Ch.14 Full Test Bank Completing the Audit Johnson

Chapter 14

Completing the Audit

Question Type: True or False

The Financial Accounting Standards Board (FASB) defines a loss contingency as an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur.

A. True

B. False

If, in addition to external legal counsel, the client also has in-house legal counsel responsible for litigation, claims, and assessments, a legal letter would NOT be sent to the in-house legal counsel.

A. True

B. False

The likelihood of loss contingencies is considered reasonably possible when the future event is likely to occur.

A. True

B. False

For public companies, the SEC (Securities and Exchange Commission) has strict deadlines for the filing of Form 10-K, which is the document that contains the company’s audited annual financial statements.

A. True

B. False

An example of a Type II subsequent event would be the bankruptcy of a client’s customer after year-end as a result of poor financial condition that existed as of the balance sheet date.

A. True

B. False

A Type I subsequent event requires an adjustment to the financial statements.

A. True

B. False

Analytical procedures may include ratio analysis, trend analysis, and other procedures.

A. True

B. False

At the conclusion of the audit, auditors revisit the materiality level determined at the beginning of the audit to ensure it is still appropriate based on the results of audit procedures.

A. True

B. False

As the audit is being performed, the engagement partner should conduct timely reviews of work completed on accounts, transactions, or disclosures that require extensive judgment or involve significant risks.

A. True

B. False

Analytical procedures during risk assessment may identify negative trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations

A. True

B. False

If auditors determine there is substantial doubt about the entity continuing as a going concern, the next step is to obtain information about management’s plans to mitigate or minimize the adverse effects of the situation.

A. True

B. False

A legal representation is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence.

A. True

B. False

AS 1301 specifies that only critical accounting policies and practices must be communicated to the audit committee.

A. True

B. False

Estimating the amount of a loss contingency from a material litigation situation is not a critical accounting estimate.

A. True

B. False

Question Type: Multiple choice

The Financial Accounting Standards Board (FASB) defines a loss contingency as _______.

A. an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur

B. an existing condition or situation involving certainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur

C. an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events fail to occur

D. an existing condition or situation involving uncertainty as to possible gain that will ultimately be resolved when one or more future events occur or fail to occur

FASB ASC Topic 450, Contingencies, provides accounting guidance for _______.

A. the accounting treatment for intangible assets

B. depreciable methods for property, plant and equipment

C. events, or potential events, that create uncertainty for a company

D. business combinations

An example of a loss contingency includes _______.

A. guarantees of debt of others

B. collection of accounts receivable

C. payment of accounts payable

D. repurchasing outstanding shares

A legal letter refers to a letter_______.

A. of inquiry sent to the client’s legal counsel

B. of inquiry sent to the prior auditor

C. sent to the Securities and Exchange Commission to advise of questionable accounting practices

D. sent to the client's internal audit function, questioning certain legal practices employed by the client

Attorneys and their clients have a _______.

A. confidential relationship

B. fiduciary relationship

C. privileged relationship

D. legal relationship

Large publicly traded companies are under great scrutiny _______.

A. from the SEC only

B. from both the public and the SEC

C. from the public only

D. from the internal audit function

Which of the following is NOT an example of a loss contingency?

A. Payment of income taxes

B. Income tax disputes

C. Guarantees of debt of others

D. Threat of expropriation of assets

Determining the likelihood of a loss contingency occurring and trying to estimate a reasonable amount for a future loss _______.

A. should be determined by the client's legal counsel

B. should be determined solely by the external auditor

C. should be determined solely by the internal auditor

D. involves significant judgment by management

Auditors should carefully consider which of the following assertions for loss contingencies?

A. Existence

B. Presentation and disclosure

C. Completeness

D. Rights and obligations

If management determines the loss contingency is probable and an amount can be reasonably estimated, then the company _______.

A. must record a liability and a related expense or loss, and disclose the relevant details of the event in the notes to the financial statements

B. must record an asset and a related expense or loss, and disclose the relevant details of the event in the notes to the financial statements

C. must record a liability and a related depreciation expense or loss, and disclose the relevant details of the event in the notes to the financial statements

D. should include a note in the notes to the financial statements but need not record an entry in accounting journals

If a loss contingency is reasonably possible or the amount cannot be reasonably estimated, _______.

A. disclosure should occur in both the financial statements and the notes to the financial statements

B. disclosure should occur in the financial statements only

C. only a disclosure in the notes is required

D. then no disclosure is required

What is loss contingency?

A. An existing condition or situation involving uncertainty to possible loss that will ultimately be resolved when one or more future events occur or fail to occur.

