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Week 4 : Materiality, Risk, and Internal Control - Midterm

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1. (TCO F) Which of the following statements is true of a public company's financial statements?
(Points : 5)

Sarbanes-Oxley requires only the CEO to certify the financial statements.


Sarbanes-Oxley requires only the CFO to certify the financial statements.
Sarbanes-Oxley requires the CEO and CFO to certify the financial statements.
Sarbanes-Oxley requires neither the CEO nor the CFO to certify the financial
statements.
2. (TCO F) 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 (Points : 5)
Yes; Yes
No; No
Yes; No
No; Yes
3. (TCO F) Which of the following statements is most correct regarding errors and fraud?
(Points : 5)

An error is unintentional, whereas fraud is intentional.


Fraud occurs more often than errors in financial statements.
Errors are always fraud and fraud is always errors.
Auditors have more responsibility for finding fraud than errors.
4. (TCO F) The auditor's best defense when material misstatements are not uncovered is to have
conducted the audit: (Points : 5)

in accordance with auditing standards


as effectively and as reasonably possible
in a timely manner
only after an adequate investigation of the management team
5. (TCO F) The Auditing Standards Board has concluded that analytical procedures are so
important that they are required during: (Points : 5)

planning and test of control phases


planning and completion phases
test of control and completion phases
planning, test of control, and completion phases

6. (TCO F) An example of a document the auditor receives from the client, but which was
prepared by someone outside the client's organization, is a(n): (Points : 5)

confirmation
sales invoice
vendor invoice
bank reconciliation
7. (TCO F) The primary purpose of performing analytical procedures in the planning phase of an
audit is to: (Points : 5)
help the auditor obtain an understanding of the client's industry and business
assess the growing concern assumption
indicate possible misstatements
reduce detailed tests
8. (TCO F) When the auditor has reason to believe an illegal act has occurred without any
corrective action being taken, the auditor should: (Points : 5)

inquire of management only at one level below those likely to be involved with the
illegality
begin communication with the FASB in accordance with PCAOB regulations
consider accumulating additional evidence to determine if there is actually an illegal act
withdraw from the engagement
9. (TCO F) When auditors use documents to support recorded transactions, the process is often
called: (Points : 5)

inquiry
confirmation
vouching
physical examination
10. (TCO G) Which of the following statements is not correct with respect to analytical
procedures? (Points : 5)

Auditing standards emphasize the need for auditors to develop and use expectations
Analytical procedures must be performed throughout the audit
Analytical procedures may be performed at any time during the audit
Analytical procedures use comparisons and relationships to assess whether account
balances appear reasonable
11. (TCO G) Which of the following ratios is best used to assess a company's ability to meet its
long-term debt obligations? (Points : 5)
Quick ratio
Return on common equity
Debt to equity

Current ratio

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1. (TCO A) Match the following definitions to the terms.

____ Public Company Accounting Oversight Board Auditing Standards


____ Generally Accepted Auditing Standards
____ Statements on Auditing Standards
a. Pronouncements providing specific guidance on auditing matters for all entities except public
companies
b. The standards used for public company audits
c. Standards used by non-public companies and for interim audits for public companies as
initially adopted by the PCAOB
(Points : 5)

2. (TCO B) The following is a portion of a qualified audit report issued for a private company:

Independent Auditor's Report


To the shareholders of Tamarak Corporation,
We have audited the accompanying balance sheet of Tamarak Corporation as of October 31,
2009, and the related statements of income, retained earnings, and cash flows for the past year.
These financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit 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 financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
The company has included in property and debt in the accompanying balance sheet certain lease
obligations that, in our opinion, should be expensed in order to conform with generally accepted
accounting principles. If these lease obligations were capitalized, property would be decreased
by $4,000,000, long-term debt by $2,000,000, and retained earnings by $180,000 as of October
31, 2009, and net income and earnings per share would be decreased by $180,000 and $0.62,
respectively, for the past year.
Required: Complete the above qualified audit report by preparing the opinion paragraph. Do not

date or sign the report.


