ACCT 431 CHAPTER 3:Audit Reports

ACCT 431 CHAPTER 3 Auditing and Assurance Services, 15e (Arens) Audit Reports Learning Objective 3-1 1) An audit of historical financial statements most commonly includes the: A) balance sheet, statement of retained earnings, and the statement of cash flows. B) income statement, the statement of cash flows, and the statement of net working capital. C) statement of cash flows, balance sheet, and the statement of retained earnings. D) balance sheet, income statement, statement of cash flows, and the statement of changes in stockholders' equity. Answer: D Terms: Audit of historical financial statements Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 2) 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 corporation. D) indicate the type of audit opinion issued. Answer: A Terms: Auditing standards require audit report title Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 3) To emphasize the fact that the auditor is independent, a typical addressee of the audit report could be: A) Company Controller Shareholders Board of Directors No Yes Yes B) Company Controller Shareholders Board of Directors No No Yes C) Company Controller Shareholders Board of Directors Yes Yes No D) Company Controller Shareholders Board of Directors Yes No No Answer: A Terms: Audit report addressee Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 4) The auditor's responsibility section of the standard unqualified audit report states that the audit is designed to: 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. Answer: D Terms: Scope paragraph of standard unqualified audit report states Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 5) 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 after the date of the financial statements. Answer: D Terms: Audit report date on standard unqualified report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 6) The standard audit report for non-public entities refers to GAAS and GAAP in which sections? A) GAAS GAAP Auditor's responsibility Auditor's responsibility B) GAAS GAAP Auditor's responsibility Introductory paragraph C) GAAS GAAP Management's responsibility and Opinion paragraph Management's responsibility and Introductory paragraph D) GAAS GAAP Auditor's responsibility Management's responsibility and Opinion paragraph Answer: D Terms: Standard unqualified audit report for non-public entities; GAAS and GAAP Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 7) Which of the following is not explicitly stated in the standard unqualified audit report? A) The financial statements are the responsibility of management. B) The audit was conducted in accordance with generally accepted accounting principles. C) The auditors believe that the audit evidence provides a reasonable basis for their opinion. D) An audit includes assessing the accounting estimates used. Answer: B Terms: Standard unqualified audit report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 8) The standard unqualified audit report for a non-public entity must: A) have a report title that includes the word "CPA." B) be addressed to the company's stockholders and creditors. C) be dated. D) include an explanatory paragraph. Answer: C Terms: Standard unqualified audit report for a non-public entity;eight parts of the report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills Topic: Public 9) The management's responsibility section of the standard audit report for a non-public company states that the financial statements are: A) the responsibility of the auditor. B) the responsibility of management. C) the joint responsibility of management and the auditor. D) none of the above. Answer: B Terms: Standard unqualified audit report for a non-public entity;eight parts of the report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 10) The introductory paragraph of the standard audit report for a non-public company performs which functions? I. It states the CPA has performed an audit. II. It lists the financial statements being audited. III. It states the financial statements are the responsibility of the auditor. A) I and II B) I and III C) II and III D) I, II and III Answer: A Terms: Introductory paragraph of standard audit report Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 11) Which of the following statements are true for the audit report of a non-public entity? I. The introductory paragraph states that management is responsible for the preparation and content of the financial statements. II. The scope paragraph states that the auditor evaluates the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management. A) I only B) II only C) I and II D) Neither I nor II Answer: B Terms: Introductory paragraph and scope paragraph Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 12) The auditor's responsibility section of the standard audit report states that the auditor is: 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. Answer: C Terms: Standard unqualified audit report for a non-public entity;eight parts of the report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 13) If the balance sheet of a private company is dated December 31, 2011, the audit report is dated February 8, 2012, and both are released on February 15, 2012, this indicates that the auditor has searched for subsequent events that occurred up to: A) December 31, 2011. B) January 1, 2012. C) February 8, 2012. D) February 15, 2012. Answer: C Terms: Audit report subsequent event dating Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 14) The appropriate audit report date for a standard nonqualified audit report for a non-public entity should be the: A) date the financial statements are given to the Board of Directors. B) date of the financial statements. C) date the auditor completed the auditing procedures in the field. D) 60 days after the date of the financial statements as required by the SEC. Answer: C Terms: Standard unqualified audit report for a non-public entity;eight parts of the report Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 15) 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. Answer: B Terms: Financial statements are presented fairly in accordance with GAAP Diff: Challenging Objective: LO 3-1 AACSB: Reflective thinking skills 16) An audit report prepared by Garrett and Brown, CPAs, is provided below. The audit for the year ended December 31, 2012 was completed on March 1, 2013, and the report was issued to Javlin Corporation, a private company, on March 13, 2013. 