Solution manual principles of accounting by arens elder beasley

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Chapter 1
Multiple-Choice Questions

1.
easy
c

Recording, classifying, and summarizing economic events in a logical manner for the purpose
of providing financial information for decision making is commonly called:
a. finance.
b. auditing.
c. accounting.
d. economics.

2.
easy
c

In the audit of historical financial statements, which of the following accounting bases is the
most common?
a. Regulatory accounting principles.
b. Cash basis of accounting.
c. Generally accepted accounting principles.
d. Liquidation basis of accounting.

3.
easy
b

Any service that requires a CPA firm to issue a report about the reliability of an assertion that is
made by another party is a(n):
a. accounting and bookkeeping service.
b. attestation service.
c. assurance service.
d. tax service.

4.
easy
a

Three common types of attestation services are:
a. audits, reviews, and “other” attestation services.
b. audits, verifications, and “other” attestation services.
c. reviews, verifications, and “other” attestation services.
d. audits, reviews, and verifications.

5. (SOX)
easy
d

The organization that is responsible for providing oversight for auditors of public companies is
called the ________.
a. Auditing Standards Board.
b. American Institute of Certified Public Accountants.
c. Public Oversight Board.
d. Public Company Accounting Oversight Board.

6. (SOX)
easy

c

The Sarbanes-Oxley Act applies to which of the following companies?
a. All companies.
b. Privately held companies.
c. Public companies.
d. All public companies and privately held companies with assets greater than $500 million.

7.
medium
d

Providing quantitative information that management and others can use to make decisions is the
function of:
a. management information systems.
b. auditing.
c. finance.
d. accounting.

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8.
medium
d

An audit of historical financial statements most commonly includes the:
a. balance sheet, the income statement, and the statement of cash flows.

b. income statement, the statement of cash flows, and the statement of net working capital.
c. statement of cash flows, the balance sheet, and the retained earnings statement.
d. balance sheet, the income statement, and the statement of cash flows.

9.
medium
c

The ___________ rate may be defined as approximately the rate a bank could earn by investing
in U.S. treasury notes for the same length as the length of a business loan.
a. nominal
b. stated
c. risk-free
d. prevailing

10.
medium
b

The use of the Certified Public Accountant title is regulated by:
a. the federal government.
b. state law through a licensing department or agency of each state.
c. the American Institute of Certified Public Accountants through the licensing departments
of the tax and auditing committees.
d. the Securities and Exchange Commission.

11.
medium
c

An operational audit has as one of its objectives to:
a. determine whether the financial statements fairly present the entity’s operations.
b. evaluate the feasibility of attaining the entity’s operational objectives.
c. make recommendations for improving performance.
d. report on the entity’s relative success in attaining profit maximization.

12.
medium
d

An audit of historical financial statements is most often performed to determine whether the:
a. organization is operating efficiently and effectively.
b. entity is following specific procedures or rules set down by some higher authority.
c. management team is fulfilling its fiduciary responsibilities to shareholders.
d. none of these choices.

13.
medium
a

An examination of part of an organization’s procedures and methods for the purpose of
evaluating efficiency and effectiveness is what type of audit?
a. Operational audit.
b. Compliance audit.
c. Financial statement audit.
d. Production audit.

14.
medium
b

An audit to determine whether an entity is following specific procedures or rules set down by
some higher authority is classified as a(n):
a. audit of financial statements.
b. compliance audit.
c. operational audit.
d. production audit.

15.
medium
d

Which of the following is a type of audit evidence?
a. Oral responses to the auditor from employees of the company under audit.
b. Written communications from company employees or outsiders.
c. Observations made by an auditor.
d. Evidence may take any of the above forms.

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16.
medium
a

Which of the following services provides the lowest level of assurance on a financial statement?
a. A review.
b. An audit.

c. Neither service provides assurance on financial statements.
d. Each service provides the same level of assurance on financial statements.

17.
medium
c

The three requirements for becoming a CPA include all but which of the following?
a. Uniform CPA examination requirement.
b. Educational requirements.
c. Character requirements.
d. Experience requirement.

18.
medium
a

In “auditing” financial accounting data, the primary concern is with:
a. determining whether recorded information properly reflects the economic events that
occurred during the accounting period.
b. determining if fraud has occurred.
c. determining if taxable income has been calculated correctly.
d. analyzing the financial information to be sure that it complies with government
requirements.

19.
medium
d

Financial statement users often receive unreliable financial information from companies. Which

of the following is not a common reason for this?
a. Complex business transactions.
b. Large amounts of data.
c. Lack of firsthand knowledge about the business.
d. Each of these choices is a common reason for unreliable financial information.

20.
challenging
d

Which of the following is not a Trust Services principle as defined by the AICPA or CICA?
a. Online privacy.
b. Availability.
c. Processing integrity.
d. Operational integrity.

21.
challenging
c

Which one of the following is more difficult to evaluate objectively?
a. Presentation of financial statements in accordance with generally accepted accounting
principles.
b. Compliance with government regulations.
c. Efficiency and effectiveness of operations.
d. All three of the above are equally difficult.

22. (SOX)
challenging
c

The Sarbanes-Oxley Act prohibits a CPA firm that audits a public company from providing
which of the following types of services to that company?
a. Reviews of quarterly financial statements.
b. Preparation of corporate tax returns.
c. Most consulting services.
d. Tax services.

23.
challenging
a

Which of the following audits can be regarded as generally being a compliance audit?
a. IRS agents’ examinations of taxpayer returns.
b. GAO auditor’s evaluation of the computer operations of governmental units.
c. An internal auditor’s review of a company’s payroll authorization procedures.
d. A CPA firm’s audit of the local school district.

24.
challenging

Which of the following can be significantly affected by an audit?
a. Business risk.

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b

b.
c.
d.

Information risk.
The risk-free interest rate.
Inherent risk.

25.
challenging
d

The trait that distinguishes auditors from accountants is the:
a. auditor’s ability to interpret accounting principles generally accepted in the United States.
b. auditor’s education beyond the Bachelor’s degree.
c. auditor’s ability to interpret FASB Statements.
d. auditor’s accumulation and interpretation of evidence related to a company’s financial
statements.

