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business
auditing

Questions and Answers of Auditing

Donald Westerman is president of Westerman Corporation, a nonpublic manufacturer of kitchen cabinets. He has been approached by Darlene Zabish, a partner with Zabish and Co., CPAs, who suggests that
The firm of McGraw and West, CPAs, has two offices, one in Phoenix and one in San Diego. The firm has audited the Cameron Corporation out of its Phoenix office for the past five years. For each of
The firm of Harwood & Toole, CPAs, has been the auditor and tax return preparer for Tucker, Inc., a nonpublic company, for several years. In the current year, the management of Tucker discharged
James Daleiden, CPA, is interested in expanding his practice through acquisition of new clients. For each of the following independent cases, indicate whether Daleiden would violate the AICPA Code of
The firm of Bell & Greer, CPAs, has been asked to perform attest services for Trek Corporation (a nonpublic company) for the year ended December 31, Year 5. Bell & Greer has two offices: one in Los
The firm of Schilling & Co., CPAs, has offices in Chicago and Green Bay, Wisconsin. Gillington Company, which has 1 million shares of outstanding stock, is audited by the Chicago office of
Gloria and Deloria, CPAs, have recently started their public accounting firm and intend to provide attestation and a variety of consulting services for their clients, which are all nonpublic. Both
Gary Watson, a graduating business student at a small college, is currently interviewing for a job. Gary was invited by both Tilly Manufacturing Co. and Watson Supply Company to travel to a nearby
Roland Company, a retail store, has utilized your services as independent auditor for several years. During the current year, the company opened a new store, and in the course of your annual audit,
Thomas Gilbert and Susan Bradley formed a professional corporation called “Financial Services Inc.—A Professional Corporation,” each taking 50 percent of the authorized common stock. Gilbert is
The issue of whether the performance of nonattest (consulting) services for audit clients impairs independence of the auditors has been widely debated within the public accounting profession.
You are the Partner-in-Charge of a large metropolitan office of a regional public accounting firm. Two members of your professional staff have come to you to discuss problems that may affect the
The International Bank of Commerce (IBC) is an audit client of your public accounting firm. IBC is a multinational financial institution that operates in 23 countries. During the current year’s
Briefly describe the two parts of the AICPA Code of Professional Conduct.
Sara Kole, CPA, has been requested by the president of Noyes Company, a closely held corporation and audit client, to cosign Noyes Company checks with the Noyes treasurer when the president is away
With respect to ethics, what are the responsibilities of the Public Company Accounting Over sight Board? What is the source of the Board's authority?
Identify the circumstances under which a CPA may not perform professional services on a contingent fee basis.
Jian Zhang is a CPA who often serves as an expert witness in court cases. Is it proper for Zhang to receive compensation in a damage suit based on the amount awarded to the plaintiff? Discuss.
In what organizational forms may CPAs practice public accounting?
Must a CPA maintain independence and an impartial mental attitude when preparing a client’s income tax return? Explain.
In preparing a client’s income tax return, a CPA feels that certain expenses are unreasonably high and probably are overstated. Explain the CPA’s responsibilities in this situation.
What board establishes international ethical standards for accountants? How do these standards compare to the AICPA Code of Professional Conduct?
The firm of Williams, Kline & Chow, CPAs, is the auditor of Yuker Corporation, a nonpublic company. The president of Yuker, Karen Lester, has been putting pressure on Chee Chow, the audit partner, to
Explain why the potential liability of auditors for professional “malpractice” exceeds that of physicians or other professionals.
What is meant by the term privity? How does privity affect the auditor’s liability under common law?
Define the term third-party beneficiary.
Briefly describe the differences in liability to third parties under the known user, foreseen user, and foreseeable user approaches to CPA liability.
Briefly describe the different common law precedents set by the Ultramares v. Touche & Co. case and the Rosenblum v. Adler case.
Contrast joint and several liability with proportionate liability.
Compare the rights of plaintiffs under common law with the rights of persons who purchase securities registered under the Securities Act of 1933 and sustain losses. In your answer, emphasize the
Why was the Ernst & Ernst v. Hochfelder decision considered a "victory" for the accounting profession?
Why did Congress enact the Racketeer Influenced and Corrupt Organizations Act? Why has it been of concern to auditors? What subsequent developments have reduced this concern?