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, 2012. These financial statements are the responsibility of the company's management. Management's Responsibility for the Financial Statements: Management is responsible for the preparation and fair presentation of the financial statements in accordance with generally accepted auditing standards; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from all misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to give an opinion on these financial statements based on our audit. We conducted our audits in accordance with auditing standards generally accepted throughout the world.Those standards require that we plan and perform the audit to obtain absolute assurance about whether the financial statements are free of misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on management's judgment, including the assessment of the risks of material misstatement of the income statement, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the auditor's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies and the accuracy of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present accurately the financial position of Javlin Corporation as of December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. Garrett and Brown, CPAs March, 2013 Answer: The audit report contains the following deficiencies: • The report title is missing. The title must include the word independent. • The audit report address is missing.The report should be addressed to shareholders and the board of directors. • The introductory paragraph should refer to an "audit," not an "examination." • The introductory paragraph should list the financial statements that were audited. • The introductory paragraph refers to the wrong company. • The introductory paragraph should not state that the financial statements are the responsibility of management. This belongs in the next section- management's responsibility. • The management's responsibility section should state that the financial statements are in accordance with "accounting principles generally accepted in the Unites States of America" not in accordance with generally accepted auditing standards." • The auditor's responsibility section should state that our responsibility is to "express" an opinion, not "give" an opinion. • The auditor's responsibility section should state the audit was conducted in accordance with "auditing standards generally accepted in the United States of America", not "throughout the world." • The auditor's responsibility section should state that the audit was planned and performed to obtain "reasonable" assurance, not "absolute "assurance. • The auditor's responsibility section should state that the financial statements are free of "material misstatements," not simply "misstatement." • The scope paragraph of the auditor's responsibility section should state that the procedures selected depend on the "auditor's" judgment, not "management's" judgment. • The scope paragraph of the auditor's responsibility section should state risk of material misstatement in the "financial statements," not the "income statement." • The scope paragraph of the auditor's responsibility section should state the auditor considers internal control relevant to management's preparation , not the entity's preparation. • The scope paragraph of the auditor's responsibility section is missing the sentence "Accordingly, we express no such opinion." This should be placed right after the second sentence. • The scope paragraph of the auditor's responsibility section should state " reasonableness" of significant accounting estimates," not "accurate." • 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." • The auditor's opinion section should state that the financial statements present "fairly, in all material respects," not present accurately. • The auditor's opinion section should include "and the results of their operations and cash flows for the year then ended." • The audit report should be dated March 1, 2013. Terms: Audit report deficiencies Diff: Challenging Objective: LO 3-1 AACSB: Analytic skills 17) Describe the standard unqualified report to be issued for an audit of a private company. Begin by specifying the eight 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. This paragraph states that an audit was performed to distinguish the report from a compilation or review report. It also lists the financial statements that were audited, including the notes to the financial statements as well as the balance sheet dates and the accounting periods for the income statement and statement of cash flows. The wording of the financial statements in the report should be identical to those used by management on the financial statements. • Management's Responsibility section. This section states that the statements are the responsibility of management. This responsibility includes selecting the appropriate accounting principles and maintaining internal control over financial reporting sufficient for preparation of financial statements that are free of material misstatements due to fraud or error. • Auditor's Responsibility section. This section contains three paragraphs: The first paragraph states that (1) the audit was conducted in accordance with auditing standards generally accepted in the United States of America, (2) the audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement. The second paragraph is called the scope paragraph and describes the scope of the audit and the evidence accumulated. This paragraph indicates that the procedures depend on the auditor's judgment and includes an assessment of the risk of material misstatements in the financial statements. It also indicates that the auditor considers internal control relevant to the preparation and fair presentation of the financial statements in designing the audit procedures performed, but this assessment of internal control is not for the purpose and is not sufficient to express an opinion on the effectiveness of the entity's internal control. The last sentence of the paragraph indicates that the audit includes evaluating the accounting policies selected, the reasonableness of accounting estimates, and the overall financial statement presentation. The third paragraph indicates the auditor believes that sufficient appropriate evidence has been obtained to support the auditor's opinion. • Opinion paragraph. This paragraph states the auditor's conclusions based on the results of the audit. It states that in the auditor's opinion the financial statements present fairly, in all material respects, the financial position of the company as of a certain date, and the results of their operations and cash flows for the the year(s) then ended, in accordance with accounting principles generally accepted in the United States of America. • 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. Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Challenging Objective: LO 3-1 AACSB: Reflective thinking skills 18) EPM, Inc., is a private manufacturing company with a calendar year-end. Their financial statements include a balance sheet, a statement of income, statement of cash flows, and statement of stockholders' equity. For the most recent audit, Harrington and Perry, LLP, audited the 2011 and 2012 financial statements. The auditors completed all significant fieldwork on March 5, 2013 and issued the audit report on March 16, 2013. Required: Consider all the facts given and write the standard unqualified auditor's report, including all eight sections of the report. Answer: Independent Auditor's Report To the Board of Directors and Shareholders of EPM, Inc. We have audited the accompanying balance sheets of EPM, Inc., as of December 31, 2012 and 2011, and the related statements of income, changes in stockholders' equity, and cash flows for the years then ended, and the related notes to the financial statements. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility 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 involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 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, 2012 and 2011, and the results of their operations and cash flows for the years then ended, in accordance with accounting principles generally accepted in the United States of America. Harrington and Perry, LLP March 5, 2013 Terms: Audit report format for private company Diff: Challenging Objective: LO 3-1 AACSB: Analytic skills 19) An audit provides a high level of assurance, but is not a guarantee that a material misstatement will exist in the financial statements. A) True B) False Answer: A Terms: Audit and reasonable assurance Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 20) AICPA auditing standards provide uniform wording for the auditor's report to enable users of the financial statements to understand the audit report. A) True B) False Answer: A Terms: Uniform wording for auditor's report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 21) Users of the financial statements rely on the auditor's report because of the absolute assurance the report provides. A) True B) False Answer: B Terms: Users of financial statements rely on auditor's report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 22) The introductory paragraph of the auditor's report states that the auditor is responsible for the preparation, presentation and opinion on financial statements. A) True B) False Answer: B Terms: Introductory paragraph of auditor's report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 23) The audit report date is the date the auditor completed audit procedures in the field. A) True B) False Answer: A Terms: Audit report date Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 24) The scope paragraph of the auditor's responsibility section of the audit report issued for financial statements of a non-public company should refer to generally accepted auditing standards . A) True B) False Answer: A Terms: Audit reports issued for financial statements of private company; Scope paragraph; Generally accepted auditing standards Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills Topic: Public 25) In the scope paragraph of the audit report issued for financial statements of a non-public company, the auditor expresses an opinion about the internal controls of the company. A) True B) False Answer: B Terms: Audit reports issued for financial statements of private company; Scope paragraph; Generally accepted auditing standards Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 26) The audit report is normally addressed to the company's president or chief executive officer. A) True B) False Answer: B Terms: Audit report normally addressed Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 27) The phrase "generally accepted accounting principles" can be found in the opinion paragraph of a standard unqualified report. A) True B) False Answer: A Terms: Generally accepted accounting principles; Opinion paragraph of standard unqualified report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills 28) The date of the auditor's report is indicative of the last day of the auditor's responsibility for the review of significant events occurring after the balance sheet date. A) True B) False Answer: A Terms: Date of auditor's report indicates auditor's responsibility Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills 29) The phrase "auditing standards generally accepted in the United States of America" can be found in the opinion paragraph of a standard, unqualified audit report for a non-public company. A) True B) False Answer: B Terms: Auditing standards generally accepted in the United States; Opinion paragraph in standard unqualified report for public company Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills Topic: Public 30) The phrase "Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material error" is included in the auditor's opinion section of an audit report. A) True B) False Answer: B Terms: Standard unqualified audit report for a non-public entity;eight parts of the report Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills Learning Objective 3-2 1) In which of the following situations would the auditor most likely issue an unqualified report? A) The client valued ending inventory by using the replacement cost method. B) The client valued ending inventory by using the Next-In-First-Out (NIFO) method. C) The client valued ending inventory at selling price rather than historical cost. D) The client valued ending inventory by using the First-In-First-Out (FIFO) method, but showed the replacement cost of inventory in the Notes to the Financial Statements. Answer: D Terms: Issued audit report; further audit tests or inquiries Diff: Challenging Objective: LO 3-2 AACSB: Reflective thinking skills 2) The standard unqualified audit report: A) is sometimes called a clean opinion. B) can be issued only with an explanatory paragraph. C) can be issued if only a balance sheet and income statement are included in the financial statements. D) is sometimes called a disclaimer report. Answer: A Terms: Conditions for standard unqualified audit report Diff: Easy Objective: LO 3-2 AACSB: Reflective thinking skills 3) There are four 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 four conditions that justify issuing a standard unqualified report are: • All statements–balance sheet, income statement, statement of changes in stockholder's equity, and statement of cash flows–are included in the financial statements. • Sufficient appropriate evidence has been accumulated, and the auditor has conducted the engagement in a manner that enables him or her to conclude that the audit was performed in accordance with auditing standards. • The financial statements are presented in accordance with U.S. generally accepted accounting principles or other appropriate accounting framework. