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1. (TCO A) There are ten generally accepted auditing standards, divided into three categories.

What are the standards of reporting? (Points: 10)

2. (TCO A) Distinguish between generally accepted auditing standards (GAAS) and generally accepted
accounting principles (GAAP). What professional organization establishes GAAS? What professional organization establishes GAAP? (Points: 15)
GAAP, developed by different types of organizations, including ASB, FASB, SFAS, etc. are standards of accounting - that means that Financial statements of the Company should be prepared in accordance w ith GAAP. GAAS, developed by AICPA, are standards of auditing, that means that the audit of financial statements of the Company should be conducted in accordance w ith GAAS.

3. (TCO B) Assume you are the partner in charge of the audit of Franklin Corporation's 2002 financial
statements. The audit report has not yet been prepared. In each independent situation following, indicate the appropriate opinion you should issue and why you would issue that opinion.

1. You have substantial doubt about Franklin's ability to continue as a going concern. 2. Franklin Corporation changed its method of computing depreciation in 2002. You concur with the 3.
change, and the change is properly disclosed in the financial statement footnotes. Ten days after the balance sheet date, one of Franklin's buildings was destroyed by a fire. Franklin refuses to disclose this information in a footnote to the financial statements, but you believe disclosure is required to conform with generally accepted accounting principles. The amount of the uninsured loss was material, but not highly material.

(Points: 15)

1. If an auditor has substantial doubt about Franklin's ability to continue as going concern, the auditor has to issue Auditors' report w ith the paragraph w hich describes situation(s) under w hich the company can not continue as going concern. For example, if a company suffered huge loss; in case of fatal fraud; in some case - w hen a company lose its only customer or supplier and can not find the other. In this case the auditor has to add the follow ing paragraph (depending on the case, I described the first one). The accompanying financial statements have been prepared assuming that the Company w ill continue as a going concern. As disclosed in Note "X" to the financial statements, the Company has suffered recurring losses and has a net capital deficiency. These conditions raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note "X". The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. 2. A change in accounting principle that has a material effect on the financial statements should be recognized in the auditor's report on the audited financial statements.

4. (TCO C) State whether there is any violation of the AICPA Code of Professional Conduct, and the nature
of the violation. Where there is a violation, evaluate the potential legal liability the accountant may face. Justify your position.

1. Tarbet, Esq., CPA has a law practice and recommended one of her clients to Wagner, CPA. Wagner 2. 3.
agreed to pay Tarbet 15% of the fee for services rendered by Wagner to Tarbet's client. Some services will be doing a Review of the company books, and some will be solely consulting. Cindy Williams, CPA, is the partner on the audit of a nonprofit charitable organization, and is also an honorary Board of Directors member. She is not involved in any management functions, but likes to hang out with the management and other Board members during happy hour. Rawling Martin, CPA took his client out fishing on the weekend before the audit was to begin. The client told Rawling that the accounts receivable records were as clean as a whistle, and that Rawling didn't have to waste valuable time or money on sending out unnecessary confirmations that might just upset his good customers. Rawling agreed to not send them out, if the client caught the bigger fish that day. The client won the bet with the biggest fish, and Rawling didn't send out confirmations.

(Points: 15)
1. If an auditor consult the Client, he can not audit books of the company. He can not do both. 2.

5. (TCO D) Discuss at least five of the actions that can be taken by individual CPAs, to protect themselves from legal liability. (Points: 20)
1. Perform a qulity audit; 2. Insure auditor's liability at Insurance company. 3. Understand the client's business; 4. Sign engagement letter in w hich all rights and responsibilities of parties are disclosed properly; 5. Conduct audit in accordance w ith GAAS and state this in Auditors' report; 6. Use porfessional scepticism extentively; 7. Obtain a representation letter; 8. Maintain independence and confidential relations.

6. (TCO E) Bobby Thigpen, waiter at Relief Stop, has been taking cash from the restaurant. Thigpen prepares a customer's check from which the customer pays. Thigpen then destroys the check, and prepares a new one with different items of lower cost. He presents the new check and indicated amount on the check to the cashier, and saves the excess cash for himself. Question: Formulate three internal control features that the restaurant could implement, to eliminate this defalcation. (Points: 25)
1. Give the w aiter adequate salary that w ould prevent defalcation. 2. The cash machine has to be certified and should be sealed. Such machines alw ays have double printing of checks. One - for customer, one remains to the company. These machines also have internal counter and show the total amount of goods sold. 3. Prohibit bearing any cash to the w aiters, all personal belongings should be closed in safe before entering w orking place. 4. Assign manager to oversight the w ork of the w aiter. 5. Install security cameras. 6. Print and install w arnings to the custmers to recount change.