B. An opinion expressed by the auditor when the auditor concludes that the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework.

C. Lack of confidence in the audit process that intended users place in the financial statements.

D. A statement in the auditor’s report that is required by generally accepted auditing standards.

Attorneys and their clients have a ______, which means attorneys cannot talk about their client’s cases to anyone without permission from the client.

A. privileged relationship

B. no permission agreement

C. confidential rapport

D. legal right

Which of the following defines a legal letter?

A. An audit inquiry sent to a client’s external and in-house legal counsel to obtain information about litigation, assessments, and claims.

B. A letter comprising the auditor’s report that is required by generally accepted auditing standards or is included at the auditor’s discretion.

C. A statement in which a CPA orders inquiry and analytical procedures to provide limited assurance that no material modifications should be made to the financial statements.

D. An engagement in which a CPA applies accounting and financial expertise to assist management in the presentation of financial statements.

The financial statements are prepared by client management _______.

A. based on beginning of year financial conditions

B. for formal review and issuance of an audit opinion by the internal auditors

C. on the basis of conditions existing at year-end, which would be December 31 for a calendar year entity

D. on the basis of conditions existing at year-end, which should always be December 31

Auditors should be alert to subsequent events _______.

A. that may occur between the date of the financial statements and the date of the auditor’s report

B. that may occur between the date of the auditor’s report and the next balance sheet date

C. and report all immaterial findings to the Securities and Exchange Commission

D. as they are particularly important to the year-end closing process

Which statement defines a Type 1 subsequent event?

A. An event that provides evidence of conditions that arose after the date of the financial statements

B. An event that provides evidence of unreported earnings that arose after the date of the financial statements.

C. An event that provides evidence of conditions that existed at the date of the financial statements. A Type I event requires an adjustment to the financial statements.

D. An event that provides evidence of conditions that did not exist at the date of the financial statements. A Type I event requires an adjustment to the financial statements.

A Type II subsequent event _______.

A. provides evidence of conditions that arose after the date of the financial statements

B. provides evidence of conditions that arose before the date of the financial statements

C. provides evidence of conditions that arose after the date of the auditor’s report

D. provides evidence of conditions that arose before the date of the auditor’s report

The financial statements are prepared by client management _______.

A. on the basis of conditions existing at year-end

B. on the basis of conditions that existed at the beginning of the year

C. on the basis of conditions existing throughout the year

D. and sent to the Securities and Exchange Commission (SEC) for approval

A form 10-K refers to _______.

A. A form filed with the Securities and Exchange Commission (SEC) relating to changing of senior management

B. a firm's audited financial statements, sent to the SEC

C. a firm only filed with the SEC by privately traded companies

D. certain required income statement disclosures

The most common user of a private company’s financial statements _______.

A. is a bank or other lender

B. are regulatory agencies such as the Internal Revenue Service (IRS)

C. are competing companies

D. are employees of the company

A Type I subsequent event refers to _______.

A. an event that occurred after the date of the financial statements

B. an event that most likely occurred before the date of the financial statements

C. a contingent event, that may or may not occur

D. an event that is typified by debit entries to contra-revenue accounts

Type II subsequent events are those events that _______.

A. likely occurred before the financial statement date

B. likely occurred after the financial statement date

C. are unlikely to require adjustment to the financial statements

D. should be reported to the Securities and Exchange Commission (SEC)

A Type I subsequent event should _______.

A. not require an adjustment to the financial statements

B. always require an adjustment to the financial statements

C. be disclosed in the notes to the financial statements only

D. should be referred to management to determine disclosure requirements

Subsequent events refer to _______.

A. events occurring between the date of the financial statements and the date of the auditor’s report

B. events occurring before the financial statement date

C. events occurring after the financial statement date

D. events occurring after completion of the audit and issuance of the audit report

An example of a Type I subsequent event would be _______.

A. a sudden change in senior management after the financial statement date

B. a filing with the Securities and Exchange Commission (SEC) of an amended form 10K after the financial statement date

C. the bankruptcy of a client’s customer after year-end as a result of poor financial condition that existed as of the balance sheet date

D. the bankruptcy of a client’s customer after year-end as a result of poor financial condition that existed after the balance sheet date

Audit standards require auditors to _______.

A. conduct specific audit procedures to identify subsequent events that may occur up through the date of the auditor’s report

B. conduct specific audit procedures to identify subsequent events that may occur after the date of the auditor’s report.

C. apply optional use of analytical procedures to increase assurance levels related to subsequent events

D. delegate auditing of subsequent events to the internal audit function

Specific audit procedures to identify subsequent events include _______.