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. • There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report. Terms: Conditions for standard unqualified report for audit of private company Diff: Moderate Objective: LO 3-2 AACSB: Reflective thinking skills Learning Objective 3-3 1) 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? I. A combined report on financial statements and internal control over financial reporting II. Separate reports on financial statements and internal control over financial reporting A) I only B) II only C) Either I or II. D) Neither I nor II. Answer: C Terms: Combined report on financial statements and internal control over financial reporting Diff: Easy Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public 2) The standard unqualified audit report for public entities includes the following three paragraphs: A) introductory, scope and management's responsibility. B) materiality, scope and report. C) introductory, scope and opinion. D) scope, fieldwork and conclusion. Answer: C Terms: Standard unqualified audit report for public entities Diff: Easy Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public 3) Auditing standards for public companies are established by the: A) SEC. B) FASB. C) PCAOB. D) IRS. Answer: C Terms: Audit standards for public companies; PCAOB Diff: Easy Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public 4) Section 404(b) of the Sarbanes Oxley Act requires that the auditor of a public company attest to management's report on the efficiency of internal controls over financial reporting. A) True B) False Answer: B Terms: Section 404(b) of Sarbanes-Oxley Act; Internal controls over financial reporting Diff: Moderate Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public 5) Auditors of public company financial statements must issue separate reports on internal control over financial reporting. A) True B) False Answer: B Terms: Auditors issue separate reports on internal control Diff: Moderate Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public Learning Objective 3-4 1) Examples of unqualified opinions which contain modified wording (without adding an explanatory paragraph) include: A) the use of other auditors. B) material uncertainties. C) substantial doubt about the audited company (or the entity) continuing as a going concern. D) lack of consistent application of GAAP. Answer: A Terms: Modified unqualified opinion Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills 2) 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. Answer: C Terms: Unqualified opinion with emphasis on specific matters regarding the financial statements Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills 3) All of the following are causes for the addition of an explanatory paragraph under both AICPA and PCAOB standards except for: A) emphasis of a matter. B) reports involving other auditors. C) lack of consistent application of generally accepted accounting principles. D) auditor agrees with a departure from promulgated accounting principles.. Answer: B Terms: Unqualified opinion with modified wording Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills 4) The term "explanatory paragraph" was replaced in the AICPA auditing standards with: A) going concern paragraph. B) emphasis-of-matter paragraph. C) departure from principles paragraph. D) consistency paragraph. Answer: B Terms: Unqualified opinion with modified wording Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills 5) Which of the following are changes that affect the comparability of financial statements but not the consistency and therefore, do not have to be included in the auditor's report? A) Error corrections not involving principles B) Changes in accounting estimates C) Variations in the format and presentation of financial information D) All of the above Answer: D Terms: Changes that affect the comparability of financial statements Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 6) Which of the following is least likely to cause uncertainty about the ability of an entity to continue as a going concern? A) The entity is suing a competitor for a minor patent infringement. B) The entity has lost a major customer. C) The entity has significant recurring operating losses. D) The entity has working capital deficiencies. Answer: A Terms: Going concern Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 7) 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. B) one year from the date of the financial statements. C) six months from the date of the audit report. D) one year from the date of the audit report. Answer: B Terms: Going concern ; time period Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 8) When the auditor concludes that there is substantial doubt about the entity's ability to continue as a going concern, the appropriate audit report could be: I. an unqualified opinion with an explanatory paragraph. II. a disclaimer of opinion. A) I only B) II only C) I or II D) Neither I nor II Answer: C Terms: Auditor concludes substantial doubt about entity's ability to continue as going concern Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 9) 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. Answer: D Terms: Justified Departure Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 10) William Gregory, CPA, is the principal auditor for a multi-national corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Gregory is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's examination. With respect to his report on the consolidated financial statements, taken as a whole, Gregory: A) must not refer to the examination of the other auditor. B) must refer to the examination of the