Last Update Monday, Feb 16, 2004
"More Signal, Less Noise"
Chapter 9. I don't understand why the preliminary judgment about materiality is inversely related to the amount of evidence the auditor is required to accumulate (pg. 249).
The preliminary judgment about materiality (PJM) is the maximum combined misstatements in dollar amount that is TOLERABLE to the auditor. For example, a PJM of $100 versus a PJM of $20. In the case of $100, the auditor can tolerate a maximum combined misstatements of up to $100 dollars, whereas in the case of $20, the same auditor can only tolerate up to a maximum of $20. Everything else remains constant, the higher the auditor's tolerance, the less amount of evidence is need for a given account under consideration, and vice versa. Therefore, a rule of thumb is that, for a given account, the lower the PJM ($20 here), the less the tolerance auditor will have for it to be misstated, and the more evidence the auditor will plan to gather regarding that account. The reverse is the case if the account has a higher PJM.
Chapter 9. I don't understand where the book says, "If planned detection risk is reduced, the auditor needs to accumulate more evidence to achieve the reduced planned risk."
The planned detection risk (DR) is defined as the risk of the auditor's procedures NOT being able to detect misstatements. For example, a DR of 20% versus a DR of 2%. In the case of 20%, the auditor's procedure run a HIGHER risk of not detecting misstatements. In the case of 2% the auditor's procedures run a LOWER risk of not detecting misstatements. Everything else remains constant, the higher (20% here) the DR, the higher the risk of not detecting misstatement, and if the risk is higher, the lower is the amount evidence is required. On the other hand, the lower (2% here) the DR, the lower the risk of not detecting misstatement, and if the risk is lower, the higher is the amount of evidence is required. As a rule of thumb, DR is inversely related to the amount of evidence. The higher the %, the higher the risk, and the lower the evidence is required, and vice versa.
Chapter 7. In my reading the text continues to referrence "footing" and "cross-footing" and I do not understand these terms. I do not recall reading about them and have been unable to obtain a definition from the text.
"Footing" means adding down a column of figures. "Cross-footing" means adding across a row of figures. They are not definitions, but jargons of auditing procedures.
Chapter 16. I don't get it. In class, you said that even if a client's internal control is weak; its management's integrity is doubtful, and there is a lot of accounts payable with zero balances, yet the auditor may not send out confirmation for accounts payable. Why?
This is because the creditors are usually reliable independent third parties that monitor the accounts payable for the auditors. Any internal understatment of accounts payable will be eventually discovered and complained by the creditors.
Chapter 3. I have questions about Chapter three. After reading the text, I still not quite sure about the meanings of Rule 102, 202, 203, 301 and 501. Please explain. Do I have to be responsible for the materials in the text that you have not talked about in class? Are the M.C. similar to the ones in the text? Please tell me how should I study for the test. I am lost.
(1)Please do not try to look for the "meanings" of these rules. Basically, there are NO meanings to them! But there are interpretations of these rules. You are responsible to read and learn the intrepretations for each rule and be able to apply them. For example, if you have read the intrepretations of Rule 501 carefully, you should be able to answer/apply to an ethical problem/situation as follows: A client refuses to pay audit fee to the auditor for the audit service provided. Is it ethical (i.e., is there a violation of the rule) for the auditor to withold the client's books and accounts until the client agrees to pay the fee? (2)Yes, you are responsible for the materials in the text that I have not covered in class given the time constraint. (3)Yes, the MC is similar to the ones in the text. However, let us have the same interpretation of the word "similar". By that, I meant the MC is similar in the degree of difficulty and addresses similar issues/problems. Therefore, it would not be useful to memorize the MC in the text.
Chapter 8. I don't understand the substance and form in regard to obtaining and understanding a client's control. Why should the auditor concentrate on either policy and procedure rather than form?
With regard to internal controls, auditor should examine whether the policies or procedures of a client's internal controls are followed/acted upon (i.e., the substance) rather than whether they are being stated/prescribed (i.e., the form) somewhere in the client's internal control manual.
Chapter 9. When they defines Inherent risk as "the set for segments.....", what does segment mean?
"Segment" as in segment of financial statements that you have learned in ACCT302. For our purpose, you may consider segment here to be the same as classes of transactions or account balances.
Chapter 4. Regarding forseen 3rd parties, is it necessary for the auditor to have prior knowledge of the forseen 3rd class? Also, I am not certain on the issue of CPC Rule 503. My understanding is that CPA's cannot recommend products or services to the client for a commission unless the commission is a referral fee $$ for referring services. However, multiple choice question 3-16a. proves otherwise, stating such an exception is in violation of the code. Please help clarify.
Yes. Auditor must have prior knowledge of ONE of the forseen 3rd parties. The rest of the 3rd parties who are in the same class or membership as the ONE whose is known to the auditor (e.g., a group of bankers, a union of suppliers, etc) can take class action 3rd parties law suit against the same auditor. That CPA question was set before the clarification of Rule 503. Thus, it was a violation under the old rule. It is not a violation now.
Chapter 6. Could you please help me to understand the difference between management's implicit and explicit assertions? I believe explicit assertions relate to the existence & occurence, completeness, valuation, rights & obs, and presentation of balances. I am unsure what implicit assertions relate to.
Quite the opposite. Usually, "presentation" is the explicit assertion whereas "existence & occurence, completeness, valuation, rights & obligations" are implicit assertions.
Chapter 6. I noticed that the book distinguishes substantive tests of transactions from other tests. To me it seems these tests overlap both tests of controls and tests of balances. Could you please help clarify what my understanding of substantive tests of transactions should encompass?
The book uses the term 'substantive tests of transactions' for both tests of controls of individual transactions and tests of balances of individual transactions. An example of a test of control of individual transactions is when the auditor tests for individual authorizations of credit memo (i.e., testing individual controls) for individual accounts receivable. On the other hand, an example of a test of balance of individual transactions is when the auditor sends individual positive/negative confirmations (i.e., testing individual balances) of individual accounts receivable. Thus, the book uses substantive tests of transactions to differentiate such tests from tests of controls (TOC) for overall controls, such as a test of the overall authorization control of the accounts receivable presented in the balance sheet, and from tests of balances (TOB) for overall balances, such as a test of the overall accuracy (from individual confirmations) of the accounts receivable presented in the balance sheet.
Chapter 22 (old text book). I have a question regarding the Subsequent Discovery of Facts (SDF). The book says that "the SDF requiring the recall or reissuance of financial statements does not arise from business events occuring after the date of the auditor's report." (p.740) However, in my notes, it says: "the Auditor must take action if event related to a condition on or before the audit report issue date", not the audit report date as stated in the book. I am not sure which one is right. Could you please make me clear.
p.740 is correct assuming that the audit report date is the same as the audit report issue date. If the two dates are not the same, then go to the last sentence in p.741 where it says "If the auditor discovers subsequent facts after the audit date, but before the financial statements (note also the audit report) are issued, the auditor will require that the financial statements be revised (that is auditor takes action) before they are issued." Thus, the notes refer to the later situation where the audit report and audit report issue date are not the same, and the audit should take action for subsequent discovery of facts that already exited on or before audit report issue date. In sum, p.740, p.741 and the notes are all correct depending on whether the audit report date and the report issue date are the same or not. As a rule of thumb, P.741 and the notes are more appropiate because the two dates are usually not the same in practice.
Chapter 4. 1) What is audit risk? How can a financial statement fairly stated and then contained an unqualified opinion and are material misstated? 2) What is recent auditor's legal responsbility to client and third party under common law?
1. I guess you find the definition for Audit Risk in p.113 confusing. After the audit IS COMPLETED, this is the risk (say 5%) that the client's financial statements may still contain misstatements that NOT DISCOVERED by the auditor DURING the audit. After the audit IS COMPLETED, the audit will accept that risk (5%) and issue a clean opinion (i.e., unqualified opinion) saying that the client's financial statements are fairly stated. Of course, the question is why would the auditor take such a risk and give a clean opinion knowing that there may still be misstatments uncovered? This is because the audit process cannot uncover 100% of the client's misstatements, that is, no absolute assurance but only reasonable assurance of the fair financial statements can be given by any audit. Note the complement of 5% risk is 95% confident, therfore, another way of defining audit risk is that the auditor gives a 95% reasonable assurance that the client's financail statements are fairly stated after the audit IS COMPLETED.2. Auditor's responsibility under contract law to client is still the same legal concept of "breach of contract" between the auditor and auditee. However, auditor's responsibility to 3rd parties is recently moving towards the legal concept of "forseen 3rd parties" concept. See the book for the legal definition of "forseen 3rd parties".