A. obtaining an understanding of how management identifies subsequent events

B. reading the client’s subsequent interim financial statements, if available, and other data such as budgets and cash flow forecasts

C. inquiring of the client’s legal counsel regarding litigation, claims, and assessments

D. All of these answer choices are correct.

The nature of the specific procedures performed for the subsequent events review _______.

A. will depend on the individual circumstances of each client

B. should be uniform across all clients, to increase consistency

C. should be agreed with management, with respect to areas to focus audit resources and effort

D. will be determined and handled by the internal audit function

Define subsequent events.

A. Events occurring between the date of the financial statements and the date of the auditor’s report.

B. Events that provide evidence of conditions that arose after the date of the auditor’s report.

C. Events that provide evidence of conditions that arose after the date of the financial statements.

D. Events that never require an adjustment to the financial statements but may require disclosure in the notes to the financial statements.

What is Type I subsequent event?

A. An event that provides evidence of conditions that existed at the date of the financial statements.

B. An event occurring between the date of the financial statements and the date of the auditor’s report.

C. An event that provides evidence of conditions that arose after the date of the financial statements.

D. An event that does not require an adjustment to the financial statements but may require disclosure in the notes to the financial statements.

Type II subsequent events occur _______.

A. after the date of the financial statements

B. between the date of the financial statements and the date of the auditor’s report

C. at the date of the financial statements

D. none of the above are correct

Final analytical procedures are intended

A. to corroborate audit evidence obtained during the audit only

B. to corroborate audit evidence obtained during the audit, and to confirm the financial statements are consistent with the auditor’s revised expectations based on evidence evaluated during the audit

C. to refute audit evidence obtained during the audit, and to confirm the financial statements are consistent with the auditor’s revised expectations based on evidence evaluated during the audit

D. to corroborate audit evidence obtained during the audit, and to confirm the financial statements are inconsistent with the auditor’s revised expectations based on evidence evaluated during the audit.

An engagement quality control reviewer _______.

A. will review selected areas of working papers prior to the issuance of the audit report

B. will review all areas of working papers prior to the issuance of the audit report

C. is typically a person with minimal audit expertise and experience

D. should be appointed by the client

During the risk response phase, _______.

A. all analytical procedures have been conducted

B. analytical procedures can be used, but are not required, as a substantive test to gather audit evidence

C. analytical procedures can be used, and are required, as a substantive test to gather audit evidence

D. the auditor should begin testing internal control

The actual analytical procedures performed at the end of an audit _______.

A. should always be the same for every client in order to increase uniformity of audits

B. will depend on senior managements preferences

C. will depend on auditor judgment and may vary by client

D. will depend on auditor judgment but should be the same for each client

At the conclusion of the audit, _______.

A. auditors typically revaluate materiality decisions made during the audit to ensure it is still appropriate based on the results of audit procedures

B. auditors typically attempt to contact the prior auditor

C. auditors may attempt to contact the client's legal counsel

D. auditors ask management for recommendations on any needed adjustments to the accounts

When the results of substantive procedures identify misstatements, _______.

A. the auditors refer the misstatements to the prior auditor for correction

B. auditors consider whether the misstatements may be indicative of the need to re-evaluate inherent risk, control risk or fraud risk

C. auditors consider whether the misstatements may be indicative of the need to re-evaluate inherent risk only

D. auditors consider whether the misstatements may be indicative of the need to re-evaluate control risk only

If controls are weak, _______.

A. auditors will perform less substantive testing as a result

B. auditors will increase the control risk assessment and perform additional substantive tests to detect material misstatements

C. auditors will decrease the control risk assessment and perform additional substantive tests to detect material misstatements

D. auditors will increase the control risk assessment and perform fewer substantive tests to detect material misstatements

When fraud is discovered, _______.

A. auditors should immediately contact the Securities and Exchange Commission (SEC)

B. auditors should determine the amounts involved, and then decide whether to report the fraud to management

C. auditors gather sufficient appropriate evidence to support their conclusion

D. the matter should immediately be referred to the internal audit function

Auditors report fraud _______.

A. to the Securities and Exchange Commission (SEC) within 72 hours

B. to a level of management at least one level above the level where the fraud occurred

C. directly to the manager that is suspected of involvement in the fraud

D. to the level below where the auditor suspects the fraud is occurring

If the auditors withdraw from an engagement, _______.

A. they will inform the appropriate level of management or those charged with governance and provide reasons for the withdrawal

B. they will inform the appropriate level of management only and will provide reasons for the withdrawal

C. the auditor should immediately cease communication with the client, and refer them to another auditor

D. they are not entitled to receive compensation for services performed

A form 8-K is used _______.