other auditor. C) may refer to the examination of the other auditor. D) must refer to the examination of the other auditors along with the percentage off consolidated assets and revenue that they audited. Answer: C Terms: Reports involving other auditors Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 11) A company has changed its method of inventory valuation from an unacceptable one to one in conformity with generally accepted accounting principles. The auditor's report on the financial statements of the year of the change should include: A) no reference to consistency. B) a reference to a prior period adjustment in the opinion paragraph. C) an explanatory paragraph that justifies the change and explains the impact of the change on reported net income. D) an explanatory paragraph explaining the change. Answer: D Terms: Consistency modifications Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 12) Which of the following modifications of the auditor's report does not include an explanatory paragraph? A) A qualified report is due to a GAAP departure. B) The report includes an emphasis of a matter. C) There is a very material scope limitation. D) A principal auditor accepts the work of an other auditor. Answer: D Terms: Shared opinions Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 13) No reference is made in the auditor's report to other auditors who perform a portion of the audit when: I. The other auditor audited an immaterial portion of the audit. II. The other auditor is well known or closely supervised by the principle auditor. III. The principle auditor has thoroughly reviewed the work of the other auditor. A) I and II B) I and III C) II and III D) I, II and III Answer: D Terms: Shared opinions Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 14) When an auditor is trying to determine how changes can affect consistency and and/or comparability, he should keep in mind that: A) changes that affect comparability but not consistency require an explanatory paragraph. B) items that materially affect the comparability of financial statements requires a disclaimer of opinion. C) changes that affect consistency require an explanatory paragraph if they are material. D) changes that involve either comparability or consistency only need to be mentioned in the footnotes. Answer: C Terms: Standard audit report; explanatory paragraph; consistency and comparability Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 15) All of the following would require an emphasis of matter paragraph except for: A) the existence of material related party transactions. B) the lack of auditor independence. C) important events occurring subsequent to the balance sheet date. D) material uncertainties disclosed in the footnotes. Answer: B Terms: Unqualified opinion with emphasis on specific matters regarding the financial statements Diff: Easy Objective: LO 3-4 AACSB: Analytic skills 16) Under AICPA auditing standards, the primary auditor issuing the opinion on the financial statements is called the: A) component auditor. B) principal auditor. C) group engagement partner. D) majority auditor. Answer: C Terms: Reports involving other auditors Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills 17) Which of the following is false concerning the principal CPA firm's alternatives when issuing a report when another CPA firm performs part of the audit? A) Issue a joint report signed by both CPA firms. B) Make no reference to the other CPA firm in the audit report, and issue the standard unqualified opinion. C) Make reference to the other auditor in the report by using modified wording (a shared opinion or report). D) A qualified opinion or disclaimer, depending on materiality, is required if the principal auditor is not willing to assume any responsibility for the work of the other auditor. Answer: A Terms: Shared opinions Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills 18) 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 common stock. D) A change in depreciation method which has no effect on current year's financial statements but is certain to affect future years. Answer: C Terms: Consistency Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills 19) Indicate which changes would require an explanatory paragraph in the audit report. A) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable Change from LIFO to FIFO Yes Yes B) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable Change from LIFO to FIFO No No C) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable Change from LIFO to FIFO Yes No D) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable Change from LIFO to FIFO No Yes Answer: A Terms: Changes that require explanatory paragraph in audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 20) Indicate which changes would require an explanatory paragraph in the audit report. A) Change in the estimated life of an asset Variation in the format of the financial statements Yes Yes B) Change in the estimated life of an asset Variation in the format of the financial statements No No C) Change in the estimated life of an asset Variation in the format of the financial statements Yes No D) Change in the estimated life of an asset Variation in the format of the financial statements No Yes Answer: B Terms: Changes that require explanatory paragraph in audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 21) Indicate which changes would require an explanatory paragraph in the audit report. A) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern Change from FIFO to LIFO Yes Yes B) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern Change from FIFO to LIFO No No C) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern Change from FIFO to LIFO Yes No D) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern Change from FIFO to LIFO No Yes Answer: A Terms: Changes that would require an explanatory paragraph in audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 22) Indicate which changes would require an explanatory paragraph in the audit report. A) A departure from GAAP which, due to unusual circumstances, does not require a qualified or adverse opinion. The CPA makes reference to the work of another auditor to indicate shared responsibility in an unqualified opinion. Yes Yes B) A departure from GAAP which, due to unusual circumstances, does not require a qualified or adverse opinion. The CPA makes reference to the work of another auditor to indicate shared responsibility in an unqualified opinion. No No C) A departure