TEST BANK for Auditing A Practical Approach, 4th Canadian Edition Moroney, Campbell, Warren. by welldoneassistant

CHAPTER 1 INTRODUCTION AND OVERVIEW OF AUDIT AND ASSURANCE CHAPTER LEARNING OBJECTIVES 1. Define an assurance engagement. An assurance engagement involves an assurance provider arriving at an opinion about some information being provided by their client to a third party. A financial statement audit is one type of assurance engagement. This engagement involves an auditor arriving at an opinion about the fair presentation of the financial statements. The audit report is addressed to the shareholders of the company being audited, but other users may read the financial statements. Learning about auditing and assurance requires an understanding of auditing and assurance terminology, including terms such as audit risk, materiality, internal controls, listed entity, and assertions. 2. Explain why there is a demand for audit and assurance services. Financial statement users include investors (shareholders), suppliers, customers, lenders, employees, governments, and the general public. These groups of users demand audited financial statements because of their remoteness from the entity, accounting complexity, their incentives competing with those of the entity’s managers, and their need for reliable information on which to base decisions. The theories used to describe the demand for audit and assurance services are agency theory, the information hypothesis, and the insurance hypothesis. 3. Differentiate between types of assurance services. Assurance services include financial statement audits, compliance audits, performance audits, comprehensive audits, internal audits, and assurance on corporate social responsibility (CSR) disclosures. 4. Explain the different levels of assurance. The different levels of assurance include reasonable assurance, which is the highest level of assurance, limited assurance, and no assurance. Reasonable assurance is provided on an audit of a company’s financial statements. Limited assurance is provided in a review of a company’s financial statements. No assurance is provided in a compilation engagement. 5. Outline different audit opinions An auditor can issue an unmodified opinion, also known as a clean report, or an unmodified opinion with an emphasis of matter paragraph. Alternatively, a modified opinion may be issued as a qualified, an adverse, or a disclaimer of opinion. 6. Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. It is the responsibility of a company’s governing body to ensure that its financial statements are relevant, reliable, comparable, understandable, and true and fair. It is the responsibility of the auditor to form an opinion on the fair presentation of the financial statements. In doing,

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so the auditor must maintain professional scepticism and utilize professional judgement and due care. The firms that provide assurance services include the Big-4 international firms, the national firms (with international links), local and regional firms, and consulting firms that tend to specialize in assurance of CSR and environmental disclosures. 7. Identify the different regulators, legislation, and regulations surrounding the assurance process. Regulators of the assurance process include the Auditing and Assurance Standards Board (AASB), Canadian Securities Administrators (CSA) and the various provincial securities commissions, and the Canadian Public Accountability Board (CPAB). Relevant legislation includes the Canada Business Corporations Act (CBCA). CPA Canada is the professional accounting body in Canada, responsible for the Chartered Professional Accountant (CPA) designation. 8. Describe the audit expectation gap. The audit expectation gap occurs when there is a difference between the expectations of assurance providers and financial statement or other users. The gap occurs when user beliefs do not align with what an auditor has actually done.

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TRUE-FALSE STATEMENTS 1. Only current investors (not potential investors) are considered to be users of the financial statements. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 2. Insurance hypothesis is a means whereby the investor can guarantee the success of their investment. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 3. A compliance audit involves gathering evidence to ascertain whether the person or entity under review has followed the rules, policies, procedures, laws, and regulations with which they must conform. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 4. An operational audit is an example of a compliance audit. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

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5. The most common types of assurance engagements are financial statement audits, confirmation audits, performance audits, comprehensive audits, and assurance on corporate social responsibility (CSR) disclosures. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 6. The nature of audit procedures refers to the reliance on evidence provided by the client and its management. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 7. It is the auditor’s responsibility to prepare the financial statements. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 8. An auditor can provide a reasonable level of assurance on information other than historical financial information. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 9. A reasonable level of assurance is the highest level of assurance that an auditor can provide.

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Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 10. A no assurance engagement is of little use as no assurance is given to the client. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 11. The Compilation Engagement Report explicitly states that no assurance is being provided. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance CPA: Audit and Assurance AACSB: Analytic 12. When conducting a review engagement, a practitioner must obtain an understanding of the entity and test the effectiveness of the entity’s internal controls. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic 13. A negative expression of opinion is only given when there is a disagreement with management and the auditor. Answer: False

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 14. All modified audit reports are qualified audit opinions. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 15. The expectation gap is caused by unrealistic user expectations such as the auditor providing complete assurance. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the audit expectation gap. Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 16. Martha Minnati was reviewing the previous year’s audited financial statements of a clothing manufacturer. Her manager explained to her that for a financial statement audit, the clothing company was the accountable party, its shareholders were the users, and the subject matter was the financial statements. What kind of audit engagement was her manager describing? a) consulting engagement b) assurance engagement c) review engagement d) compliance engagement Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement. Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic 17. An engagement performed by an auditor or practitioner to enhance the reliability of the subject matter can best be described as a(n) a) compilation engagement. b) review engagement. c) consultancy engagement. d) assurance engagement. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement. Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic 18. An example of the three parties in an assurance engagement would be: a) audit client, employee, customer. b) audit client, supplier, auditor. c) auditor, shareholder, general public. d) auditor, general public, employees. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement.