26.
challenging
b

Attestation services on information technology include WebTrust services and SysTrust
services. Which of the following statements most accurately describes SysTrust services?
a.
SysTrust services provide assurance on business processes, transaction integrity and
information processes.
b.

SysTrust services provide assurance on system reliability in critical areas such as security
and data integrity.
c.
ysTrust services provide assurance on internal control over financial reporting.
d.
SysTrust services provide assurance as to whether accounting personnel are following
procedures prescribed by the company controller.

Essay Questions
27.
easy

Discuss the three primary requirements for becoming a CPA.
Answer:
The three primary requirements for becoming a CPA are:
Educational requirement. An undergraduate degree with a major in accounting is
required. Most states now require 150 semester hours for licensure and some states
require 150 semester hours before taking the CPA exam.
Uniform CPA examination requirement. This is a four-part exam with components on
auditing and attestation, financial accounting and reporting, regulation, and business
environment and concepts.
Experience requirement. The experience requirement varies from state to state with
some states requiring no experience, while other states require up to two years of audit
experience.

28.
easy

Two types of attestation services provided by CPA firms are audits and reviews. Discuss the
similarities and differences between these two types of attestation services. Which type provides

the least assurance?
Answer:
Two primary types of attestation services are: audits of historical financial statements and
reviews of historical financial statements. While both services involve the accumulation
and evaluation of evidence regarding assertions made by management in the company’s
financial statements, a review involves a less extensive examination and provides a lower
level of assurance about the client’s financial statements than an audit.

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29.
medium

Discuss the differences and similarities between the roles of accountants and auditors. What
additional expertise must an auditor possess beyond that of an accountant?
Answer:
The role of accountants is to record, classify, and summarize economic events in a logical
manner for the purpose of providing financial information for decision making. To do this,
accountants must have a sound understanding of the principles and rules that provide the
basis for preparing the financial information. In addition, accountants are responsible for
developing systems to ensure that the entity’s economic events are properly recorded on a
timely basis and at a reasonable cost.
The role of auditors is to determine whether the financial information prepared by
accountants properly reflects the economic events that occurred. To do this, the auditor
must not only understand the principles and rules that provide the basis for preparing
financial information, but must also possess expertise in the accumulation and evaluation
of audit evidence. It is this latter expertise that distinguishes auditors from accountants.

30.
medium

Discuss the similarities and differences between financial statement audits, operational audits,
and compliance audits. Give an example of each type.
Answer:
Financial statement audits, operational audits, and compliance audits are similar in that
each type of audit involves accumulating and evaluating evidence about information to
ascertain and report on the degree of correspondence between the information and
established criteria. The differences between each type of audit are the information being
examined and the criteria used to evaluate the information. An example of a financial
statement audit would be the annual audit of IBM Corporation, in which the external
auditors examine IBM’s financial statements to determine the degree of correspondence
between those financial statements and generally accepted accounting principles. An
example of an operational audit would be an internal auditor’s evaluation of whether the
company’s computerized payroll-processing system is operating efficiently and
effectively. An example of a compliance audit would be an IRS auditor’s examination of
an entity’s federal tax return to determine the degree of compliance with the Internal
Revenue Code.

31.
medium

Discuss the similarities and differences between the roles of independent auditors, GAO
auditors, internal revenue agents, and internal auditors.
Answer:
The roles of all four types of auditors are similar in that they involve the accumulation and
evaluation of evidence about information to ascertain and report on the degree of
correspondence between the information and established criteria. The differences in their

roles center around the information audited and the criteria used to evaluate that
information. Independent auditors primarily audit companies’ financial statements. GAO
auditors’ primary responsibility is to perform the audit function for Congress. IRS auditors
are responsible for the enforcement of federal tax laws. Internal auditors primarily perform
operational and compliance audits for their employing company.

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32. (SOX)
medium

What is an engagement to attest on internal control over financial reporting?
Answer:
Section 404 of the Sarbanes-Oxley Act requires public companies to report management’s
assessment of the effectiveness of internal control over financial reporting. The Act further
requires auditors to attest to the effectiveness of internal control over financial reporting.
This evaluation, which is integrated with the audit of financial statements, provides
forward-looking information, because effective internal controls reduce the likelihood of
future misstatements in the financial statements.

33.
challenging

To do an audit, it is necessary for information to be in a verifiable form and some criteria by
which the auditor can evaluate the information. (A) What information and criteria would an
independent CPA firm use when auditing a company’s historical financial statements? (B) What
information and criteria would an Internal Revenue Service auditor use when auditing that same

company’s tax return? (C) What information and criteria would an internal auditor use when
performing an operational audit to evaluate whether the company’s computerized payroll
processing system is operating efficiently and effectively?
Answer:
(A) The information used by a CPA firm in a financial statement audit is the financial
information in the company’s financial statements. The most commonly used criteria are
accounting principles generally accepted in the United States.
(B) The information used by an IRS auditor is the financial information in the company’s
federal tax return. The criteria are the internal revenue code and interpretations.
(C) The information used by an internal auditor when performing an operational audit of
the payroll system could include various items such as the number of errors made, costs
incurred by the payroll department, and number of payroll records processed each month.
The criteria would consist of company standards for departmental efficiency and
effectiveness.

34.
challenging

Explain what is meant by information risk, and discuss the four causes of this risk.
Answer:
Information risk is the possibility that information upon which a business decision is made
is inaccurate. Four causes of information risk are:
remoteness of information,
biases and motives of the provider,
voluminous data, and
complex exchange transactions.

35.
challenging

Attestation services fall into five categories. What are these categories?
Answer:
The five categories of attestation services include:
audits of historical financial statements,
attestation on internal control over financial reporting,
reviews of historical financial statements,
attestation services on information technology, and
other attestation services that may be applied to a broad range of subject matter.

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36.
challenging

Discuss four factors that are likely to significantly reduce information risk in the next five to ten
years.
Answer:
Four factors that are likely to significantly reduce information risk in the next five to ten
years are:
technological advances,
more companies will go on-line, reducing the risk of investors obtaining outdated
information,
new accounting and auditing standards, and
auditors will find more efficient and effective audit techniques.

