ch02 - Defining Professional Responsibility Quality Standards and Ethics.pdf

Defining Professional Responsibility: Quality Standards and Ethics MULTIPLE CHOICE:

1.

Which of th e following did not result at least partially due to the alleged audit failures of the 1980s and 1990s? a. b. c. d.

The Treadway Report. An SAS fur ther def ining the auditor’s responsibility for fraud detection. Formation of th e AICPA Fraud Commission. Formation of the In dependence Standards Board.

ANSWER: 2.

3.

Competence as a certified public accountant includes all of the following except a. Having the technical qualifications to per form an engagement. b. Possessing the ability to supervise and evaluate the quality of staff work. c. Warranting the inf allibility of the work performed. d. Consulting others if ad ditional technical information is needed. ANSWER: C Which of the following is mandatory if the auditor is to comply with generally accepted auditing standards? a. Possession by the au ditor of adequate technical training. b. Use of ana lytical review on aud it engagements. c. Use of statistical sampling whenever feasible on an audit engagement. d. Confirmation by the au ditor of material accounts receivable balances. ANSWER:

4.

C

A

As a guidance fo r measuring the quality of th e performance of an auditor, the auditor should refer to a. Statements of the Financial Accounting Sta ndards Board. b. Generally Accepted Auditing Standards. c. Interpretations of the Statements on Auditing Standards. d. Statements on Qu ality Control Standards. ANSWER:

B

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5.

Chapter 2 Defining Professional Responsibility

In addition to auditing, CPAs perform other services for their clients. Standards governing the quality of these services are covered in the attestation standards generally, and performance requirements are more explicitly defined in sets of statements relating to each type of service. Which of the following is not such a set? a. Statements on Standards for Consulting Services. b. Statements on Responsibilities in University Audits. c. Statements on Sta ndards for Accounting and Review Services. d. Statements on Responsibilities in Tax Practice. ANSWER:

6.

Which of the following is a violation of Rule 301 (Confidential Client Information) of the Code of Professional Conduct? a. The CPA, in re sponse to a court subpoena, submits auditor-prepared workpapers as evidence of possible illegal acts perpetrated by the client. b. The CPA discloses to the board of di rectors a scheme concocted by top management to intentionally inflate earnings. c. The CPA warns Client B as to the inadvisability of acquiring Client A. The CPA bases this war ning on knowledge of Client A's financial condition and a belief that the management of Client A lacks integrity. This knowledge was obtained by the CPA as a result of auditing Client A during the past several years. d. The CPA, wh en que stioned in co urt, ad mits to knowledge of certain illegal acts perpetrated by the client. ANSWER:

7.

B

C

Which of the following statements best describes why the CPA profession has deemed it essential to promulgate ethical standards and to establish means for ensuring their observance? a. A requirement for a profession is the establishment of ethical standards that stress primarily a responsibility to clients and colleagues. b. A requirement of mo st st ate laws ca lls for the profession to establish a code of ethics. c. An essential means of self-protection for the profession is the establishment of flexible ethical standards by the profession. d. A distinguishing mark of a profession is its acceptance of responsibility to the public. ANSWER:

D

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8.

Which of th e following best de scribes what is generally accepted auditing standards? a. Audit objectives generally determined on engagements. b. Acts to be pe rformed by th e au ditor. c. Measures of the qua lity of the aud itor's d. Procedures to be us ed to gather ev idence financial statements. ANSWER:

meant by audit performance. to support

C

9. Which of the following best describes what is meant by generally accepted auditing standards? a. Pronouncements issued by the Auditing Sta ndards Boa rd. b. Procedures to be us ed to gather ev idence to support financial statements. c. Rules acknowledged by the accounting pro fession because of their universal compliance. d. Measures of the qua lity of the aud itor's performance. ANSWER: 10.