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Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic 19. A limitation of an audit is caused by a) the nature of financial reporting. b) the nature of audit procedures. c) the need for the audit to be conducted within a reasonable period of time and at a reasonable cost. d) all of these answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement. Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic 20. Which of the following groups would be considered users of the financial statements? a) governments b) current shareholders c) general public d) all of these answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 21. The causes of information risk do not include a) independence. b) complexity. c) reliability. d) competing incentives. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

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22. An audit is one way for investors to insure against at least part of their loss should the company they invest in fail – this is an example of a) agency theory. b) information hypothesis. c) insurance hypothesis. d) competing incentives. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 23. According to the agency theory, demand for audit is due to conflicts between a) managers and owners. b) managers and agents. c) owners and principals. d) auditors and owners. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 24. While awaiting a meeting in his firm’s boardroom, the senior partner, Bill Goldsworthy, read the following statement in an article in The Globe & Mail: “The greater the perceived quality of the information contained in the financial statements, the more likely it will be relied upon by the users of that information.” This statement best describes a) the expectations gap. b) agency theory. c) information hypothesis. d) insurance hypothesis. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance

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AACSB: Analytic 25. As users of the financial statements, suppliers would least consider which of the following aspects of the financial statements? a) solvency of the entity b) profitability of the entity c) return on investment of the entity d) corporate social responsibility of the entity Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 26. Which of the following is incorrect? A government can be considered to be a user of the general purpose financial statements because a) it is the sole basis for the calculation of taxes owed to the government. b) it can determine whether certain regulations have been complied with. c) it can gain a better understanding of the entity’s activities. d) governments need to assess the entity so that they can provide the entity with grants that will benefit society. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 27. Agency theory can be described as the theory of a) hiring an agency to review the work of the management, in this case it is the auditor. b) when the finance function is outsourced to an outside party, and the auditor is required to audit the outside party’s work. c) the relationship between the owner and the management of the business when the owner is not the manager of the business. d) the relationship between the auditor and the management of the business. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance

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AACSB: Analytic 28. Insurance hypothesis tells us that a) investors will demand that financial statements be audited as a way of insuring against some of their loss should their investment fail. b) investors can insure themselves against loss by investing in a diverse investment portfolio should an individual investment fail. c) investors cannot insure themselves against loss when investing in an entity. d) the entity can take out insurance to protect itself from such risks as employee or management fraud which can lead to material misstatements in the financial statements. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 29. Vera Sobczyk spent a week at a client’s wholesale operation determining whether the client’s remittances to the tax authorities were in accordance with tax regulations. This is an example of a(n) a) taxes payable mandate. b) financial audit. c) operational audit. d) compliance audit. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 30. Ming Yao reviewed the operations of a basketball academy. His objectives were to determine how effectively the academy delivered its many programs. What kind of an audit did he perform? a) operational b) compliance c) financial d) comprehensive Answer: a Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 31. Matt Fuller reports to the board and evaluates how the company can improve risk management practices, internal control procedures, and certain governance issues. Who is he? a) President b) Controller c) Treasurer d) Internal Auditor Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 32. Which of the following is not true about Corporate Social Responsibility assurance? a) reporting is voluntary and is becoming more widespread b) includes both financial and non-financial information c) is required to be performed by an auditor d) disclosures include environmental, employee, and social reporting Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 33. Which of the following is a component of the “Other Information” section of the auditor’s report? a) auditor’s responsibilities with respect to the audited financial statements b) management’s responsibility for internal controls as they relate to the financial statements c) responsibility of those charged with governance to oversee the financial reporting process d) management’s responsibility for other information Answer: d Bloomcode: Knowledge Difficulty: Easy

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Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic 34. Which of the following is not a component of the Review Engagement Report? a) practitioner’s responsibility for the financial statements b) management’s responsibility for the financial statements c) practitioner’s opinion over the reasonableness of the financial statements d) procedures applied to the review engagement and how they differ from an audit engagement Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic 35. Michael Stiller performed work for a client in the real estate business and issued a Compilation Engagement Report. What degree of assurance does a compilation engagement provide to the user of the statements? a) reasonable assurance b) moderate assurance c) no assurance d) complete assurance Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 36. Theodore Heinrich prepared a set of financial statements based on information provided to him. He checked mathematical accuracy of the data, and the client complimented him on the reasonable cost of the work he performed. Theodore performed a) a compilation engagement. b) a review engagement. c) an audit engagement. d) an operational audit engagement Answer: a Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 37. Jimmy Bunting, the practitioner at Yanzhou Coal Mining and Minerals, performed the following tasks: he used analytical procedures and he had discussions with management. These activities were a basis for a conclusion on the financial information. What did Jimmy Bunting perform? a) a qualified report b) an unmodified opinion c) a compilation engagement d) a review engagement Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 38. Which of the following would be an example of a reasonable assurance engagement? a) the review of annual financial statements b) the audit of annual financial statements c) the reporting of procedures performed by the auditor as agreed by the client d) the compilation of annual financial statements Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 39. The wording of a limited assurance engagement expresses a conclusion that generally states a) there is nothing wrong with the subject matter. b) there is something wrong with the subject matter. c) there is nothing that has come to the attention of the auditors that would lead them to believe that the information being assured is not true and fair. d) there is something that has come to the attention of the auditors that would lead them to believe that the information being assured is not true and fair.

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Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 40. In a review engagement, which of the following is least likely to occur during the engagement? a) analytical procedures b) inquiries with management and other personnel c) substantive audit procedures d) review of the accounting systems of the entity. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 41. Maggie Oh performed an audit of a client that had undergone flooding to its operations in St-Jean Sur Richelieu. The client was insured and was able to keep operating. However, there was material damage to the client’s warehouse and Maggie felt it would be appropriate to inform the users of the financial statements of this fact in the audit report. This form of audit report is called

a) an adverse opinion. b) an unmodified opinion – emphasis of matter. c) a modified opinion. d) a disclaimer of opinion. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 42. Based on the evidence gathered, if an auditor concludes all noted misstatements in the financial statements to be immaterial, individually and collectively, then the auditor would