Chapter 7 (old text book). 1) On p.163 what is analytical procedures means? 2) What is transaction class means? 3) According to the transaction related audit objective, what is the difference between accuracy and classification or timing. If we make a wrong record on classification, we are still not accurate? 4) On p.166 6-20, why the answer is 3 instead of 1?
1. Analytical procedures is a group of auditing procedures that uses mathematical comparisons, such as comparing this year's profit with last 10 years' profit figures, and financial ratio analyses, such as interpretating the ups and downs of inventory turnovers to infer a conclusion about an account or class of transaction. It derives its name from the "analytical" process by which the auditor infers a conclusion from using this group of audit procedures. 2. A "transaction class" refers to all transactions that share a similar accounting characteristic. For example, the transactions of Sales, Sales Discounts, and Sales Returns are grouped under a same "transaction class of Sales" because they are all related to Sales. 3. Accuracy refers to mathematical errors, such as addition or subtraction errors in an account. Classification refers to misclassifying, for example, instead of entering an account to CURRENT assets, it is wrongly entered to FIXED assets. Timing refers to posting to the wrong time period, for example, sales invoice of Feb 9 get posted as Feb 10. In sum, they are all accounting errors but belongs to different TYPES of accounting errors. 4. You did not say which MQ question of 6-20 -- a, b or c. I assume it is a that you are asking. Answer 1 is incorrect because to check for existence or occurrence, the auditor will need to test the physical existence, that is, go to the client's warehouse to physically touch and observe them. By analysing inventory turnovers, this (ie answer 1) cannot be achieved.
Chapter3. Is it true that all partners cannot owe any stock from client or they can owe some stock from client as long as it is indirect and the amount is not material?
Yes. All partners cannot own any stock (direct investment) in all clients of their CPA firm. For nonpartners, the rule only applies if they are involved in auditing the clients. For staffs, the rule only applies if they actually engaged in auditing the clients. Yes, indirect investment is no violation so long the amount is immaterial.
Chapter 3. Financial interest of next of kin, is it true that all partners' close relative cannot owe any stock from the client or the close relative can owe stock as long as they have infrequent contact or geographical separation relationship with the partners?
Yes. All close relatives of all partners cannot own any stock in all clients of the CPA firm. However, it MAY BE consider a no violation if the partners have infrequent contact or geographically separated from the close relatives. It is a "MAY BE" because it is up to the Ethics Committee of AICPA to decide.
Chapter 2. Independence Standards Board, what is Independence Discussions with Audit Committee talking about? Why the auditor has to report to the SEC in order to inform the audit committee? Why the auditor just report to the audit committee directly?
This ISB is jointly established by the SEC and ACIPA to monitor any independent issue relating to a CPA FIRM (NOT an INDIVIDUAL CPA). No, you read it wrongly. It says "...auditors intending to be independent of companies reporting to the SEC ..." that is, the COMPANIES (the auditor's clients) who are members of the SEC and REPORT to the SEC. Thus, you incorrectly read it as the auditor reporting to the SEC. However, if the auditor is auditing such a company, who is a member of the SEC, then the auditor has to DISCLOSE to THAT COMPANY'S (the client's) audit committee about their independent from the company. Note, auditor does not REPORT but rather DISCLOSE to the client's audit committee. Also note that, the auditor is required to do so under the ISB standard #1 which, effectively, is an indirect requirement of the SEC.
Chapter 3. What is rule 203---Accounting principles talking about?
The Accounting principles here are your good old Generally Accepted Accouniting Principles (GAAP).
Chapter 7 (old text book). (1) On p.184,why check from acquisition journal to supporting document is vouching but check from supporting document to acquisition journal is not a vouch? (2) On p.193 Compute ratios and percentage relationships for comparison with previous years, why relationships of data to other data is ignored? (3) p.194, compare client data with client determined expected results, why the personnel has to change financial information to conform with the budget? In discovering this problem, why the auditor need to assess control risk and detail audit test? (4) For the answer on RQ7-19, what is level of aggregation of data mean? (5) For the answer on MQ7-20b, why the answer is not 3 or 4, instead the correct answer is 1? (6) For the answer on MQ7-20d, why answer 4 is more reliable than answer 1? (7) For the answer on MQ7-21c, why answer 1 is not correct?
1) From journal to source document is call VOUCHING whereas from source document to jpurnal is call TRACING. 2) When raw data is compared against raw data, they are just figures (e.g., 2m Inventory in 1999 versus 3m Inventory in 2000). It tells you nothing about the underlying relationship, such as how much inventory increase or decrease between the two years. Such relationship can only be known by working out the ratios or percentage, in other words, raw data versus raw data IGNORES such underlying relationship. 3) Here, a client's personnel cannot meet the budget. Therefore, instead of get risk being fired, he/she chooses to massage the books in order to conform with the budget. Of course the auditor is concern about the client's lack of (risk of )control over budgeting and wants to flush out that personnel by conducting detail audit tests. 4) That is the amount of adding up data. 5)I pointed out in class the various degree of stringency of the audit procedures and evidence. I asked the class to mark EXAMINATION a number 8, which ranks it the highest degree of stringency. 6) Answer 4 is the least persuasive evidence because NO response on NEGATIVE confirmation means the auditor ASSUMES the amount to be confirmed is correct. A very big assumption. 7) Answer 1 refers to UNRECORDED item by clients. As a rule of thumb, unrecorded item has the least chance of being detected. The question askes for the best chance of being detected.
Chapter 3. I do not understand the terms - qualified opinion & unqualified opinion.
In auditing, a qualified opinion means the auditor judges that the client's financial statements contain material misstatements. In contrast, an unqualified opinion means the auditor judges that the client's financial statements do not contain material misstatements. Sometimes, a qualified opinion is referred to as a bad opinion whereas an unqualified opinion is referred to as a good opinion. The usage of the terms is different from our normal understanding of the terms qualified (typically means good) and unqualified (typically means bad).
Chapter12 (old text book).1) Why when tolerable rate decrease, IR and CR decrease and TODB increase? 2) On p.444 3rd paragraph, what is the difference between exception and deviation? 3) On p. 447 7th paragraph, why TER is higher for multiple control environment than in single control environment? 4) On p.448 the 3rd paragraph, why a decrease ACR will led to a decrease in ARACR? I think a better control environment will make a auditor accept a greater risk and therefore increase the ARACR? 5) On p.450 the 1st paragraph, if a small precision is a more precise estimate, why it needs a larger sample? 6) On p.450, what is the difference between PER and SER? why it is difficult for them to equal to each other? 7) On p.451 the 2nd paragraph, why the auditor doesn't use CUER when the sample size is small? 8) On p.455 the last 2nd paragraph, if we increase ACR, how can we not increase sample size? 9) On p.455, when you find there is a 5% CUER, what is that mean? 10) On p.456, when CUER>TER, what is that mean?
1)This question does not make sense. Please give me the exact reference (page number and paragraph) in the book for the question, and I will try to solve the question again. 2)The term 'exception' as in exception condition. This term is used in both attribute and variable sampling approaches, e.g., expected population exception rate. Usually, the term 'deviation" is used in attribute sampling approach, e.g., expected population deviation rate. This makes more sense because in attribute sampling, we are interested in testing for any departure, or deviation, from a certain control. 3)Think of the multiple control environment as having lots of 'backup' in case any one of the controls fails. Thus one can have a higher tolerance for control failures, i.e., higher TER, in multiple control than single control environment. The later has no 'backup', hence, ones tolerance is lower in such environment. 4)A decrease in ACR (in % say from 40% to 30%) means a better control environment, which means the ARACR can now be assessed to be lower than before ( in % say from 5% to 4%). In other words, the risk of wrongly assessing the control risk too low (i.e., CR too low at 30%) is less than before (i.e., CR at 40%). 5)Read precision = sampling risk. Sampling risk is the risk of the sample characteristics not representing the population characteristics. In statistics, the sample risk is smaller if the sample size is larger because the larger the sample size, the more the characteristics of the population is represented by the sample. Therefore, for a smaller precision, a smaller sampling risk is called for, and a larger sample size is in order. 6)PER is the number of errors in the population. SER is the number of errors FOUND in the sample. The two seldom equal (i.e., PER = SER) because of the present of sampling risk (see answer to question 5 above) or refer back to your BA212 Statistics course to refresh your memory on statistics. Alternatively, think of the chance that the sample found ALL errors in the population, very low indeed for PER = SER. 7)This sentence should read as a generic statement that if the auditor use SER to generalize the sampling results (i.e., using NONSTATISTICAL sampling), then CUER is never an issue here because CUER is calculated (look up from table to be precise) only if STATISTICAL sampling is used to generalize the sampling results. Thus, CUER is not calculated when SER is used, regardless of the sample size. 8)The book says "..an auditor is willing to reduce assessed control risk", that is, a reduction in ACR from say 60% to 40%. This means internal control is assessed to be better than before. If control is better than before, one can afford a SMALLER (decrease) sample size. 9)CUER is the Maximum Population Exeception Rate that can occur to a population based on the number of execption found a sample (i,e, Sample Exception Rate) in statistical sampling approach. 10)This is the decision rule, when CUER>TER, the auditor REJECTS the control under consideration as not satisfactory.