Under which of the following circumstances may a CPA agree with a departure from an accounting principle promulgated by that body designated by AICPA Council to formulate such principles? a. When the pri nciple was one for mulated by the Acc ounting Principles Board inasmuch as the APB is no longer the body so designated by Council. b. When th e CPA can demonstrate that ap plication of th e principle in question would make the financial statements materially misleading. c. When the disputed principle is con trary to industry practice. d. When ad option of the pr inciple would cause the financial statements to be inconsistent with prior years. ANSWER:

11.

D

B

Pursuant to the AICPA rules of conduct, the auditor's responsibility to the profession is defined by a. The AICPA Code of Pr ofessional Co nduct. b. Federal laws gov erning licensed professionals who are involved in interstate commerce. c. Statements on Auditing Standards. d. The Bylaws of the AICPA. ANSWER:

A

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12.

Chapter 2 Defining Professional Responsibility

An auditor who accepts an audit engagement and does not possess the industry expertise of the business entity, should a. Engage financial experts familiar with the nature of the business entity. b. Obtain a knowledge of mat ters that relate to th e nature of the entity's business. c. Refer a substantial portion of th e audit to an other CPA who will act as the principal auditor. d. First inform management that an unqualified opinion cannot be issued. ANSWER:

13.

Which of the following factors is most important concerning an auditor's responsibility to detect errors and fraud? a. The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles. b. The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements. c. The possibility that management fraud, defalcations, and misappropriation of assets may indicate the existence of illegal acts. d. The risk that mistakes, falsifications, and omissions may cause the financial statements to contain material misstatements. ANSWER:

14.

D

The standard of due audit care requires the auditor to a. Apply judgment in a conscientious manner, carefully weighing the relevant factors before reaching a decision. b. Ensure th at th e financial statements ar e free fr om error. c. Make pe rfect judgment de cisions in al l cases. d. Possess skills cl early above the average for the profession. ANSWER:

15.

B

A

The exercise of due professional care requires that an auditor a. Examine all available corroborating evidence. b. Critically review the judgment exercised at eve ry level of supervision.

Chapter 2 Defining Professional Responsibility

c. d.

Reduce control risk below the maximum. Attain the pro per balance of pro fessional experience and formal education.

ANSWER: 16.

B

The first general standard recognizes that regardless of how capable an individual may be in other fields, the individual cannot meet the requirements of the auditing standards without the proper a. Business and finance courses. b. Quality control and p eer review. c. Education and experience in auditing. d. Supervision and review skills. ANSWER:

19.

C

The first general standard requires that a person or persons have adequate technical training and proficiency as an auditor. This sta ndard is met by a. An un derstanding of th e field of bus iness and finance. b. Education and experience in the field of au diting. c. Continuing professional education. d. A thorough kn owledge of th e Statements on Auditing Standards. ANSWER:

18.

B

A CPA who has never audited a commercial bank a. May not accept such an e ngagement. b. May accept th e engagement on ly if the accounting fir m specializes in the audit of commercial banks. c. May accept the engagement after attaining a suitable level of understanding of the transactions and accounting practices unique to commercial banking . d. May accept th e engagement be cause training as a CPA transcends unique industry characteristics. ANSWER:

17.

13

C

In determining estimates of fees, an auditor may take into account each of the following, except the a. Value of th e se rvice to th e cl ient. b. Degree of responsibility assumed by undertaking the engagement. c. Skills required to perform the service. d. Attainment of spe cific findings. ANSWER:

D

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20.

Chapter 2 Defining Professional Responsibility

A CPA, while performing an audit, strives to achieve independence in appearance in order to a. Reduce risk and liability. b. Comply with the generally accepted standards of field work. c. Become independent in fact. d. Maintain public confidence in the pr ofession. ANSWER:

21.

Which of the following best describes why publicly traded corporations follow the practice of having the outside auditor appointed by the board of directors or elected by the stockholders? a. To comply with the regulations of the Financial Accounting Standards Board. b. To emphasize auditor independence from the management of the corporation. c. To encourage a policy of rotation of the independent auditors. d. To provide the corporate owners with an opportunity to voice their opinion concerning the quality of the auditing firm selected by the directors. ANSWER:

22.