Other Objective Answer Format Questions
37.

easy
a

The criteria by which an auditor evaluates the information under audit may vary with the
information being audited.
a. True
b. False

38.
easy
b

The criteria used by an external auditor to evaluate published financial statements are known as
generally accepted auditing standards.
a. True
b. False

39. (SOX)
easy
b

The Sarbanes-Oxley Act establishes standards related to the audits of privately held companies.
a. True
b. False

40. (SOX)
easy
a

The Sarbanes-Oxley Act is widely viewed as having ushered in sweeping changes to auditing

and financial reporting.
a. True
b. False

41.
easy
b

Only companies that file annual statements with the Securities and Exchange Commission are
required to have an annual external audit.
a. True
b. False

42.
easy
b

The financial statements most commonly audited by external auditors are the balance sheet, the
income statement, and the statement of changes in retained earnings.
a. True
b. False

43.
medium
b

The primary purpose of a compliance audit is to determine whether the financial statements are
prepared in compliance with generally accepted accounting principles.
a. True
b. False

44.
medium
a

Results of compliance audits are typically reported to someone within the organizational unit
being audited rather than to a broad spectrum of outside users.
a. True
b. False

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45.
medium
b

The primary role of the United States General Accounting Office is the enforcement of the
federal tax laws as defined by Congress and interpreted by the courts.
a. True
b. False

46.
medium
b

CPA firms are never allowed to provide bookkeeping services for audit clients.
a. True

b. False

47. (SOX)
medium
a

Section 404 of the Sarbanes-Oxley Act requires public companies to have an external auditor
attest to their internal control over financial reporting.
a. True
b. False

48. (SOX)
challenging
b

The Sarbanes-Oxley Act requires a company’s chairman of the board of directors, CEO, and
CFO to certify the company’s financial statements.
a. True
b. False

49. (SOX)
challenging
b

The criterion that is most likely to be used as a framework in evaluating a company’s internal
control over financial reporting under Section 404 of the Sarbanes-Oxley Act is the Enterprise
Risk Management framework.
a. True
b. False

50.
challenging
a

Most public companies’ audited financial statements are available on the SEC’s EDGAR
database.
a. True
b. False

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Chapter 2
Multiple-Choice Questions

1.
easy
a

Which one of the following is not one of the three General Standards?
a. Proper planning and supervision.
b. Independence of mental attitude.
c. Adequate training and proficiency.
d. Due professional care.

2.
easy
b

Which one of the following is not a Field Work Standard?
a. Adequate planning and supervision.
b. Due professional care.
c. Understand the entity and its environment including internal control.
d. Sufficient appropriate audit evidence.

3.
easy
b

The General Standards stress the importance of:
a. evidence accumulation.
b. personal qualities the auditor should possess.
c. communicating the auditor’s findings to the reader.
d. general supervision of the audit.

4.
easy
a

The generally accepted auditing standard that requires “Adequate technical training and
proficiency” is normally interpreted as requiring the auditor to have:
a. formal education in auditing and accounting.
b. worked for an entity similar to the entity being audited.
c. independence in mental attitude
d. a graduate degree in a business field.

5. (SOX)
easy

d

Members of the Public Company Accounting Oversight Board are appointed and overseen by:
a. the U.S. Congress.
b. the American Institute of Certified Public Accountants.
c. the Auditing Standards Board.
d. the Securities and Exchange Commission.

6.
easy
b

Statements on Auditing Standards provide auditors of privately held companies with ______
guidance regarding the conduct of financial statement audits.
a. fairly extensive
b. some limited
c. practically no
d. specific and detailed

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7.
easy
c

Which of the following statements most accurately captures the intent of the standards of field
work?

a. Field work standards are primarily concerned with personal attributes necessary during the
conduct of the audit.
b. Field work standards provide extensive guidance regarding the conduct of an audit.
c. Field work standards are primarily directed at the auditor’s planning, understanding of
internal control, and evidence accumulation.
d. Field work standards are primarily concerned with the conduct of substantive testing as
opposed to testing of internal controls.

8. (SOX)
easy
c

Prior to the passage of the Sarbanes-Oxley Act, which of the following was responsible for
establishing auditing standards?
a. Securities and Exchange Commission
b. Public Company Accounting Oversight Board
c. Auditing Standards Board
d. National Association of Accounting

9. (SOX)
medium
b

Standards issued by the Public Company Accounting Oversight Board must be followed by
CPAs who audit:
a. both private and public companies.
b. public companies only.
c. private companies, public companies, and nonprofit entities.
d. private companies only.

10.
medium
b

Which of the following is the least likely form of business for a CPA firm?
a. General partnership
b. General corporation
c. Limited liability company
d. Limited liability partnership

11.
medium
a

The Statements on Auditing Standards issued by the Auditing Standards Board:
a. are interpretations of generally accepted auditing standards.
b. are the equivalent of laws for audit practitioners.
c. must be followed in all situations.
d. are optional guidelines which an auditor may choose to follow or not follow when
conducting an audit.

12.
medium
a

An auditor need not abide by a particular auditing standard if the auditor believes that:
a. the issue in question is immaterial in amount.
b. more expertise is needed to fulfill the requirement.
c. the requirement of the standard has not been addressed by the PCAOB.
d. any of the above three are correct.

13. (SOX)
medium
b

The Public Company Accounting Oversight Board does not:
a. perform inspections of the quality controls at audit firms that audit public companies.
b. establish auditing standards that must be followed by CPAs on all audits.
c. oversee auditors of public companies.
d. perform any of the above functions.

14.
medium
b

The form that must be completed and filed with the Securities and Exchange Commission
whenever a company experiences a significant event that is of interest to public investors is the:
a. Form S-1.
b. Form 8-K.
c. Form 10-K.
d. Form 10-Q.

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15.
medium
a

The form that must be filed with the Securities and Exchange Commission whenever a company
plans to issue new securities to the public is the:
a. Form S-1.
b. Form 8-K.
c. Form 10-K.
d. Form 10-Q.