(Points : 20)

3. (TCO C) The following situation involves a possible violation of the AICPA's Code of

Professional Conduct. For each situation, (1) determine the applicable rule number from the
Code, (2) decide whether or not the Code has been violated, and (3) briefly explain how the
situation violates (or does not violate) the Code.
Your answer should be set up something like this:
Rule # __________
Violation? Yes or No
1 or 2 line explanation:
Jim is the audit partner for the small CPA firm of Jim, CPA, PA. Jim's neighbor Duffy has a
financial advisement practice whereby she sells mutual funds to individuals for their retirement.
Jim's firm is performing the audit for a privately held company Jim's best friend Cressy owns. Jim
refers Cressy to Duffy for retirement advice. Cressy buys 10 units of ABC Mutual Fund which
generates Duffy a fat little commission fee. Duffy buys Jim a $25 gift certificate to the local movie
theater.
(Points : 10)

4. (TCO C) The following situation involves a possible violation of the AICPA's Code of

Professional Conduct. For each situation, (1) determine the applicable rule number from the
Code, (2) decide whether or not the Code has been violated, and (3) briefly explain how the
situation violates (or does not violate) the Code.
Your answer should be set up something like this:
Rule # __________
Violation? Yes or No
1 or 2 line explanation:
Brad Heist, CPA, was traveling from Dallas to Houston, Texas, when he was pulled over by a
police officer on suspicion of driving under the influence. The breath-a-lyzer and a subsequent
blood test revealed that Brad was definitely impaired. He was convicted in court of driving while
under the influence of alcohol (DUI). This was Brad's fourth conviction of DUI in less than a year,
a felony under current Texas law. Accordingly, Brad was sentenced to 18 months in prison.
(Points : 10)

5. (TCO C) Brandt, CPAs has obtained Big-Bucks, a new publicly-held client. Big-Bucks has

various accounting-related needs that Brandt, CPAs would like to fulfill. Partner-in-charge D.
Brandt has discussed with Big-Bucks the possibility of performing the annual audit of Big-Bucks
as well as preparing the tax returns, business plan, quarterly write-up services, and providing
consultation on the viability and valuation of mining gas reserves in Tennessee. An outside expert
would be hired by Brandt CPAs to provide expert advice to the CPA firm on mining gas reserves.
Additionally, Brandt, CPA's audit manager who will be assigned to this audit has previously been
approached by Big-Bucks to come work for the company as Chief Financial Officer. The audit
manager has refused the offer, since his cousin's sister-in-law is a 10 percent shareholder in BigBucks and does not want her to have any say in his employment.
Under the Sarbanes-Oxley Act of 2002, what issues do you see and how would you advise
Brandt, CPAs? Is there ever a time when Brandt, CPAs could perform any of these services for
Big-Bucks?
(Points : 25)

6. (TCO D) Discuss the sanctions the Securities and Exchange Commission can impose on
auditors. (Points : 25)

7. (TCO F) Match five of the terms (a-h) with the definitions provided below (1-5):

a. Audit documentation
b. Audit procedures
c. Audit objectives
d. Analytical procedures
e. Budgets
f. Reliability of evidence
g. Sufficiency of evidence
h. Persuasiveness of evidence
____ 1. Use of comparisons and relationships to assess the reasonableness of account balances
____ 2. Detailed instructions for the collection of a type of audit evidence
____ 3. The degree to which evidence can be considered believable or trustworthy
____ 4. Contains all the information that the auditor considers necessary to conduct an adequate
audit and to provide support for the audit report
____ 5. This is determined by the amount of evidence obtained

(Points : 25)

8. (TCO G) Auditors routinely conduct analytical procedures in the planning, testing, and

completion phases of the audit. Identify the primary and secondary purposes of performing
analytical procedures in each phase of the audit. (Points : 25)