7. (TCO G) Three types of legal documents and records that auditors examine in the planning phase of an
audit are the corporate charter and bylaws, corporate minutes of meetings of the board of directors and stockholders, and contracts. Discuss the audit-relevant information contained in each of these three types of documents that an auditor should be aware of early in the audit. (Points: 25)

Corporate Charter is the most informative document about the company's business. It indicates all types of the company's business, volume of Shareholders' equity and the quantity of shares (both voting and privilege), structure of the company, rights and obligations of its shareholders, frequency of shareholders' meetings, etc. Minutes of the Board of directors and shareholders may help to plan audit and gather required information regarding the specific regulation of the business segment, corporate structure, plans about future, obtain information about possible of past frauds, receive evidence about going-concern assumption, acquisition of property, new loans, contracts and agreements, etc. As an integral part of audit, aimed to get familiar w ith Clients business, Auditor has to scan all contracts, obtain understanding of contracts signed by the company, and form an opinion on w herether there are any threads for the company. All these documents are an integral part of the auditors' w orking papers file.

Time Remaining:


1. (TCO F) What are specific audit objectives? Explain their relationship to the general audit objectives. (Points: 25)

2. (TCO H) Explain why it is necessary to allocate the preliminary judgment about materiality to individual
accounts (segments) in the financial statements. Also explain why allocating to balance sheet accounts is more common than allocating to income statement accounts. (Points: 25)

The preliminary judgment about materiality is to be allocated to individual accounts in the financial statements because auditors gather evidence for separate accounts and then form opinion on the w hole financial statements. Moreover, it is done in the balance sheet as it contains less number of accounts as opposed to the income statement and helps to avoid double entry accounting.

3. (TCO I) For each of the following potential misstatements, provide one potential audit test that could be
used to detect the misstatement. Recorded sale for which there was no shipment Sale recorded more than once Shipment made to nonexistent customers

(Points: 25)
Recorded sale for w hich there w as no shipment The auditor has to compare selected entries in the sales journal to the copies of shipping document/ bill of parcel. Sale recorded more than once. The auditor has to scan the numbers in in sales ledger. No corrections/duplicates should be made w ithin this list. Shipment made to nonexistent customers. The auditor has to obtain the payment information. If there w as no payment then there is no actual customer.

4. (TCO I) Describe how the auditor tests the classification objective for accounts receivable. (Points: 25)

The auditor has to review the classification of A/R in the Aged Trial balance for material receivables from affiliates, officers, directors, or other related parties. Auditors should verify that notes receivable or accounts that should be classified as noncurrent assets are separated from regular accounts, and significant credit balances in accounts receivable are reclassified as accounts payable.

5. (TCO I) The design of tests of details of balances for inventory is affected by audit results from multiple
cycles. Identify the cycles, other than the inventory and warehousing cycle, that affect the audit of inventory.

(Points: 25)
Except Inventory and w arehousing cycle there are the follow ing cycles: 1. Tests of the Acquisition and Payment. When auditor verifies inventory acquisitions as part of the test of the acquisition and payment cycle, he also obtains evidence about the accuracy and all manufacturing overhead costs incurred except labor. 2. Tests of the Payroll and Personnel Cycle. Cost accounting records for direct and indirect labor costs can be tested as part of the audit of the payroll and personnel cycle. 3. Tests of the Sales and Collection Cycle. Most of the audit testing in the storage of finished goods, as w ell as the shipment and recording of sales takes place w hen the sales and collection cycle is tested.

6. (TCO J) Describe three computer auditing techniques available to the auditor. (Points: 25)

The first one is Test Data Approach. The auditor has to develop several different types of transactions that should be entered under his control using the Client's softw are. The second is Parallel Simulation. The auditor has to count Client's data, using the Client's formulas and obtain the same result. The third is Embedded Audit Module. The auditor develops and plugs in an audit module that capture client's tranactions w ith characteristics that are of interest to the auditor.

7. (TCO K) Match seven of the terms (a-p) with the description/definitions provided below (1-7):
a. Commitments b. Completing the engagement checklist c. Contingent liability d. Dual-dated audit report e. Financial statement disclosure checklist f. Independent review g. Inquiry of clients attorneys h. Letter of representation i. Other information in annual reports j. Review for subsequent events k. Subsequent events l. Unadjusted misstatement worksheet m. Management letter n. Pending claim o. Unasserted claim p. Audit documentation review

_____ 1. A review of the financial statements and the entire set of audit files by an independent reviewer to whom the audit team must justify the evidence accumulated and the conclusions reached. _____ 2. A potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. _____ 3. A written communication from the client to the auditor formalizing statements that the client has made about matters pertinent to the audit. _____ 4. A potential legal claim against a client where the condition for a claim exists but no claim has been filed. _____ 5. Transactions that occurred after the balance sheet date, which affect the fair presentation or disclosure of the statements being audited. _____ 6. Agreements that the entity will hold to a fixed set of conditions, such as the purchase or sale of

merchandise at a stated price. _____ 7. The use of one audit report date for normal subsequent events and a later date for one or more subsequent events.

(Points: 25)