B

Which of the following is not required by the generally accepted auditing standard that states that due professional care is to be exercised in the performance of the examination? a. Observance of th e standards of fi eld work and reporting. b. Critical re view of the audit work pe rformed at ev ery level of supervision. c. Degree of skill commonly po ssessed by ot hers in the profession. d. Responsibility for losses because of er rors of judgment. ANSWER:

23.

D

D

The third general standard states that due care is to be exercised in the performance of the examination. This standard means that a CPA who undertakes an engagement assumes a duty to perform each audit a. As a professional po ssessing th e degree of skill commonly possessed by others in the field. b. In conformity with generally acc epted accounting principles.

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Chapter 2 Defining Professional Responsibility

c. d.

With reasonable diligence and without fault or error. To the satisfaction of governmental agencies and investors who rely upon the audit.

ANSWER:

A

COMPLETION:

24.

Client “outsourcing” of certain accounting functions, such as internal auditing, to the national accounting firms may cause financial statement users to question ___________ _______________. ANSWER: AUDITOR INDEPENDENCE (OR INDEPENDENCE OF THE AUDITOR)

25. Throughthe ,the AICPA has provided a framework for defining the acceptable quality of independent audits and other services rendered by CPAs. ANSWER: 26.

Proper study and evaluation of internal accounting control is needed because virtually all independent audits are . ANSWER:

27.

CODE OF PROFESSIONAL CONDUCT

TEST BASED

The generally accepted auditing standards, as promulgated by the American Institute of Certified Public Accountants, define the ______________ of independent auditing. ANSWER:

QUALITY

28. T he general standards relate to the of the auditor. ANSWER: 29.

CHARACTER, COMPETENCE

The field work standards are concerned with the process. ANSWER:

30.

and

AUDIT

The reporting standards relate to the ANSWER:

MATCHING:

ATTEST

function.

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31. Match each of the following actions with the Code of Conduct rule violated by the action. No rule is used more than once. Briefly explain why the action is a violation of the rule cited. a. b. c. d. e. f. g. h. i. j. k.

Rule Rule Rule Rule Rule Rule Rule Rule Rule Rule Rule

101: 102: 201: 202: 203: 301: 302: 501: 502: 503: 505:

Independence Integrity and objectivity General standards Compliance with standards Accounting principles Confidential client information Contingent fees Acts discreditable Advertising and other forms of solicitation Commissions and referral fees Form of practice and name

____1. Juanita Garcia, CPA, refused to be associated with a client’s financial statements after the client declined to correct a material misstatement. Garcia later contacted James Jordan, CPA, retained by the client to replace Garcia, and informed Jordan of the misstatement. ____2. Brianna Lopez, CPA, agreed to review loan applications for First Charter Bank, an audit client. The bank granted or denied the loans on the basis of Lopez’ recommendations. ____ 3. In defense of a lawsuit alleging negligence, Melissa Franklin, CPA, explained that she was not an expert in commodities trading and therefore did not detect the accounting fraud perpetrated by her client, a commodities broker. ____ 4. Rudy Boesch, CPA, accepted an audit engagement for a fixed fee of $27,000 plus 1% of audited net assets. ____ 5. In reviewing the corporate tax return for Eager Turnstiles, Inc., Abba Shah, CPA, discovered that Eager’s controller had incorrectly reported a $500,000 purchase of painting equipment as repairs expense. When Shah informed the controller of the tax code violation, she refused to correct the return. Shah signed the return as preparer ____ 6. Ben Williams, CPA, issued an unqualified opinion on a set of financial statements, even though he felt uncomfortable about an accounting practice applied by

Chapter 2 Defining Professional Responsibility

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the client. Although the practice in question was in accordance with GAAP, it increased net income significantly above a level that Williams considered reasonable. ____ 7. Jones Transfer Company wishes to defer charging certain research and development expenditures to current income on the basis that the expenditures are virtually certain to benefit future operations. For this reason, Jack Risher, CPA and Jones’ auditor, agrees with the proposed accounting treatment. SOLUTION: 1.

f:

2.

a:

3.

c:

