Deck 24: Completing the Audit

Question 1

With which of the following client personnel would it generally not be appropriate to inquire about commitments or contingent liabilities?

A) controller
B) president
C) accounts receivable clerk
D) vice president of sales

Answer 1

C

Question 2

A commitment is best described as

A) an agreement to commit the firm to a set of fixed conditions in the future.
B) an agreement to commit the firm to a set of fixed conditions in the future that depends on company profitability.
C) an agreement to commit the firm to a set of fixed conditions in the future that depends on current market conditions.
D) a potential future obligation to an outside party for an as yet to be determined amount.

Answer 2

A

Question 3

If a potential loss on a contingent liability is remote, the liability usually is

A) disclosed in footnotes, but not accrued.
B) neither accrued nor disclosed in footnotes.
C) accrued and indicated in the body of the financial statements.
D) disclosed in the auditor's report but not disclosed on the financial statements.

Answer 3

B

Question 4

Which of the following groups has the responsibility for identifying and deciding the appropriate accounting treatment for recording or disclosing contingent liabilities?

A) auditors
B) legal counsel
C) management
D) management and the auditors

Question 5

Audit tests performed in earlier audit phases often provide sufficient appropriate evidence about contingent liabilities and subsequent events.

Question 6

You are auditing Rodgers and Company. You are aware of a potential loss due to noncompliance with environmental regulations. Management has assessed that there is a 40% chance that a $10M payment could result from the non-compliance. The appropriate financial statement treatment is to

A) accrue a $4 million liability.
B) disclose a liability and provide a range of outcomes.
C) since there is less than a 50% chance of occurrence, ignore.
D) since there is greater that a remote chance of occurrence, accrue the $10 million.

Question 7

An example of a presentation and disclosure-related objective is determining that current and noncurrent receivables are classified, separately, and any factoring or discounting of notes receivable is disclosed.

Question 8

Inquiries of management regarding the possibility of unrecorded contingencies will be useful in uncovering

A)
B)
C)
D)

Question 9

Which of the following is a contingent liability with which an auditor is particularly concerned?

A)
B)
C)
D)

Question 10

Which of the following is an accurate statement regarding presentation and disclosure?

A) Auditors generally set the risk as low that all required information may not be completely disclosed in the footnotes.
B) Audit tests performed in earlier audit phases provides sufficient appropriate evidence about contingent liabilities and subsequent events.
C) Auditors do not conduct tests of controls related to disclosures when the initial assessment of control risk is below maximum.
D) In phase IV (completing the audit), auditors evaluate whether the overall presentation of the financial statements and related footnotes complies with accounting standards.

Question 11

The auditor's primary concern relative to presentation and disclosure-related objectives is

A) accuracy.
B) existence.
C) completeness.
D) occurrence.

Question 12

Due to the unique nature of disclosures related to contingent liabilities and subsequent events, auditors often assess the risk as high that all required information may not be completely disclosed in the footnotes.

Question 13

An auditor is reconciling the amounts included in the long-term debt footnotes to the information examined and supported in the audit files for long-term debt. Which audit objective is being satisfied?

A) accuracy and valuation
B) occurrence and rights and obligations
C) completeness
D) classification and understandability

Question 14

As part of phase IV of the audit, auditors evaluate evidence they obtained during the first three phases of the audit to determine whether they should perform additional procedures for presentation and disclosure-related objectives.

Question 15

Often, procedures for the presentation objectives are integrated with the auditor's tests for transaction-related and balance-related audit objectives.

Question 16

Which of the following is not considered a commitment?

A) agreements to purchase raw materials
B) pension plans
C) agreements to lease facilities at set prices
D) Each of the above is a commitment.

Question 17

Auditors often integrate procedures for presentation and disclosure objectives with

A)
B)
C)
D)

Question 18

Audit procedures related to contingent liabilities are initially focused on

A) accuracy.
B) completeness.
C) existence.
D) occurrence.

Question 19

Auditors approach obtaining evidence for presentation and disclosure objectives different with how they approach obtaining evidence for transaction-related and balance-related objectives.

Question 20

When an auditor reviews the financial statements to determine if assets are properly classified between current and noncurrent, he or she is satisfying the audit objective of occurrence and rights and obligations.

Question 21

With what types of contingencies might an auditor be concerned?

Question 22

Many of the audit procedures for finding contingencies are usually performed as an integral part of various segments of the audit rather than as a separate activity near the end of the audit.

Question 23

One of the primary approaches in dealing with uncertainties in loss contingencies uses a(n) ________ threshold.

