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Part I: Multiple Choices (40%)

1. In which of the following instances would the independence of the CPA not be considered to be impaired? The CPA has been retained as the auditor of a a. charitable organization in which an employee of CPA serves as treasurer. b. municipality in which the CPA owns !"#$### of the !$"##$### indebtedness of the municipality. c. cooperative apartment house in which the CPA owns an apartment and is not part of the management. d. company in which the CPA%s investment club owns a one&tenth interest. !. As audit evidence$ physical e'amination and confirmation$ may only be obtained using which of the following types of tests? a. Tests of controls. b. Tests of details. c. Analytical procedures. d. Tests of transactions. (. A basic ob)ective of a CPA firm is to provide professional services to conform to professional standards. *easonable assurance of achieving this basic ob)ective is provided through a. continuing professional education. b. compliance with generally accepted reporting standards. c. a system of +uality control. d. a system of peer review. ,. -hich of the following statements is not true? a. A large sample of highly competent evidence is not persuasive unless it is relevant to the ob)ective being tested. b. A large sample of evidence that is neither competent nor timely is not persuasive. c. A small sample of only one or two pieces of relevant$ competent$ and timely evidence lac.s persuasiveness. d. The persuasiveness of evidence can be evaluated after considering its competence and its sufficiency. ". In /auditing 0 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 ta'able income has been calculated correctly. d. analyzing the financial information to be sure that it complies with government re+uirements.

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1. The test of details of balance procedure which re+uires the auditor to account for unused inventory tag numbers to ma.e sure none have been deleted is associated with the audit ob)ective of a. accuracy. b. e'istence. c. completeness. d. detail tie&in.

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2. -hich one of the following is not an auditor%s concern about a .ey authorization point in the sales3collection cycle? a. The receiving room must have authorization before releasing items to inventory control. b. Credit must be authorized before the sale. c. 4oods must be shipped after the authorization. d. Prices must be authorized. 5. In what order should the following steps occur? A.Assess client business ris. 6. 7nderstand the client%s business and industry C. Perform preliminary analytical procedures 8.Assess ris. of material misstatements a. 8$ 6$ C$ A. b. 6$ A$ 8$ C. c. 6$ 8$ A$ C. d. 8$ C$ 6$ A. 9. An independent auditor studies and evaluates a client%s IT system. The auditor%s study includes two phases: ;1< a review of the system and ;!< tests of controls. The latter phases might include which of the following? a. ='amination of systems flowcharts to determine whether they reflect the current status of the system. b. ='amination of organization charts to determine whether IT department responsibilities are properly separated to afford effective control. c. ='amination of the systems manuals to determine whether e'isting procedures are satisfactory. d. ='amination of the machine room log boo. to determine whether control information is properly recorded. 1#. -hich of the following discoveries by the auditor would not raise the red flag of increased inherent ris.? a. >anagement bonuses are based on a percentage of net income. b. A bond indenture re+uires a current ratio of at least (:1. c. Client ma.es e'tensive use of notes receivable and notes payable rather than buying and selling on open account. d. Client is a parent company with a subsidiary. 11. -hich of the following most li.ely would be detected by an auditor%s review of a client%s sales cutoff * a. ='cessive sales discounts. b. 7nrecorded sales for the year.

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c. 7nauthorized goods returned for credit. d. ?apping of year&end accounts receivable.