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a) resign from the engagement. b) emphasize the errors in the audit report. c) issue an unqualified opinion. d) issue a qualified opinion. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 43. An unqualified opinion is also known as a(n) a) clean opinion. b) adverse opinion. c) unmodified opinion. d) both clean opinion and unmodified opinion. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 44. An example of an unmodified audit opinion is a) qualified audit opinion. b) adverse audit opinion. c) unqualified audit opinion with an emphasis of matter. d) denial of audit opinion. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 45. Which of the following is not a type of opinion? a) qualified opinion b) adjusted opinion c) adverse opinion d) disclaimer of opinion

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Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 46. The following can be said about an emphasis of matter: a) it is included when the auditor’s opinion has changed and the auditor wants to bring the users’ attention to a particular matter. b) it is only used in unqualified audit opinions. c) it is included when the auditor’s opinion has not changed and the auditor wants to bring the users’ attention to a particular matter. d) it cannot be used when expressing an audit opinion that has pervasive misstatements. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 47. A financial statement auditor is required to audit all of the following except a) income statement and balance sheet. b) statement of cash flows. c) management discussion and analysis. d) notes to the financial statements. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 48. For a financial report to be relevant, it must a) be free from material misstatement. b) have an impact on the decisions made by users regarding the performance of the entity. c) be periodically audited by an independent auditor. d) include an audit report

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Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 49. For a financial report to be reliable, it must a) be free from material misstatement. b) have an impact on the decisions made by users regarding the performance of the entity. c) be periodically audited by an independent auditor. d) be reviewed by an internal auditor Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 50. When conducting an audit, an auditor should use a) professional scepticism. b) professional judgement. c) due care. d) all of these answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 51. The top tier of accounting firms is comprised of a) Deloitte, Ernst & Young, PricewaterhouseCoopers (PwC), and KPMG. b) Ernst & Young, PricewaterhouseCoopers (PwC), KPMG, and BDO. c) Deloitte, Ernst & Young, KPMG, and Grant Thornton. d) WHK Group, Deloitte, KPMG, and PricewaterhouseCoopers (PwC).

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Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 52. Mary Logan was careful to undertake her audits in a most responsible manner. Her audit manager complimented her on her diligence and how well she documented her work at the different stages of the audit process. Which element of responsibility did she display?

a) due care b) professional judgment c) professional scepticism d) professional attitude Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 53. Larry Dibitonto is a partner in his firm and runs management consulting, mergers and acquisitions, insolvency, tax, and accounting services. How are these services referred to collectively? a) audit b) non-assurance services c) reviews d) compilations Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

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54. In addition to the preparation of financial statements, it is also the responsibility of those charged with governance to a) identify the financial reporting framework to be used in the preparation and presentation of their financial statements. b) establish and maintain internal controls that are effective in preventing and detecting material misstatements. c) selecting and applying appropriate accounting policies and making reasonable accounting estimates. d) all of these answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 55. Which of the following is not true in relation to comparability? a) able to identify trends that may influence their perception of how well the entity is doing b) able to assess performance of the entity over time and with other entities c) able to be understood d) able to consistently apply accounting principles Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 56. Professional scepticism does not involve a) the professional requirement that all management representations be substantiated with supporting documentation. b) seeking independent evidence to corroborate information provided by their client. c) being suspicious when evidence contradicts documents held by their client or inquiries made of client personnel. d) the attitude adopted by the auditor when conducting the audit. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

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Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 57. The largest accounting firms in Canada are known collectively as the a) ‘Big-3’. b) ‘Big-4’. c) ‘Big-5’. d) ‘Big-6’. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 58. Auditors of reporting issuers are required to be a member in good standing with a) CPAB. b) CSA. c) CPA Canada. d) OSFI. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different regulators, legislation, and regulations surrounding the assurance process. Section Reference: 1.7 The role of regulators and regulations CPA Competency: Audit and Assurance AACSB: Analytic 59. Under the Canada Business Corporations Act, the auditor has a responsibility to form an opinion on the company’s a) operations. b) independence. c) financial statements. d) tax calculation. Answer: c Bloomcode: Knowledge Difficulty: Easy

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Learning Objective: Identify the different regulators, legislation, and regulations surrounding the assurance process. Section Reference: 1.7 The role of regulators and regulations CPA Competency: Audit and Assurance AACSB: Analytic 60. The expectation gap is caused by a) realistic auditor expectations. b) unrealistic user expectations. c) realistic user expectations. d) unrealistic auditor expectations. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the audit expectation gap. Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic 61. The expectation gap cannot be reduced by a) auditors performing their duties properly. b) enhanced reporting to explain what processes have been followed in arriving at an audit or a review opinion. c) assurance providers reporting accurately the level of assurance being provided. d) management preparing the financial statements. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the audit expectation gap. Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic 62. The audit expectation gap is the difference in the expectations of the a) assurance providers and the financial statement users. b) assurance providers and the audit client. c) audit client and the financial report or other users. d) audit client and the regulator. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the audit expectation gap. Section Reference: 1.8 The audit expectation gap

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CPA Competency: Audit and Assurance AACSB: Analytic