A) monetary
B) materiality
C) probability
D) analytical

Question 24

Companies ordinarily describe all commitments either in a separate footnote or combine them with a footnote related to contingencies.

Question 25

If the auditor concludes that there are contingent liabilities, he or she must evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements. Which of the following statements is not true?

A) The potential liability is sufficiently well known in some instances to be included in the financial statements as an actual liability.
B) Disclosure may be unnecessary if the contingency is highly remote or immaterial.
C) A CPA firm often obtains a separate evaluation of the potential liability from its own legal counsel rather than relying on management or management's attorneys.
D) The client's attorneys must remain independent when evaluating the likelihood of losing the lawsuit.

Question 26

Define the term contingent liability and discuss the criteria accountants and auditors use to classify these accounting events.

Question 27

If an auditor concludes there are contingent liabilities, then he or she must evaluate the

A)
B)
C)
D)

Question 28

Auditing standards make it clear that the auditor is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities due to the complexity of this topic.

Question 29

Financial statement disclosure is required if the likelihood of occurrence of an event is probable, reasonably possible, or remote.

Question 30

The first stop in the audit of contingencies is to determine the amount of the contingency.

Question 31

When using the probability threshold for contingencies, the likelihood of the occurrence of the event is classified as

A) not likely, likely, or highly likely.
B) remote, reasonably possible, or probable.
C) slight, moderate, great.
D) remote, likely, possible.

Question 32

Contingent liability disclosure in the footnotes of the financial statements would normally be made when

A) the outcome of the accounting event is deemed probable, but a reasonable estimation as to the amount cannot be made by the client or auditor.
B) a reasonable estimation of the loss can be made, but the outcome is not probable.
C) the outcome of the accounting event is deemed probable, and a reasonable estimation as to the amount can be made.
D) the outcome of the accounting event as well as a reasonable estimation of the loss cannot be made.

Question 33

When dealing with contingencies,

A) all contingencies must be disclosed or footnoted.
B) the auditor must exercise considerable professional judgment when evaluating whether the client has applied the appropriate treatment.
C) it is easy for the auditor to uncover contingencies without management's cooperation.
D) the review for contingent liabilities is only performed at the beginning and the end of the audit.

Question 34

Which of the following is not a common audit procedure used to search for contingent liabilities?

A) examine letters of credit
B) examine payroll reports
C) review internal revenue agent reports
D) analyze legal expense

Question 35

The probability threshold for dealing with uncertainty in loss contingencies uses the terms likely and unlikely.

Question 36

A lawsuit has been filed against your client. If, in the opinion of legal counsel, the likelihood your client will lose the lawsuit is remote, no financial statement accrual or disclosure of the potential loss would generally be required.

Question 37

Current professional auditing standards make it clear that management, not the auditor, is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities.

Question 38

Three conditions are required for a contingent liability to exist. Which of the following is not one of those conditions?

A) There is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition.
B) The outcome must be resolved by a third-party.
C) There is uncertainty about the amount of the future payment or impairment.
D) The outcome will be resolved by some future event or events.

Question 39

A lawsuit has been filed but not yet resolved against an audit client. This lawsuit does not meet the conditions required for a contingent liability.

Question 40

Distinguish between contingent liabilities and commitments.

Question 41

An environmental clean-up lawsuit is pending against your client. What information about the lawsuit would you as the auditor need in order to determine the proper accounting treatment?

Question 42

The standard letter sent by the auditor to the attorney requests the attorney communicate about contingencies up to approximately the date of the auditor's report.

Question 43

Describe some audit procedures commonly used to search for contingent liabilities.

Question 44

What needs to be included in a standard inquiry to the client's attorney letter sent to a client's legal counsel?

A)
B)
C)
D)

Question 45

If an attorney refuses to provide the auditor with information about material existing lawsuits or unasserted claims, current professional standards require that the auditor consider the refusal as a scope limitation.

Question 46

When preparing a standard inquiry to the client's attorney letter, the client's letterhead should be used, and the letter should be signed by the client company's officials.

Question 47

The standard inquiry to the client's attorney should be prepared on

A) plain paper (no letterhead) and be unsigned.
B) lawyer's stationery and signed by the lawyer.
C) auditor's stationery and signed by an audit partner.
D) client's letterhead and signed by a company official.

Question 48

Management furnishes the independent auditor with information concerning litigation, claims, and assessments. Which of the following is the auditor's primary means of initiating action to corroborate such information?