16.
medium
c

The third general standard states that due care is to be exercised in the performance of an audit.
This standard is generally interpreted to require:
a. objective review of the adequacy of the technical training of firm personnel.
b. thorough review of the existing internal control structure.
c. critical review of work done at every level of supervision.
d. periodic review of a CPA firm’s quality control procedures.

17. (SOX)
medium
d

Assume the Public Company Accounting Oversight Board (PCAOB) identifies a violation
during its inspection of a registered accounting firm.
a. The PCAOB may not enforce some disciplinary action against the accounting firm.
b. The PCAOB may not report the matter to the Securities and Exchange Commission.
c. The PCAOB may not report the matter to the appropriate state accountancy board
d. The PCAOB may not suspend the license to practice of the CPA guilty of the violation.

18.
medium
d

Which of the following statements best describes the primary purpose of Statements on
Auditing Standards?
a. They are guides intended to set forth auditing procedures that are applicable to a variety of
situations.
b. They are procedural outlines that are intended to narrow the areas of inconsistency and
divergence of auditor opinion.
c. They are authoritative statements, enforced through the Code of Professional Conduct, and
are intended to limit the degree of auditor judgment.
d. They are interpretations that are intended to clarify the meaning of “generally accepted
auditing standards.”

19.
medium
a

Statements on Standards for Accounting and Review Services are issued by the:
a. Accounting and Review Services Committee.
b. Professional Ethics Executive Committee.
c. Securities and Exchange Commission.
d. Financial Accounting Standards Board.

20.
medium
c

Consulting Standards are issued by the:

a. Accounting and Review Services Committee.
b. Securities and Exchange Commission.
c. Management Consulting Services Executive Committee.
d. Financial Accounting Standards Board.

21.
medium
d

The auditor’s judgment concerning the overall fairness of presentation of financial position,
results of operations, and changes in cash flow is applied within the framework of:
a. quality control.
b. generally accepted auditing standards which include the concept of materiality.
c. the auditor’s evaluation of the audited company’s internal control.
d. generally accepted accounting principles.

22.
medium
c

A basic objective of a CPA firm is to provide professional services to conform to professional
standards. Reasonable assurance of achieving this basic objective is provided through:
a. continuing professional education.
b. compliance with generally accepted reporting standards.

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c.
d.

a system of quality control.
a system of peer review.

23.
medium
c

Within the context of quality control, the primary purpose of continuing professional education
and training activities is to enable a CPA firm to provide its personnel with:
a. technical training that assures proficiency as a valuation expert.
b. professional education that is required in order to perform with due professional care.
c. knowledge required to fulfill assigned responsibilities.
d. knowledge required to perform a peer review.

24.
medium
d

Williams & Co., a member of the Private Companies Practice Section, is to have a “peer
review.” The peer review can be performed by:
a. a CPA firm selected by Williams & Co.
b. a review team selected by the state society.
c. internal auditors.
d. either a or b.

25.
medium

a

Hansen Corporation’s stock is listed on a national stock exchange and registered with the
Securities and Exchange Commission. Hansen’s management hires a CPA to perform an
independent audit of Hansen’s financial statements. The primary objective of this audit is to
provide assurance to the:
a. investors in Hansen Corporation’s stock.
b. stock exchange.
c. Securities and Exchange Commission.
d. management of Hansen Corporation.

26.
medium
a

Which of the following is not an essential component of quality control?
a. Policies and procedures to ensure that firm personnel are actively engaged in marketing
strategies.
b. Policies and procedures to ensure that the work performed by firm personnel meet
applicable professional standards.
c. Policies to ensure that personnel maintain their independence in fact and in appearance.
d. Policies that ensure that monitoring activities are effectively applied.

27.
challenging
c

Which of the following is true regarding the AICPA-approved practice monitoring programs?
a. The Center for Public Company Audit Firms does not offer a peer review program.
b. Firms registered with the PCAOB must not enroll in an AICPA-approved practice

monitoring program.
c. Public accounting firms must be enrolled in an AICPA-approved practice monitoring
program for members in the firm to be eligible for membership in the AICPA.
d. The AICPA peer review program is administered through the SEC.

28.
challenging
c

Which of the following statements is true as it relates to limited liability partnerships?
a. Only senior partners are liable for the partnership’s debts.
b. Partners have no liability in a limited liability partnership arrangement.
c. Partners are personally liable for the acts of those under their supervision.
d. All partners must be AICPA members.

29. (SOX)
challenging
a

If an auditor of a public company cannot find guidance issued by the PCAOB on a particular
audit matter, the auditor should generally seek guidance from which of the following sources?
a. Statements on Auditing Standards.
b. Statements on Standards for Accounting and Review Services.
c. Regulations issued by the Securities and Exchange Commission.
d. The AICPA Code of Professional Conduct.

30.

The SEC requirements of greatest interest to CPAs are set forth in the SEC’s:

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challenging
a

a.
b.
c.
d.

Regulation S-X and Accounting Series Releases.
S-1 through S-16 forms.
Director’s newsletter.
Forms 8-K, 10-K, and 10-Q.

31.
challenging
d

The AICPA has authority to establish standards and rules in all but which of the following
areas?
a. Auditing standards applicable to financial statements of private companies.
b. Compilation and review standards.
c. Professional conduct.
d. Auditing standards applicable to financial statements of private and public companies.

32.

challenging
c

Generally Accepted Auditing Standards (GAAS) and Statements on Auditing Standards (SAS)
should be looked upon by practitioners as:
a. ideals to work towards, but which are not achievable.
b. maximum standards that denote excellent work.
c. minimum standards of performance that must be achieved on each audit engagement.
d. benchmarks to be used on all audits, reviews, and compilations.

33.
challenging
c

Which one of the following is not a requirement for belonging to the Private Companies
Practice Section of the American Institute of Certified Public Accountants?
a. Adherence to quality control standards.
b. Mandatory peer review.
c. Partner rotation after a period of ten consecutive years.
d. Continuing education.

34.
challenging
b

Statements on Auditing Standards issued by the AICPA’s Auditing Standards Board are:
a. part of the generally accepted auditing standards under the AICPA Code of Professional
Conduct.
b. interpretations of generally accepted auditing standards and departures from such
statements must be justified.

c. interpretations of generally accepted auditing standards and such standards must be
followed in every engagement.
d. generally accepted auditing procedures that are not covered by the AICPA Code of
Professional Conduct.