from GAAP which, due to unusual circumstances, does not require a qualified or adverse opinion. The CPA makes reference to the work of another auditor to indicate shared responsibility in an unqualified opinion. Yes No D) A departure from GAAP which, due to unusual circumstances, does not require a qualified or adverse opinion. The CPA makes reference to the work of another auditor to indicate shared responsibility in an unqualified opinion. No Yes Answer: C Terms: Changes that would require an explanatory paragraph in audit report Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills 23) Discuss each of the five circumstances when an auditor would issue an unqualified audit report with an explanatory paragraph or modified wording. Answer: An unqualified report with an explanatory paragraph or modified wording is appropriate in the following circumstances: • Lack of consistent application of GAAP. When the client has not followed generally 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. Terms: Circumstances where an auditor will issue modified unqualified report with explanatory paragraph or modified wording Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 24) A modified unqualified audit report arises when the auditor believes the financials are fairly stated but also believes additional information should be provided. A) True B) False Answer: A Terms: Modified unqualified audit report Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills 25) Changes in accounting estimates requires the auditor to issue a modified unqualified audit report with a consistency paragraph inserted after the opinion paragraph. A) True B) False Answer: B Terms: Changes of accounting estimates; Modified unqualified audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 26) The only modified unqualified opinion that does not include an explanatory paragraph is when other auditors are involved. In this case only the introductory paragraph is modified. A) True B) False Answer: B Terms: Modified unqualified opinion Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 27) Items that materially affect the comparability of the financial statements generally require disclosure in the footnotes. A) True B) False Answer: A Terms: Items that materially affect comparability of financial statements Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 28) Changes in an estimate, such as a change in the estimated useful life of an asset for depreciation purposes, affect consistency but not comparability, and therefore require an explanatory paragraph in the audit report. A) True B) False Answer: B Terms: Comparability vs. consistency Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 29) Changes in reporting entities, such as the inclusion of an additional company in combined financial statements, affect comparability but not consistency, and therefore do not require an explanatory paragraph in the audit report. A) True B) False Answer: B Terms: Comparability and consistency Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills 30) When an auditor relies upon a different CPA firm to perform part of the audit and chooses to issue a shared opinion, only the auditor's responsibility paragraph should be modified. A) True B) False Answer: B Terms: Auditor reliance on different CPA firm to perform part of audit; Shared opinion Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills 31) When other auditors are involved in the audit and they qualify their portion of the audit, the principal auditor must decide if the amount in question is material to the financial statements as a whole. A) True B) False Answer: A Terms: Shared responsibility Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills Learning Objective 3-5 1) As a result of management's refusal to permit the auditor to physically examine inventory, the auditor must depart from the unqualified audit report because: A) the financial statements have not been prepared in accordance with GAAP. B) the scope of the audit has been restricted by circumstances beyond either the client's or auditor's control. C) the financial statements have not been audited in accordance with GAAS. D) the scope of the audit has been restricted. Answer: D Terms: Auditor must depart from unqualified audit report; Management refusal to permit the auditor to physically examine inventory Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills 2) An adverse opinion is issued when the auditor believes: A) some parts of the financial statements are materially misstated or misleading. B) the financial statements would be found to be materially misstated if an investigation were performed. C) the auditor is not independent. D) the overall financial statements are so materially misstated that they do not present fairly the financial position or results of operations and cash flows in conformity with GAAP. Answer: D Terms: Adverse opinion Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills 3) An auditor can express a qualified opinion due to a: A) Departure from GAAP Lack of Consistency Lack of Sufficient Evidence Yes No No B) Departure from GAAP Lack of Consistency Lack of Sufficient Evidence No Yes No C) Departure from GAAP Lack of Consistency Lack of Sufficient Evidence Yes No Yes D) Departure from GAAP Lack of Consistency Lack of Sufficient Evidence Yes Yes Yes Answer: C Terms: Qualified opinions Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills 4) An auditor determines the financial statements include at least a material departure from GAAP. Which type of opinion may be issued? A) Disclaimer Qualified Adverse Yes No No B) Disclaimer Qualified Adverse No Yes No C) Disclaimer Qualified Adverse Yes No Yes D) Disclaimer Qualified Adverse No Yes Yes Answer: D Terms: Opinion , GAAP departure Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 5) A qualified opinion can be issued for which of the following? I. When a limitation on the scope of the audit has occurred II. When the auditor lacks independence III. When generally accepted accounting principles have not been used A) I and II B) I and III C) II and III D) I, II and III Answer: B Terms: Qualified opinion Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 6) In which situation would the auditor be choosing between "except for" qualified opinion and an adverse opinion? A) The auditor lacks independence. B) A client-imposed scope limitation C) A circumstance imposed scope limitation D) Lack of full disclosure within the footnotes Answer: D Terms: Qualified opinion and adverse