Chapter 22 (old text book). The answer to multiple question no.5 on the website of the book shows the first bullet as the correct answer. Shouldn’t the answer be the second bullet?
At first sight, I too make the mistake of thinking that the answer is the second bullet. But upon reading it more carefully, the answer should indeed be the first bullet. The website is right. The contingent liability is "probable" and the amount can be "reasonably estimated". The question is tricky in that instead of saying that the amount can be reasonably estimated, it uses the phrase "the amount...is only reasonably possible ..." Therefore, the correct answer is the first bullet, that is, the contingent liability needs to be adjusted, specifically accrued in the financial statement.
Chapter 22 (old text book). Page 744 of the book said that subsequent event occurs up to the audit report date. But in class you said it is up to the audit report issue date. Which is right?
Both correct. The book asumes that the audit report date concised with the audit report issue date. In this case, subsequent event occurs up to the audit report date, which is the same as the audit report issue date. However, in class, I mentioned that the audit report issue date usually comes after the audit report date because it takes time for the F/S and audit report to get printed and issued to the stockholders. In that case, subsequent event occurs up to the audit report issue date. Figure 23-8, p745 of the book shows the second scenario.
Chapter 3 (old text book) 1. online exercise chap 4-9 (T/F) Lucy Luff, CPA, is the partner-in-charge of the audit of Matador, Inc., a closely held corporation. Lucy's husband's sister is the CFO in Matador, Inc. This situation violates Rule 101 of the AICPA Code of professional Conduct. Answer key: F I think it is T, because husband's sister can be considered close kin. 2. online exercie chap 6-2 (T/F) Does irregularity also mean fraud? 3. online exercise chap6-9&10 (multimple choice) How to diferentiate the transaction is for audit objective of existence or completeness? 4. MQ 6-18 b (page 165 of textbook) An independent audit aids in the communication of economic data because the audit answer key: lend credibility to the fanancial statments I don't know why the 3rd choice-guarantees that financial data are fairly presented is wrong.
1.The term "close kin" under Rule 101 Independent is defined in terms of "financial dependent kin". Since it is unlikely that Lucy's husband's sister is financially depending on Lucy for a living, there is no violation of the Rule here. The answer F is correct. 2.Yes. fraud is a special type of irregularity. 3.When a transaction is investigated for the audit objective of existence, the auditor is looking for the bona fide physical existence of that transaction. On the other hand, when the same transaction is investigated for the audit objective of completeness, the auditor is looking for the correct entry of that transaction in the accounting records. 4.The reason is in the word "guarantees". Auditor never guarantees that financial data are fairly presented. Rather, auditor provides reasonable assurance that the financial data are fairly presented. It is impossible for auditor to guarantee, i.e., absolute assurance, that the financial data are fairly presented.
Chapter 4 (old text book).I have a question, in chapter 5 you told us that the majority of law suits against the auditor are form 3rd parties but in the book they say it is from the client. Who should I believe??
I assume you refer to p115 which states "The most common source of lawsuits against CPAs is from clients". The phrase "most common source" refers to the "most common reason" for the lawsuits is originated from the clients, such as the client engaged in fraudulent financial reporting. The phrase does not refer to the "the majority of " law suits against the auditor that I mentioned in class. There, I refer to the "largest number of " lawsuits came from 3rd parties law suits. In short, the book is right to say that the "most common reason" for the lawsuits originated from the client, and what I said in class is also right in that the "largest number of" law suits is initiated by the 3rd parties.
About Exam. Currently to prepare for an exam, I first read the chapters, then I combine the chapters and the class notes into a study guide written in my own words. After that I take the online multiple choice and true/false exams, and the CPA exam questions from the end of each chapter. I see where I made mistakes on those three, and go back to the representative chapter to reinforce that material. Through-out this process I'm continually reviewing my study guide. Is my study method prepare me well for your ACCT506 exam?
Yes, it is the best study method to prepare for the ACCT506 exams.
Chapter 15. Would appreciate it very much if you would help me with the following questions: 1. what is scrap sales? 2. what is the difference of account receivable account and A/R control account? 3. Is vouchers payable department the same as account payable department? 4. For effective internal control, the accounts payable department generally should A. obliterate the quantity ordered on the receiving department copy of the purchase order B. Establish the agreement of the vendor's invoice with the receiving report and purchase order C. Stamp, perforate, or otherwise cancel supporting documentation after payment is mailed D. Ascertain that each requisition is approved as to price, quantity, and quality by an authorized employee Though I chose the right answer-B, I think the other choices are also effective internal control measures which are responsible by A/P department. Right? 5. The two major audit objectives when verifying current-period acquisitions of manufacturing equipments are A. accuracy and classification B. cutoff and completeness C. existence and rights D. detail tie-in and presentation and disclosure I think the answer is A, but the solution guide says D.
1.Think of a car. When it is fully depreciated, and can no longer run, it would be stripped into parts and sold as parts. This selling of parts is referred to as scrap sales. In general, it refers to any sales of the bits and pieces of useless assets. 2.Accounts receivable accounts are individual debtors' accounts. The balance of each of these individual debtors' accounts are transferred (posted) say once a month to a control ledger known as Accounts Receivable control account. At the end of the financial year, the balance of the A/R control account is posted to the balance sheet under the subheading of Current Assets. 3.Yes. This a tricky question. A,B, C, and D all contribute to effective internal control of the accounts payable department. But, as you have correctly identified, B contributes most (the most important) to the internal control in comparison to the other three in A/Payable. 4.The key is in D's audit objective of "detail tie-in" which INCLUDES all the procedures performed under the audit objectives of "accuracy and classification" in A. Therefore, the complete answer is D which in essence is A + presentation and disclosure.
Chapter 17 (old text book). In preparing for Test No. 3, I am confused with several multiple questions at the end of chapter 20. Could you point out the correct anser and describe why correct? The questions making me confused are: Question b. 20-18, page 666 and Question c. 20-19, page 666
For Question b, 20-18 the answer is 2 because receiving report establishes the incoming units of inventory for the perpetual inventory system. The other three belongs to Expenditure Cycle not the Inventory Cycle in question here. For Queston c, 20-19 1 is not the answer because it deals with pricing of inventory. 3 is not the answer because the auditor will use Monetary Unit Sampling instead of attribute sampling here. 4 is no the answer because this is an inventory observation procedure. Therefore, 2 is the answer in which attribute sampling is used to extrapolate the % of slow-moving inventory from a sample of slow-moving inventory.
Chapter 22. I'm not clear on the audit report date. For example if a report is dated 2/29, the last day of field work, what happens when there is a subsequent event? Is it standard to date a report on the last day of field work? Please clearify.
It depends on whether that particular subsequent event happens in between the balance sheet date (12/31) and audit report date (2/29) or in between the audit report date (2/29) and the audit report issue date (say 3/15). In the former case, the standard to date the audit report at field work completion date applies. However, in the latter case, there are the three options of dating the audit report as that I mentioned in class. Usually, the 2nd option of "Dual Dating " applies.
Chapter 22. Would appreciate it very much if you would help me with the following questions: 1. What are NSF checks on Interim Proof of Cash (page 712)? 2. Is it possible there are different reporting treatments on F/S if we use accounting rule-direct/indirect or auditing rule - foreseen/unforeseen? The book uses the direct effect/indirect effect on the F/S to determine auditors' treatment on F/S. I think for some of the subsequent events that are considered having direct effect on the F/S might be unforeseen. For example, declaration of bankruptcy by a customer with an outstanding A/R because of deteriorating financial condition. On the other hand, some events that are listed as having indirect effects on F/S might be foreseen. For example, the issuance of bonds or equity securities, which definitely takes take to plan ahead. 3. Since I am confused with the reporting rules, I have problems with the following two M/C: A client acquired 25% of its outstanding capital stock after year-end and prior to completion of the auditor's fieldwork. The auditor should 1) advise management to adjust the balance sheet to reflect the acquisition 2) issue pro forma financial statements giving effect to the acquisition as if it had occurred at year-end 3) advise management to disclose the acquisition in the notes to the F/S 4) disclose the acquisition in the opinion paragraph of the auditor's report I think the answer is 1) because it is foreseen. But the answer key is 3). 4. An example of an event occurring in the period of auditor's fieldwork subsequent to the end of the year being audited that normally would not require disclosure in the F/S or auditor's report would be 1) decreased sales volume resulting from a general business recession 2) serious damage to the company's plant from a widespread flood 3)issuance of a widely advertised capital stock issue with restrictive covenants 4)settlement of a large liability for considerably less than the amount recorded I think the answer is 2) because no one can foresee a nature disaster, but the answer is 1). Why 1)? When economy is in recession, most people foresee a slow sales. 5. The last question is about the timeline of management Representation Letter. Should we date it on the date we complete the field work or the date we date our audit report?