Essay Questions
35.
easy

Distinguish between generally accepted auditing standards (GAAS) and generally accepted
accounting principles (GAAP). What professional organization establishes GAAS? What
professional organization establishes GAAP?
Answer:
Generally accepted auditing standards are general guidelines to help auditors meet their
professional responsibilities in the audit of historical financial statements. They are
considered to be the minimum standards of performance for auditors to follow and are
established by the Auditing Standards Board of the American Institute of Certified Public
Accountants for private companies and by the Public Company Accounting Oversight
Board for public companies. Generally accepted accounting principles are the guidelines
which an entity’s management normally follows when preparing historical financial
statements. GAAP is established by the Financial Accounting Standards Board.

36.

Discuss the relationship between quality control and generally accepted auditing standards.

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easy
Answer:
For a CPA firm, quality control encompasses the methods used to make sure that the firm
meets its professional responsibilities to clients. Quality control is closely related to, but
distinct from, GAAS. A CPA firm must make sure that GAAS are followed on every
audit. Quality controls are the procedures used by the CPA firm that help it meet
requirements demanded by GAAS on every engagement in a consistent manner.

37.
easy

Describe the various staff levels and responsibilities of a typical public accounting firm.
Answer:
Staff assistant - Staff assistants, or staff accountants, perform most of the detailed
audit work.
Senior or In-charge auditor - Seniors coordinate and are responsible for the audit field
work, including the supervision and review of staff assistants’ work.
Manager - Managers assist the senior plan and manage the audit, review the senior’s
work, and manages relations with the client. A manager may be responsible for
multiple engagements at the same time.
Partner - Partners review the overall audit work and they are involved in all
significant audit decisions. As owners of the firm, partners are ultimately responsible
for conducting the audit and serving the client.

38.
medium

Discuss the five elements of quality control. Who establishes the standards for quality control?
Answer:

Independence, integrity and objectivity - Personnel on engagement should maintain
independence in fact and in appearance, perform all professional responsibilities with
integrity and maintain objectivity in performing their professional responsibilities.
Personnel management - Policies and procedures should be established to provide the
firm with reasonable assurance that all new personnel are qualified to perform their
work, work is assigned to personnel who have adequate training, and personnel
should participate in continuing professional education.
Acceptance and continuation of clients and engagements - Policies and procedures
should be established for deciding whether to accept or continue a client relationship.
These policies should minimize the risk of associating with a client whose
management lacks integrity.
Engagement performance - Policies and procedures should exist to ensure that
engagement personnel perform work that meets applicable professional standards and
the firm’s standards of quality.
Monitoring - Policies and procedures should exist to ensure that the other four quality
control elements are being effectively applied.
Quality control standards are established by the Auditing Standards Board for auditors
of private companies and by the Public Company Accounting Oversight Board for
auditors of public companies.

39.
medium

Describe the six organizational structures available to CPA firms.
Answer:
CPA firms can take one of six organizational forms:
Proprietorship. This form is limited to firms with only one owner.
General partnership. This form is similar to a proprietorship, except that it applies to
multiple owners.
General corporation. Unlike a general partnership, shareholders in a general

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corporation are liable only to the extent of their investment in the corporation.
Professional corporation. Professional corporations can have one or more
shareholders. Personal liability protection for shareholders in professional
corporations varies widely from state to state.
Limited liability company. This form combines the most favorable attributes of a
general corporation and a general partnership. LLCs are taxed like a general
partnership, but its owners have limited personal liability like shareholders of a
general corporation.
Limited liability partnership. An LLP is structured and taxed like a general
partnership. However, the personal liability protection of an LLP is less than that of a
general corporation or an LLC, but it is greater than a general partnership. Many
accounting firms now operate as LLPs.

40.
medium

There are ten generally accepted auditing standards, divided into three categories. List, by
category, each of these ten standards.
Answer:
General Standards
Adequate technical training and proficiency.
Independence in mental attitude.
Due professional care.
Standards of Fieldwork

Adequate planning and supervision.
Understand the entity and its environment including internal control.
Sufficient appropriate audit evidence.
Standards of Reporting
Whether statements were prepared in accordance with GAAP.
Circumstances when GAAP was not consistently followed.
Adequacy of informative disclosures.
Expression of opinion on financial statements as a whole.

41.
medium

In the context of auditing, explain what is meant by an independent mental attitude. Discuss
how internal auditors can have an independent mental attitude when they are employed by the
company they audit.
Answer:
Independent mental attitude refers to a state of mind in which the CPA is totally unbiased
with respect to the client and the financial information under audit.
Although internal auditors are employees of the organization for which their audits are
performed, internal auditors should be independent of the function being examined and
should report their findings to a level high enough in the organization to allow the auditor
to be free from influence by the party, or parties, being examined.

42. (SOX)
medium

The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board
(PCAOB). What are the PCAOB’s primary functions? Who performed these functions prior to
the PCAOB?
Answer:

The PCAOB has responsibility for providing oversight auditors of public companies,
establishing auditing and quality control standards for public company audits and

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performing inspections of the quality controls at audit firms performing those audits.
These functions were formerly the responsibility of the American Institute of Certified
Public Accountants.

43.
challenging

What are four of the major functions of the AICPA?
Answer:
Major functions of the AICPA include:
Establishing standards and rules that practicing CPAs must follow. These standards
consist of auditing standards for auditors of private companies, compilation and
review standards, other attestation standards, and the Code of Professional Conduct.
Research and publication. AICPA publications include the Journal of Accountancy,
industry audit guides, periodic updates of the Codification of Statements on Auditing
Standards, and the Code of Professional Conduct.
Promoting the accounting profession.
Developing specialist certifications.
Writing and grading the uniform CPA examination.
Providing continuing education seminars for its members.

