First midterm examination

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Respond to the essay questions on separate sheets of paper and to the multiple choice questions on the test paper. On the essay questions, be as concise, neat and to the point as possible. Remember that the quality of your ability to communicate is important as well as the content of your answers. Leave space at the bottom of each page for my notes.
Answer ALL BUT ONLY the question asked. Remember to SIGN AND DATE the front page of the test paper and EACH PAGE of your answer sheets.
Please note that you do not have to answer all the essay questions, but you do have to answer all the multiple choice questions.
1. On September 30, 1999, the stock market began to fall and, in spite of periodic recoveries, lost 20% of its value by December 31, 1999. During this time, there was wide-spread publicity of the market decline in the broadcast and print media. By the end of the final audit work on your client, VirtualE-Products, Inc., for the year ended December 31, 1999, the client’s stock had fallen from $104 per share to $76 per share. By March 3, 2000, the last day you were at the company’s headquarters, it was uncertain whether the client’s stock had reached its low. The client’s management had included the high/low price range and closing price of its stock for each quarter in the last two years in the company section of the 1999 annual report to shareholders, as required by SEC regulations, but did not include disclosure of this situation in the notes to the financial statements for 1999 and 1998 included in the annual report along with the balance sheets, statements of operations, statements of retained earnings and statements of cash flows. Management is willing to make any changes you suggest. When you returned to your office at Kaplansky, Zeluck & Ruben, your firm, on March 6, 2000, you discussed the situation with the partner on this engagement, Francine Salazar. By March 9, 2000, when she had cleared the last of her review points, Francine agreed with your handling of the issue. Assuming there were no other material problems, draft the appropriate auditors’ report for this engagement and explain briefly why you chose that form of report. Kaplansky, Zeluck & Ruben has audited this client for many years.

2. While you are at lunch with other staff accountants at your CPA firm, the subject of materiality comes up. One staff accountant, Susie Rich, who graduated from USC, questions why materiality limits are set during the planning phase of the audit. She asserts the materiality limits should be set after the final part of the audit work so the auditors will know what balances will be reflected in the audited financial statements before making a decision. Do you agree or not? Explain why or why not.

3. What role does analytical review play in the planning of an audit? In addition, explain the significance of each of the following to the auditor’s planning process, what information each provides the auditor, and how each is determined:

a. Current ratio

b. Return on equity

c. Variations analysis

4. What significant elements should a CPA firm’s methodology for assessing internal controls have? Why is each of these elements important? What risk does the CPA firm run if each of these elements were not included in the assessment of internal controls process?
1. Generally accepted accounting principles are mentioned in:

_____ a. The introductory paragraph of the standard unqualified auditors’ report.

_____ b. The scope paragraph of the standard unqualified auditors’ report.

_____ c. The scope and the opinion paragraphs of the standard unqualified auditors’


___X_ d. The opinion paragraph of the standard unqualified auditors’ report.

2. If the auditors find a client has not used a generally accepted accounting principle with regard to a material item, which of the following changes to the standard auditors’ report would be most appropriate:

_____ a. Change only the scope paragraph and the opinion paragraph.

_____ b. Add only a qualifying paragraph after the scope paragraph.

__X__ c. Add a qualifying paragraph after the scope paragraph and change the opinion


_____ d. Add a qualifying paragraph after the opinion paragraph and change the opinion




3. A disclaimer of opinion discloses to readers that:

_____ a. The financial statements are not fairly presented in accordance with generally

accepted accounting principles in a very significant way.

__X__ b. The auditor is unable to give an opinion on the financial statements.

_____ c. There are very significant contingent losses or liabilities which cannot be


_____ d. The auditors have been unable to determine what accounting methods the client

has used.
4. If an auditor finds an error in applying generally accepted accounting principles which is considered not material, which of the following would probably occur:

_____ a. No disclosure in auditor’s report but an adjustment to financial statements.

_____ b. No adjustment to financial statements but disclosure in auditor’s report.

__X__ c. No disclosure in auditor’s report and no adjustment to financial statements.

_____ d. Only disclosure in the notes to the financial statements..
5. If a client’s current ratio increases from 1.5 to 2.2, an auditor would conclude:

__X__ a. The change is good.

_____ b. The current ratio may constitute a significant risk area.

_____ c. The change is not good.

_____ d. The client is not leveraged enough.
6. The ten basic generally accepted auditing standards require all the following except for:

_____ a. Audits should be adequately planned.

__X__ b. Receivables should be confirmed and inventories should be observed.

_____ c. Staff assigned to an audit should be properly supervised.

_____ d. Personnel assigned to an audit should have adequate technical training and proficiency.
7. A decrease in the days to collect ratio indicates that a client is generally:

_____ a. More capable of delivering products to customers promptly.

_____ b. Billing customer invoices promptly.

_____ c. Worse off than before.

__X__ d. Better off than before.
8. From a profitability perspective, the debt-to-equity ratio generally:

__X__ a. Is better the higher it becomes.

_____ b. Is better the lower it becomes.

_____ c. Must be used with the debt-to-asset ratio.

_____ d. Should not rise above 2.0%


9. A discussion and observation test generally establishes that the client’s control techniques:

_____ a. Meet the related control objectives.

_____ b. Reduce business risk.

_____ c. Were effective during the year audited.

__X__ d. Were effective while you observed.

10. Which of the following does not represent an audit risk?

__X__ a. Risk that inflation may drive prices up during the period.

_____ b. Risk that a sales invoice may not reflect what was shipped to customer.

_____ c. Risk that a cash sale may not be rung up on a cash register.

_____ d. Risk that the client may have provided an excessive Allowance for bad debts.



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