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1!.7nderstanding components of internal control and assessing the level of control ris. are primarily used by the auditor to a. determine whether procedures and records concerning the safeguarding of assets are reliable. b. ascertain whether the opportunities to allow any person to both perpetrate and conceal irregularities are minimized. c. modify the initial assessments of inhere ris. and preliminary )udgments about materiality levels. d. determine the nature$ timing$ and e'tent of substantive tests for financial statement assertions. 1(.-hich of the following is not one of the principal CPA firm%s alternatives when issuing a report if a different CPA firm performed part of the audit? a. Issue a )oint report signed by both CPA firms. b. >a.e no reference to the other CPA in the audit report$ and issue the standard un+ualified opinion. c. >a.e reference to the other auditor in the report by using modified wording. d. A +ualified opinion or disclaimer$ depending on materiality$ is re+uired if the principal auditor is not willing to assume any responsibility for the wor. of the other auditor. 1,.-hen audit procedures have been completed for an attributes sampling application$ the auditor must generalize from the sample to the population. -hich of the following statements would be incorrect regarding this process? a. The auditor would use an attributes sampling table to determine the computed upper e'ception rate. b. It would be wrong for the auditor to conclude that the population e'ception rate is e'actly the same as the sample e'ception rate. c. The computed upper e'ception rate is the highest e'ception rate in the population that the auditor is willing to accept. d. In selecting the table corresponding to the ris. of overreliance$ it should be the same as the acceptable ris. of assessing control ris. too low ;A*AC*< used for determining the initial sample size. 1".In connection with a public offering of first mortgage bonds by 8u>ond Corp.$ the bond underwriter has as.ed 8u>ond%s CPA to furnish him with a comfort letter giving as much assurance as possible relative to 8u>ond%s unaudited financial statements for the three months ended >arch (1$ !###. The CPA had e'pressed an un+ualified opinion on 8u>ond%s financial statements for the year ended 8ecember (1$1999@ he has performed a limited review of 8u>ond%s financial statements for the three months ended >arch (1$ !###. Aothing has come to his attention that would indicate that the >arch (1$ !### statements are not properly presented. 7nder these circumstances$ the CPA%s response to the underwriter%s re+uest should be to

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a. furnish to the underwriters an opinion that the >arch (1$ !### statements are fairly presented sub)ect to year&end audit ad)ustment. b. give negative assurance as to the >arch (1$ !### financial statements but disclaim an opinion on these statements. c. inform the underwriters that no comfort letter is possible without an audit of the financial statements for the three months ended >arch (1$ !###. d. Burnish to the underwriters an adverse opinion covering financial statements for the three months ended >arch (1$ !###. 11.-hich of the following factors is most important concerning an auditor%s responsibility to detect errors and irregularities? a. The susceptibility of the accounting records to intentional manipulations$ alterations$ and the misapplication of accounting principles. b. The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements. c. The possibility that management fraud$ defalcations$ and the misappropriation of assets may indicate the e'istence of illegal acts. d. The ris. that mista.es$ falsifications$ and omissions may cause the financial statements to contain material misstatements. 12. -hen the auditor .nows that an illegal act has occurred$ the auditor must a. report it to the proper governmental authorities. b. consider the effects on the financial statements$ including the ade+uacy of disclosure. c. withdraw from the engagement. d. issue an adverse opinion. 15.The report issued in attestation engagement may provide positive or negative assurance to the reader. -hich of the following types of engagements would provide positive assurance? a. An e'amination. b. A review. c. An agreed&upon procedures engagement. d. A compilation. 19. The concept of /dual dating0 on the auditor%s report refers to a. the client%s date on the statements ;1!3(13#!< and the auditor%s date on the report ;(3(#3#(<. b. the auditor%s date on the report ;(3(#3#(< and the review re+uired when the client files a registration

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statement with the C=C ;"3(#3#(<. c. the auditor%s date on the report representing the end of the fieldwor. ;(3(#3#(< and the review of an important event that occurred after the completion of fieldwor. ;,3"3#(< but before the auditor%s report was issued. d. the wording problem created because some of client%s statements are for a period of time ;for year ended 1!3(13#!< and others are for one specific date ;1!3(13#!<. !#. -hich of the following errors would be least li.ely to be discovered during the tests of the ban. reconciliation? a. Payment to an employee for more hours than he wor.ed. b. Cash received by the client subse+uent to the balance sheet date was recorded as cash receipts in the current year. c. The e'istence of payments on notes payable that were debited directly to the ban. balance by the ban. but were not entered in the client%s records. d. 8eposits recorded in the cash receipts records near the end of the year$ deposited in the ban.$ and included in the ban. reconciliation as a deposit in transit.