44.

challenging

Discuss the purpose of the Securities and Exchange Commission and its influence on setting
generally accepted accounting principles.
Answer:
The overall purpose of the SEC is to assist in providing investors with reliable information
upon which to make investment decisions. As a result of its authority for specifying
financial reporting requirements, the SEC has considerable influence in setting generally
accepted accounting principles. Although the SEC has taken the position that accounting
principles should be set by the profession (FASB), the SEC’s opinion is generally
considered in any major change in GAAP proposed by the FASB.

45.
challenging

The purpose of the AICPA’s CPA Vision Project is to help CPAs make sense of our changing
and complex world. The Project has identified core values that CPAs must be aware of in the
future. What are the top five core values?
Answer:
Continuing education and lifelong learning
Competence
Integrity
Attuned to broad business issues
Objectivity

Other Objective Answer Format Questions
46.
easy
b

Membership in the AICPA is restricted to CPAs who are currently practicing as independent
auditors.
a. True
b. False

47.

Membership in the AICPA is mandatory for all licensed practicing CPAs.

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easy
b

a.
b.

48.
easy
a

Any public accounting firm can be a member of the AICPA if the firm meets the membership
requirements.
a. True
b. False

49.

easy
b

Statements on Auditing Standards (SASs) are issued by the Public Company Accounting
Oversight Board.
a. True
b. False

50. (SOX)
easy
b

Auditors of public companies should, in the absence of guidance issued by the PCAOB, follow
auditing standards issued by the SEC.
a. True
b. False

51. (SOX)
medium
b

The U.S. Congress has oversight responsibility for the PCAOB.
a. True
b. False

52.
medium
b

Form 10-K must be filed with the SEC whenever a public company experiences a significant

event.
a. True
b. False

53.
medium
b

In a limited liability partnership, partners are personally liable for liabilities arising from
negligent acts of other partners, but not for liabilities arising from acts of other employees.
a. True
b. False

54.
medium
a

Limited liability companies are structured and taxed like a general partnership, but their owners
have limited personal liability similar to that of a general corporation.
a. True
b. False

55. (SOX)
medium
b

All CPA firms registered with the PCAOB are required to undergo a peer review at least once
every two years.
a. True
b. False

56.
medium
a

Statements on Auditing Standards (SASs) are considered to be interpretations of the ten
generally accepted auditing standards.
a. True
b. False

57. (SOX)
medium
a

Any CPA firm that audits more than 100 public companies is required to have an annual
inspection by the PCAOB.
a. True
b. False

58.
medium
a

The overall purpose of the Securities and Exchange Commission is to assist in providing
investors with reliable information upon which to make investment decisions.
a. True
b. False

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59.
medium
a

International Standards on Auditing are issued by the International Auditing Practices
Committee.
a. True
b. False

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Chapter 3
Multiple-Choice Questions

1.
easy
a

Auditing standards require that the audit report must be titled and that the title must:
a. include the word “independent.”
b. indicate if the auditor is a CPA.

c. indicate if the auditor is a proprietorship, partnership, or incorporated.
d. indicate the type of audit opinion issued.

2.
Medium
a

To emphasize the fact that the auditor is independent, a typical addressee of the audit report
could be:

a.
b.
c.
d.

Company Controller
No
No
Yes
Yes

Shareholders
Yes
No
Yes
No

Board of Directors
Yes
Yes

No
No

3.
easy
b

The purpose of the introductory paragraph in the standard unqualified report is:
a. to identify that the type of opinion issued is unqualified.
b. to identify the financial statements audited and the dates and time periods covered by the
report.
c. to indicate the CPA followed applicable audit standards.
d. to indicate all the financial statements are in accordance with GAAP.

4.
easy
d

The scope paragraph of the standard unqualified audit report states that the audit is designed to:
a. discover all errors and/or irregularities.
b. discover material errors and/or irregularities.
c. conform to generally accepted accounting principles.
d. obtain reasonable assurance whether the statements are free of material misstatement.

5.
easy
d

The audit report date on a standard unqualified report indicates:
a.

the last day of the fiscal period.
b.
the date on which the financial statements were filed with the Securities and Exchange
Commission.
c.
the last date on which users may institute a lawsuit against either client or auditor.
d.
the last day of the auditor’s responsibility for the review of significant events that
occurred subsequent to the date of the financial statements.

6.
easy
d

As a result of management’s refusal to permit the auditor to physically examine inventory, the
auditor has not accumulated sufficient appropriate evidence to conclude whether financial
statements are stated in accordance with GAAP. The auditor must depart from the unqualified
audit report because:
a. the financial statements have not been prepared in accordance with GAAP.
b. the scope of the audit has been restricted by circumstances beyond either the client’s or
auditor’s control.
c. the auditor has lost independence.
d. the scope of the audit has been restricted.

7.
easy
d

An adverse opinion is issued when the auditor believes:
a. some parts of the financial statements are materially misstated or misleading.

b. the financial statements would be found to be materially misstated if an investigation were

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c.
d.

performed.
the auditor is not independent.
the overall financial statements are so materially misstated that they do not present fairly
the financial position or results of operations and cash flows in conformity with GAAP.

8.
easy
c

If a misstatement is immaterial to the financial statements of the entity for the current period,
but is expected to have a material effect in future periods, it is appropriate to issue a(n):
a. adverse opinion.
b. qualified opinion.
c. unqualified opinion.
d. disclaimer of opinion.

9. (Public)
easy
c

Whenever an auditor issues an audit report for a public company, the auditor can choose to
issue a report in which of the following forms?
a. A combined report on financial statements and internal control over financial reporting.
b. Separate reports on financial statements and internal control over financial reporting.
c. Either a or b.
d. Neither a nor b.

10.
easy
b

When determining whether an exception is “highly material,” the extent to which the exception
affects different elements of the financial statements must be considered. This concept is called:
a. materiality.
b. pervasiveness.
c. financial analysis.
d. ratio analysis.

11.
medium
d

An auditor determines the financial statements include a material departure from GAAP.
Which type of opinion may be issued?

a.
b.
c.
d.

Disclaimer
Yes
No
Yes
No

Qualified
No
Yes
No
Yes

Adverse
No
No
Yes
Yes

12. (Public)
easy
c

If an auditor performs an audit of a public company, the scope paragraph should make reference
to which standards?
a.
Accounting standards.
b.
Generally accepted auditing standards.
c.
Standards issued by the PCAOB (U.S.).

d.
Any of the above standards.