(1). NSF stands for Not Sufficient Funds. Thus, an NSF check is drawn but rejected by the bank due to insufficient cash to clear the check. The example on p.712 shows that all NSF checks were subsequently redeposited and cleared by the bank. (2). In my opinion, the foreseen/unforeseen rule is more consistent than the direct/indirect effect rule. The declaration of bankruptcy by a customer with an outstanding A/R because of deteriorating financial condition is foreseen in the sense that on or before the balance sheets date, the reported A/R is known to suffer from deteriorating financial condition. After the balance sheet date, it went bankrupt as to be expected, ie a foreseen event. Therefore, it requires adjustment to the F/S which is a written off of bad debt against that A/R. The issuance of bonds or equity securities, which takes time to plan ahead on or before the balance sheet date, but the eventual outcome is unknown, that is, it may or may not be issued after the balance sheet date. Note the difference between planning for an event and the actual happening of an event. For example, the bond issues can be cancelled at the last minute not withstanding the planned issuance. Therefore, it is an unforeseen event, and only requires a footnote to the F/S. (3). The same logic as in 2. above about the bond issues. The clients may plan months ahead for the acquisition, but the actual happening of the acquisition is unknown until it actually happens as planned after the balance sheets date. Therefore, it is unforeseen, and the key (3) is correct. (4). First, consider why 2,3, and 4 are not the answer. 2 is unforeseen, therefore disclosure is needed as footnote in the F/S. 3 is also unforeseen. Although it is widely advertise on or before the balance date does not necessarily means that it will be issued as advertised. Again, it is unforeseen, and disclosure is needed as footnote in the F/S .4. The final settlement amount is clearly unforeseen, therefore, disclosure is needed as footnote in the F/S. 1 is foreseen. A general economy slow down that affects sales is foreseen on or before the balance sheets date, and according to the reporting rule, it would require an adjustment to the F/S. BUT fluctuation in sales is normal from month to month. It is NOT a subsequent event at all. Therefore, the rule does not applies here and NO disclosure is needed as per the question. 1 is the correct key. (5) Neither. It should be dated as CLOSE to the audit report date as possible. Note the completion of field work date and the audit report date and the director's report date are collapsed into one date.
Chapter 22 (old text book). Regarding the timeline of the Management Representation Letter, you mentioned that we should date it close to the audit report date and normally the fieldwork completion date and audit report date are the same date. But in the online M/C #12, different dates are set for fieldwork completion and audit report: complete the preparation of F/S: 02/13/2000 complete fieldwork:03/24/2000 complete audit report:03/28/2000 What is the date for representation letter? I chose 03/28, but the answer is 03/24. Am I wrong?
Oh, this is a very tricky question. The trick is in the word "complete" of audit report. You should not read "completion" as "dating" the audit report. The audit report is completed but not dated on the day of completion of the audit report. It is required (ie SAS requirement) to be dated the same day as the completion of field work. In other words, the completion of fieldwork date IS the date for the audit report. Therefore, your choice of 03/28 is correct as per the required dating of the management letter (close to the audit report date) but is wrong here because 03/28 is the completion of audit report but not the dating of audit report. Just imagine the auditor finishes writing up the audit report but leaves the report undated for the time being. The actual date of the audit report is the completion of field work date, and in fact, it is usually the client's director report date. The answer 03/24 is correct.
Chapter 1. Page 3 & page 4: Compilation service. In the box for "Assurance services", it says, "Assurance services also encompasses compilation services....." But in Figure 1-2 on page 4, compilation is shown in the box for "Nonassurance Services" Would you kindly clarify?
The "compilation" in Figure 1-2 is in the wrong location. It should be with the rest of the assurance services but outside the circle of attestation services.
Chapter 3. Page 22: Contingent Fees. Rule 302 says that "A member in public practice shall not.... prepare an original or amended tax return... for a contingent fee.." Tax services are nonassurance/nonattestation services accoriding to Figure 1-2. But on page 22, after the paragraphs in italics, it says, "Contingent fee is prohibited for attestation services only." Would you also clarify?
In Figure 1-2, Tax services are nonattestation services, which is correct. In page 22, contingent fee is prohibited for attestation services only, which is also correct. Therefore, Rule 302 PROHIBITS a CPA to receive contingent fees for preparing tax return (nonattestation services) for a client when the CPA is also performing auditing services (attestation services) for the SAME client. In other words, if a CPA prepares tax return for a client but does no auditing or other attestation services for the same client, the CPA is PERMITTED to receive contingent fee for preparing the tax return. The reason why Rule 302 does not make this distinction clear can be traced back to an unusual conflict between two government agencies in 1988 -- the FTC who wanted to allow contingent fees for CPAs in both attestation and nonattestation services, whereas the IRS who wanted to allow contingent fees for CPAs in nonattestation services only. In the end, FTC backed down and sent a "consent order" to AICPA, which effectively interprets Rule 302 as prohibits a CPA to receive contingent fee for preparing tax return (a nonattestation service) for a client when the CPA is also auditing (an attestation service) the same client.
Chapter 4 p.39 Multiple choice 4-1. I am confused about the term "minimum care" because on page 30 gross negigence is defined as "failure to exercise even a SLIGHT CARE in the circumstances." Does minimum care mean due professional care? Please confirm if "c" is the correct answer.
Yes. "minimum care" is the same as "due professional care" and "ordinary negligence". "Minimum care" is not the same as "not even a slight care." "Not even a slight care" is the same as "due diligence" and "gross negligence". Accordingly, "c" is the correct answer.
Chapter 6. I am confused about MQ 6-5 and MQ 6-13. Could you help me understand the answer?
MQ 6-5 First, auditor is more likely to confirm a client's accounts receivable than accounts payable. Both b. and c. are accounts receivable. Therefore they are out of the equation. Between the two accounts payable left, i.e., a. and d., auditor is less likely to confirm bond payable than accounts payable because a. has better bond documents and more reliable third party bond trustees. Therefore, d. is the answer. MQ 6-13 The answer is simply c. because property, plant, and equipment should not be recorded at current market value. Rather, it should be at cost less the appropriate depreciation or amortization.
Chapter 2. I came into the same question as MQ 2-10 in Wiley's CPA Exam review book of 2001 edition and found that the suggested answer in that book is not "a system of peer review," but "a system of quality control." Which one is correct?
Our answer d. "a system of peer review" is correct. First, see Table2-4 under "monitoring". A system of quality control will work only if the policies and procedures are well monitored. Now go to Table 2-1 and read under "Quality control standards committee" to see how "a system of peer review" helps to achieve this monitoring process. In short, answer d. is more precise than answer a. within the context of the question.
