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Chapter 3
Multiple-Choice Questions

1.
easy
a

Auditing standards require that the audit report must be titled and that the title must:
a. include the word “independent.”
b. indicate if the auditor is a CPA.
c. indicate if the auditor is a proprietorship, partnership, or incorporated.
d. indicate the type of audit opinion issued.

2.
Medium
a

To emphasize the fact that the auditor is independent, a typical addressee of the audit report
could be:

a.
b.
c.
d.

Company Controller
No
No
Yes

a. discover all errors and/or irregularities.
b. discover material errors and/or irregularities.
c. conform to generally accepted accounting principles.
d. obtain reasonable assurance whether the statements are free of material misstatement.

5.
easy
d

The audit report date on a standard unqualified report indicates:
a.
the last day of the fiscal period.
b.
the date on which the financial statements were filed with the Securities and Exchange
Commission.
c.
the last date on which users may institute a lawsuit against either client or auditor.
d.
the last day of the auditor’s responsibility for the review of significant events that
occurred subsequent to the date of the financial statements.

6.
easy
d

As a result of management’s refusal to permit the auditor to physically examine inventory, the
auditor has not accumulated sufficient appropriate evidence to conclude whether financial
statements are stated in accordance with GAAP. The auditor must depart from the unqualified
audit report because:
a. the financial statements have not been prepared in accordance with GAAP.

If a misstatement is immaterial to the financial statements of the entity for the current period,
but is expected to have a material effect in future periods, it is appropriate to issue a(n):
a. adverse opinion.
b. qualified opinion.
c. unqualified opinion.
d. disclaimer of opinion.

9. (Public)
easy
c

Whenever an auditor issues an audit report for a public company, the auditor can choose to
issue a report in which of the following forms?
a. A combined report on financial statements and internal control over financial reporting.
b. Separate reports on financial statements and internal control over financial reporting.
c. Either a or b.
d. Neither a nor b.

10.
easy
b

When determining whether an exception is “highly material,” the extent to which the exception
affects different elements of the financial statements must be considered. This concept is called:
a. materiality.
b. pervasiveness.
c. financial analysis.
d. ratio analysis.

11.

easy
c

If an auditor performs an audit of a public company, the scope paragraph should make reference
to which standards?
a.
Accounting standards.
b.
Generally accepted auditing standards.
c.
Standards issued by the PCAOB (U.S.).
d.
Any of the above standards.

13.
easy
b

If an auditor performs an audit of a private company, the scope paragraph should make
reference to which standards?
a.
Accounting standards.
b.
U.S. generally accepted auditing standards.
c.
Standards issued by the PCAOB (U.S.).
d.
Any of the above standards.

14.

d.

16.
easy
c

A CPA may wish to emphasize specific matters regarding the financial statements even though
an unqualified opinion will be issued. Normally, such explanatory information is:
a.
included in the scope paragraph.
b.
included in the opinion paragraph.
c.
included in a separate paragraph in the report.
d.
included in the introductory paragraph.

17.
challenging
d

An auditor who issues a qualified opinion because sufficient appropriate evidence was not
obtained should describe the limitations in an explanatory paragraph. The auditor should also
refer to the limitation in the:

more conservative principle.
principle with equal authoritative support.
preferable principle.
principle detailed in a FASB pronouncement.


change should be evaluated based on:
a.
the prior years presented.
b.
the current year effect of the change.
c.
guidelines included in GAAS.
d.
the effect on total assets.

19.
medium
b

Conditions requiring a departure from an unqualified audit report include all but which of the
following?
a. Management refused to allow the auditor to confirm significant accounts receivable for
which there were no alternative procedures performed.
b. Management decided not to allow the auditor to confirm significant accounts receivable,
but the auditor obtained sufficient appropriate evidence by examining subsequent cash
receipts.
c. The audit partner’s dependent child received a gift of 100 shares of a client’s stock for her
birthday from a grandparent.
d. Management has determined that fixed assets should be reported in the balance sheet at
their replacement values rather than historical costs. The auditors do not concur.

20.
medium
b


a. responsible for the financial statements and the opinion on them.
b. responsible for the financial statements.
c. responsible for the opinion on the financial statements.
d. jointly responsible for the financial statements with management.

23. (Public)
medium
a

PCAOB Auditing Standard No. 2 requires the audit of internal control over financial reporting
to be integrated with:
a. the audit of the financial statements.
b. the quarterly review of financial information.
c. the review of annual financial statements.
d. none of the above.