How does the SEC regulate auditors who appear and practice before the commission?
In the 1136 Tenants' Corporation case, what was the essential difference in the way the client and the CPAs viewed the work to be done in the engagement?
Rogers and Green, CPAs, admit they failed substantially to follow generally accepted auditing standards in their audit of Martin Corporation. "We were overworked and understaffed and never should
Glover, Inc., engaged Herd & Irwin, CPAs, to assist in the installation of a new computerized production system. Because the firm did not have experienced staff available for the engagement, Herd
Jensen, Inc., filed suit against a public accounting firm, alleging that the auditors' negligence was responsible for failure to disclose a large defalcation that had been in process for several
Gordon & Moore, CPAs, were the auditors of Fox & Company, a brokerage firm. Gordon & Moore examined and reported on the financial statements of Fox, which were filed with the Securities and Exchange
Multiple Choice QuestionsSelect the best answer for each of the following questions and explain the reasons for your choice.a. If a CPA performs an audit recklessly, the CPA will be liable to third
Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was
Match the important cases listed below with the appropriate legal precedent or implication.a. Hochfelder v. Ernstb. Escott v. BarChris Construction Corp.c. Credit Alliance v. Arthur Andersen & Co.d.
Items (a) through (f) relate to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. For each item, determine whether it must be proved assuming application
For each definition (or portion of a definition) in the first column, select the term that most closely applies. Each term may be used only once or not at all.Partial (or Complete) Definition a. A
Risk Capital Limited, a publicly held Delaware corporation, was considering the purchase of a substantial amount of the treasury stock held by Florida Sunshine Corporation, a closely held
Meglow Corporation, a closely held manufacturer of dresses and blouses, sought a loan from Busch Factors. Busch had previously extended $50,000 credit to Meglow but refused to lend any additional
After Commuter Airlines was forced into bankruptcy, the company’s stockholders brought suit against Thomas & Ross, the company’s independent auditors. Three independent assumptions concerning
Charles Worthington, the founding and senior partner of a successful and respected public accounting firm, was a highly competent practitioner who always emphasized high professional standards. One
The limitations on professional responsibilities of CPAs when they are associated with unaudited financial statements are often misunderstood. These misunderstandings can be reduced substantially if
Mark Williams, CPA, was engaged by Jackson Financial Development Company to audit the financial statements of Apex Construction Company, a small closely held corporation. Williams was told when he
Cragsmore & Company, a medium-sized partnership of CPAs, was engaged by Marlowe Manufacturing, Inc., a closely held corporation, to audit its financial statements for the year ended December 31,
The following appeared in a brief article in a major business newspaper: A local court is in the process of ruling on whether the public accounting firm of James Willis and Co., CPAs, PC, should be
You are a partner in the Denver office of a national public accounting firm. During the audit of Mountain Resources, you learn that this audit client is negotiating to sell some of its unproved oil
Distinguish between ordinary negligence and gross negligence within the context of the CPAs’ work.
What landmark case was embraced by the court in the case of Credit Alliance Corp. v. Arthur Andersen & Co.? Identify the two factors that the court stated must be proved for the auditors to be held
Compare auditors’ common law liability to clients and third-party beneficiaries with their common law liability to other third parties.
How was the Continental Vending case unusual with respect to penalties levied against auditors?
Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be “liable” or “not liable” for the following losses proximately caused by
Describe the relationship between detection risk and audit risk.
Distinguish among routine, nonroutine, and estimation transactions. Include an example of each.
In a conversation with you, Mark Rogers, CPA, claims that both the sufficiency and the appropriateness of audit evidence are a matter of judgment in every audit. Do you agree? Explain.
As part of the verification of accounts receivable as of the balance sheet date, the auditors might inspect copies of sales invoices. Similarly, as part of the verification of accounts payable, the
Evaluate the following statement: A canceled check is not considered particularly reliable evidence since the check was prepared within the client’s organization.
When in the course of an audit might the auditor find it useful to apply analytical procedures?
List and briefly describe the three approaches to auditing accounting estimates that are included in a client’s financial statements.
What are related party transactions?
Evaluate the following statement: “Identifying related parties and obtaining a client representation letter are two required audit procedures normally performed on the last day of fieldwork.”