Chapter 7. MC7-7. Yes, you went over this question in class. I think the original answer (c) is right -- misstatement in the "19x0" accounts (not 19x1 accounts). Pls. correct me if I am wrong. MC question: 19x0-- accounts receivable turnover 4 times 19x1-- AR turnover 2 times Choose the most likely explanation My interpretation: The key issue is what is meant by "unrecorded credit sales". Either (1)Both credit entry to Sales and debit entry to AR are unrecorded,or (2)Only credit entry to Sales is unrecorded and debit entry to AR is Recorded. The credit could have been wrongly made to another account. But interpretation number 1 seems more reasonable. If that is the case, having "unrecorded credit sales" in 19x1 would NOT decrease the AR turnover to 2 times. It would INCREASE it. I used some numbers: Let's say in 19x0 Sales -- $80,000 AR -- $20,000 AR turnover = 4 times Then in 19x1 both sales and AR increase by 20% Sales --$96,000 AR -- $24,000 AR turnover still remains 4 times But out of the total sales $96,000 in 19x1, credit sales of $10,000 were unrecorded -- omitted in both sales figure and AR figure Misstated amounts Sales --$86,000 AR --$14,000 As a result, the 19x1 AR turnover became: 86000/14000 = 6.1 (Higher than 4, Not lower than 4!) Alternatively, if only credit sales $10,000 are omitted from Sales but AR is correct, then Sales ---$86,000 AR --$24,000 AR would drop to only 3.58. It would be hard to make up numbers so that it would drop from 4 times to 2 times. On the other hand, what if the 19x1 AR turnover of 2 times is right and something's wrong with the 19x0 accounts? In 19x0, Recorded in client's account Sales -- $80,000 AR -- $20,000 AR turnover = 80,000/20,000 = 4 times (& this is incorrect) But in fact, there are unrecorded sales of $40,000 Correct figures are: Sales $120,000 AR $60,000 Correct AR turnover = 120,000/60,000 = 2 times Then in 19x1, sales and AR increase by 20% Sales = $120,000 x 1.2 = 144,000 AR=$60,000 x 1.2 = 72,000 AR turnover = 144,000/72,000 = 2 times These would explain why the 19x0 AR turnover is 4 times and 19x1 AR turnover is 2 times. CONCLUSION: I think the original answer (c) is correct: "there were unrecorded credit sales in 19x0" (NOT 19x1) Please tell me if this makes sense. Thanks :-)
Thank you for taking time out to sort out your question using some numbers. However, these numbers confused you even further because your premise for those numbers is wrong in the first place. That is, your interpretation number (1) in "My interpretation" is wrong. The answer c in 7-7 says "unrecorded credit sales", that's all, it does not say AR is unrecorded. That is, your interpretation number (2) in "My interpretation" should be the right one. Once your premise is right, then the correct answer c of "unrecorded credit sales in 19x1" in 7-7 can be illustrated by the following simple example: 19x0 19x1 Salesx0/ARx0 Salesx1/ARx1 4/1 = 4 times 2/1 = 2 times Therefore, unrecorded CREDIT sales of "2" (4-2) in 19x1 is most likely the explanation for a drop of 2 times (4-2) across the two years. Of course, unrecorded CREDIT sales of "2" (4+2) in 19x0 will cause a drop of 4 times (6-2) across the two years. P/s You also seem to confuse Sales with Credit sales in making up your numbers. Sales includes both cash and credit sales; only the credit sales portion of the Sales figure in the numerator of the formula is affected.
Chapter 9. Please help me with the following: (1) Chapter 9: MC 9-4. Is answer "d" correct? I thought it's answer "b". At the bottom of p.87, Mr. A assigned a higher TM of $30,000 to Inventory because he "anticipated more misstatements in inventory account." Why then is answer "b" not correct? (2) Chapter 9: MC 9-12. should the answer be "b" instead? P.85 says, "most practicing auditors allocate materiality to balance sheet rather than income statement accounts......"
For MC 9-4. In class, I crossed out "d" and said it should be "b". Did you miss that class? For MC 9-12. In class, I crossed out "d" and said it should be "b". Again, did you miss that class?
Chapter 10. MC 10-8. I may have written down something wrong in class. There's no change in the answer (which is "b"), right?
No, in class I crossed out "b", and said it should be "c". Probably it is my accent to blame; "b", "c", and "d" they all sounded like "z", "z", "z" from me.
Chapter 7. MC 7-3: I think both a and d are the correct answers. I don't know why the answer is a instead of d. MC7-7: I choose answer b. But the answer is c. I am confused.
MC 7-3:(d) deals with presentation and disclosure which can be effectively examined by analytical procedures such as comparing the figures of two financial years for consistency in presentation and disclosure. On the other hand, (a) deals with right and obligation which will not be effectively examined by any one of the 6 categories of common analytical procedures on page 64. Normally, right and obligation can only be effectively examined by physically examining the contracts and other similar documents, not by analytical procedures. MC 7-7: (b) and (d) can't be right because better or worst credit management impacts on the RECOVERY of accounts receivable, NOT on the SPEED of accounts receivable turnover, which is accounts receivable turnover ratio is about.
MC 11-6: Please read step 12 bullet one on page 111, the answer is right there. MC 11-11:This question requires you to think as follows: 1. The auditor uses previous year's SER (sample exception/sample size) to estimate EPER; say the previous year's SER is 4/100 = 4%. Thus, EPER is estimated to be 4% based on previous year's SER of 4%. (2) Now, look at Table 11-4 on page 113, given EPER of 4% and sample size of 100, the tolerable exception rate (TER) would be 9%. (3) Next, scan down to Table 11-5 on page 113, consistent with previous year, the auditor would expect to find 4 exceptions out of a sample of 100, which means the CUER (or MPER) would be 9% in Table 11-5. (4) However, the SER for this year turns out to be 2%, that is, the auditor found only 2 exception out of a sample of 100 (2/100 = 2%). Given this findings, look at Table 11-5 again for the exception found of 2 and sample size of 100, which show the CUER (or MPER) is 6.2% instead of 9%. (5) Therefore, this cause it to be less than the TER of 9% in (2) above, which is the answer (a) to this question. MC 11-19:The key is in the word "relax" of (a) "Revise and relax the tolerable exception rate ...". In a court of law, the auditor may revise as much as he/she likes, but to revise and RELAX the tolerable exception rate ...etc in (a) will call for the auditor to justify (defend) his/her decision to relax the rate and yet would not lead to negligent in evaluating sample results. In other words, the non-negligent performance defense is not the best defense here, recall chapter 4 on legal responsibility.
They are for your bed time reading and additional knowledge. They won't be in the exam -- well, make sure you read them, I am going to check on you -- just kidding!
Chapter 11. I have some questions about chapter 11. How to think for MC11-12 and MC11-15?
MC11-12. Think in terms of: (a) Population is usually larger than 5000. See Table 14-8, no effect here. (b) (+direct relationship) + (-Inverse relationship) = offsetting effect. (c) (-Inverse relationship) - (+direct relationship) = magnifying effect. (d) (-Inverse) - (-Inverse) = offsetting effect. Therefore, the answer is (c) which has the greatest effect. MC11-15. Think in terms of: From Table 11-5 an increase in the sample size will always lead to a decrease in the CUDR if the new sample exception rate (SER) = exception found/ the increased sample size, does no change. For example, from Table 11-5, if originally the actual number of exception found is 3, and sample size is 100, the CUDR is 7.6 and the SER is 3/100 = 3%. Now if sample size increases by 50 to 150, the CUDR is now 5.1 (decrease from 7.6) if the new exception found in the increased sample of 50 does not change, that is, if the new exception found is 1.5 which gives the new SER the same 3% =1.5/50. Therefore, (c) and (d) are out, because as shown in this example, it is not the number of exceptions, rather the SER (a) and (b) that have statistical impact on the CUDR. Since (a) SER increases (i.e., changes) it is not the answer. Only (b) SER does not change that is the answer. The mathematics behind the above is beyond the scope of ACCT506.
Chapter 11. P.117, Table 14-8. Relationship between CR(Control Risk) and Sample Size -- should it be Inverse instead? Because CR and TER has a direct relationship and TER and Sample Size has an inverse relationship; the same for CR and ARO.
(1) Table 14-8 meant to be read row by row independent of one another. Do not infer relationship beyond each row. The table is a memory aid not a mathematically constructed table. (2) CR is directly related to sample size because, for example, the STRONGER the control, the SMALLER the control risk (the risk of control NOT preventing or detecting exceptions); and naturally a SMALLER the sample size is needed to test the control assuming every thing else remains constant. (3) CR is directly related to ARO because, for example, the STRONGER the control, the SMALLER the control risk (the risk of control NOT preventing or detecting exceptions); and naturally a SMALLER ARO to avoid (risk of over-reliance on the control which is basically strong) assuming every thing else remains constant.
Chapter 15. I have some questions : 1. what is C.O.D. basis on MC15-7? 2. How to think for MC15-8,15-14?
C.O.D. stands for Cash On Delivery.MC15-8: The specific objective here refers to the "Cutoff" specific objective in Table 15-4, p.155. Therefore, the associated TOC procedure in that table indicates that the receiving report date (the date the merchandise has been received) should be no later than the date the check that is cut (written) to pay for the purchase. To do otherwise means that the check is cut (written) before the merchandise is received (receiving report). (a) is the answer. MC15-14: No thinking is required here. The answer (c) - completeness specific objective - comes straight from Table 15-4, p.155 on "completeness" that associates with the audit procedure of "scan for numerical sequence of checks" in the last column of that table.
Chapter 13. MC13-4, how to think b/w answer a and answer b? I don''t know how to do 13-6? totally don't know how to start it.