opinion Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 7) When the auditor determines that the financial statements are fairly stated, but there is a nonindependent relationship between the auditor and the client, the auditor should issue: A) an adverse opinion. B) a disclaimer of opinion. C) either a qualified opinion or an adverse opinion. D) either a qualified opinion or an unqualified opinion with modified wording. Answer: B Terms: Audit report when auditor not independent Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 8) If the auditor lacks independence, a disclaimer of opinion must be issued: A) if the client requests it. B) only if it is highly material. C) only if it is material but not pervasive. D) in all cases. Answer: D Terms: Disclaimer when auditor lacks independence Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 9) If the phrase "except for" is present in the opinion paragraph of the audit report, the auditor has issued a(n): A) adverse opinion. B) disclaimer of opinion. C) unqualified opinion. D) qualified opinion. Answer: D Terms: Departure from unqualified audit report Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 10) A client has changed their method of valuing inventory from FIFO to LIFO and the change has a material effect on the financial statements. If the auditor does not concur with the appropriateness of the change, the auditor should issue a(n): A) disclaimer. B) adverse opinion. C) unqualified opinion. D) qualified opinion. Answer: D Terms: Change in valuing inventory and auditor does not concur with change Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 11) Items that materially affect the comparability of financial statements generally require disclosure in the footnotes. If the client refuses to properly disclose the item, the auditor will most likely issue: A) a disclaimer. B) an unqualified opinion. C) a qualified opinion. D) an adverse opinion. Answer: C Terms: Disclosure and comparability Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 12) Which of the following scenarios does not result in a qualified opinion? A) A scope limitation prevents the auditor from completing an important audit procedure. B) Circumstances exist that prevent the auditor from conducting a complete audit. C) The auditor lacks independence with respect to the audited entity. D) An accounting principle at variance with GAAP is used. Answer: C Terms: Qualified opinion Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 13) 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. D) qualification of both scope and opinion whenever materiality is in question. Answer: C Terms: Client imposed restrictions on scope of audit Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 14) In which of the following circumstances would an auditor most likely express an adverse opinion? A) The CEO refuses to let the auditor have access to the board of director meeting minutes. B) The financial statements are not in conformity with the FASB statement on loss contingencies. C) Information comes to the auditor's attention that raises substantial doubt about the ability for the client to continue as a going concern. D) Tests of controls show that the internal control structure is so poor that the auditor has to assess control risk at the maximum. Answer: B Terms: Adverse opinion circumstances Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 15) Which of the following statements is true? I. The auditor is required to issue a disclaimer of opinion in the event of a material uncertainty. II. The auditor is required to issue a disclaimer of opinion in the event of a going concern problem. A) I only B) II only C) I and II D) Neither I nor II Answer: D Terms: Disclaimer of opinion Diff: Challenging Objective: LO 3-5 AACSB: Reflective thinking skills 16) The most common case in which conditions beyond the client's and auditor's control cause a scope restriction in an engagement is when the: A) auditor is not appointed until after the client's year-end. B) client won't allow the auditor to confirm receivables for fear of offending its customers. C) auditor doesn't have enough staff to satisfactorily audit all of the client's foreign subsidiaries. D) client is going through Chapter 11 bankruptcy. Answer: A Terms: Scope restriction beyond client and auditor control Diff: Challenging Objective: LO 3-5 AACSB: Reflective thinking skills 17) When the client fails to make adequate disclosure in the body of the statements or in the related footnotes, it is the responsibility of the auditor to: A) inform the reader that disclosure is not adequate, and to issue an adverse opinion. B) inform the reader that disclosure is not adequate, and to issue a qualified opinion. C) present the information in the audit report and issue an unqualified or qualified opinion. D) present the information in the audit report and to issue a qualified or an adverse opinion. Answer: D Terms: Inadequate disclosure Diff: Challenging Objective: LO 3-5 AACSB: Reflective thinking skills 18) There are three conditions necessitating a departure from an unqualified audit report. Name, discuss and state the appropriate audit report for each of these three conditions. Answer: The three conditions requiring a departure from an unqualified report are: • Scope Restrictions. A scope restriction can be imposed by the client or due to circumstances beyond the auditor's or client's control. In either case the scope restriction prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP. The type of opinion, depending upon materiality, would be either a qualified or a disclaimer of opinion report. • GAAP Departures. In this situation the financial statements are not prepared in accordance with GAAP. Accordingly, the auditor would issue a qualified opinion if the GAAP violation were moderately material, or an adverse opinion if the GAAP violation were highly material. • Auditor lacks independence. Independence is ordinarily determined by Rule 101 of the rules of the Code of Professional Conduct. When the auditor is not independent, the only report the auditor can issue is a disclaimer of opinion. Terms: Conditions necessitating a departure from an unqualified audit report Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 19) A qualified audit report is issued when all auditing conditions have been met, no significant misstatements have been discovered, and it is the auditor's opinion that the financial statements are fairly stated in accordance with GAAP. A) True B) False Answer: B