A) Request that client lawyers undertake a reconsideration of matters of litigation, claims, and assessments with which they were consulted during the period under examination.
B) Request that client management send a standard inquiry to the client's attorney letter to those lawyers with whom management consulted concerning litigation, claims, and assessments.
C) Request that client lawyers provide a legal opinion concerning the policies and procedures adopted by management to identify, evaluate, and account for litigation, claims, and assessments.
D) Request that client management engage outside attorneys to suggest wording for the text of a footnote explaining the nature and probable outcome of existing litigation, claims, and assessments.

Question 49

Attorneys in recent years have become reluctant to provide certain information to auditors because of their own exposure to legal liability for providing incorrect or confidential information. State the two main reasons that attorneys refuse to provide the auditors with complete information.

Question 50

If an attorney refuses to provide the auditor with information about material existing lawsuits or unasserted claims,

A) the attorney may face sanctions from the American Bar Association.
B) the auditors must modify their audit report to reflect the lack of available evidence.
C) the attorney can no longer represent the client.
D) the auditor must withdraw from the engagement.

Question 51

Discuss three audit procedures commonly used to search for contingent liabilities.

Question 52

What is one of the main reasons an attorney may refuse to provide auditors with complete information about contingent liabilities?

A)
B)
C)
D)

Question 53

Auditors, as part of completing the audit, will request the client to send a standard inquiry to the client's attorney letter to those attorneys the company has been consulting with during the year under audit regarding legal matters of concern to the company. The primary reason the auditor requests this information is to

A) determine the range of probable loss for asserted claims.
B) obtain a professional opinion about the expected outcome of existing lawsuits and the likely amount of the liability, including court costs.
C) obtain an outside opinion of the probability of losses in determining accruals for contingencies.
D) obtain an outside opinion of the probability of losses in determining the proper footnote disclosure.

Question 54

Attorneys must report material violations of federal securities laws to the company's audit committee.

Question 55

In a standard inquiry to the client's attorney letter, the attorney is requested to communicate about contingencies up to the balance sheet date.

Question 56

The American Bar Association has refused to amend its attorney-client confidentiality rules to permit attorneys to breach confidentiality if a client is committing a crime or fraud.

Question 57

Auditors will generally send a standard inquiry to the client's attorney letter to

A) only those attorneys who have devoted substantial time to client matters during the year.
B) every attorney that the client has been involved with in the current or preceding year, plus any attorney the client engages on occasion.
C) every attorney whose legal fees for the year exceed a materiality threshold.
D) only the attorney who represents the client in proceeding where the client is defendant.

Question 58

An attorney is aware of a violation of a patent agreement that could result in a significant loss to the client if it were known. This is an example of a(n)

A) commitment.
B) unasserted claim.
C) pending litigation.
D) subsequent event.

Question 59

As directed by the Sarbanes-Oxley Act,

A) an attorney must report material violations of federal securities law to the public company's chief legal counsel or chief executive officer.
B) attorneys cannot breach confidentiality rules even if a client is committing a crime or a fraud.
C) if the audit committee fails to remedy any material violations of the federal securities law, the attorney must report the violation to the SEC.
D) All of the above are required by Sarbanes-Oxley.

Question 60

What are the three required conditions for a contingent liability to exist?

Question 61

An auditor's decision concerning whether or not to "dual date" the audit report is based upon the auditor's willingness to

A) extend auditing procedures and assume responsibility for a greater period of time.
B) accept responsibility for subsequent events.
C) permit inclusion of a footnote captioned: event (unaudited) subsequent to the date of the auditor's report.
D) assume responsibility for events subsequent to the issuance of the auditor's report.

Question 62

State three items that should be included in a standard inquiry to the client's attorney letter.

Question 63

The audit procedures for the subsequent events review can be divided into two categories: (1) procedures integrated as a part of the verification of year-end account balances, and
(2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures is in the first category?

A) Inquire of client regarding contingent liabilities.
B) Obtain a letter of representation written by client.
C) Subsequent period sales and purchase transactions are examined to determine whether the cutoff is accurate.
D) Review journals and ledgers of year 2 to determine the existence of any transactions related to year 1.

Question 64

After the balance sheet date, but prior to the issuance of the audit report, the client suffers an uninsured loss of their inventory as a result of a fire. The amount of the loss is material. The auditor should

A) adjust the financial statements for the year under audit.
B) add a paragraph to the audit report.
C) advise the client to disclose the event in the notes to the financial statements.
D) advise the client to delay issuing the financial statements until the economic loss can be determined.

Question 65

An auditor performs interim work at various times throughout the year. The auditor's subsequent events work should be extended to the date of

A) the auditor's report.
B) a post-dated footnote.
C) the next scheduled interim visit.
D) the final billing for audit services rendered.