SHORT ANSWER QUESTIONS 63. Indicate whether you agree or disagree with the following statements and explain your reasoning. a) Maurice Lecuyer feels that an internal auditor that reports to the chief financial officer of the company can be as independent as an auditor that reports to the audit committee. b) Jillian Humphrey discovered a very material overstatement in the financial statements of Humphrey’s Holistic Medicine. She felt that the misstatement would have an impact on the decisions of users of the financial statements, and indicated to her audit senior that she would be including it as an “emphasis of matter” paragraph in the audit report. c) An auditor is responsible for the preparation and fair presentation of the financial statements in accordance with International Financial Reporting Standards, and for such internal control as is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. d) An assurance engagement involves evaluation or measurement of subject matter against criteria. Answer: a) Disagree. The internal auditor’s independence is protected best when they report to the highest level of governance, usually the Audit Committee of the Board or to the President of the company. b) Disagree. The pervasiveness of the material misstatement will require an adverse opinion. In this case, the misstatements affect the financial statements materially and will require disclosures that are vital to a user’s understanding of the financial statements. When statements are pervasively and materially misstated, an adverse opinion is appropriate. c) Disagree. The above statement describes management’s responsibilities. An auditor has the responsibility to express an opinion on financial statements based on an audit. d) Agree. An assurance engagement is an engagement where a practitioner issues a written report and concludes on a subject matter for which the accountable party is responsible. Therefore, a prerequisite for an assurance engagement is the existence of an accountability relationship, where one party is answerable to another for the subject matter. Bloomcode: Application Difficulty: Medium Learning Objective: Define an assurance engagement. Learning Objective: Differentiate between types of assurance services. Learning Objective: Explain the different levels of assurance. Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.1 Auditing and assurance defined Section Reference: 1.3 Different assurance services

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Section Reference: 1.4 Different levels of assurance Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic 64. Outline the reasons for the demand for assurance services. Answer: Remoteness – As most users do not have access to the entity under review, this makes it difficult to determine whether the information contained in the report is a fair presentation of the entity and its activities for the relevant period. Complexity – Most financial statement users do not have the accounting and legal knowledge to enable them to assess the complex accounting and disclosure choices being made by the entity. Competing incentives – Management may have their own incentives to present the information in a particular light which may help them achieve their own objectives. This may introduce bias in what is being presented. Reliability – As the information is being depended upon to make important decisions, it is important that the information being presented is reliable Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services. Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 65. The main assurance service the general public are familiar with are financial statement audits. Briefly describe the other services that an auditor can provide. Answer: A compliance audit involves gathering evidence to ascertain whether the person or entity under review has followed the rules, policies, procedures, laws, and regulations with which they must conform. Performance audits are concerned with the economy, efficiency, and effectiveness of an organization’s activities. A comprehensive audit may encompass elements of a financial statement audit, a compliance audit, and a performance audit. Internal audits are conducted to provide assurance about various aspects of an organization’s activities. Corporate social reporting disclosures include environmental, employee, and social reporting. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services. Section Reference: 1.3 Different assurance services

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CPA Competency: Audit and Assurance AACSB: Analytic 66. Identify the three levels of assurance. Identify the three types of engagements relating to each level of assurance and the expression of opinions that would be provided by the assurance provider Answer: Level of Assurance Reasonable Limited None

Type of Engagement Audit Review Agreed-Upon Procedures

Expression of Opinion Positive Negative None

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic 67. Identify the three types of engagements, the level of assurance each engagement provides, and describe the types of procedures that would be performed for each engagement. Answer: Audit Engagement: Provides a high level of assurance (reasonable assurance). Procedures performed to obtain sufficient appropriate evidence include a combination of inspection, observation, confirmation, recalculation, re-performance, analytical procedures, and inquiry. Review Engagement: Provides limited assurance. Procedures performed to obtain sufficient appropriate evidence include inquiry and analytical procedures. Compilation Engagement: Provides no assurance. The practitioner should gain an understanding of the business, systems, and operations, and discuss with management the assumptions made in the preparation of the financial statements. The practitioner would also format the financial statements and verify the mathematical accuracy. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance. Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic 68. What does pervasive mean? What report would an auditor use if financial statements contained a misstatement that was material and pervasive? Answer: ”Pervasive” refers to misstatements that are not confined to individual accounts or elements of a financial statement, or, if confined, the misstatements impact an extensive portion of a financial statement or are disclosures that are vital to a user’s understanding of the financial statements.

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An auditor would use an audit report that identified material and pervasive misstatements either in a situation that the auditor was either able to identify (adverse) or not able to identify (disclaimer of opinion) through sufficient and appropriate audit procedures. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions. Section Reference: 1.5 Difference audit opinions CPA Competency: Audit and Assurance AACSB: Analytic 69. How is the expectation gap caused and how can the effects on the expectation gap be reduced? Answer: In particular, the gap is caused by unrealistic user expectations such as: • the auditor is providing complete assurance • the auditor is guaranteeing the future viability of the entity • an unqualified (clean) audit opinion is an indicator of complete accuracy • the auditor will definitely find any fraud • the auditor has checked all transactions. The expectation gap can be reduced by: • auditors performing their duties appropriately, complying with auditing standards, and meeting the minimum standards of performance that should be expected of all auditors; • peer reviews of audits to ensure that auditing standards have been applied correctly; • auditing standards being reviewed and updated on a regular basis to enhance the work being done by auditors; • education of the public; • enhanced reporting to explain what processes have been followed in arriving at an audit (reasonable assurance) or a review (limited assurance) opinion (significant improvements have been introduced by standard setters improving assurance reporting); and • assurance providers reporting accurately the level of assurance being provided (reasonable, limited or none). Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the audit expectation gap. Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 70. Vince Deroy owns Val D’Or Vineyards, a successful winery in the Thousand Islands region. Annual sales are $3,500,000 and he has a $1,200,000 loan with a local bank.