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Part II !ssa" #uestio$s (60%)

Problem I (17%)
8etermine what effect a change in acceptable audit ris.$ inherent ris.$ or control ris. would have on the amount audit evidence you would gather. ='ample: Compared to the audit of inventory$ the audit of prepaid e'penses for the same company will DDDDDDDtheDDDDDDD ris.$ causing the amount of re+uired evidence to ;Answer: decrease$ inherent ris.$ decrease< a. A change from auditing a privately held company to auditing a publicly held company would DDDDDDDris.$ causing the amount of re+uired evidence to evidence to . the . the ris.$ causing re+uired b. A large increase in an account balance from the previous year would the .

c. Eou determined during the planning phase of the audit that there has been a significant improvement in the client%s financial condition relative to the previous year. This year$ you would DDDDDDDDDris.$ causing re+uired evidence to DDDDDDDDDDDthe . .

d. This is the second&year engagement$ and there were good audit results in the previous year. Eou would ris.$ causing the amount of re+uired evidence to e. In discussion with the client$ you learn that management is planning to sell the business in the ne't few months. 6ecause of the planned changes$ several .ey accounting personnel +uit several months age. Eou would the ris. and the ris.$ causing the amount of re+uired evidence to .

Problem II (18%) Cavage$ CPA$ has been as.ed by an audit client to perform a nonrecurring engagement involving implementing an IT information and control system. The client re+uests that$ in setting up the new system and during the period prior to conversion to the new system$ Cavage FCounsel on potential e'pansion of business activity plans. FCearch for and interview new personnel. FGire new personnel. FTrain personnel. In addition$ the client re+uests that$ during the three months subse+uent to the conversion$ Cavage FCupervise the operation of the new system.

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F>onitor client&prepared source documents and ma.e changes in basic IT&generated data as Cavage may deem necessary without the concurrence of the client. Cavage responds that he may perform some of the services re+uested but all of them. &e'uire(: -hich of these services may Cavage perform$ and which of them may Cavage not perform?

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Problem III (10%) Post$ CPA$ accepted an engagement to audit the financial statements of 4eneral Company$ a new client. 4eneral is a publicly held retailing entity that recently replaced its operating management. In the course of applying auditing procedures$ Post discovered that 4eneral%s financial statements may be materially misstated due to the e'istence of fraud. &e'uire(: a. 8escribe Post%s responsibilities to report on 4eneral%s financial statements and other communications if Post is precluded from applying necessary procedures in searching for fraud. b. 8escribe Post%s responsibilities to report on 4eneral%s financial statements and other communications if Post concludes that 4eneral%s financial statements are materially affected by fraud. Problem IV (15%) ?ernout H Gauspie ;?HG< was the world%s leading provider of speech and language technology products$ solutions$ and services to businesses and individuals worldwide. 6oth >icrosoft and Intel invested millions in ?HG. Gowever$ accounting scandals and fraud allegations sent the company%s stoc. crashing$ and forced the firm to see. ban.ruptcy protection in 6elgium and the 7nited Ctates. The following selected information pertains to ?HG%s sales and accounts receivable: FConsolidated revenue increased 15, percent from the 1992 fiscal year to the 1995 fiscal year. F*evenue in Couth Iorea$ which has a reputation as a difficult mar.et for foreign companies to enter$ increased from 92$### in the first +uarter of 1999 to appro'imately "9 million in the first +uarter of !###. FIn the second +uarter of !###$ sales grew by 1#, percent but accounts receivable grew by 1!5 percent. FAverage days outstanding increased from 1(5 days in 1995 to 11# days for the si'&month period ended June (#$ !###. &e'uire(: a. 6ased on the above information$ which audit ob)ectives for accounts receivable should the auditor be most concerned with? -hy? b. -hat audit evidence should the auditor gather to verify the audit ob)ectives for accounts receivable? 6e specific as to how each type of evidence relates to the assertions you mentioned in part a of this +uestion.

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