Questions Accounting Class Quiz

2-15 Which of the following is not a part of the role of internal auditors? a. Assisting the external auditors. b. Providing reports on the reliability of financial statements to investors and creditors. c. Consulting activities. d. Operational audits. 2-16 Operational auditing is oriented primarily toward a. Efficiency and future improvements to accomplish the goals of management. b. The accuracy of data reflected in management’s financial records. c. Verification that an entity’s financial statements are fairly presented. d. Past protection provided by existing internal control. 2-17 Which of the following would be considered a nonattest assurance service engagement? I. Expressing an opinion about the reliability of an entity’s financial statements. II. Reporting that a company’s sustainability metrics are complete and accurate. a. I only. c. Both I and II. b. II only. d. Neither I nor II. 2-18 Which of the following best places the events of the last decade in proper sequence? a. Sarbanes-Oxley Act, increased consulting services to auditees, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB. b. Increased consulting services to auditees, Sarbanes-Oxley Act, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB. c. Enron and other scandals, Sarbanes-Oxley Act, increased consulting services to auditees, prohibition of most consulting work for auditees, establishment of PCAOB. d. Increased consulting services to auditees, Enron and other scandals, SarbanesOxley Act, prohibition of most consulting work for auditees, establishment of PCAOB. 2-19 Which of the following statements best describes management’s and the external auditor’s respective levels of responsibility for a public company’s financial statements? a. Management and the external auditor share equal responsibility for the fairness of the entity’s financial statements in accordance with GAAP. b. Neither management nor the external auditor has significant responsibility for the fairness of the entity’s financial statements in accordance with GAAP. c. Management has the primary responsibility to ensure that the company’s financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement. d. Management has the primary responsibility to ensure that the company’s financial statements are prepared in accordance with GAAP, and the auditor provides a guarantee that the statements are free of material misstatement. 2-20 Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions? a. To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity’s information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed. b. To achieve its strategies, a business formulates objectives and implements processes, which are carried out through the entity’s information and internal control systems. Transactions are conducted to ensure that the processes are properly executed, captured, and processed. c. To achieve its objectives, a business formulates strategies to implement its transactions, which are carried out through business processes. The entity’s information and internal control systems must be designed to ensure that the processes are properly executed, captured, and processed. d. To achieve its business processes, a business formulates objectives, which are carried out through the entity’s strategies. The entity’s information and internal control systems must be designed to ensure that the entity’s strategies are properly executed, captured, and processed. 2-21 The Public Company Accounting Oversight Board a. Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies. b. Is a quasi-governmental organization that has legal authority to set accounting standards for public companies. c. Is a quasi-governmental organization that has a policy to ignore public comment and input in the process of setting auditing standards. d. Is a quasi-governmental organization that is independent of the SEC in setting auditing standards. 2-22 Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States? ASB a. Nonpublic company audits b. Public company audits c. Nonpublic company audits d. Public company audits PCAOB Nonpublic company audits Public company audits Public company audits Nonpublic company audits 2-23 Which of the following best describes the general character of the section of the “Principles Underlying an Audit of Financial Statements,” titled “Performance”? a. Description of the competence, independence, and professional care of persons performing the audit. b. Criteria for the content of the auditor’s report on financial statements and related footnote disclosures. c. Criteria for audit planning and evidence gathering. d. The need to maintain an independence of mental attitude in all matters relating to the audit. 2-24 Audits can be categorized into five types: (1) financial statement audits, (2) audits of internal control, (3) compliance audits, (4) operational audits, and (5) forensic audits. Required: For each of the following descriptions, indicate which type of audit (financial statement audit, audit of internal control, compliance audit, operational audit, or forensic audit) best characterizes the nature of the audit being conducted. Also indicate which type of auditor (external auditor, internal auditor, government auditor, or forensic auditor) is likely to perform the audit engagement. a. Evaluate the policies and procedures of the Food and Drug Administration in terms of bringing new drugs to market. (Operational, Government) b. Determine the fair presentation of Ajax Chemical’s balance sheet, income statement, and statement of cash flows. (Financial statement audits, external auditor) c. Review the payment procedures of the accounts payable department for a large manufacturer. (audit of internal control, internal auditor) d. Examine the financial records of a division of a corporation to determine if any