Sales are split between wine sales (88%) and wine tasting and catering (12%). Vince has excellent personal relationships with his suppliers and has been provided with special contractual terms which allow him delays of up to 120 days to make invoice payments. These arrangements run out this year and he will have 30 days to pay after being invoiced. The bank has made the $1,200,000 loan to Val D’Or Vineyards based on an understanding that the company will undergo an annual audit of its financial statements. Vince is an astute entrepreneur and has set up an advisory board which consists of his bank manager, another wine grower in the region, his old high school ethics instructor and track coach, himself, and his accountant. The board has discussed certain issues including the following: • The need for assurance service providers to audit his financial statements so that users can be provided with assurance that his statements are relevant and reliable. • Non-audit services that would provide advice on special projects he may be considering in the future. • A proper accounting firm to conduct an audit mandate. Required: a) What is the objective of a financial statement audit and how does it relate to Val D’Or Vineyards? b) Vince Deroy’s financial statements must be relevant and reliable. What do these two terms mean in the context of this case? c) What three characteristics should Val D’Or Vineyards’ auditors possess when conducting an audit? Explain them briefly. d) What are non-audit services? Can you describe possible non-audit services that Val D’Or Vineyards might employ? Answer: a) A financial statement audit provides reasonable assurance about whether the financial statements are prepared in all material respects in accordance with the financial reporting framework. The Val D’Or Vineyards auditors will use the rules of Canadian GAAP (either IFRS or ASPE) to ensure that the main current users (shareholders, bank, tax authorities) and potential users (suppliers, future investors) are provided with audited statements that will provide them with assurance. The auditors will lend credibility to the information because they are independent. b) Information is relevant if it has an impact on the decisions made by users regarding the performance of the entity. For example, the bank would be interested in evaluating past decisions made by Val D’Or Vineyards management and predicting whether the entity will remain viable (that is, a going concern) into the future. This will give them confidence that the $1,200,000 loan will be repaid. Users like the bank or key suppliers of Val D’Or

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Vineyards can use current information to estimate the future ability of the entity to meet its obligations. Information is reliable when it is free from material misstatements (errors or fraud). The information must be unbiased; it must not be presented in such a way as to influence the decision-making process of the user. The best way Val D’Or Vineyards can ensure others will perceive that its financial statements are without bias, is through an independent audit of the statements. c) When undertaking an audit, the auditor should use professional scepticism, professional judgement, and due care. Professional scepticism Professional scepticism is an attitude adopted by the auditor when conducting the audit. It means that the auditor remains independent of the entity, its management, and its staff when completing the audit work. In a practical sense, it means that the auditor maintains a questioning mind and thoroughly investigates all evidence presented by the client. The auditor must seek independent evidence to corroborate information provided by the client and must be suspicious when evidence contradicts documents held by the client or enquiries made of client personnel (including management and those charged with governance). Professional judgement Professional judgement relates to the level of expertise, knowledge, and training that an auditor uses while conducting an audit. An auditor must utilize their judgement throughout the audit. For example, an auditor must determine the reliability of an information source and decide on the sufficiency and appropriateness of evidence gathered, the procedures to be used in testing, and an appropriate sample size. Due care Due care refers to being diligent while conducting an audit, applying technical and statutebacked standards, and documenting each stage in the audit process. d) Non-assurance services include management consulting, mergers and acquisitions, insolvency, tax, and accounting services. Accounting firms are not the only providers of non-assurance services. Val D’Or Vineyards could hire someone to review its plan to expand its vineyard operations, as an example. Other types of services: corporate social responsibility, employee safety, tax planning, insurance arrangements for key officers of the company, etc. Bloomcode: Analysis Difficulty: Medium Learning Objective: Differentiate between types of assurance services. Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services. Section Reference: 1.3 Differentiate assurance services Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

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CHAPTER 2 ETHICS, LEGAL LIABILITY, AND CLIENT ACCEPTANCE CHAPTER LEARNING OBJECTIVES 1. Describe the fundamental principles of professional ethics. The fundamental principles of professional ethics include professional behaviour (upholding the reputation of the profession); integrity (being straightforward and honest) and due care (acting diligently and complying with both technical and professional standards); professional competence (maintaining knowledge and skill at an appropriate level); confidentiality (not sharing information that is learned at work); and objectivity (not allowing personal feelings or prejudices to influence professional judgement). There are also specific rules that incorporate the guiding ethical principles and that are enforceable. Some of these rules concern fees and pricing, advertising, contact with predecessor auditors, firm names, and professional contact. Despite principles and rules to guide professional conduct, professional accountants can expect to face ethical dilemmas over their careers. A framework for solving ethical dilemmas includes identifying the ethical issues, determining who is affected by the outcome of the dilemma and how each individual or group is affected, identifying the likely alternatives available to the person who must resolve the dilemma, and deciding on the appropriate action. 2. Describe professional judgement and professional skepticism. Professional judgement relates to the level of expertise, knowledge, and training that an auditor uses throughout an audit. A framework for professional judgement decision-making includes identifying the problem, gathering the facts, performing the analysis, making a decision, and documenting the decision-making process. Professional skepticism is a component of professional judgement. Professional skepticism means having a questioning mind, being alert to conditions that indicate a misstatement whether due to fraud or error, and critically assessing evidence. While there are qualities associated with professional skepticism, external factors and unconscious biases can impede it. Common biases that can impede auditor professional skepticism are the availability bias, confirmation bias, overconfidence bias, and the anchoring bias. 3. Define and assess auditor independence. Independence is the ability to make a decision that is free from bias, personal beliefs, and client pressures. An external auditor must not only be independent of their client, they must also appear to be independent of their client. Threats to auditor independence include self-interest, self-review, advocacy, familiarity, and intimidation threats. A self-interest threat can occur when an auditor has a financial interest in a client. A self-review threat can occur when an auditor must form an opinion on their own work or work done by others in their firm. An advocacy threat can occur when an auditor acts on behalf of their client. A familiarity threat can occur when there is a close relationship between the auditor and their client. An intimidation threat can occur when an auditor feels threatened by their client. Safeguards to auditor independence include the code of ethics, legislation, the establishment of audit committees by clients, client acceptance and continuance procedures, partner rotation policies, and education within accounting firms.

