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204 EJCECUTING A..'l l~TLGltATEDAUDIT
Going concern. Term used to apply to the situation in
which there is significant uncertainty about an entity's
ability to continue in business for the next year.
ICFR. Internal control over financial reporting.
Initial public offering (IPO). Occurs when a company
offers equity secruities on the public markets for the first
time. Requires a registration statement, which is a docu-
ment including audited financial statements that must be
filed with the SEC.
internal audit. A function performed by corporate
employees; activities may include financial statement
audits, efficiency and effectiveness audits, forensic audits,
and special projects.
Internal control over financial reporting (ICFR) .
Controls that relate to the preparation of reliable pub-
lished financial statcmenis, including interim and con-
densed financial statements and selected financial data
derived from those statements, such as earnings releases,
that are reported publicly.
Letter to shareholders. Communication to shareholders
included in the annual report, usually signed by the com-
pany president.
Management discussion and analysis. Disclosure
required in reports filed with the SEC including risk infor-
mation and trend analysis.
Management philosophy and operating style. Part of
the control environment; related to i~ues such as busi-
ness risks accepted, communication style and attitudes,
and actions toward financial reporting.
Management representation letter. A letter from the
client, signed by upper management, to the auditor, doc-
umenting client assertions to the auditor in areas related
to the financial statements, completeness of information,
recognition, measurement, disclosure, subsequent events,
and internal control.
Material misstatement. A misstatement in the financial
statements from error or fraud that is judged to be impor-
tant enough to be material.
Material weakness in ICFR. A deficiency, or a combina-
tion of deficiencies, in ICFR causing a greater than remote
chance that a material misstatement of the company's
annual or interim financial statements will not be
16iilHl~IIHlMIM
5-1 (LO 21 Professional standards related to client
acceptance are legally required by
(a) AICPA.
(b) PCAOB.
(c) SOX.
(d) all of the above.
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prevented or detected on a timely basis. (See also
Rea5011able possibility.)
Nonaudit services. General term used for all services
performed by a CPA that are not audit.~.
Organizational structure. The layout of an entity,
including division of authority, responsibility, and
duties. A centralized organization structure is "tall,"'
indicating numerous layer,~ of management, while a
decentralized organization structure is "flat," indicating
limited layers of management with delegation of
authority and responsibility to lower layers of the entity.
Outsource. Contracting with and using an outside ser-
vice organization to perform a service rather than having
the function handled in-house.
Predecessor auditor. A CPA firm that fo rmerly audited
a specific company.
Professional competence. Having the skill and knowl-
edge to perform an engagement with due professional
Proposal process. The process through which a CPA
firm presents to the potential client details about its plan
to perform the audit engagement and the estimated
costs.
Quality Control Standards. Professional guidance
regarding the procedures of a public accounting firm.
Reasonable assurance. A high, but not absolute, level of
assurance provided by an audit.
Related party transactions. Transactions in which one
party has the ability to influence the decisions, manage-
ment, or operating policies of the other party. Related par-
ties maybe an affiliated company or any entity with which
a client deals.
Request for proposal (RFP). A document issued and
distributed by a company requesting submissions by
firms, in this situation by auditors, regarding details
and terms under which they would perform the
engagement.
Working papers, work papers. Records that document
the evidence gathered by auditors and show thei r audit
work, procedures, and conclusions. Though referred to as
working "papers;' these are typically created and main-
tained in electronic format.
5-2 (LO 1) AnRFP
(a) is required for a client to change auditors.
(b} contains information about the proposal
process and engagement.
(c) is only used by publicly traded companies.
(d) is issued by the auditor.
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CLIENT ACCEPTANCE.ANO CONTINUANC.F. AND PRELIMINARY ENGAGEMENT PROCEDURES
5-3 (LO 3] Independence issues that would stop an
8 audit firm from proposing on a potential client
8 (a) can only he determined at the end of the client
investigation process.
{b) may result from financial and business interest
in the potential company.
(c) are not affected by the Sarbanes-Oxley Act.
(d) are only binding for clirnts who arc SEC
registrants.
5-4 (LO 3J When financial statements are "restated;' it
may result from
(a) retrospective application.
(b) discovery of an error in past financial statements.
(c) an adjustment of previously issued financial
statements to reflect a change in reporting entity.
(d) all of the above.
5-5 (LO 3) Which of the following is least important lo
the auditor when investigating a potential new
audit client?
(a) Whether the audit committee has a financial
expert
(b) Level of the CEO's charitable giving in the
community
(c) Existence of a company code of ethics
(d) Extensive amounts of regulatory oversight in
the company's industry
5-6 (LO 3} Although they may all be informative
regarding risk, which of the following may be of
concern for a large, international audit firm con-
sidering accepting a company as a new client?
(a) Management authority is concentrated in one
or two people, even though the client company
is very large.
(b) The potential client has multinational opera-
tions with many operating locations.
(c) The potential client has either a highly cen-
tralized or highly decentralized organizational
structure.
(d) There is a history of (successful) products that
have very quick technological obsolescence.
5-7 (LO 1] Auditors review the financial information of
potential clients to