A. to file a company's audited financial statements

B. for management to report a change of auditors, and the reason for the change

C. for management to report a change of internal auditors, and the reason for the change

D. to disclose fraudulent transactions that have occurred within a company to the Securities and Exchange Commission (SEC)

When evaluating the effect of uncorrected misstatements, _______.

A. only quantitative factors are considered

B. only qualitative factors are considered

C. both quantitative and qualitative factors are considered

D. neither quantitative and qualitative factors are considered

The individual responsible for the audit engagement, its performance, and for the auditor’s report that is issued on behalf the firm is _______.

A. the senior audit manager

B. the audit partner

C. the Chief Executive Officer (CEO) of the client firm

D. the Chief Financial Officer (CFO) of the client firm

An engagement quality control reviewer _______.

A. will review selected areas of working papers prior to the issuance of the audit report

B. will review all areas of working papers prior to the issuance of the audit report

C. should be impartial and chosen by the client's senior management

D. should be chosen from a different audit firm

Who considers whether work has been performed in accordance with appropriate audit standards?

A. Working paper reviewer

B. Engagement partner

C. Quality control reviewer

D. Audit partner

_______ are used near the end of the audit to assist the auditor in forming an overall conclusion about whether the financial statements are consistent with the auditor’s understanding of the entity.

A. Analytical procedures

B. Engagement procedures

C. Quality control procedures

D. Audit standards

At the end of the audit, which of the following is NOT reevaluated by the auditors?

A. Misstatements found during the audit

B. Materiality decisions made during the audit

C. Inherent risk based on audit findings

D. Fraud risk based on audit findings

The going concern assumption _______.

A. is not the responsibility of the auditor, and should be left to management to determine

B. is a fundamental principle in the preparation of the financial statements

C. is the legal responsibility of the auditor

D. relates to the comparability and verifiability of a firm’s financial statements

With respect to the going concern assumption, auditors also draw their own conclusions _______.

A. about whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time

B. about whether there is substantial doubt about the entity’s ability to continue as a going concern for an indefinite period of time

C. as to whether the client is likely to be a target for an acquisition by another company in the near future

D. as to whether the client is likely to attempt to acquire another company in the near future

If auditors determine there is substantial doubt about the entity continuing as a going concern, _______.

A. the next step is to obtain information about management’s plans to mitigate or minimize the adverse effects of the situation

B. the next step is to obtain information about the auditor’s plans to mitigate or minimize the adverse effects of the situation

C. they should immediately issue an adverse opinion and withdraw from the engagement

D. the auditors should immediately invoice the client for the cost of the audit and request payment within 30 days

The assumption that relates to the entity continuing in business for the foreseeable future is called _______.

A. the entity assumption

B. the going concern assumption

C. the solvency assumption

D. the liquidity assumption

Responsibility for evaluating the going concern assumption in accordance with the applicable financial reporting framework rests with _______.

A. the auditor

B. management

C. the internal audit function

D. the clients legal counsel

If management determines there is substantial doubt about continuing as a going concern, _______.

A. then management must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation.

B. then management must make list an estimated loss contingency in the financial statements about the circumstances, including any plans management may have to mitigate the situation.

C. nothing should be disclosed in the notes to the financial statements until management is reasonably certain it will be an issue

D. then future debt issues will likely enjoy lower interest rates

With respect to the going concern assumption, under Generally Accepted Accounting Principles (GAAP), a reasonable period of time is _______.

A. considered to be 90 days

B. considered to be 180 days

C. one year from the date the client issues financial statements

D. two years from the date the client issues financial statements

Analytical procedures during risk assessment of a going concern _______.

A. May identify negative trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations

B. May identify positive trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations

C. May identify only external matters that have occurred such as loss of a key franchise, loss of a principal customer, or work stoppages due to natural disaster

D. May identify internal matters that have occurred such as legal proceedings

If auditors determine there is substantial doubt about the entity continuing as a going concern, _______.

A. then the auditor should immediately notify the Securities and Exchange Commission (SEC)

B. the next step is to obtain information about management’s plans to mitigate or minimize the adverse effects of the situation

C. the next step is to obtain information about the auditor’s plans to mitigate or minimize the adverse effects of the situation.

D. the next step is to ensure the client is immediately billed for all services performed, to ensure payment

After considering management’s plans, if auditors determine there is substantial doubt about the entity’s ability to continue as a going concern, _______.