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4. Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Auditors report to their clients’ shareholders. These are the owners who rely on the audited financial statements when evaluating the performance of their company. The board of directors represents the shareholders and oversees the activities of the company and its management. It is the directors’ responsibility to ensure that the financial statements being audited are fairly presented. The audit committee is responsible for liaising between the external auditor, the internal auditor, and those charged with governance to aid the board of directors in ensuring that the financial statements are fairly presented and that the external auditor has access to all records and other evidence required to form their opinion. The external auditor may use the work performed by the internal auditors after considering the function’s objectivity, technical competence, and due professional care, and the effectiveness of communication between internal and external auditors. 5. Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Contributory negligence is where a client is found to be negligent and to have contributed to the loss suffered by the plaintiff. To successfully sue an auditor, a plaintiff must prove that a duty of care was owed by the auditor, there was a breach of that duty, and a loss was suffered as a result of that breach. Several cases are discussed in the chapter in relation to an auditor’s liability to third parties. To establish that an auditor owes them a duty of care, a third party must now establish that the auditor was aware that the third party was going to use the financial statements and that the users relied on the financial statements for the purpose for which they were prepared. 6. Identify the factors to consider in the client acceptance or continuance decision. Factors to consider include the integrity of a client, such as the client’s reputation and attitude to risk, accounting policies, and internal controls. An auditor will gain an understanding of the client through communication with the client’s previous auditor (in the case of a client acceptance decision), staff, management, and other relevant parties. The final stage in the client acceptance or continuance decision process involves preparing an engagement letter, which sets out the terms of the audit engagement to avoid any misunderstandings between the auditor and their client.

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TRUE-FALSE STATEMENTS 1. Compliance with the fundamental ethical principles is mandatory for all members of the accounting profession. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic 2. Objectivity refers to the obligation that all members of the professional bodies be Straightforward and honest. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic 3. The auditor uses professional skepticism during the decision-making process as an element of professional judgement. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism. Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 4. Trusting in management’s ability to make appropriate estimates is a strategy to avoid bias. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism.

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Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 5. Independence in appearance is the ability to act with integrity, objectivity and professional scepticism. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 6. An example of an advocacy threat is encouraging others to buy shares or bonds being sold by the client. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 7. An effective audit committee will enhance the independence of the external audit function. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 8. When auditors divest themselves of shares owned in a client company, they are eliminating their self-review threat to independence. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

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Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 9. The key difficulty for third parties in successfully claiming against the auditor is establishing that the client's management contributed to the third party's loss. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 10. Ensuring compliance with auditing regulations will not assist auditors in avoiding litigation. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 11. Third parties are anyone other than the client and its shareholders that use the financial statements to make a decision. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 12. Being negligent means not exercising due care. Answer: True Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 13. Auditors can help avoid litigation by implementing policies and procedures that ensure all work is fully documented. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 14. When assessing client integrity, the auditor will consider the appropriateness of the client's interpretation of accounting rules. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 15. An engagement letter sets out the terms of the engagement. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 16. An engagement letter does not include an overview of the client's responsibility for the

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preparation of the financial statements. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 17. Jim Spence wrote up an advertisement for his firm. In his draft to the local newspaper, he indicated that the firm was able to provide services that he knew it could not deliver. Which part of the profession’s standards or codes of conduct was Jim breaking? a) objectivity b) professional behaviour c) confidentiality d) communication Answer: b Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics 18. Members must attain a level of competence and keep up to date with changes in regulations. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer? a) objectivity b) professional competence and due care c) professional behaviour d) integrity Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic 19. All members of professional bodies must be straightforward and honest. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer? a) confidentiality b) objectivity c) integrity d) professional behaviour Answer: c

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic 20. The obligation is that all members of the professional bodies are not allowed to let their personal feelings influence their judgment. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer? a) confidentiality b) objectivity c) integrity d) professional behaviour Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic 21. Which of the following is not one of the fundamental principles of the Code of Ethics for Professional Accountants? a) confidentiality b) objectivity c) integrity d) intelligence Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic 22. Which of the following is a fundamental principle of professional ethics? a) confidentiality b) objectivity c) integrity

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d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics 23. Professional behaviour refers to the obligation that all members of the professional bodies a) ensure that they do not harm the reputation of the accounting profession. b) not allow their personal feelings or prejudices to influence their professional judgment. c) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. d) be straightforward and honest. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics 24. Objectivity refers to the obligation that all members of the professional bodies a) be straightforward and honest. b) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. c) not allow their personal feelings or prejudices to influence their professional judgment. d) ensure that they do not harm the reputation of the accounting profession. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional. Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics 25. Which of the following is not a common form of bias that may affect an auditor? a) objectivity bias

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b) confirmation bias c) availability bias d) overconfidence bias Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism. Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 26. Qualities associated with professional skepticism include all of the following except a) withholding judgement until appropriate evidence is gathered b) trust in management’s ability to make appropriate estimates c) tendency to inquire d) self-confidence to challenge assumptions Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism. Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 27. Which of the following are considered qualities associated with professional skepticism? a) withholding judgement until appropriate evidence is gathered b) self-confidence to challenge assumptions c) tendency to inquire d) All of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism. Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 28. Faith Goodfellow has been an audit manager at Happy & Gumble LLP, CPA’s the past ten years. Two years ago, she performed human resources and internal audit functions for 9 months while her client underwent a major restructuring. Her firm has a policy of changing audit

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partners and managers every five to seven years. She is reluctant to take on the audit because she believes there is an independence threat. Which threat is in play? a) integrity threat b) familiarity threat c) self-review threat d) advocacy threat Answer: c Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Ethics 29. Jane Lee just joined the firm of Jansen & Dennison LLP (JD). She found out that she owns shares in a client company of JD. She is going to divest herself of these shares. Which threat to her independence will she be eliminating? a) self-interest threat b) self-review threat c) familiarity threat d) advocacy threat Answer: a Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Ethics 30. Moanna Johnson, CPA lives in the same neighbourhood as one of her major clients. She and her children are involved in the Lower Thames Yacht Club, as are many of her client’s management employees. How would her independence threat best be described? a) self-interest threat b) self-review threat c) advocacy threat d) none of these Answer: d Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