(a) look for information about related parties.
(b) assess management philosophy regarding
employee overtime.
(c) determine the competence of the audit
committee.
(d) all of the above.
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205
5-8 (LO 3) An auditor issm:s a going-concern opinion
when
(a) the client company is in the process of
liquidation.
(b) the auditor feels an obligation to warn finan-
cial statement users about the company's tight
cash flow.
(c) there is uncertainty about whether the com-
pany will have or be able to obtain sufficient
resources to meet its obligations in the upcom-
ing year.
(d) there is not enough information available to be
able to issue an unqualified report.
5-9 [LO 3} Auditors obtain information about potential
clients from all of the following except
(a) shareholders.
(b) prior auditors.
(c) published documents.
(d) business contacts.
5-10 (LO 4] An engagement letter
(a) must be in a particular format and include
information on fees.
(b) must be signed by the CEO and head of the
audit committee.
(c) documents the understanding of the engage-
ment betv.·een the auditor and client.
(d) is only created prior to beginning work in the
firs t year of auditing a new client.
5-11 [LO 3) Which of the following would the auditor
8 not consider as an indicator of the need for further
8 investigation of a potential new client?
(a) One of the directors, though not a member of
the audit committee, was recently convicted of
tax evasion.
(b) The company is highly decentralized; top man-
agement delegates a significant amount of deci-
sion-making authority and spends most of its
management time on oversight of those deci-
sion makers.
(c) The industry is experiencing a significant
downturn, and a number of similar companies
have filed for bankruptcy.
(d) The company has an audit committee, although
none of the members qualifies as a financial
expert.
5-12 (LO 3] Which of the following may be difficult
B information for an auditor to obtain prior to
le::::, accepting a public company as a client?
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206 EXECUTING A."I INTF.GRATFD AUDIT
(a) The amount and quality of information avail-
able to the people within the company who
have decision-making responsibility.
(b) The existence of b usiness locations that may
have uncertain or questionable business
pu rposes.
(c) A going-co ncern uncertainty that has been in
existence for seYeral years.
(d) That management habitually provides inap-
propriately optimistic commentary about the
com pany to outsiders.
5-13 (LO 3) Financial statement restatements
(a) arc an important consideration for an auditor
investigating a potential client.
(b ) may be needed to correct an error.
(c) may be an indicator of the possibility of a
material weaknesses in ICFR.
(d) all of the above.
5- 14 (LO 1) An auditor investigates a potential client's
business activities
(a ) because public companies keep many of their
business activities secret.
(b) to confi rm that the company's business activi-
ties are com patible with what the audit firm
wants in its client portfolio.
(c) because companies that are involved in several
different industries are not required to disclose
all of the ind ustry information.
(d) none of the above.
5-1 5 (LO 2] Professional guidance useful to the client
acceptance and continuance process is found in
{a) Quality Control Standards and Auditing
Standards on fraud.
(b ) COSO Enterprise Risk Management and
Internal Control frameworks .
(c) Auditing Standards on risk and Auditing
Standards on ICFR.
(d) All of the above.
5- J 6 (LO 3) Inquiry of the predecessor auditor.
(a) is no t helpful because the predecessor does not
have to respond.
(b ) is helpful even if the predecessor responds with
a statement indicating that no information or
only a limited response can be made.
(c) is useful b ecause the predecessor auditor is not
limited in communicating any confidential
clien t information since the individual
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requesting the information is also a CPA and
therefore is subject to confidentiality rules.
(d) is a standardized procedure that must be per-
formed at a specific stage of the client ac.cep-
ta nce process.
5- 17 (LO 4] An engagement letter
(a) includes a copy of the management rep resen•
talion letter.
(b) for an audit can only address the audit and can -
no t include terms for any other services; a sep-
arate engagement letter must be drafted for
other services.
(c) specifies that the auditor has responsibility for
the accuracy of the company's financial state-
m ent~ and effectiveness of internal control.
(d) distinguishes those responsibilities that are
managem ent's and those responsibilities that
arc the auditor's.
5· 18 [LO 3) Which of the following would not cause the
e auditor concerns about management?
'S (a) Management stays fully informed about the
financial performance of the company o n a
regular basis.
(b) Nonaccounting managen1ent is always involved
and has sign ificant influence in the choice of
accounting principles and structuring the way
transactions are recorded.
(c) A very large company has a small management
gro up with most of the decision-making
authority limited to one or two people.
(d ) Management expresses a strong preference to
provide as little disclosure about related parties
as possible.
5- 19 [LO 2, 3) Related party transactions
(a) tend to make auditors avoid companies as
potential clients.
(b) must be disclosed.
(c) cannot be shown on the financial statements
hecause they are assumed to be non-arms length.
(d ) are very uncommon and create an unaccept-
able level of audit risk.
5·20 [LO 3] An audit firm's knowledge and experience
(a) d o no t limit the clients a firm can audit because
the firm can always get sufficient knowledge
from the auditing standards.
(b ) are not add res.~ed in the audit guida nce as
potential limiting factors affecting the accep-
tance of audit clients.
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(c) are important because a firm must have SEC (d) must be considered by the audit firm in client
experience before accepting a public company acceptance decisions to determine whether the
as an audit client. firm has the competence to provide the pro-
fessional services requested.