A. the auditor should consider withdrawing from the engagement

B. the next steps are to consider the possible effects on the financial statements and on the auditor’s report

C. the next steps are to consider the possible effects on the financial statements and on the internal auditor’s report

D. the auditor should attempt to locate alternative lines of debt and equity capital for the client

The final step for the auditor to perform with respect to doubts about an entity's ability to remain a going concern is to communicate_______.

A. all relevant findings to the internal audit function

B. all relevant findings to common stockholders

C. with those charged with governance

D. with all preferred stockholders

If the auditors decide to issue a modified auditor’s report due to doubt about an entity's ability to continue as a going concern _______.

A. the report should always be adverse

B. the report should always be a disclaimer of opinion

C. the matter should be communicated with those charged with governance

D. the should be communicated to the client’s legal counsel for disclosure to senior management

An example of a factor that mitigates doubts about an entity's ability to continue as a going concern would be _______.

A. a letter of guarantee from a parent company

B. the ability to raise additional funds through the issuance of more stock

C. the ability to sell an unprofitable segment of the business

D. All of these examples are mitigating factors.

What is the going concern assumption?

A. The viability of an entity to remain in business for the foreseeable future

B. The period of time required by the applicable financial reporting framework

C. The responsibility to perform any audit procedures

D. An overall conclusion on the audit drawn by auditors

According to Generally Accepted Accounting Principles (GAAP), to meet the “going-concern” standard an entity must be viewed as capable of staying in business for ____________ after the date of the financial statements.

A. a reasonable period of time

B. six months

C. nine months

D. two years

The management representation letter _______.

A. can sometimes serve as a substitute for certain audit procedures that were not able to be performed

B. is a letter from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements

C. is a letter from the auditor to management acknowledging management’s responsibility for the preparation of the financial statements

D. should only be sent to the client's legal counsel; not directly to the client

The written representation from management _______.

A. supplements the inquiries made of management regarding subsequent events and the evidence gathered from audit procedures

B. supplements the inquiries made of the auditor regarding subsequent events and the evidence gathered from audit procedures

C. can be drafted by the auditor and signed by the internal audit function on behalf of management

D. transfers legal liability for any financial statement errors to the auditor

A written representation is _______.

A. a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence

B. a written statement drafted by the internal audit function, and provided to the auditor to confirm certain matters or to support other audit evidence

C. should be filed as part of court filings by the client, to confirm the details of the representing attorney

D. a statement from the prior auditor, confirming there were no material misstatements found in prior audits

Generally, a written representation _______.

A. is sufficient evidence to issue an unmodified audit report

B. complements other audit procedures that were performed and generally does not provide sufficient appropriate audit evidence on its own

C. replaces other audit procedures that were performed and generally does provide sufficient appropriate audit evidence on its own

D. should be drafted by the client’s legal counsel and signed with the auditor

The responses to the inquiries that auditors have made of management throughout the course of the audit _______.

A. are recorded in the client's permanent file

B. are confidential and not shared with senior management

C. are documented in the auditor’s working papers

D. are sent to the prior auditor to be checked for prior year consistency

A management representation letter is a letter _______.

A. that is sent from the auditor to management, and then signed off on by the client's legal counsel

B. that is sent from management to the auditor, and then signed off on by the client's legal counsel

C. from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements

D. from the auditor to management acknowledging management’s responsibility for the preparation of the financial statements

The management representation letter _______.

A. can sometimes be used as a substitute for the gathering of audit evidence

B. is not a substitute for obtaining sufficient, appropriate evidence regarding the financial statements through other audit procedures

C. can replace analytical procedures conducted as part of the audit, but cannot replace the audit of internal control

D. can replace the audit of internal control conducted as part of the audit, but cannot replace the analytical procedures

Governance structures will _______.

A. typically be the same for each client

B. typically be the same within an industry

C. typically vary by client

D. be determined by auditor recommendations

Auditors communicate significant findings or issues from the audit to those charged with governance _______.

A. typically at the beginning of the audit

B. typically during the audit

C. typically towards the end of the audit

D. via the client's legal counsel

AS 1301 specifies that _______.

A. critical accounting policies and practices and critical accounting estimates must be communicated to the audit committee

B. significant and immaterial accounting policies and practices and critical accounting estimates must be communicated to the audit committee

C. the auditor should bill audit clients at distinct phases of the audit process

D. auditors should always consult with their own legal counsel before issuing an unmodified opinion

Which of the following characteristics exist in critical accounting communications?

A. the nature of the estimate is material due to the levels of subjectivity

B. judgment is necessary to account for highly uncertain matters or the susceptibility of such matters to change

C. the impact of the estimate on financial condition or operating performance is material

D. All of these answer choices are correct.

(1) the nature of the estimate is material due to the levels of subjectivity,

(2) judgment is necessary to account for highly uncertain matters or the susceptibility of such matters to change, and

(2) the impact of the estimate on financial condition or operating performance is material.