4.

g:

5.

d:

6.

b:

This is a vi olation of client confidence. Had Garcia been contacted by Jordan, with her former client’s permission, she could have informed Jordan of the disagreement. Th e independence ru le pr ohibits a member fr om bei ng associated with an audit client in any capacity equivalent to that of a member of management. Making loan recommendations casts Lopez in that capacity. Rule 201 (A) Permits a member to undertake only those engagements that the member or the member’s firm can complete with professional competence. Before accepting this engagement, therefore, Franklin should have received training in commodities trading and related accounting practices. A member is no t permitted to pe rform an a ttest engagement on a contingent fee basis. In this case, the higher the audited net income, the higher will be the audited net assets, and the higher will be the audit fee. Such arrangements impair auditor objectivity. Rule 202 requires members to co mply with all of the standards governing the practice of public accounting as set by those AICPA bodies responsible for prom ulgating them. One of these sets of standards is the Statements on Responsibilities in Tax Practice, which prohibits members from being associated with tax returns known to contain material errors. Rule 10 2 st ates th at a member s hall no t kn owingly misrepresent facts or subordinate his or her judgment to others. In this case, Williams, in agreeing to the questionable practice, subordinated his judgment to that of management,

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7.

e:

thereby failing to adequately represent the interests of the stockholders. A member m ay not agree to a de parture from a n accounting principle promulgated by the body designated by Council to establish such principles unless the departure is necessary in order not to make the financial statements materially misleading. In the present case, inasmuch as the R & D expenditures are not directly reimbursable, they must be charged to expense in the current period; and, therefore, Risher is wrong in agreeing to the departure from GAAP.

Problem/Essay

33. John Block, CPA, has been approached by a prospective new audit client, Snappy Enterprises, Inc. Snappy had previously been aud ited by another CPA. Before acc epting the engagement, Block discussed several matters with Snappy’s controller and (with Snappy’s permission) the other CPA. As a result of these discussions, the following information was obtained. Incorporated in 1992, Snappy’s primary business is buying, developing, selling, and leasing commercial real estate. Apartment complexes, shopping malls, and industrial parks make up the major portion of the company’s business. Starting out in Albuquerque, New Mexico and the surrounding area, Snappy gradually expanded its operations to include most of southwestern United States, including the Phoenix--Scottsdale--Mesa area of Arizona. After two years of losses, the company reported its first earnings in 1994. From 1995 to 2000, revenues and earnings increased dramatically. Earnings for 2001 and 2002, however declined from earlier levels. For the current year, 2003, unaudited net income has rebounded to the 2000 level. Block has learned from discussions with Snappy’s controller that, as of 12/31/03, the end of the current year, the company was in the process of completing a major mall project. The company currently owns several apartment complexes and leases its completed shopping malls to numerous retail establishments. After having been developed, industrial properties are sold either to municipalities or to companies locating in the complexes. In discussing past audits with the CPA formerly engaged by Snappy, Block learned that several disagreements had arisen over the years, many of which had not been resolved to the satisfaction of the former auditors. The disagreements related to accounting matters as well as to the substance of certain transactions with lessees.

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Required:

a. In deciding whether to accept this engagement, what factors should Block consider? b. If he de cides to ac cept th e engagement, in wh at ar eas should he concentrate his audit resources? SOLUTION: a.

b.

Factors Block should consider are the fo llowing: 1. Seriousness of dis agreements with the prior auditor and their potential impact on the financial statements 2. Whether the disagreements demonstrate lack of management integrity 3. Competence of Blo ck to sat isfactorily perform the audit The increase in unaudited earnings suggests possible overstatement of revenues or understatement of expenses. For this reason, Block should focus on the following areas: 1. Cost allocations to the uncompleted mall project. Operating expenses may have been inappropriately allocated to the project and reflected as assets 2. Adequacy of pro visions for uncollectible lease rentals 3. Whether financing leases have been incorrectly treated as “sales type leases” 4. Whether revenues or gai ns have been improperly recognized as a result of transactions with lessees (related parties)