24.
medium
d

The audit report indicates that (1) management is responsible for the content of the financial
statements and (2) the auditor is responsible for evaluating the appropriateness of the
accounting principles chosen by management. Which paragraph contains those statements?
a. Both are in the introductory paragraph.
b. Both are in the scope paragraph.
c. Both are in the opinion paragraph.
d. None of the above are true.

25.
medium

them.

28.
medium
c

The necessity to issue a disclaimer of opinion may arise because of:
a. a severe limitation on the scope of the audit.
b. a lack of independence between the auditor and client.
c. either a or b.
d. neither a nor b.

29.
medium
b

When the auditor determines the financial statements are fairly stated and then determines that
the auditor lacks independence, the auditor should issue:
a.
an adverse opinion.
b.
a disclaimer of opinion.
c.
either a qualified opinion or an adverse opinion.

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d.
all of the above.

32.
medium

When comparing misstatements with a measurement base, the auditor must consider the
pervasiveness of the misstatement. Of the following examples, the most pervasive misstatement
is a(n):
a.
understatement of inventory.
b.
understatement of retained earnings caused by a miscalculation of dividends payable.
c.
misclassification of notes payable as a long-term liability when it should be current.
d.
misclassification of salary expense as a selling expense when it should be allocated
equally to both selling and administrative expense.

a

33.
medium
b

The dollar amount of some misstatements cannot be accurately measured. For example, if the
client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect
on:
a. net income.
b. users of the financial statements.

The client has presented all required financial statements with the exception of the statement of
cash flows. The auditor has completed the audit and is satisfied that all other statements are
presented fairly. The auditor:
a. may issue either an unqualified or a qualified opinion.
b. must issue an adverse opinion with “except for” in the opinion paragraph.
c. may issue an unqualified opinion.
d. must issue a qualified opinion with “except for” in the opinion paragraph.

37.

When a disclaimer is issued because the auditor lacks independence:

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medium
d

a.
b.
c.
d.

no report title is included on the report.
a one-paragraph audit report is issued.
the only reason cited for issuing the disclaimer is the lack of independence.
all of the above are correct.


most likely issue:
a.
a disclaimer.
b.
an unqualified opinion.
c.
a qualified opinion.
d.
an adverse opinion.

41.
medium
c

Auditors sometimes encounter situations in which the outcome of a matter cannot be reasonably
estimated at the time the financial statements are issued. These matters are referred to as:
a. inestimable matters.
b. non sequiturs.
c. uncertainties.
d. in-suspense matters.

42.
medium
b

When there is uncertainty about a company’s ability to continue as a going concern, the
auditor’s concern is the possibility that the client may not be able to continue its operations or
meet its obligations for a “reasonable period of time.” For this purpose, a reasonable period of
time is considered not to exceed:
a. six months from the date of the financial statements.


an accounting principle at variance with GAAP is used.

45.
medium
b

When a company’s financial statements contain a departure from GAAP with which the auditor
concurs, the departure should be explained in:
a. the scope paragraph.
b. an explanatory paragraph that appears before the opinion paragraph.
c. the opinion paragraph.
d. an explanatory paragraph after the opinion paragraph.

46.
medium
b

Which of the following representations does an auditor make explicitly and which implicitly
when issuing an unqualified opinion?
Conformity
Adequacy of
with GAAP
disclosure
a. Explicitly
Explicitly
b. Explicitly
Implicitly
c. Implicitly
Explicitly

d. an explanatory paragraph explaining the change.

49. (Public)
medium
a

Sarbanes-Oxley requires auditors of a public company to audit a company’s financial statements
and attest to management’s report on the effectiveness of internal control over financial
reporting. What type of assurance does the auditor provide in this report?
a. Positive assurance on the financial statements and on the effectiveness of internal control
over financial reporting.
b. Positive assurance on the financial statements and negative assurance on the effectiveness
of internal control over financial reporting.
c. Limited assurance on the financial statements and on the effectiveness of internal control
over financial reporting.
d. There is no guidance on what level of assurance to provide.

50.
medium
c

Whenever the client imposes restrictions on the scope of the audit, the auditor should be
concerned that management may be trying to prevent discovery of misstatements. In such cases,
the auditor will likely issue a:
a. disclaimer of opinion in all cases.
b. qualification of both scope and opinion in all cases.
c. disclaimer of opinion whenever materiality is in question.

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challenging
c

For the report containing a disclaimer for lack of independence, the disclaimer is in the:
a. third or opinion paragraph.
b. second or scope paragraph.
c. first and only paragraph.
d. fourth or explanatory paragraph.