The outcome of litigation _______.

A. is usually decided relatively quickly

B. does not affect the auditor

C. may be highly uncertain, and the circumstances may change over the course of a long court battle that spans several years

D. may be highly certain, and the circumstances may change over the course of a long court battle that spans several years

What is a written representation?

A. A written statement by management provided to the auditor to confirm certain matters or to support other audit evidence.

B. A letter from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements.

C. A written statement containing details of any verbal representations made by management during the course of the audit.

D. A letter from auditor to the management informing their concerns.

Define a management representation letter.

A. A letter from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit.

B. A written statement by management provided to the auditor to confirm certain matters or to support other audit evidence.

C. A letter from auditor informing management about concerns.

D. A written statement containing details of any verbal representations made by management during the course of the audit.

Which of the following refer(s) to accounting policies and practices that are most important to the portrayal of the company’s financial condition and results and that require management’s most difficult, subjective, or complex judgments?

A. Critical accounting policies and practices

B. Critical accounting estimates

C. Critical accounting projections

D. A disclosure agreement

Question Type: Text Entry

A _______ is an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur.

loss contingency

A/an _______ is an audit inquiry sent to a firm’s in-house legal counsel to obtain information about litigation, assessments, and claims.

legal letter

Type _______ subsequent events are those that provide evidence about conditions that developed subsequent to year-end.

Two | two | 2

An example of a _______ would be the bankruptcy of a client’s customer after year-end as a result of poor financial condition that existed as of the balance sheet date.

Type I subsequent event

A/an _______ is responsible for the audit engagement, its performance, and for the auditor’s report that is issued on behalf of the firm.

engagement partner

Under the _______, an entity is viewed as continuing in business for the foreseeable future with neither the intention nor the need for liquidation.

going concern assumption

A _______ is a letter from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit.

management representation letter

The nature of the critical accounting estimates is _______ due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.

material

Question Type: Drop down

In the given table, match the sections of a legal letter on the left with the corresponding explanations on the right.

A. The legal letter is prepared on the client’s letterhead

||The client must grant permission for the attorneys to respond.

B. Date of the letter

||The letter is sent about mid-way through the completion of year-end fieldwork.

C. Name and address of attorneys

||A legal letter should be sent to all attorneys the client hired during the year for legal services, as well as in-house counsel.

D. Request for information

||This paragraph identifies the financial statements under audit and states a request to supply information directly to the auditors.

The legal letter is prepared on the client’s letterhead: The client must grant permission for the attorneys to respond.

Date of the letter: The letter is sent about mid-way through the completion of year-end fieldwork.

Name and address of attorneys: A legal letter should be sent to all attorneys the client hired during the year for legal services, as well as in-house counsel.

Request for information: This paragraph identifies the financial statements under audit and states a request to supply information directly to the auditors.

Match the audit procedures on the left with the descriptions on the right.

A. Confirmation with related parties and third parties of the details of arrangements to provide or maintain financial support

||May identify possible financial difficulties such as default on financing arrangements, restructuring of financing agreements, and need to seek new sources or methods of financing

B. Reading of minutes of meetings with stockholders, board of directors, and other important committees of the board

||May identify internal or external matters that have occurred such as labor difficulties, arrearages in dividends, and substantial dependence on the success of a particular project

C. Review of compliance with terms of debt and loan agreements

||May identify possible financial difficulties such as restructuring of debt, default on loan or similar agreements, and need to dispose of substantial assets

D. Inquiry of client’s legal counsel

||May identify external matters that have occurred such as legal proceedings that might jeopardize the client’s ability to operate

Confirmation with related parties and third parties of the details of arrangements to provide or maintain financial support may identify possible financial difficulties such as default on financing arrangements, restructuring of financing agreements, and need to seek new sources or methods of financing.

Reading of minutes of meetings with stockholders, board of directors, and other important committees of the board may identify internal or external matters that have occurred such as labor difficulties, arrearages in dividends, and substantial dependence on the success of a particular project.

Review of compliance with terms of debt and loan agreements may identify possible financial difficulties such as restructuring of debt, default on loan or similar agreements, or need to dispose of substantial assets.

Inquiry of client’s legal counsel may identify external matters that have occurred such as legal proceedings that might jeopardize the client’s ability to operate.

Match the significant findings or issues from the audit on the left with their explanations on the right.

A. Corrected misstatements

||Misstatements that were brought to management’s attention and corrected during the audit.