MC13-4: No thinking is required here. The answer (a) - existence assertion - comes straight from Table 13-3, p.139 on "validity" the specific audit objective that is translated from the "existence assertion," and is associated with the "supporting documents" under Internal Control in the middle column of that table. MC13-6: This question deals with separation of duties. The trick here is not to be fooled by (d) which is cash PAYMENT function (Not cash RECEIVE function). No problem here since it is cash payment. (a) and (c) are also no problem here because they are simply mechanical procedures not involving cash (accounts receivable). However, (b) must be separated from accounts receivable posting function because a bogus credit memo can be written out, and the cash stolen can be then covered up by fraudulently posting the associated account receivable account.
The table is correct. Because if the response rate is low, it does not matter whether a customer agrees or disagrees with the amount, so long he/she does not response, it is ASSUMED to be the correct amount by the auditor. This is also why negative confirmation is inferior to positive confirmation, everything else stays constant.
Chapter 15, MC15-5 Answer (a) says that the Receptionist should be responsible for mailing signed checks. Why? I read in another book that the Treasurer signs checks and MAILS them. But I think in reality the Treasurer himself does not mail checks and he delegates the job to someone. Would answer (b) be correct? I am confused. Pls. help.
To clarify your confusion: that other book is dead wrong (which book is that?). You are right, the Treasurer himself/herself never MAILS out signed checks. He/she does not even make his/her cup of coffee in the office. Moreover, the Treasurer usually does not PHYSICALLY signed the checks, the signatures are preprinted on the checks. Therefore, all that the receptionist has to do is to carry out the mechanical process of MAILING out the SIGNED checks. Notice the key words "mailing SIGNED checks" in MC15-5 -- not to be misinterpreted as "mailing and SIGNING checks." Therefore, answer (a) is correct. Note: if the question is about auditor sending confirmation requests on accounts receivable, then the auditor MUST mail them out himself/herself -- not by the receptionist, the Treasurer, or the Janitor!
Chapter 13. On 13-10, if there are unbilled shipments, wouldn't it be possible that the shipping documents won't exist. So it would be impossible to detect the unbilled shipments from the shipping documents but you can detect them from the sales journal like in answer "a".
Yes, that is possible. BUT this possibility is NOT stated in the question. The question is simply about testing for "unbilled shipments" nothing more and nothing less. As such, (b) is the answer. Always be careful not to fall into the trap of inferring more than what is simply stated in the question. For example, if the question states "... test for unbilled shipments some of which are nonexistence", then (a) is the answer.
Chapter 14. For 14-9, answer "a" - second confirmation request - is the same as follow-up confirmation request, right? So shouldn't "a" also be true?
No. A "follow-up" is NOT the same as a "second" confirmation request. A "follow-up" confirmation request follows the original confirmation request; it can be the first, second, third, fouth, ... nth "follow-up" requests to the original confirmation request. On the other hand, a "second" confirmation request refers to a DIFFERENT confirmation request that is sent to REPLACE the "first" confirmation request. This second confirmation request is not an alternative to the first confirmation request because it does not test the first confirmation request in a different way such as in (b), (c) or (d). Therefore, (a) is the anwer.
Chapter 15. MC15-3, I'm wondering why quantity ordered has to be omitted. Shouldn't the receiving dept need to know? What are the potential dangers with that? MC15-15, I'm thinking the answer is "b". When a company comletes a purchase order, shouldn't it know its liability from that order?
MC15-3. No. I have explained this in class, usually the $ amount ordered is omitted to reduce the temptation of theft at the receiving department, but the quantity is also omitted to FURTHER REDUCE (hence the word "STRENGTHEN" in the question) the temptation of theft at the receiving department. MC15-15. The key is the difference between the word "know" in your question above, and the word "recognize" in the MC 15-15. The word to "recognize" in the question refers to the usual GAAP of recognizing a purchase and related liability when the order is actually received, i.e. (c) is the correct answer. Of course, if the question is to ask when a company "know" (as your thinking above) the purchase and related liability, then "b" is the answer.
Chapter 19. MC19-4 Answer (c) looks correct to me. Why is it wrong? MC19-7 Why is (b) a weakness and (c) not a weakness? I also read answer (c) in relation to MC19-20. I thought returning unclaimed payroll checks to the paryoll department is not a good practice and so I chose (c). MC19-12 Maybe Form 1120 is mentioned in your text but I can't find it. Can you tell me what it is and why is answer (b) the right one? MC19-20 Just curious to know how a company deposit an unclaimed salary check in a special bank account? The check is in a person's name and so how does the company deposit it in a special bank account?
For MC19-4. The question states ... segregating the duties of HIRING personnel from distributing payroll check ...so, (c) can't be the answer because it is about segregating "authorization transactions" (NOT "authorization HIRING") from "custody-related assets" (i.e., custody of payroll checks). For MC19-7. (b) is a weakness because the payroll department should COMPUTE (i.e., do all the necessary calculations) but not PREPARE (i.e. actual cut the checks), It should be prepared in the general accounting department based on the computation done in the payroll department (akin to (a)). (c) is not a weakness because that is what the employee should do after the distribution. Imagine he or she took those unclaimed payroll checks home instead of returning them to the payroll department. Therefore, in relation to MC19-20, return to the payroll department is better than taking them home. Of course, it is better still if they are deposited in a special bank account than in the payroll department, thus, the correct answer of (d) in MC19-20. For MC19-12. Form1120 is the standard IRS form a company uses to file its payroll tax. Therefore, the answer (b) is self-evidence. For MC119-20. Very simple. The company added up all the unclaimed checks; cut a new check for the total unclaimed $ amount, and deposit it in the special bank account usually called "unclaimed wages account". Later, when employees turn up to claim their payroll checks, new individual checks are cut from this special bank account for them. Of course, if no one turns up to claim them, then it is an indication of fictitious employees.
Chapter 22. MC22-2 I was struggling between answers (a) and (b). Why is the auditor more interested in determing (b) than (a)? MC22-13 I don't understand the question. What is the contingent liability in this case? Why is there a credit to the notes receivable account? MC22-14 Answer (d) also looks right. Would you explain why (c) is better than (d)?
For MC22-2. The answer is simple - the auditor is more interested in determining (b) because the time in which the litigation occurs will determine whether this contingent item should be accounted for as an usual contingent item, or as a subsequent event item, or a SDOF. (a) is of least interest to the auditor because as far as the auditor is concerned, so long an appropriate contingency is established for the litigation under consideration, how long it will take for the litigation to RESOLVE (by the lawyer) has no accounting implication. For MC22-13. Recall the basic accounting entries. Notes receivable account usually has a debit balance. When actual cash is received for the notes receivable, a credit entry is made to the notes receivable and a corresponding debit entry is made to the cash RECEIPTS record. In this case, a credit entry is made to the notes receivable but the corresponding debit entry is made to the cash DISBURSEMENTs record. Therefore, it indicates that a contingent liability account was set up previously in anticipation of the non-payment (by the nasty notes holder whoever s/he is) of the notes receivable. This contingent liability account was set up with a credit to the contingent liability for the anticipated non-payment. When it becomes a reality (i.e., the nasty notes holder indeed has not paid on time), a debit entry is made to the contingent liability account by debiting the cash DISBURSEMENTs record and a corresponding credit to the notes receivable account to "settle" the contingent liability account. Do not read "contingent liability" as a "liability" account; instead, read it as a "provision" account - which is a more appropriate term for the contingent liability account (i.e., it should be read as a "provision for contingency" account). For MC22-14. The key is in the words "extremely high probability" in (c). Regardless of how much work the attorney has done in (c) and (d); in the case of (c), disclosure by the auditor would increase the already "extremely high probability" of detrimental effect on the client. On the other hand, (d) like (a) and (b), the probability of their detrimental effect is unknown (more precisely, is purposely not stated in (a), (b) and (d)).
Chapter23. (i)MC 23-12 and MC 23-18 If (c) is the answer for MC23-12, that means omitting the statement of cash flow is fine - it will still result in an "unqualified audit opinion without an explanatory paragraph." Then why is it that in MC 23-18, omitting the statement of cash flow results in answer (a) - a qualified opion? I wonder if, in fact, (b) is the right answer for MC 23-12. Pls. solve the apparent contradiction. (ii) MC23-13: The question asks which situation would the auditor NOT include MORE THAN ONE than one modification -- I take it to mean include just one modification. In (a), a material scope limitation requires a qualified report. In (b),material GAAP violation also requires a qualified report. I don't understand how the effect of (a) differs from (b). Pls. explain more about the meaning of the question.