Question 66

The auditor has completed her or his assessment of subsequent events. The proper accounting for subsequent events that have a direct effect on the financial statements is to

A) adjust the financial statements for the year under audit.
B) disclose in the notes to the financial statements the amount of the adjustment.
C) duly note in the audit workpapers that next year's financial statements need to be adjusted.
D) make no adjustment of the financial statements for the year under audit.

Question 67

Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued?

A) loss of a plant as a result of a flood
B) sale of long-term debt or capital stock
C) settlement of litigation in excess of the recorded liability
D) major purchase of a business that is expected to double the sales volume

Question 68

An auditor has the responsibility to actively search for subsequent events that occur subsequent to the

A) balance sheet date.
B) date of the auditor's report.
C) balance sheet date, but prior to the audit report.
D) date of the management representation letter.

Question 69

Which event that occurred after the end of the fiscal year under audit but prior to issuance of the auditor's report would not require disclosure in the financial statements?

A) sale of a bond or capital stock issue
B) loss of plant or inventories as a result of fire or flood
C) a significant decline in the market price of the corporation's stock
D) a merger or acquisition

Question 70

Which type of subsequent event requires consideration by management and evaluation by the auditor?

A)
B)
C)
D)

Question 71

Whenever subsequent events are used to evaluate the amounts included in the statements, care must be taken to distinguish between conditions that existed at the balance sheet date and those that come into being after the balance sheet date. The subsequent information should not be incorporated directly into the statements if the conditions causing the change in valuation

A) took place before the balance sheet date.
B) did not take place until after the balance sheet date.
C) occurred both before and after the balance sheet date.
D) are reimbursable through insurance policies.

Question 72

The audit procedures for the subsequent events review can be divided into two categories: (1) procedures normally integrated as a part of the verification of year-end account balances, and
(2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures is in the second category?

A) Correspond with attorneys.
B) Test the collectability of accounts receivable by reviewing subsequent period cash receipts.
C) Subsequent period sales and purchase transactions are examined to determine whether the cutoff is accurate.
D) Compare the subsequent-period purchase price of inventory with the recorded cost as a test of lower of cost or market valuation.

Question 73

An auditor's decision concerning whether or not to dual date an audit report is primarily based on the auditor's decision to

A) extend appropriate audit procedures.
B) assume responsibility for events after the date of the auditor's report.
C) assume responsibility for event from fiscal year-end to the date of the audit report.
D) roll the dice and hope for a successful outcome.

Question 74

If the auditor determines that a subsequent event that affects the current period financial statements occurred after fieldwork was completed but before the audit report was issued, what date(s) may the auditor use on the report?

A)
B)
C)
D)

Question 75

The auditor's responsibility for "reviewing the subsequent events" of a public company that is about to issue new securities is normally limited to the period of time

A) beginning with the balance sheet date and ending with the date of the auditor's report.
B) beginning with the start of the fiscal year under audit and ending with the balance sheet date.
C) beginning with the start of the fiscal year under audit and ending with the date of the auditor's report.
D) beginning with the balance sheet date and ending with the date the registration statement becomes effective.

Question 76

Which of the following would be a subsequent discovery of facts which would not require a response by the auditor?

A) discovery of the inclusion of material nonexistent sales
B) discovery of the failure to write off material obsolete inventory
C) discovery of the omission of a material footnote
D) discovery of management's intent to increase selling prices in the future

Question 77

Subsequent events affecting the realization of assets ordinarily will require an adjustment of the financial statements under examination because such events typically represent

A) the culmination of conditions that existed at the balance sheet date.
B) additional new information related to events that were in existence on the balance sheet date.
C) final estimates of losses relating to casualties occurring in the subsequent events period.
D) preliminary estimate of losses relating to new events that occurred subsequent to the balance sheet date.

Question 78

The auditor has a responsibility to review transactions and activities occurring after the balance sheet date to determine whether anything occurred that might affect the statements being audited. The procedures required to verify these transactions are commonly referred to as the review for

A) contingent liabilities.
B) subsequent year's transactions.
C) late unusual occurrences.
D) subsequent events.

Question 79

In connection with the annual audit, which of the following is not a "subsequent events" procedure?

A) Prepare any necessary closing journal entries.
B) Examine the minutes of stockholders' and directors' meetings subsequent to the balance sheet date.
C) Review journals and ledgers.
D) Obtain a letter of representation.

Question 80

Which of the following subsequent events is most likely to result in an adjustment to a company's financial statements?

A) merger or acquisition activities
B) bankruptcy (due to deteriorating financial condition) of a customer with an outstanding accounts receivable balance
C) issuance of common stock
D) an uninsured loss of inventories due to a fire