B. Written representation

||Auditors should provide those charged with governance with a copy of the management representation letter.

C. Business conditions affecting the entity

||If there are industry, economic, or other uncertainties that could affect the entity’s ability to continue as a going concern, these matters should be communicated to those charged with governance.

D. Consultations with other accountants

||If auditors and management disagree on an issue, management may contact other outside accountants to see if they may agree with management’s views. If auditors are aware that management has consulted with other accountants, then it should be brought to the attention of those charged with governance. Auditors should communicate their own views on the issue and how they differ from management’s views.

Corrected misstatements: Misstatements that were brought to management’s attention and corrected during the audit.

Written representation: Auditors should provide those charged with governance with a copy of the management representation letter.

Business conditions affecting the entity: If there are industry, economic, or other uncertainties that could affect the entity’s ability to continue as a going concern, these matters should be communicated to those charged with governance.

Consultations with other accountants: If auditors and management disagree on an issue, management may contact other outside accountants to see if they may agree with management’s views. If auditors are aware that management has consulted with other accountants, then it should be brought to the attention of those charged with governance. Auditors should communicate their own views on the issue and how they differ from management’s views.

Question Type: Multiple choice multi select

Identify three risk assessment and risk response procedures that may identify loss contingencies.

A. Inquiring of management regarding the completeness of recorded liabilities

B. Inspecting tax returns and correspondence with the IRS (Internal Revenue Service)

C. Confirming with financial institutions, including guarantees of debt

D. Threat of expropriation of assets

Examples of inquiries of management regarding subsequent events include which three of the following?

A. Has the company entered into new commitments, borrowings, or guarantees?

B. Have sales occurred or are planned that may affect the carrying value or classification of assets?

C. Are there any plans to issue new shares or debt instruments (debentures)?

D. Have competitors diversified their portfolio?

1) Has the company entered into new commitments, borrowings, or guarantees?

2) Have sales occurred or are planned that may affect the carrying value or classification of assets?

3) Are there any plans to issue new shares or debt instruments (debentures)?

Which three of the following are items to consider when reviewing working papers?

A. Work has been performed in accordance with appropriate audit standards.

B. Significant findings or issues have been raised for further consideration or audit testing.

C. Consultations among team members and others within or outside of the audit firm, have taken place, as needed, and the resulting conclusions have been documented.

D. Competitors have changed their business plans.

Identify two examples of mitigating factors that could offset going concern issues.

A. Reduction of expenditures

B. Ability to sell assets without interrupting the entity’s operating capacity

C. Inability to sell an unprofitable segment of the business

D. Increase in expenditures

Which three of the following are matters to be communicated with those charged with governance?

A. Appropriateness of significant accounting policies

B. Difficulties encountered during the audit

C. Process used by management in developing sensitive accounting estimates

D. Agreements with management

Question Type: Drag and Drop

A/_ ______ is an audit inquiry sent to a client’s external and in-house legal counsel to obtain information about litigation, assessments, and claims.

[legal letter] | loss contingency | working papers | audit evidence

_______ events provide evidence of conditions that existed at the date of the financial statements and require adjustment to the financial statements.

[Type I] | Type II | Type III | Subsequent

The audit file _______ deadline is seven years from the audit report release date.

[retention] | assembly | review | litigation

_______ are accounting estimates whose nature and impact on the financial statements are material because of the high levels of subjectivity and judgment necessary to account for highly uncertain matters.

[Critical accounting estimates] | Critical accounting policies and practices | critical accounting projections | management representation practices

Question Type: Short Answer

Explain briefly auditors' responsibility for subsequent discovery of facts existing at the date of the auditors' reports.

If auditors become aware of facts that existed at the date of the reports, auditors should require the client to disclose the facts and their impact on the financial statements to persons relying on the financial statements if the following conditions exist:
1. The facts are reliable and existed at the report date.
2. The facts affect the financial statements and auditors' reports.
3. Persons are continuing to rely on the financial statements and auditors' reports.
If the client refuses to make the appropriate disclosures (as discussed above), auditors should notify each member of the board of directors that they will be notifying regulatory agencies having jurisdiction over the client (such as the Securities and Exchange Commission) as well as other persons who are currently relying on the reports.

Define what is meant by the term "subsequent event". In addition, identify the two types of subsequent events and indicate how auditors should modify the engagement for the discovery of subsequent events.

A subsequent event is an event that occurs between the balance sheet date and audit report release date that may affect the presentation and disclosure in the client's financial statements.

A Type I subsequent event provides new information regarding a condition that existed at the balance sheet date (such as a loss on uncollectible accounts receivable or settlement of litigation for an amount different than estimated).

