 and 20X0, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

Phoenix, Arizona
December 31, 20X1

Required:

Smith reviewed Abler's draft and stated in the Supervisor's Review Notes below that there were deficiencies in Abler's draft. Items 1 through 10 represent the deficiencies noted by Smith. For each deficiency, indicate whether Smith is correct or incorrect in the criticism of Abler's draft.

1.		The report's title is incorrect as it should include the word “independent.”
2.		The report should have an addressee such as the board of directors.
3.		There should be a section entitled Management's Responsibility for the Financial Statements.
4.		The first sentence of the Auditors' Responsibility section should state that “Our responsibility is to provide assurance …,” not “Our responsibility is to express an opinion …”
5.		The Auditors' Responsibility and the Opinion sections should both refer to the component auditors.
6.		The third paragraph under the Auditors' Responsibility section is not required—let's omit it.
7.		The emphasis of matter paragraph should follow the opinion paragraph.
8.		The Opinion section should indicate that the principles were consistently applied except for the change in method of inventory valuation.
9.		The report should be dated as of the date sufficient appropriate audit evidence has been gathered, not as of year-end.
10.		The names of the individual financial statements should be included in the Opinion section.

* Note that this simulation has more parts than one would expect in a particular CPA exam simulation. We present it to provide examples of many types of reporting situations in one problem.

When financial statements are affected by a material departure from generally accepted?

. 18 When financial statements are materially affected by a departure from generally accepted accounting principles and the auditor has audited the statements in accordance with the standards of the PCAOB, he or she should express a qualified (paragraphs . 19 through . 39) or an adverse (paragraphs .

Which of the following is not a part of the auditors responsibility?

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 material to the financial statements are detected. .

Which one of the following procedures would not be appropriate for the auditors in discharging their responsibilities concerning the client's physical inventories? Supervising the taking of the annual physical inventory.

Which of the following best describes the auditor's response to a client's use of statistical sampling techniques to estimate inventory?

Completeness. Which of the following best describes the auditors' response to a client's use of statistical sampling techniques to estimate the inventory? The auditors should withdraw from the engagement. The auditors should qualify their opinion, because the client must perform a complete count of the inventory.

Which of the following is an auditor least likely to consider a departure from generally accepted accounting principles?

When financial statements are affected by a material departure from generally accepted?

Which of the following is not a part of the auditors responsibility?

Which of the following best describes the auditor's response to a client's use of statistical sampling techniques to estimate inventory?

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Which of the following is an auditor least likely to consider a departure from generally accepted accounting principles?

When financial statements are affected by a material departure from generally accepted?

Which of the following is not a part of the auditors responsibility?

Which of the following would not be an appropriate audit procedure related to the client's physical inventories?

Which of the following best describes the auditor's response to a client's use of statistical sampling techniques to estimate inventory?

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