54.
challenging
a

Which of the following is not a primary category of attestation report?
a. Compilation report.
b. Review report.
c. Audit report.
d. Special audit report based on a basis of accounting other than GAAP.

55.
challenging
b

Most auditors believe that financial statements are “presented fairly” when the statements are in
accordance with GAAP, and that it is also necessary to:
a. determine that they are not in violation of FASB statements.
b. examine the substance of transactions and balances for possible misinformation.
c. review the statements using the accounting principles promulgated by the SEC.
d. assure investors that net income reported this year will be exceeded in the future.


The auditor has the option, but is not required, to issue a disclaimer of opinion for a
material uncertainty or for a going concern problem.

58.
medium
a

The most common case in which conditions beyond the client’s and auditor’s control cause a
scope restriction is an engagement:
a.
agreed upon after the client’s balance sheet date.
b.
where the client won’t allow the auditor to confirm receivables for fear of offending its

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c.
d.

customers.
where the auditor doesn’t have enough staff to satisfactorily audit all of the client’s
foreign subsidiaries.
where the client is going through Chapter 11 bankruptcy.

59.
challenging
d

62.
challenging
c

The “unqualified report with explanatory paragraph” and the “unqualified report with modified
wording”:
a. arise as a result of an incomplete audit.
b. arise when the financial statements are not “presented fairly.”
c. meet the criteria of a complete audit with satisfactory results.
d. meet the criteria of a complete audit but with unsatisfactory results.

63.
medium
c

Which of the following will not cause the auditor to issue a standard unqualified report with an
explanatory paragraph or modified wording?
a. Emphasis of a matter.
b. Reports involving other auditors.
c. Auditor disagrees with client’s departure from GAAP.
d. Lack of consistent application of GAAP.

64.
challenging
a

Which of the following is not one of the principal CPA firm’s alternatives when issuing a report
if a different CPA firm performed part of the audit?
a.
Issue a joint report signed by both CPA firms.

than three paragraphs.

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66.
challenging
a

Brown Co.’s financial statements adequately disclose uncertainties that concern future events,
the outcome of which are not reasonably estimable. The auditor’s report should include a(n):
a. unqualified opinion.
b. disclaimer.
c. “except for” qualified opinion.
d. adverse opinion.

67.
challenging
c

Which of the following requires recognition in the auditor’s opinion as to consistency?
a.
The correction of an error in the prior year’s financial statements resulting from a
mathematical mistake in capitalizing interest.
b.
A change in the estimate of provisions for warranty costs.
c.
The change from the cost method to the equity method of accounting for investments in

Correction of an error by changing from an
accounting principle that is not generally
acceptable to one that is generally acceptable
a.
Yes
b.
No
c.
Yes
d.
No

70.
Medium
b

Change from LIFO to FIFO
Yes
No
No
Yes

Indicate which changes would require an explanatory paragraph in the audit report.

Change in the estimated life of an asset
a.
Yes
b.
No
c.

d.
No

72.
Challenging
c

Indicate which changes would require an explanatory paragraph in the audit report.
A departure from GAAP which, due to
unusual circumstances, does not require a
qualified or adverse opinion.
a.
Yes
b.
No
c.
Yes
d.
No

73.
Easy
a

Change from FIFO to LIFO
Yes
No
No
Yes


Yes
d.
No

74.
Challenging
b

Change from FIFO to LIFO
Yes
No
No
Yes

Important events occurring subsequent to
the balance sheet date
Yes
No
No
Yes

Which auditor report would require only one paragraph?

Disclaimer due to lack of independence
a.
Yes
b.
No
c.
Yes

77.
Challenging
d

Which auditor report must have at least four paragraphs?

Unqualified opinion indicating shared
responsibility with another auditor
a.
Yes
b.
No
c.
Yes
d.
No
78.
Challenging
c

Disclaimer due to a scope
restriction
Yes
No
No
Yes

Which auditor report must have at least four paragraphs?
Qualified opinion due to departure from
GAAP

d.
No
79.
Medium
a

Qualified opinion due to scope
restriction
Yes
No
No
Yes

Adverse opinion due to departure
from GAAP
Yes
No
No
Yes

Which auditor report must have at least four paragraphs?

Disclaimer due to lack of independence
a.
Yes
b.
No
c.
Yes
d.