13.
easy
b

If an auditor performs an audit of a private company, the scope paragraph should make
reference to which standards?
a.
Accounting standards.
b.
U.S. generally accepted auditing standards.
c.
Standards issued by the PCAOB (U.S.).
d.
Any of the above standards.

14.
easy
a

Examples of unqualified opinions which contain modified wording (without adding an
explanatory paragraph) include:
a.
the use of other auditors.
b.
material uncertainties.
c.
substantial doubt about the audited company (or the entity) continuing as a going

concern.
d.
lack of consistent application of GAAP.

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15.

GAAP requires that changes in accounting principles be to a:

medium
c

a.
b.
c.
d.

16.
easy
c

A CPA may wish to emphasize specific matters regarding the financial statements even though
an unqualified opinion will be issued. Normally, such explanatory information is:
a.
included in the scope paragraph.
b.

included in the opinion paragraph.
c.
included in a separate paragraph in the report.
d.
included in the introductory paragraph.

17.
challenging
d

An auditor who issues a qualified opinion because sufficient appropriate evidence was not
obtained should describe the limitations in an explanatory paragraph. The auditor should also
refer to the limitation in the:

more conservative principle.
principle with equal authoritative support.
preferable principle.
principle detailed in a FASB pronouncement.

Scope
paragraph
a.
Yes
b.
No
c.
No
d.
Yes

Opinion
paragraph
No
Yes
Yes
Yes

Notes to the
financial statements
Yes
Yes
No
No

18.
medium
b

When the auditor evaluates the effect of a change in accounting principle, the materiality of the
change should be evaluated based on:
a.
the prior years presented.
b.
the current year effect of the change.
c.
guidelines included in GAAS.
d.
the effect on total assets.

19.

medium
b

Conditions requiring a departure from an unqualified audit report include all but which of the
following?
a. Management refused to allow the auditor to confirm significant accounts receivable for
which there were no alternative procedures performed.
b. Management decided not to allow the auditor to confirm significant accounts receivable,
but the auditor obtained sufficient appropriate evidence by examining subsequent cash
receipts.
c. The audit partner’s dependent child received a gift of 100 shares of a client’s stock for her
birthday from a grandparent.
d. Management has determined that fixed assets should be reported in the balance sheet at
their replacement values rather than historical costs. The auditors do not concur.

20.
medium
b

The introductory paragraph of the standard audit report states that the financial statements are:
a. the responsibility of the auditor.
b. the responsibility of management.
c. the joint responsibility of management and the auditor.
d. none of the above.

21.
medium
d

The introductory paragraph of the standard audit report states that the financial statements and

the opinion expressed about those statements are:
a. the responsibility of the auditor.
b. the responsibility of management.
c. the joint responsibility of management and the auditor.

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d.

none of the above.

22.
medium
c

The introductory paragraph of the standard audit report states that the auditor is:
a. responsible for the financial statements and the opinion on them.
b. responsible for the financial statements.
c. responsible for the opinion on the financial statements.
d. jointly responsible for the financial statements with management.

23. (Public)
medium
a

PCAOB Auditing Standard No. 2 requires the audit of internal control over financial reporting
to be integrated with:

a. the audit of the financial statements.
b. the quarterly review of financial information.
c. the review of annual financial statements.
d. none of the above.

24.
medium
d

The audit report indicates that (1) management is responsible for the content of the financial
statements and (2) the auditor is responsible for evaluating the appropriateness of the
accounting principles chosen by management. Which paragraph contains those statements?
a. Both are in the introductory paragraph.
b. Both are in the scope paragraph.
c. Both are in the opinion paragraph.
d. None of the above are true.

25.
medium
c

If the balance sheet of a company is dated December 31, 2009, the audit report is dated
February 8, 2010, and both are released on February 15, 2010, this indicates that the auditor has
searched for subsequent events that occurred up to:
a. December 31, 2009.
b. January 1, 2010
c. February 8, 2010
d. February 15, 2010.

26. (Public)

medium
b

A combined report on financial statements and internal control over financial reporting includes
all but which of the following types of paragraphs?
a. Inherent limitations paragraph.
b. Description paragraph.
c. Opinion paragraph.
d. Each of the above paragraphs is included.

27.
medium
d

Whenever an auditor issues a qualified opinion, the implication is that the auditor:
a. does not know if the financial statements are presented fairly.
b. does not believe the financial statements are presented fairly.
c. believes the financial statements are presented fairly.
d. believes the financial statements are presented fairly “except for” a specific aspect of
them.

28.
medium
c

The necessity to issue a disclaimer of opinion may arise because of:
a. a severe limitation on the scope of the audit.
b. a lack of independence between the auditor and client.
c. either a or b.
d. neither a nor b.

29.
medium
b

When the auditor determines the financial statements are fairly stated and then determines that
the auditor lacks independence, the auditor should issue:
a.
an adverse opinion.
b.
a disclaimer of opinion.
c.
either a qualified opinion or an adverse opinion.

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d.

either a qualified opinion or an unqualified opinion with modified wording.

30.
medium
d

If the auditor lacks independence, a disclaimer of opinion must be issued:
a.
if the client requests it.

b.
only if it is highly material.
c.
only if it is material but not highly material.
d.
in all cases.

31.
medium
d

Misstatements must be compared with some measurement base before a decision can be made
about materiality. A commonly accepted measurement base includes:
a.
net income.
b.
total assets.
c.
working capital.
d.
all of the above.

32.
medium

When comparing misstatements with a measurement base, the auditor must consider the
pervasiveness of the misstatement. Of the following examples, the most pervasive misstatement
is a(n):
a.
understatement of inventory.

b.
understatement of retained earnings caused by a miscalculation of dividends payable.
c.
misclassification of notes payable as a long-term liability when it should be current.
d.
misclassification of salary expense as a selling expense when it should be allocated
equally to both selling and administrative expense.

a

33.
medium
b

The dollar amount of some misstatements cannot be accurately measured. For example, if the
client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect
on:
a. net income.
b. users of the financial statements.
c. the auditor’s exposure to lawsuits.
d. management’s future decisions.