What are the major functions of audit working papers?
Why are the prior year’s audit working papers a useful reference to staff assistants during the current audit?
List the major types of audit working papers and give a brief explanation of each. For example: One type of audit working paper is an account analysis. This working paper shows the changes that
Audit working papers are the property of the auditors, who may destroy the papers, sell them, or give them away.” Criticize this quotation.
Describe a situation in which a set of audit working papers might be used by third parties to support a charge of gross negligence against the auditors.
Should the working trial balance prepared by the auditors include revenue and expense accounts if the balances of these accounts for the audit year have been closed into retained earnings prior to
Should the auditors prepare adjusting journal entries to correct all errors they discover in the accounting records for the year under audit? Explain.
Explain the meaning of the term permanent file as used in connection with audit working papers. What kinds of information are usually included in the permanent file?
List several rules to be observed in the preparation of working papers that reflect current professional practice.
Financial statements contain a number of assertions about account balances, classes of transactions, and disclosures.a. Identify who makes these assertions.b. List and describe each of the
Marion Watson & Co., CPAs, is planning its audit procedures for its tests of the valuation of inventories of East Coast Manufacturing Co. The auditors on the engagement have assessed inherent
In an audit of financial statements, the auditors gather various types of audit evidence. List seven major types of evidence and provide a procedural example of each.
Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging
Analytical procedures are extremely useful throughout the audit.a. Explain how analytical procedures are useful in:(1) The risk assessment stage of the audit.(2) The substantive procedures stage of
When analytical procedures disclose unexpected changes in financial relationships relative to prior years, the auditors consider the possible reasons for the changes. Give several possible reasons
Auditors are required on every engagement to obtain a representation letter from the client.a. What are the objectives of the client’s representation letter?b. Who should prepare and sign the
What would you accept as satisfactory documentary evidence in support of entries in the following?a. Sales journal.b. Sales returns journal.c. Voucher or invoice register.d. Payroll journal.e. Check
“Working papers should contain facts and nothing but facts,” said student A. “Not at all,” replied student B. “The audit working papers may also include expressions of opinion. Facts are
Multiple Choice QuestionsSelect the best answer for each of the following questions. Explain the reasons for your selection.a. Which of the following is not a financial statement assertion made by
Auditors consider financial statement assertions to identify appropriate audit procedures. For items a through f, match each assertion with the statement that most closely approximates its meaning.
State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk.a. The risk of material misstatement
Audit risk should be considered when planning and performing an audit of financial statements in accordance with generally accepted auditing standards.a. Define audit risk.b. Describe its components
Assume that the auditors find serious weaknesses in the internal control of Oak Canyon, Inc., a producer and distributor of fine wines. Would these internal control weaknesses cause the auditors to
During your examination of the accounts receivable of Hope Ranch, a new client, you notice that one account is much larger than the rest, and you therefore decide to examine the evidence supporting
Trend analysis, common-size financial statements, and ratios are presented for the Brody Corporation in Figure. Assume that you are auditing Brody’s financial statements for the year ended
Included in the financial statements are a variety of accounting estimates (e.g., allowance for doubtful accounts, obsolete inventory warranty liability). Audit procedures should be designed to
Criticize the following working paper that you are reviewing as senior auditor on the December 31 audit of Pratt Company.ž€The client saved a copy of the deposit slip that is filled out.
Marilyn Terrill is the senior auditor for the audit of Uden Supply Company for the year ended December 31, 20X4. In planning the audit, Marilyn is attempting to develop expectations for planning
Houseco, an audit client of Jones, CPA, for the past five years, is a manufacturer of various household products. Approximately four years ago, Houseco developed a better toaster than had been
You are the partner on the audit of Datasave, Inc., a small publicly held corporation that manufactures high-speed disk drives for the computer industry. The audit of Datasave had been progressing
Marshall and Wyatt, CPAs, has been the independent auditor of Interstate Land Development Corporation for several years. During these years, Interstate prepared and filed its own annual income tax
Identify and describe the two components of the risk of material misstatement.
Define inherent risk. Can the auditors reduce inherent risk by performing audit procedures?
Distinguish between the components of audit risk that the auditors gather evidence to assess versus the component of audit risk that they collect evidence to restrict.

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