Terms: Qualified report Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills 20) Auditors should issue a disclaimer of opinion when there is a highly material client-imposed scope restriction. A) True B) False Answer: A Terms: Disclaimer of opinion; Client-imposed scope restriction Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 21) Whenever an auditor issues a qualified report, he or she must use the term "except for " in the opinion paragraph. A) True B) False Answer: A Terms: Qualified report; Except for in opinion paragraph Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 22) A qualified report can take the form of a qualification of both the scope and the opinion or of the opinion alone. A) True B) False Answer: A Terms: Qualified report; Scope limitation Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 23) When an auditor discovers a highly material GAAP violation in the financial statements and the client refuses to correct it, the auditor should issue a disclaimer of opinion. A) True B) False Answer: B Terms: Disclaimer of opinion; Highly material GAAP violation in the financial statements and client refuses to correct it Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 24) Client imposed restrictions on the audit always require a disclaimer of opinion. A) True B) False Answer: B Terms: Disclaimer of opinion; Client imposed restrictions on audit Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills 25) An auditor should issue a qualified opinion with an explanatory paragraph whenever there is a material uncertainty affecting the financial statements. A) True B) False Answer: B Terms: Qualified opinion with explanatory paragraph Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills Learning Objective 3-6 1) A misstatement in the financial statements can be considered material if knowledge of the misstatement will affect a decision of: A) the PCAOB. B) a reasonable user of the financial statements. C) an accountant. D) the SEC. Answer: B Terms: Materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 2) Misstatements must be compared with some measurement base before a decision can be made about materiality. A commonly accepted measurement base includes: A) net income. B) total assets. C) working capital. D) all of the above. Answer: D Terms: Misstatements and materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 3) 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. Answer: A Terms: Pervasive misstatements Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 4) 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. C) the auditor's exposure to lawsuits. D) management's future decisions. Answer: B Terms: Misstatements accurately measured Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 5) If most or all users' decisions that are based on the financial statements are likely to be significantly affected, the materiality level is: A) unrestricted. B) material. C) pervasive. D) risky. Answer: C Terms: Materiality qualifications Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 6) When a client fails to follow GAAP, the audit report can be unqualified, qualified, or adverse depending on the materiality. What factors affect materiality that an auditor should consider? A) The dollar amount in comparison to a base B) If the misstatement can be measured C) The nature of the item D) All the above are factors an auditor should consider regarding materiality. Answer: D Terms: Client fails to follow GAAP; Materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 7) Which of the following is a correct statement regarding materiality? A) There are well-defined guidelines that enable auditors to determine if something is material. B) Misstatements must be compared with some benchmark before a decision can be made about the materiality level of the failure of a company to follow GAAP. C) Pervasiveness is not considered when comparing potential misstatements with a base or benchmark. D) To evaluate overall materiality, the auditor does not combine all unadjusted misstatements. Answer: B Terms: Materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills 8) Discuss how materiality affects audit reporting decisions. Answer: When determining the appropriate audit report to issue, the auditor considers three levels of materiality for a given condition. These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) so material and so pervasive that overall fairness of the statements is in question. For conditions involving a GAAP violation, the materiality level of the violation influences 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. Terms: Materiality affect on audit reporting decisions Diff: Easy Objective: LO 3-6 AACSB: Reflective thinking skills 9) Materiality is essential when an auditor considers his/her determination of the appropriate report for a given set of circumstances. A) True B) False Answer: A Terms: Materiality; Appropriate report Diff: Easy Objective: LO 3-6 AACSB: Reflective thinking skills 10) A pervasive exception is one that affects different parts of the financial statements. A) True B) False Answer: A Terms: Pervasive exception Diff: Easy Objective: LO 3-6 AACSB: Reflective thinking skills 11) An item with a "psychic" effect (e.g., where the item maintains an increasing earnings trend) is a qualitative factor that may affect the auditors decision regarding materiality. A) True B) False Answer: A Terms: Psychic effect; Materiality Diff: Challenging Objective: LO 3-6 AACSB: Reflective thinking skills Learning Objective 3-7 1) The explanatory paragraph for a qualified opinion would: A) precede the scope paragraph. B) follow the scope paragraph. C) follow the opinion paragraph. D) either precede or follow the opinion paragraph depending on the materiality. Answer: B Terms: Explanatory paragraph for qualified opinion Diff: Easy Objective: LO 3-7 AACSB: Reflective thinking skills 2) 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 modify the: A) Scope paragraph Opinion paragraph Notes to the financial statements Yes No Yes B) Scope paragraph Opinion paragraph Notes to the financial statements No Yes Yes C) Scope paragraph Opinion paragraph Notes to the financial statements No Yes No D) Scope paragraph Opinion paragraph Notes to the financial statements Yes Yes No Answer: D Terms: Qualified opinion insufficient evidence Diff: Challenging Objective: LO 3-7 AACSB: Reflective thinking skills 3) When an auditor issues a qualified report due to a scope limitation an explanatory paragraph is normall