34.
medium
d

Whenever there is a scope restriction, the appropriate response is to issue a(n):
a. disclaimer of opinion.
b. adverse opinion.
c. qualified opinion.

d. unqualified report, a qualification of scope and opinion, or a disclaimer, depending on
materiality.

35.
medium
a

Which of the following is least likely to cause uncertainty about the ability of an entity to
continue as a going concern?
a. A client’s lawsuit against another company which claims the other company has infringed
on its patent.
b. Loss of major customers.
c. Significant recurring operating losses.
d. Working capital deficiencies.

36.
medium
d

The client has presented all required financial statements with the exception of the statement of
cash flows. The auditor has completed the audit and is satisfied that all other statements are
presented fairly. The auditor:
a. may issue either an unqualified or a qualified opinion.
b. must issue an adverse opinion with “except for” in the opinion paragraph.
c. may issue an unqualified opinion.
d. must issue a qualified opinion with “except for” in the opinion paragraph.

37.

When a disclaimer is issued because the auditor lacks independence:

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medium
d

a.
b.
c.
d.

no report title is included on the report.
a one-paragraph audit report is issued.
the only reason cited for issuing the disclaimer is the lack of independence.
all of the above are correct.

38.
medium
d

When a client has not applied GAAP consistently from the prior year to the current year, the
auditor does not concur with the appropriateness of the change, and the change in GAAP has a
material effect on the financial statements, the auditor should issue a(n):
a. disclaimer.
b. adverse opinion.
c. unqualified opinion.
d. qualified opinion.

39.
medium
c

Which of the following is not a change that affects consistency and, therefore, does not require
an explanatory paragraph?
a. Change in accounting principle, such as a change from LIFO to FIFO.
b. Change in reporting entity, such as the inclusion of an additional company in combined
financial statements.
c. Change in an estimate, such as a decrease in the life of an asset for depreciation purposes.
d. Correction of errors by changing from non-GAAP to GAAP.

40.
medium
c

Items that materially affect the comparability of financial statements generally require
disclosure in the footnotes. If the client refuses to properly disclose the item, the auditor will
most likely issue:
a.
a disclaimer.
b.
an unqualified opinion.
c.
a qualified opinion.
d.
an adverse opinion.

41.

medium
c

Auditors sometimes encounter situations in which the outcome of a matter cannot be reasonably
estimated at the time the financial statements are issued. These matters are referred to as:
a. inestimable matters.
b. non sequiturs.
c. uncertainties.
d. in-suspense matters.

42.
medium
b

When there is uncertainty about a company’s ability to continue as a going concern, the
auditor’s concern is the possibility that the client may not be able to continue its operations or
meet its obligations for a “reasonable period of time.” For this purpose, a reasonable period of
time is considered not to exceed:
a. six months from the date of the financial statements.
b. one year from the date of the financial statements.
c. six months from the date of the audit report.
d. one year from the date of the audit report.

43.
medium
d

When the auditor concludes that there is substantial doubt about the entity’s ability to continue
as a going concern, the appropriate audit report would be:
a. an unqualified opinion with an explanatory paragraph.

b. a disclaimer of opinion.
c. neither a nor b.
d. either a or b.

44.
medium
c

An auditor may not issue a qualified opinion when:
a. a scope limitation prevents the auditor from completing an important audit procedure.
b. the auditor’s report refers to the work of a specialist.
c. the auditor lacks independence with respect to the audited entity.

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d.

an accounting principle at variance with GAAP is used.

45.
medium
b

When a company’s financial statements contain a departure from GAAP with which the auditor
concurs, the departure should be explained in:
a. the scope paragraph.
b. an explanatory paragraph that appears before the opinion paragraph.

c. the opinion paragraph.
d. an explanatory paragraph after the opinion paragraph.

46.
medium
b

Which of the following representations does an auditor make explicitly and which implicitly
when issuing an unqualified opinion?
Conformity
Adequacy of
with GAAP
disclosure
a. Explicitly
Explicitly
b. Explicitly
Implicitly
c. Implicitly
Explicitly
d. Implicitly
Implicitly

47.
medium
c

William Gregory, CPA, is the principal auditor for a multi-national corporation. Another CPA
has examined and reported on the financial statements of a significant subsidiary of the
corporation. Gregory is satisfied with the independence and professional reputation of the other
auditor, as well as the quality of the other auditor’s examination. With respect to his report on

the consolidated financial statements, taken as a whole, Gregory:
a. must not refer to the examination of the other auditor.
b. must refer to the examination of the other auditor.
c. may refer to the examination of the other auditor.
d. may refer to the examination of the other auditor, in which case Gregory must include in
the auditor’s report on the consolidated financial statements a qualified opinion with
respect to the examination of the other auditor.

48.
medium
d

A company has changed its method of inventory valuation from an unacceptable one to one in
conformity with generally accepted accounting principles. The auditor’s report on the financial
statements of the year of the change should include:
a. no reference to consistency.
b. a reference to a prior period adjustment in the opinion paragraph.
c. an explanatory paragraph that justifies the change and explains the impact of the change
on reported net income.
d. an explanatory paragraph explaining the change.

49. (Public)
medium
a

Sarbanes-Oxley requires auditors of a public company to audit a company’s financial statements
and attest to management’s report on the effectiveness of internal control over financial
reporting. What type of assurance does the auditor provide in this report?
a. Positive assurance on the financial statements and on the effectiveness of internal control
over financial reporting.

b. Positive assurance on the financial statements and negative assurance on the effectiveness
of internal control over financial reporting.
c. Limited assurance on the financial statements and on the effectiveness of internal control
over financial reporting.
d. There is no guidance on what level of assurance to provide.

50.
medium
c

Whenever the client imposes restrictions on the scope of the audit, the auditor should be
concerned that management may be trying to prevent discovery of misstatements. In such cases,
the auditor will likely issue a:
a. disclaimer of opinion in all cases.
b. qualification of both scope and opinion in all cases.
c. disclaimer of opinion whenever materiality is in question.

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