(i) MC23-12 and MC23-18. You are right, the answer for MC23-12 should be (b) not (c). This is because(c) refers to the financial statements that present "financial position" and "results of opertations". This means it includes ALL the financial statements i.e Income Statement, Balance sheet, Statement of Retained Earnings and Statement of Cash Flows. In the case of ALL the financial statements, it requires a qualified opinion for the missing statement of cash flows. Thus, the original answer in our book for MC23-12 of (c) is wrong. It should be (b). With this correction, there is no more apparent contradiction between MC23-12 and MC23-18. That is, like (c) of MC23-12, the question in MC23-18 refers to ALL the financial statements. Thus, (a) is the correct answer -- a qualified opinion is required for the missing statement of cash flows. (ii) MC23-13. Your interpretation of the question is correct. The problem is with the typos in (a). Instead of (a) "There is material scope limitation, and the auditor is not independent", it should be (a) "There is material scope limitation, and there is a material GAAP violation." (b) remains the same as "There is a material GAAP violation, and the auditor is not independent". With this correction in (a), the essential idea to be learnt from this question is clear as follows: for (a) we have qualified and qualified reports -- therefore there is a "neutralizing" effect as stated in the question, consequently, only one modification is needed, i.e., one qualified report is sufficient. On the other hand, for (b) we have qualified and disclaimer reports -- therefore there is no "neutralizing" effect, consequently, two modifications are needed - qualified and disclaimer reports. (c) does not involves more than one modification and (d) is simply runs out of idea in setting the question.
Chapter 19. (i)MC 19-10. I remember in class you asked us to refer to Table 19-5, but I could not find the answer from that table. (ii)MC 19-11. How are we suppose to know which type of organization requires more TOC for proper classifications?
For(i) MC 19-10 See the last entry (row) in Table 19-5, "Analyze ... accounts", which points to (a) to be the best for detecting this fraud. (b), (c), and (d) are all after the documents have been massaged, therefore, audit procedures on these documents are not effective. For (ii) MC 19-11 This question requires you to recall your basic knowledge learned in managerial accounting (ACCT305) and intermediate financial accounting (ACCT302). Recall only a manufacturing organization needs a clear classification of DIRECT and INDIRECT labor (i.e., payroll transactions) for the main purpose of computing cost of goods sold. On the other hand, (b), (c), and (d) are usually lumped together as payroll transactions. Although some service organizations divide payroll transactions into "wages" for blue collar workers and "salaries" for white collar workers, but that is just for labelling not accounting.
Chapter 21. MC 21-6, I am struggling between answer "b" and "d".
(b) can't be right because checks dated BEFORE the year end would have been correctly included as outstanding checks at year end bank RECONCILIATION. Thus, such tracing by the auditor using the cutoff bank statement serves no purpose. On the other hand, checks dated AFTER the year end would NOT have been correctly included as outstanding checks at year end bank RECONCILIATION. Therefore, such tracing by the auditor using the cutoff bank statement is useful in discovering any such mistake (i.e. should not have included those outstanding checks) at the year end bank reconciliation.
Chapter 24. MC 24-6, why is "a" correct? I cannot find the statement in the text.
You are correct. The answer should be (c) which can be found in the text (specifically Table 24-4). On the other hand, (a), (b) and (d) are not the right answers as they cannot be found in Table 24-4 or Figure 24-8.
Chapter22 (i)MC 22-15, is "d" also a possible answer? (ii)22-16, I understand the answers a, c, d are all wrong. But does the written documentation have a higher quality of evidence than oral responses?
(i)No. (d) is not a possible answer because the auditor is NOT in a position to judge whether an attorney has/has not form a conclusion regarding LCAs. (The formation of a conclusion about LCAs is the job of the lawyer not the auditor) On the other hand, (b) is the correct answer because the auditor IS in a position to judge (or suspect) whether an attorney has/has not disclose LCAs (The disclosure of LCAs is the job of the auditor not the lawyer. (ii)Oh yes, yes, yes, yes in all time. Written responses is always far more superior than oral responses as far as evidential matter is concerned.
Chapter 23. MC 23-4. Shouldn't the answer be (b), ...with explanatory paragraph? It looks exactly like the first bullet on p227.
Please read the question carefully. MC23-4 A client ....has no material effect ... with a (n). Now read the sentence under 1. Lack of consistency in applying GAAP on p227. If there is ... that materially affects ... Accordingly, the example under the first bullet on p227 is for MATERIAL effect change in accounting principle (and for other examples there). When there is no material effect, footnotes to the financial statement is sufficient.
Chapter 3. MC 3-9. The interpretations of the Rules of Conduct #101, defines materiality for investor-investee relationships as: Either 5% of the audit client's total assets or 5% of income before taxes, whichever is more restrictive. How were we supposed to get this from our text book material since it does not state it directly, were we supposed to interpret something from what we were given?
Thank you for your enquiry. In deed, our textbook and all available auditing textbooks could not cover ALL the interpretations of the CPC. This question is an example that you have to interpret it in light of what is given. In addition, the question is tricky in that answer c "... whichever is more restrictive" is the most precise interpretation of the four options.
Chapter 3. commission & referral fee: Pleasetell me if I am right: According to my understanding, (1)auditors can receive/ give both commissions & referral fees in connection to clients with no attestation services. Given that it's disclosed to clients.(2)auditors can receive/give referral fees only (not commission) in connection to clients with attestation services. Given that it's disclosed to clients.
(1)Yes. You are right. (2) Yes. You are right again!
Chapter 11. (1) MC 11-11 What is the role of SER in evaluating the results of attributes sampling? According to my understanding it's ARO%, actual # of exception found & sample size bring the result of MPER. What about SER? (2) MC 11-12 Please explain why the negative effect less positive effect has the greatest effect on sample size.
(1)Yes. Your understanding is correct. However, note that, as per your understanding, given an ARO%, the actual # of exception found & sample size is actually the SER, i.e. actual # of exception divides by sample size. As explained in class, the calculation of SER is normally for the benefit of formulating EPER in future years' audit; it does not play a role in the sample evaluation for the current year audit. This MC implicitly assumed that the SER of previous year is used to formulate the EPER of the current year audit. So, the MC implies that last year's SER is 4%, therefore, the current year's EPER is around 4%, and for a given TER (say 9%), the sample size (100) is determined (see Table 11-4, p.113). Now, for a sample size of 100 (use Table 11-5), the auditor is expected to find 4 # of exceptions (4/100 = 4%) to match the SER of 4%, which yields a MPER of 9 % (see Table 11-5, p.113). However, if the actual SER is less than 4% (i.e. 2% as stated in the MC, or in other words, actually found 2# of exceptions instead of 4#), then, everything else reminds constant, MPER is now 6.2% (see Table 11-5) which is less than the TER of 9% (hence option a. is the answer) for this MC. (2)This is because mathematically it reads as: (- inverse relationship) - (+ direct relationship), and removing the brackets, it becomes a double minus, and therefore, it magnifies the effect ( or the greatest effect) in option c which is the answer for this MC.
Chapter 12 In the text of CH.12, it involves a lot of calcation details which are not reflected in your after text MC Qs. Suppposed all those calculations do not carry as much weight as it's covered in text?
Those calculations are for your learning and acquiring knowledge of the sampling technique. As explained in class, the MC questions are usually not set up to test your knowledge of the calculations (the pure mechanics of using the calculator); rather, they are set up to test your understanding of the relationships (or underlying concepts) of the various factors involved in the sample technique ( as reflected in the MC).
Chapter 11. On page 117 table 11-8, the relationship between CRand sample size is direct according to your table. But I think it's inverse, because the relationship between CR and TER is direct, TER and sample size is inverse, so CR and sample size has to be inverse. Am I right?
Please see my response to the same question 43 above that has been raised by another student. CR and sample size is direct and correct.
Chapter 18. (1)MC 18-1: official answer is b For cutoff test: the normal auditing procedure is examining a sample of receiving reports a few days before & after the year end to make sure recording the inventory purchased in the proper period. No revelant ans is found here. For b & c: it's more revelant to ownership & disclosure For a & d: purchased & owned are not specified as receiving report. Seems like nothing is appropriate among the 4 options. Could you explain why b is the best option? & reveleant to cutoff test? (2) MC 18-7: What are negotiable receipts?
