CHAPTER 16 MULTIPLE CHOICE c An auditor accepted an engagement to audit the 2005 financial statements of EFG Corporation and began the fieldwork on September 30 EFG gave the auditor the 2005 financial statements on January 17, 2006 The auditor completed the fieldwork on February 10, 2006, and delivered the report on February 16, 2006 The client's representation letter normally would be dated a December 31, 2005 b January 17, 2006 c February 10, 2006 d February 16, 2006 (AICPA ADAPTED) b a b c d a A written representation letter from a client's management that, among other matters, acknowledges responsibility for the fair presentation of financial statements, should normally be signed by the a Chief executive officer and the chief financial officer b Chief financial officer and the chairman of the board of directors c Chairman of the audit committee of the board of directors d Chief executive officer, the chairman of the board of directors, and the client's lawyer (AICPA ADAPTED) b If a lawyer refuses to furnish corroborating information regarding litigation, claims, and assessments, the auditor should a Honor the confidentiality of the client–lawyer relationship b Consider the refusal to be tantamount to a scope limitation c Seek to obtain the corroborating information from management d Disclose the fact in a footnote to the financial statements (AICPA ADAPTED) b An auditor should obtain written representations from management concerning litigation claims c The audit inquiry letter to the client's legal counsel should be mailed only by the Client after the auditor has reviewed it for appropriate content Auditor after preparation by the client and review by the auditor Auditor's attorney after preparation by the client and review by the auditor Client after review by the auditor's attorney (AICPA ADAPTED) a b c d and assessments These representations may be limited to matters that are considered either individually or collectively material, provided an understanding on the limits of materiality for this purpose has been reached by The auditor and the client's lawyer Management and the auditor Management, the client's lawyer, and the auditor The auditor independently of management (AICPA ADAPTED) a b c d Which of the following auditing procedures is ordinarily performed last? Reading of the minutes of the director's meetings Confirming accounts payable Obtaining a management representation letter Testing of the purchasing function (AICPA ADAPTED) 113 d a b c d When auditing contingent liabilities, which of the following procedures would be least effective? Reading the minutes of the board of directors Reviewing the bank confirmation letter Examining invoices for professional services Examining customer confirmation replies (AICPA ADAPTED) d Management's refusal to furnish a written representation on a matter, which the auditor considers essential, constitutes a Prima facie evidence that the financial statements are not presented fairly b A violation of the Foreign Corrupt Practices Act c An uncertainty sufficient to preclude an unqualified opinion d A scope limitation sufficient to preclude an unqualified opinion (AICPA ADAPTED) c a b c d A representation letter issued by a client Is essential for the preparation of the audit program Is a substitute for testing Does not reduce the auditor's responsibility Reduces the auditor's responsibility only to the extent it is relied upon (AICPA ADAPTED) d 10 Which of the following subsequent events will be least likely to result in an adjustment to the financial statements? a Culmination of events affecting the realization of accounts receivable owned as of the balance sheet date b Culmination of events affecting the realization of inventories owned as of the balance sheet date c Material changes in the settlement of liabilities, which were estimated as of the balance sheet date d Material changes in the quoted market prices of listed investment securities since the balance sheet date (AICPA ADAPTED) b 11 Which of the following material events occurring subsequent to the December 31, 2004, balance sheet would not ordinarily result in an adjustment to the financial statements before they are issued on March 2, 2005? a Write-off of a receivable from a debtor who had suffered from a deteriorating financial condition for the past six years The debtor filed for bankruptcy on January 23, 2005 b Acquisition of a subsidiary on January 23, 2005 Acquisition had begun in December 2004 c Settlement of extended litigation on January 23, 2005, in excess of the recorded year-end balance d A 3-for-5 reverse stock split effective on January 23, 2005 (AICPA ADAPTED) c 12 a b c d "Subsequent events" for reporting purposes are defined as events which occur subsequent to the Balance sheet date Date of the auditor's report Balance sheet date but prior to the date of the auditor's report Date of the auditor's report and concern contingencies that are not reflected in the financial statements (AICPA ADAPTED) 114 c 13 a b c Which of the following is not a subsequent events procedure? Review available interim financial information Read available minutes of meetings of stockholders and directors Make inquiries with respect to the financial statements covered by the auditor's previously issued report if new information has become available during the current examination that might affect that report d Discuss with officers the current status of items in the financial statements that were accounted for on the basis of tentative, preliminary, or inconclusive data (AICPA ADAPTED) a 14 After an auditor has issued an audit report on a nonpublic entity, there is no obligation to make any further audit tests or inquiries with respect