A Type II subsequent event involves a matter that occurs after the balance sheet date, such as a bond sale, capital stock issuance, or loss of plant or inventories as a result of fire or flood.

Because the related matters existed at the balance sheet date, Type I subsequent events require adjustment of reported amounts in the financial statements. In contrast, Type II subsequent events will require disclosure.

In some cases, the effect(s) of the events may be of such a magnitude that pro forma financial statements are prepared.

In cases where the events are discovered after the audit completion date but prior to the audit report release date, auditors would recommend adjustment or disclosure in the financial statements and dual date the reports. If the events are discovered after the audit report release date, auditors should recommend client disclosure of the event to persons relying on the financial statements if (1) the facts are reliable and existed at the report date, (2) the facts affect the financial statements and auditors' reports, and (3) persons are continuing to rely on the financial statements and auditors' reports.

Tinley Corporation is being audited for the calendar year 2018. Among other items related to the audit, Tinley Corporation was being sued for personal injury resulting from the malfunction of one of their products. The lawsuit was initiated by Mr. John Jones in September 2018.

Tinley's senior management and their outside legal counsel estimated the loss from the suit to be approximately $200,000. This amount is accrued and properly disclosed in the footnotes of the financial statements. The auditors have no reason to believe that the estimate is inaccurate.

The audit is completed, and the report is dated February 1, 2019. The financial statements were issued on February 14, 2019. On March 30, 2019, the auditor reads an article in a trade journal about the Tinley Corporation and the recent jury award to Mr. John Jones for $1.5 million his personal injury lawsuit.

Discuss the nature of these events and what responsibility, if any, does the auditor have regarding the news of the jury award on March 30, 2019.

The outcome of the lawsuit would ordinarily be considered a Type I event. It is a subsequent event that provides new information regarding a financial condition that existed at the date of the balance sheet. However, auditors have no responsibility with regard to the March 30 outcome because it occurred after the audit completion date and audit report release date. Since the best estimate had been properly recorded and disclosed in the financial statements issued, auditors have no additional responsibility in this situation.

Ms. Wood accepted an engagement to audit the 2017 financial statements of XYZ Company. XYZ completed the preparation of the 2017 financial statements on February 5, 2018, and Ms. Wood began the field work on February 20, 2018. Ms. Wood completed gathering sufficient appropriate evidence on March 25, 2018 and issued the report on March 31, 2018. When should management representations be dated and why?

A. Management representations should be dated March 25, 2018, as that was the date on which sufficient evidence had been gathered.

Marcella Good is the audit manager on the Green Tree Landscaping audit. Management has refused to sign the management representation letter. Draft a short letter to the Green Tree management explaining the purpose of the management representation letter and the ramifications of refusing to sign the letter.

Solution: Student answers will vary but should cover:

A management representation letter is a letter from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. However, the management representation letter is not a substitute for obtaining sufficient, appropriate evidence regarding the financial statements through other audit procedures.

If management refuses to sign a management representation letter, that would cause the auditors to question management’s integrity, competence, and ethical values. And, it could have serious ramifications for the audit. Auditors would be especially concerned about the reliability of audit evidence obtained through inquiry of management. The refusal by management to sign the representation letter would be considered a scope limitation and could affect the auditor’s opinion on the financial statements or the ability to provide an opinion on the financial statements.

Explain briefly (a) management representations, (b) internal control communications, and (c) management letters. In your answer, include the general content of the communication, the parties involved with the communication, the required form of the communication, and whether the communication is required under generally accepted auditing standards.

A. Management representations normally take the form of a letter on the client's letterhead, addressed to auditors, and signed by a responsible officer of the client. The purpose of this letter is to impress upon management its responsibility for the financial statements. Included in the letter are statements on (1) management's responsibility for financial statements, (2) the availability of all financial records and related data, (3) management's responsibility for design and implementation of programs and controls to prevent and detect fraud, (4) disclosure of all significant deficiencies in internal control, and (5) information concerning fraud involving management, employees who have significant roles in internal control, or cases where the fraud could have a material effect on the financial statements. This communication is required by generally accepted auditing standards and must be in writing.

b. An internal control communication is normally made by auditors to the client or client's audit committee (those charged with governance). It involves the communication of deficiencies in the client's internal control. This communication is required by generally accepted auditing standards and should be made in writing.

c. The management letter is sent by auditors to the client after the completion of the audit. The letter can include recommendations for improvement and suggestions for other possible auditors' services. Management letters are not required by generally accepted auditing standards; while they are typically prepared in writing, the related communication can be made orally.