Medium
d

A CPA would express an unqualified opinion with at least four paragraphs for:

An unjustified accounting change
a.
Yes
b.
No
c.
Yes
d.
No
83.
Medium
b

84.
Medium
d

A justified accounting change,
properly accounted for
Yes
No
No
Yes

A justified accounting change, properly

whether an unqualified, qualified, or adverse opinion is issued. For conditions involving a
scope restriction, the materiality of the restriction influences whether an unqualified
report, a qualified scope and opinion report, or a disclaimer of opinion is issued.

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86.
medium

There are five conditions that must be met before an auditor can issue a standard unqualified
report for the audit of a private company. Please discuss each of these five conditions.
Answer:
The five conditions that justify issuing a standard unqualified report are:
All statements—balance sheet, income statement, statement of retained earnings, and
statement of cash flows—are included in the financial statements.
The three general standards of GAAS have been followed in all respects on the
engagement.
Sufficient appropriate audit evidence has been accumulated and the auditor can
conclude that the three fieldwork standards have been followed.
The financial statements are presented in accordance with GAAP.
There are no circumstances requiring the addition of an explanatory paragraph or
modification of the wording of the report.

87.
medium

There are three conditions requiring a departure from an unqualified audit report. Discuss each

accepted accounting principles consistently in the current period in relation to the
preceding period, an unqualified opinion with an explanatory paragraph following
the opinion paragraph is appropriate.
Substantial doubt about continuing as a going concern. When an auditor concludes
there is substantial doubt about the client’s ability to continue as a going concern, an
unqualified opinion with an explanatory paragraph following the opinion paragraph
is appropriate. The auditor also has the option of issuing a disclaimer of opinion.
A departure from GAAP with which the auditor concurs. If adherence to GAAP
would result in misleading financial statements, an unqualified opinion with an
explanatory paragraph is appropriate.
Emphasis of a matter. If the auditor wants to emphasize specific matters in the audit
report, an explanatory paragraph discussing those matters may be added to an
unqualified report.
Reports involving other auditors. When an auditor relies upon a different CPA firm
to perform part of the audit, the auditor can indicate that responsibility for the audit is
shared with another CPA firm by modifying the wording of an unqualified report.

89.
medium

An audit report prepared by Garrett and Brown, CPAs, is provided below. The audit for the year
ended December 31, 2007 was completed on March 1, 2008, and the report was issued to Javlin
Corporation, a private company, on March 13, 2008. List any deficiencies in this report. Do not
rewrite the report.

We have examined the accompanying financial statements of Dalton Corporation as of
December 31, 2007. These financial statements are the responsibility of the company’s
management. Our responsibility is to express an opinion on these statements based on our audit.
We conducted our audit in accordance with generally accepted accounting principles.
Those principles require that we plan and perform the audit to provide reasonable assurance

The scope paragraph should contain the following phrase: “An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.”

Following the scope paragraph, there should be an explanatory paragraph that
discusses the GAAP violation related to the failure to capitalize certain lease
obligations.
In the opinion paragraph, the auditor should state that the financial statements present
fairly…, not present accurately…
In the opinion paragraph, the phrase “…in all material respects…” should be
included.
In the opinion paragraph, the phrase “…and the results of its operations and its cash
flows for the year then ended…” should be included.
The audit report should be dated March 13, 2008.

90.
medium

Discuss the differences regarding how matters affecting consistency and matters affecting
comparability are referred to in the audit report. Provide two examples of each type of change.
Answer:
The auditor should disclose a material lack of consistent application of GAAP by adding
an explanatory paragraph after the unqualified opinion paragraph. The explanatory
paragraph should discuss the nature of the change and should refer to the footnote in the
financial statements that discusses the change. Changes that affect comparability, but not
consistency, require no such explanatory paragraph in the audit report, assuming the
change is disclosed in the footnotes.
Examples of changes affecting consistency include changes in accounting principles,
changes in reporting entities, and correction of errors involving accounting principles.
Examples of changes affecting comparability include changes in an estimate, error

The company has excluded from property and debt in the accompanying balance sheet
certain lease obligations that, in our opinion, should be capitalized in order to conform with
generally accepted accounting principles. If these lease obligations were capitalized, property
would be increased by $14,500,000, long-term debt by $13,200,000, and retained earnings by
$1,300,000 as of December 31, 2007, and net income and earnings per share would be increased
by $1,300,000 and $2.25, respectively, for the year then ended.

Required:
Complete the above adverse audit report by preparing the opinion paragraph. Do not date or
sign the report.
Answer:
In our opinion, because of the effects of the matters discussed in the preceding paragraph,
the financial statements referred to above do not present fairly, in conformity with
generally accepted accounting principles, the financial position of Wallace Corporation as
of December 31, 2007, or the results of its operations and its cash flows for the year then
ended.

