Auditing and Assurance Training Fundamentals 5 — Questions and Answers
Question 1: Which of the following is an example of a 'subsequent event' that requires adjustment to the financial statements?
- A major acquisition completed after year-end that was not contemplated before year-end
- Settlement of a lawsuit after year-end for an amount significantly different from the year-end accrual (Correct answer)
- Issuance of new common stock after year-end to raise capital
- A natural disaster after year-end that destroys a plant
Correct answer: Settlement of a lawsuit after year-end for an amount significantly different from the year-end accrual
A Type I subsequent event provides additional evidence about conditions that existed at year-end and requires adjustment, such as a lawsuit settlement differing from the recorded accrual.
Question 2: What is the auditor's primary responsibility regarding fraud under auditing standards?
- To detect all instances of fraud, including immaterial amounts
- To plan and perform the audit to obtain reasonable assurance about whether material misstatements due to fraud exist (Correct answer)
- To investigate and prosecute fraudulent acts discovered during the audit
- To design internal controls that prevent fraud
Correct answer: To plan and perform the audit to obtain reasonable assurance about whether material misstatements due to fraud exist
Auditors must plan and perform procedures to provide reasonable assurance of detecting material fraud, but are not guarantors of detecting all fraud.
Question 3: Which of the following audit procedures provides the strongest evidence regarding the existence of inventory?
- Reviewing purchase orders for inventory items
- Obtaining written representation from management that inventory exists
- Physically observing and test-counting inventory at year-end (Correct answer)
- Comparing inventory balances to the prior-year amounts
Correct answer: Physically observing and test-counting inventory at year-end
Physical observation is the most direct and reliable evidence for existence because the auditor personally verifies the inventory is present.
Question 4: When a client imposes a scope limitation that the auditor cannot overcome, and the potential effects are pervasive, the auditor should:
- Issue a qualified opinion with a basis for qualification paragraph
- Withdraw from the engagement or disclaim an opinion (Correct answer)
- Issue an adverse opinion
- Proceed and issue an unmodified opinion with explanatory language
Correct answer: Withdraw from the engagement or disclaim an opinion
A pervasive client-imposed scope limitation that cannot be resolved requires the auditor to withdraw from the engagement or issue a disclaimer of opinion.
Question 5: Under the COSO Internal Control – Integrated Framework, which component addresses the organization's values and the 'tone at the top'?
- Risk Assessment
- Monitoring Activities
- Control Environment (Correct answer)
- Information and Communication
Correct answer: Control Environment
The Control Environment is the foundation of internal control and encompasses integrity, ethical values, governance structure, and management's commitment to competence.
Question 6: What does 'audit documentation' (workpapers) primarily serve to demonstrate?
- That the client's financial statements are free from error
- That the auditor complied with applicable professional standards and that conclusions are supported (Correct answer)
- That the engagement was profitable for the audit firm
- That management reviewed and approved all audit procedures
Correct answer: That the auditor complied with applicable professional standards and that conclusions are supported
Audit documentation provides the principal record that the audit was planned and performed in accordance with professional standards and supports the auditor's conclusions.
Question 7: Which of the following is the most appropriate action when an auditor identifies a related-party transaction that was not disclosed by management?
- Ignore it if the amount is below the materiality threshold
- Require management to disclose the transaction and evaluate its impact on the financial statements (Correct answer)
- Immediately withdraw from the engagement and report to the SEC
- Include a note in the workpapers and take no further action
Correct answer: Require management to disclose the transaction and evaluate its impact on the financial statements
Undisclosed related-party transactions must be brought to management's attention and properly disclosed, as they can affect the fair presentation of the financial statements.
Auditing and Assurance Training Fundamentals 5
Which of the following is an example of a 'subsequent event' that requires adjustment to the financial statements?