(1)The answer can be found by referring to Table 18-3 under "ownership". This same procedure is performed for the cut off test of inventory. Also, I think you are confused between inventory that are actually sold and have shipped out of the warehouse (thus no longer included in the inventory), and inventory that are sold but on consignment or "bill and hold" and have YET to be shipped out of the storeroom (thus there is a likelihood of accidently included in the inventory, hence the reason for the cut-off test). Also, do not confuse checking of the receiving reports for purchase cut-off with the cut off test procedure here for inventory. (2)These are public warehouse receipts (for inventory stored by the audit client) that are pledged as collateral to a sum of money borrowed by the audit client from a particular lender or bank.
Chapter 13. For MC13-6, I know you have explained it in your FAQ, but it is easy to misunderstand (d) to be "cash payment by customers." Also, the credit in (b) sounds to me like the pre-sales credit granting, not the credit for post-sales returns/discounts. For MC13-8, (c) seems confusing. Isn't making journal entries the same as recording transactions? I understand the answer should either be about separation of duties or proper authorization. So I think the answer should be something like "all write-off authorization forms are properly authorized by a separate person."
No. Your interpretation of "cash payment by customers" in (d) is wrong. The interpretation of (d) should be consistent with the question which states, " ... the person that is responsible ... should not also handle ...". Therefore, "the person" is an employee of the company who should not also handle "cash payment function" of the company. It cannot be cash payment by customers. Your distinction between "pre-sales credit granting" or "post-sales credit for sales returns/discount" is a none-issue and unnecessary. They are all "credit granted to customer" in (b), i.e., an "authorization" function which must be separated from the "posting" function. No. I think you forget the generic term "accounting" for a transaction -- a transaction is first "journalized" , i.e., making a journal entry; once the entry is made, it is then "recorded", i.e., posting to a ledger. Your suggestion of "all write-off authorization forms are properly authorized by a separate person." is good only if the question states that the write off SHOULD BE authorized by someone other than the cashier who is stealing the money. The question DOES NOT state this, therefore, you should not read more than what is in the question, i.e., assume that the cashier is not authorized to write-off accounts. In the absence of whether the cashier is/is not authorized to write-off accounting, the best procedure is (C).
Chapter 14. For MC14-1, since the question says it is in a "tight money" environment, isn't it natural to increase the balance in the allowance for bad debt expense to accommodate the increased likelihood of nonpayment so that the financial statements are stated more fairly? For MC14-13, I chose (a). But why does the answer focuses on accuracy, but not on existence and occurence (validity)? It seems to me that the most important concept in Chapter 14 is confirmation, and it tests for validity. Shouldn't it be done first? If an A/R is not valid (does not exist), it does not make much sense to test for its accuracy.
The answers for MC14-1 are all correct. It is a question of priority, which is the auditor should do (d) first, then (c), followed by (a) and finally (b). In short, your choice of "increase the allowance ...", i.e, (a), is not the top priority from the auditor's point of view (may be a top priority from the client's point of view). In deed, the most important audit objective is "validity". But the most important audit objective is not necessary the one to perform FIRST. In this case, the question asks which audit objectiven is to perform first, not which is the most important. First, the auditor checks that the records are accurately processed, then the auditor checks for non-existence records. Again, your reasoning "If an A/R is not valid (does not exist), it does not make much sense to test for its accuracy" shows that you read more than what is in the question, i.e., assume that there is non-existence A/R, which is simply not stated in the question.
Chapter 15. For MC15-2, I chose (c), because you said in many cases purchase requisitions are informal or oral, so how can a receiving clerk match the goods with it (as you mentioned, probably on a piece of toilet paper)?
Yes. I did say it could be on a piece of toilet paper :), BUT in option (a) it states (a) The ... requisition FORM. Therefore, it is a proper FORM, not a piece of toilet paper. I appreciat that you paid attention to what I said in class, but read carefully what is given in the question.
Chapter 16. For MC16-8, I have eliminated (b) and (c). How should I choose between (a) and (d)?
Very simple, there is no basis for (a) i.e., more or less material between the two accounts, as such, no basis to use different procedures between the two accounts based on materiality.
Chapter 18. For MC18-1, I have read your explanation in the FAQ but am still not convinced that (b) is the right answer. My understanding is that a cutoff test is performed with time as a reference, so I think it has something to do with year-end. Also, are you suggesting that cutoff and ownership are related?
No. I do not suggest cutoff and ownership are related. I think you are not convinced that (b) is the right answer based on your " My understanding is that a cutoff test is performed with time as a reference", which is true for individual cut-off test, such as sales cutoff, purchase cutoff, or inventory cutoff, EACH ON ITS OWN. But, the question combined two cutoffs -- "... PURCHASE cutoff..." in the question and " ... INVENTORY cutoff ..." in each of the 4 options (a) to (d). Recall I mentioned in class the combined cutoffs that are frequently performed by the auditor. Think about the objective of the combined cutoffs, the answer (b) is clearly the key audit objective over your choice of (d).
Chapter 4. am confused by the difference between ordinary negligence and gross negligence. According to the defination, the gross negligence is failture to exercise even a SIGHT care in the circumstance. But in Q1, " The auditor's failure to exercise MINIMUM care in an audit...", the answer is ordinary negligence. These two concepts seem important, but I cannot distinguish them.
The word is "SLIGHT" not "SIGHT". Without even a slight care means not a trace of care at all. Without a MINIMUM care means there is a trace of care but it fails the minimum standard of care required.
Chapter4.Another question is about Q23 and Q24. You give us hints in Q23 "negligently" and Q24 "fraudulently". But I still have no idea to choose the correct answers in these two questions.
Read Table 4-16 on page 45 carefully and many times. Then match the options in Q23 and Q24 against Table 4-16 and you should be able to choose the right answers.
Chapter 19. MC19-4. I checked your website and it says (c) is not the answer. I want to know the answer. Hiring personnel is human resource function and payroll disbursement is administrative function and internal accounting function. And controllship is payroll processing function. So, (a) and (b) can not be anwers. So please tell me the anwer.
Sorry for the confusion. The website says (c) is not the answer because all the functions were not clearly defined in the old edition of the book. Now, the new edition has "Note:" besides these functions. So, (c) is the right answer in this new edition. Thanks for this, my previous response in this website does not apply anymore.
Chapter 20. MC20-8(p288). I am confusing (a) or (d)?
The key word is "renewal" in this question. Think in terms of a library book (notes payable) that you have borrowed which is due to return to the library (pay the lender in full) on Dec 31. But you forgot to return the book (management deliberately hide the notes payable from the auditor) on Dec 31. After the due date (Dec 31 balance sheet date), you go to the library and renew the book so as to avoid the fine (management negotiate with the lender for a new term and perhaps new rates). So, the auditor, by watching for any renewal items shortly after the balance sheet date is most likely to obtain physical existence evidence of those hidden notes payable prior to year end. The solution (a) is correct. (d) is partially correct because non-existence notes payable has no impact on the valuation and allocation assertion until auditor has gathered evidence to proof the existence of such non-existence notes payable, and then, the valuation and allocation assertion will be retrospectively adjusted.
Chapter3. MC3-27, I think the concept of materiality is relevant to all 4 answer choices, and it is most important to choice c, and least important to choice b. But the correct answer (least important) is c. Would you please explain? I can not find the answer in the text.
Materiality is least important to direct financial interest (i.e., the correct answer c) because direct financial interest, material or immaterial, is strictly prohibited. Thus, materiality is not an issue (i.e., its importance is never considered) in the case of direct investment in audit client. You can find the relevant passage in p.29 of the text, under Table3-2, the first paragraph of second bullet "financial interest".
Chapter4. MC4-29, I think the best defense will be that A did not cause C's substantial loss, i.e. choice c. But the correct answer is d. I think d is a defense. But as in case Escott V. Bar Chris, the PMM's review program was in accordance to GAAS, but PMM was still found liable. So I think choice c is a better answer. I would like to know your opinion.
First, question 4-29 is a law suit by client on breach of contract in COMMON LAW. Thus, as stated in the text on p.50, under Table 4-9, the best defense should be "Contributory negligence". However, this is not one of the choices in question 4-29. Therefore, the next best defense is "non-negligent performance" (i.e the correct answer d) because as I explained in class, "absence of causal connection" (i.e., your preferred answer c) is not determined by the defense lawyer of the auditor (i.e, the judge determines the cause and effect). As such, answer c is a weaker defense than d as far as the defense lawyer is concerned. Second, your citing of Bar Chris case is inappropriate here, as this case is a law suit by SEC in STATUTORY LAW. Therefore, it does not apply to common law suit in question 4-29. Moreover, Bar Chris case is about not satisfying S-1 review requirement of Securities Act 1933 (Refer to p.17 of the text, under Table 2-6, first bullet). It is not about PMM's compliance with the GAAS requirements and no loss is caused to the audit client C.