to the audited financial statements covered by that report unless a New information comes to the auditor's attention concerning an event that occurred prior to the date of the auditor's report that may have affected the auditor's report b Material adverse events occur after the date of the report c Final determination or resolution was made on matters that had resulted in a qualification in the auditor's report d Final determination or resolution was made of a contingency that had been disclosed (AICPA ADAPTED) SHORT ANSWER Describe an auditor's responsibilities to the client after the audit work has been completed Answer: An auditor continues to be responsible to: • Communicate with the audit committee, including fraudulent financial reporting, • To discover facts existing at the date of the auditor's report, and • To consider omitted procedures after the report date Describe the two classifications of types of subsequent events Answer: • • Type I Events: Subsequent events that reveal or confirm conditions existing at or before the balance sheet date and require adjustment to the financial statements Type II Events: Subsequent events that reveal conditions arising after the balance sheet date and require disclosure in, but not adjustment to, the financial statements What is required to be present in the notes for Type II subsequent events? Answer: • • • • Explanatory note Parenthetical explanation Reference in the financial statements to pro forma information If warranted, a qualified opinion, adverse opinion, or disclaimer opinion 115 Explain the purpose of management representation letters in a financial statement audit Answer: Management representation letters add persuasiveness to management's representations, both written and oral The audit/engagement partner is responsible for reaching an overall opinion on an entity's financial position, result of operations, and cash flows, only after what three steps? Answer: • • • Performing an overall review of the financial statements through analytical procedures, Reviewing audit working papers, and Obtaining a review of the working papers by an audit partner not assigned to the engagement PROBLEMS Name five procedures an auditor can use to provide guidance for identifying related-party transactions Answer: The student may answer in any combination of the following procedures: Request the client to provide the audit team with the names of known related parties Review the minutes of meetings of the board of directors and executive or operating committees for information about material transactions authorized or discussed at their meetings Review proxy material filed with the SEC for information about material transactions with related parties Review conflict-of-interests statements obtained by the entity from its management Review the extent and nature of business transacted with major customers, suppliers, borrowers, and lenders for indications of previously undisclosed relationships Review invoices from law firms for indications of the existence of related parties or related-party transactions Review confirmations of loans receivable and payable for indications of guarantees Complete the working paper review checklist below, addressing seven items to confirm mechanical accuracy and seven items to confirm audit scope Mechanical Accuracy 116 Audit Scope Answer: Student answers can vary to include at least seven items in each category Mechanical Accuracy Trace supporting balances on individual working paper schedules to lead schedules Trace lead schedule balances to working trial balances Trace trial balance amounts to the financial statements Review compliance with restrictive loan covenants Review indexing of working paper Test significant calculations in the working papers Determine that all audit working papers are complete, properly headed, and dated Audit Scope Determine that the consideration of internal control is adequate and that the scope of year-end substantive tests of details is justified given the level of control risk Determine that audit programs were appropriate for the circumstances Determine that audit procedures adequately addressed the audit assertions of existence or occurrence, completeness, rights and obligations, valuation or allocation, and presentation and disclosure Determine that the scope and results of the accounts receivable confirmations were reasonable Determine that the physical inventory observation procedures were adequate Determine that management representation letters are accurate, complete, and signed by management Determine that legal letters are appropriate and signed Determine that related-party transactions are disclosed as necessary Review all proposed adjusting journal entries Determine that the audited financial statements are properly presented in accordance with GAAP Determine that the opinion expressed in the audit report (unqualified, qualified, adverse, or disclaimer of opinion) is justified by evidence documented within the working papers Determine that all exceptions and reviews notes within the working papers have been cleared 117 118 ... existence or occurrence, completeness, rights and obligations, valuation or allocation, and presentation and disclosure Determine that the scope and results of the accounts receivable confirmations... conflict-of-interests statements obtained by the entity from its management Review the extent and nature of business transacted with major customers, suppliers, borrowers, and lenders for indications of... that management representation letters are accurate, complete, and signed by management Determine that legal letters are appropriate and signed Determine that related-party transactions are disclosed