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Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 31. Krista Kirschfield audits a company that has market capitalization of $20,000,000. There is also a requirement that the partners in her firm be rotated every seven years and the audit committee must pre-approve all services provided to the client by Krista’s firm. What kind of client is this? a) small business b) diversified c) reporting issuer d) partnership Answer: c Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 32. When Jeffrey Bona, CPA tried to collect last year’s audit fees, he was told that he would receive the fees for the previous year and the current year upon finishing this year’s work and issuing a “clean” audit opinion. This was non-negotiable and he was told that if he did not want to go along with it, the client would get another auditor. When he decided to leave his client, what threat to his independence did he mitigate? a) self-interest threat b) self-review threat c) advocacy threat d) intimidation threat Answer: d Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 33. The firm of McMaster and Martin, CPAs is concerned that its client’s current corporate culture may have an impact on the firm’s independence. What kinds of safeguards can the client introduce or create to reduce the threat to independence?

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a) introduce appropriate corporate governance mechanisms such as the establishment of an audit committee b) ensure that the responsibility for the appointment and removal of an auditor rests with independent directors on the audit committee or the board c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 34. Auditor independence is a) defined as acting with integrity, objectivity and professional scepticism. b) essential when complying with the ethical principles to act with integrity and objectivity. c) both a and b d) not fundamental to every audit. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 35. Independence in appearance is a) the ability to act with integrity, objectivity and professional scepticism. b) the belief that independence of mind has been achieved. c) the ability to make a decision that is free from bias, personal beliefs and client pressures. d) also referred to as actual independence. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

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36. Threats to the independence of auditors include a) familiarity threats. b) self-interest threats. c) advocacy threats. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 37. A self-interest threat refers to the threat that can occur when an accounting firm or its staff a) is threatened by the client's staff or directors. b) has a financial interest in an audit client. c) needs to form an opinion on their own work or work performed by others in the firm. d) acts on behalf of its assurance client. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 38. Which of the following is an example of a familiarity threat to independence? a) a bank account held with the client b) performing services for the client that are then assured c) owning shares of the client d) a former partner of the assurance firm holding a senior position with the client Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

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39. What type of threat to independence arises when an accounting firm acts on behalf of its assurance client? a) advocacy threat b) self-interest threat c) intimidation threat d) self-review threat Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 40. Intimidation threats to independence include a) the threat that that the client will use a different assurance firm next year. b) a close business relationship with the client. c) representing the client in a legal dispute. d) preparing information for the client that is then assured. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 41. Safeguards to independence are created by a) the general public. b) the profession, legislation or regulation. c) lawyers. d) dependent directors. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

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42. An example of a safeguard to independence created by accounting firms is a) the establishment of a code of ethics. b) legislation that requires that an auditor be independent. c) the existence of client acceptance and continuation procedures. d) the establishment of an audit committee. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 43. Having policies and procedures to ensure the quality of an assurance engagement is an example of a safeguard to independence created by a) the client's audit committee. b) the Canada Business Corporations Act. c) the client's board of directors. d) the accounting firm. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 44. When the external auditors perform work they are responsible for auditing the financial statements. Which users are the auditors least likely to deal with in fulfilling their duties? a) executive directors of the board b) audit committee of the board c) shareholders d) internal auditors Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others

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CPA Competency: Audit and Assurance AACSB: Analytic 45. What key groups have a professional link with the external auditor? a) client's board of directors, audit committee, and prospective shareholders b) client’s shareholders, the board of directors, audit committee and the internal audit team c) client’s shareholders and prospective shareholders and board of directors d) client’s shareholders only Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 46. The audit committee should a) consist of only non-executive directors of the Board of Directors. b) consist of major shareholders of the client company. c) report to the shareholders at the annual general meeting. d) consist of both executive and non-executive directors of the Board of Directors. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 47. The audit committee a) communicates with the auditor regarding any disagreements with management regarding accounting policies and the financial statements. b) has the responsibility to ensure that the financial statements are presented fairly. c) makes decisions regarding the appointment and/or removal of auditors. d) reports directly to the shareholders. Answer: b Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 48. The relationship between the external and internal auditor can be described as a) the internal audit function is separate and independent of the external audit. b) the external auditor can review the effectiveness of the internal audit function to modify the nature and timing of audit testing. c) the external auditor relies solely on the internal auditor’s reports. d) non-existent. Under no circumstances can the external auditor rely on any work of the internal audit function. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 49. The main recipients of the financial statements and the attached audit report are acknowledged as a) the board of directors. b) the shareholders or members. c) the audit committee. d) the provincial stock exchanges. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 50. Examples of board committees include the a) risk committee. b) nomination committee.