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92.
medium

The following is a portion of a qualified audit report issued for a private company:
Independent Auditor’s Report
To the shareholders of Tamarak Corporation
We have audited the accompanying balance sheet of Tamarak Corporation as of October
31, 2007, and the related statements of income, retained earnings, and cash flows for the year

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93. (Public)
medium

The following is a portion of a qualified scope and opinion report due to a scope restriction.
(Note: A separate report was issued on the effectiveness of internal control over financial
reporting.)
Independent Auditor’s Report
To the shareholders of Fast Times Corporation
We have audited the accompanying balance sheet of Fast Times Corporation as of September
30, 2007, and the related statements of income, retained earnings, and cash flows for the year
then ended. These financial statements are the responsibility of the company’s management.
Our responsibility is to express an opinion on these financial statements based on our audit.
Except as discussed in the following paragraph, we conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
We were unable to obtain audited financial statements supporting the company’s investment in
a foreign affiliate stated at $1,040,000, or its equity in earnings of that affiliate of $501,000,
which is included in net income, as described in Note 14 to the financial statements. Because of
the nature of the company’s records, we were unable to satisfy ourselves as to the carrying
value of the investment or the equity in its earnings by means of other auditing procedures.

Required:
Complete the above report by preparing the opinion paragraph. Do not date or sign the report.


Describe the standard unqualified report to be issued for an audit of a private company. Begin
by specifying the seven parts of the report, and then discuss the contents of each part.
Answer:
The parts of the standard unqualified report are as follows:
Report title. The title must include the word “independent.” Examples of appropriate
titles are “independent auditor’s report,” or “report of independent accountant.”
Report address. The report is usually addressed to the company’s stockholders or
board of directors. It should not be addressed to company management.
Introductory paragraph. There are three important components of the introductory
paragraph. First, it states that an audit was performed. Second, it lists the financial
statements that were audited and their dates. Third, it states that management is
responsible for the financial statements, and that the auditor is responsible for
expressing an opinion on those statements based on an audit.
Scope paragraph. The scope paragraph is a factual statement about what was done
during the audit. It first states that auditing standards generally accepted in the United
States of America were followed by the auditor. It then states that an audit is
designed to obtain reasonable assurance about whether the statements are free of
material misstatement. It concludes by stating that the auditor evaluated the
appropriateness of the accounting principles used, and estimates made, by
management, and of the financial statement disclosures and presentations given.
Opinion paragraph. This paragraph states the auditor’s opinion concerning whether
the financial statements present fairly the client’s financial position and results of its
operations and cash flows in conformity with generally accepted accounting
principles.
Name of CPA firm. Typically, the name of the CPA firm, and not the name of an
individual auditor, is used.
Audit report date. The audit report is normally dated as of the last day of fieldwork.

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Required:
Consider all the facts given and rewrite the complete auditor’s report, including report title,
address, body of report, name of firm, and audit report date.

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Answer:
Independent Auditor’s Report
To the shareholders of EPM, Inc.
We have audited the accompanying balance sheets of EPM, Inc., as of December 31, 2007 and
2006, and the related statements of income, retained earnings, and cash flows for the years then
ended. These financial statements are the responsibility of the company’s management. Our
responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects,
the financial position of EPM, Inc., as of December 31, 2007 and 2006, and the results of its
operations and its cash flows for the years then ended in conformity with generally accepted
accounting principles.
As discussed in Note 4 to the financial statements, EPM, Inc., changed its method of computing
depreciation in 2007.

statements. Include the report title, address, body, date, and your signature.

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Answer:
Independent Auditor’s Report
To the Board of Directors of O’Malley Corporation:
We have audited the accompanying consolidated balance sheets of O’Malley Corporation
as of December 31, 2007 and 2006 and the related consolidated statements of income, retained
earnings, and cash flows for the years then ended. These financial statements are the
responsibility of the company’s management. Our responsibility is to express an opinion on
these financial statements based on our audit. We did not audit the financial statements of
Tom’s Supply Company, a consolidated subsidiary, which statements reflect total assets of
$950,000 and $900,000 as of December 31, 2007 and 2006, respectively, and total revenues of
$1,845,000 and $1,650,000 for the years then ended. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it relates to the
amounts included for Tom’s Supply Company, is based solely on the report of the other
auditors.
We conducted our audits in accordance with auditing standards generally accepted in the
United States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
During the year, O’Malley changed its method of valuing inventory from the first-in, firstout method to the last-in, first-out method. This change was made because management