accounting irregularities have occurred. (Forensic audit, forensic auditor) e. Evaluate the feasibility of forecasted rental income for a planned low-income public housing project. (operational, internal) f. Evaluate a company’s computer services department in terms of the efficient and effective use of corporate resources. (operational audit, internal auditor) g. Audit the partnership tax return of a real estate development company. (compliance, government) h. Investigate the possibility of payroll fraud in a labor union pension fund. (forensic audit, forensic auditor) 2-26 Part I: Merry-Go-Round (MGR), a clothing retailer located primarily in shopping malls, was founded in 1968.11 By the early 1990s, the company had gone public and had expanded to approximately 1,500 stores, 15,000 employees, and $1 billion in annual sales. The company’s locations in malls targeted the youth and teen market. The company was listed by Forbes magazine as one of the top 25 companies in the late 1980s. However, in the early 1990s, the company faced many challenges. One of its cofounders died, and the other left to pursue unrelated business interests. The company faced stiff competition from other retailers (e.g., The Gap and Banana Republic), fashion trends changed, and mall traffic declined. Sales fell, and experts speculated that MGR failed to anticipate key industry trends and lost sight of its customer market. To try to regain its strong position, the company acquired Chess King, Inc., a struggling chain of men’s clothing stores located in malls, in 1993. The company’s sales continued to fall, and later in 1993 the company brought back one of its cofounders to manage the company and wrote down a significant amount of inventory. However, this inventory write-down caused the company to violate loan covenants. Facing bankruptcy, the company, based on the advice of its newly hired law firm Swidler and Berlin, hired turnaround specialists from Ernst and Young (E&Y) to help overcome the financial crisis and develop a longterm business plan. However, the company’s decline continued, and it filed for Chapter 11 reorganization in 1994. In 1996, the remaining assets were sold for pennies on the dollar. Subsequently, a group of 9,000 creditors (including former employees and stockholders) began litigation against parties it deemed responsible for their losses. These parties included E&Y, which the creditors sued for $4 billion in punitive and compensatory damages (E&Y’s fees from MGR totaled $4.5 million). The lawsuit alleged that E&Y’s incompetence was the main cause of MGR’s decline and demise. The lawsuit alleged in part that ∙ The turnaround team did not act quickly enough. ∙ The leader of the team took an eight-day vacation at a critical point during the engagement. ∙ The cost-cutting strategy called for only $11 million in annual savings, despite the fact that the company was projected to lose up to $200 million in 1994. ∙ While closing unprofitable stores was key to MGR’s survival, by 1995 only 230 of 1,434 stores had been closed and MGR still operated two stores in some malls. ∙ The turnaround team included inexperienced personnel—a retired consultant, a partner with little experience in the United States or with retail firms in general, and two recent college graduates. ∙ E&Y charged exorbitant hourly rates and charged unreasonable expenses (e.g., charges included reimbursement for a dinner for three of the consultants totaling in excess of $200). E&Y denied any wrongdoing but in April 1999 agreed to pay $185 million to settle with the injured parties. Required: a. Although this was not an audit engagement for E&Y, some of the allegations against the firm can be framed in terms of the Principles Underlying an Audit Conducted in Accordance with Generally Accepted Auditing Standards. Which of the Principles was E&Y alleged to have violated? b. Should there be specific professional standards for CPAs who consult? Given that non-CPAs who consult do not have formal professional standards, describe the advantages and disadvantages that result from CPAs being subject to such standards. a. EY is alleged to have violated the Principles of responsibilities and performance. • • _The firm is alleged to have violated the Principle of responsibilities in the sense that it appeared that the staff assigned to the engagement did not have sufficient training or experience for the engagement. EY’s relationship with MGR’s landlords and attorneys likely caused them to violate this Principle, which requires compliance with relevant ethical requirements. • • _Poor staff assignments, the leader’s vacation, and the use of inexperienced personnel all suggest that the engagement was not adequately planned and that assistants were not properly supervised, which violates the Principle of performance. Also, the inadequate nature of EY’s recommendations suggests that they likely did not gain a sufficient understanding of the entity and its operations. b. There are arguments both for and against having formal standards for CPAs who consult. Advantages include potential increase in public trust, some assurance that a minimal level of service quality would be attained, and perhaps more guidance for consultants (to allow them to perform more effective consulting engagements). The primary disadvantage would result from the fact that CPAs who consult compete with consulting firms comprised of non-CPAs. If standards were not thought out carefully, perhaps the standards would put CPAs at a disadvantage relative to non-CPAs in the sense that CPAs would be subject to standards that constrain their activities or perhaps result in their not being able to compete with non-CPAs in the area of fees. Note that CPAs face certain restrictions in providing consulting services to audit clients. These restrictions are covered in a later chapter.