IDf'Jffl~MIUIIUIIJiii1i/f
5-2 1 [LO 1, 3] What happens to client companies that arc not desired as clients by the CPA

~
Ethlu
firms that are very concerned about client reputation? These might be companies with
known management integrity issues or fee disputes with prior auditors. Will these
companies still be able to get audits? From whom? What do you think this means
regarding protecting the public interest and integrity of the capital markets?
5-22 (LO 3) Why docs a recent or upcoming IPO create more risk for the auditor? "Which
8 audit firms seem best positioned to accept the risk? Which audit firms likely have the
\5 greatest expertise with that type of client? What would be the ultimate outcome if
the most qualified audit firms turn down companies with lPOs because they do not
want the risk, and the companies must use audit firms with less experience and exper-
tise? How does this scenario fit in with protecting the public interest?
5-23 (LO 3] Why would an auditor be concerned about a potential client with an over-
worked accounting staff? With a potential client that has had multiple turnover of
people in top accounting positions?
5-24 [LO 3) What circumstances might motivate an audit firm to hire an investigative
agency to research a potential client?
5-25 (LO 4) What is the purpose of an engagement letter? Is the engagement letter con-
sidered a binding contract between both parties? If a CPA fi rm works over the explic-
itly specified engagement hours provided for in the engagement letter, do you think
the firm can bill the client and collect for those hours? What might impact the firm's
ability to collect?
5-26 (LO 4) Asswning no independence issues, if you are a partner at a CPA firm and your
firm is engaged to audit your best friend's company; should you take on the engagement
on a verbal contract agreement? Why or why not? What influences your decision?
5-27 [LO 1] Your firm has been the auditor of a company for the last 15 years. In those 15
years, your firm has never identified any significant red flags regarding the company. By
all methods of judging, your client is a dream client. Considering the professional rela-
tionship your firm has with the company, should you still undergo client acceptance/
continuation procedures? Why or why not?
5-28 (LO 1) What is an RFP? Who issues an RFP? What information can the auditor expect
to obtain from a company's RFP? Contrast the benefits and disadvantage of formal
and informal proposal processes.

5-29 (LO 3) Global ·rechnologiesCorporation (GTC) is a large, international electronics com-

pany that is headquartered and traded in the United States. GTC was founded in 1976,
went public in 1983, and has had no known accounting"issues" since it went public. GTC
has diversified operations on five continents around the world in the electronics, research,
energy, and communic.ations industries. GTC recently issued an RFP for an audit.
Required:
identify and list the important items a potential auditor should consider when decid-
ing whether to propose on the GTC audit work.

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