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c) compensation committee. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 51. It is the responsibility of the board of directors to a) ensure that the financial statements are fairly presented. b) provide an opinion on the fair presentation of the financial statements. c) direct the auditors to audit specific financial statement accounts. d) determine if shareholders should sell their investment in the company. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 52. Executive directors are a) part of the company's management team. b) full-time employees of the company. c) not members of the company's board of directors. d) both a and b Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 53. Yollande Beauchemin withdrew from a client engagement. The client sued her for not

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fulfilling the understanding in the engagement letter and can establish that Yollande owed him a duty of due care. How can this be done using legal means? a) the client can sue the auditor for breach of contract b) the client can claim that the auditor failed to take reasonable care in the performance of the audit c) both a and b d) none of the above Answer: a Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 54. The Kingston Cotton Mill case states that the duty of the auditor is to a) assume that the clients’ statements are not materially misstated. b) approach the audit with professional scepticism. c) approach the audit with suspicion. d) always issue a clean opinion on the client’s financial statements. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 55. The Pacific Acceptance case set the standards of reasonable care and skill required for the conduct of an audit. Which one of the following was not one of the recommendations? a) closely supervise and review the work of junior staff b) properly document procedures used c) duty to use reasonable care and skill d) promptly report material fraud Answer: d Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 56. Contributory negligence means a) the actions of the client as well as the actions of the auditor lead to losses suffered. b) actions by the client and shareholders led to losses suffered. c) actions of the client lead to the losses suffered. d) actions of the auditor lead to losses suffered. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 57. Which of the following statements regarding the auditor’s responsibility to third parties is correct? a) The auditor has no legal responsibility to third parties. b) Third parties can sue the auditor under contract for any losses suffered. c) Third parties can sue the auditor if they were owed a duty of care, suffered a loss, and the auditor was negligent in the conduct of the audit. d) Third parties can sue, whether or not they suffered a loss, as long as they establish that the auditor owed them a duty of care and the auditor was negligent. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 58. An auditor can decrease the possibility of litigation by a) preparing engagement letters. b) complying with ethical principles and pronouncements. c) ensuring all audit staff have the required skills and competence to conduct the audit.

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d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 59. Management failed to put in a system of adequate internal controls. The public accounting firm uncovered the weakness, but did not report it to the Board members of the company. What kind of liability, if any, would the auditors be exposed to? a) breach of contract b) contributory negligence c) both a and b d) no liability Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 60. The principles established by Justice Moffitt in the Pacific Acceptance case do not include a) auditors are watchdogs but not bloodhounds. b) auditors must properly document procedures used. c) auditors have a duty to use reasonable skills and care. d) auditors must audit the whole year. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

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61. Under tort law, to prove that an auditor has been negligent the plaintiff must establish a) there was a breach of the duty of care. b) a loss was suffered as a result of the breach of duty of care. c) a duty of care was owed by the auditor. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 62. Auditors can decrease the possibility of litigation by a) ensuring compliance with ethical regulations. b) meeting with the client's nomination committee to discuss any significant audit issues. c) training their staff and regularly updating their knowledge. d) both a and c Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 63. James Taggert has reviewed the engagement letter his firm has prepared for a client. Which of these elements would he be surprised to find? a) unrestricted access to persons within the entity in order to obtain audit evidence b) references to Canadian generally accepted auditing standards c) management’s responsibilities d) previous year’s internal control issues Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions

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CPA Competency: Audit and Assurance AACSB: Analytic 64. Which of the following statements is not true regarding engagement letters? a) Engagement letters are prepared by the client and acknowledged by the auditor before commencement of each audit. b) Engagement letters are a form of contract between the auditor and the client. c) Engagement letters are prepared before commencing every audit engagement. d) Engagement letters set out the terms of the audit engagement. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 65. If a prospective new audit client does not allow the auditor to contact its existing auditor, a) the auditor should contact the existing auditor anyway because it is the duty. b) the auditor should refuse to take on the prospective new client. c) the existing auditor should contact the new auditor to tell them all about the client. d) the auditor should respect the prospective client’s right to privacy. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 66. An auditor's assessment of their client's integrity would not include a) whether the auditor has sufficiently competent staff to complete the audit. b) the client's attitude to audit fees and its willingness to pay a fair amount. c) the client's attitude to risk exposure and management. d) the reputation of the client and its management. Answer: a Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 67. The final stage in the client acceptance and continuance decision process involves a) the auditor obtaining a management representation letter from the client. b) the auditor preparing an independence declaration statement. c) the client's audit committee meeting with the auditor. d) the preparation of an engagement letter. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 68. Explain the five fundamental principles of professional ethics. Answer: The fundamental ethical principles that apply to all members of the professional bodies are to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. Integrity refers to the obligation that all members of the professional bodies be straightforward and honest. Objectivity refers to the obligation that all members of the professional bodies not allow their personal feelings or prejudices to influence their professional judgment. Professional competence and due care refers to the obligation that all members of the professional bodies maintain their knowledge and skill at a level required by the professional bodies. Confidentiality refers to the obligation that all members of the professional bodies refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. Professional behaviour refers to the obligation that all members of the professional bodies comply with rules and regulations and ensure that they do not harm the reputation of the profession. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethics CPA Competency: Audit and Assurance AACSB: Analytic 69. For the following scenarios, state the violation(s) to the Rules of Professional Conduct: a) Chance Randall, CPA, began a telephone campaign to grow his client base. He began calling companies listed in the telephone directly within a twenty mile radius advising them of his accounting services. After making several phone calls, Chase finally landed a new audit client, Big Bob’s Auto Sales and Leasing Ltd. In order to secure this new business, Chase entered into an agreement with Big Bob whereby Chase would receive a flat fee every time he referred one of his clients to Big Bob’s. He would also earn a 1% percent commission on any vehicle sale or lease that resulted from the referral. As their business relationship grew overtime, Chase asked Big Bob for a loan claiming he wanted to expand his accounting practice. He in fact took the funds for his own personal use without advising his client. b) Anand Lee, CPA, was the CFO of ABC Incorporated. In his role as CFO, he became aware of a material error in the company’s inventory for the annual financial statements in the amount of approximately $1.5 million. Anand brought the matters to the attention of senior management, who casually indicated that year end was already completed and thus they did not want to harm investor confidence by reissuing the financial statements, but Anand did not seek assistance or guidance from either the professional body or the securities commission. c) Sahajpreet Singh, CPA, obtained his designation in 2000. Since that time, he has built up a significant tax practice. In late 2015, a new client approached Sahajpreet and asked him to perform an audit engagement. Believing this could lead to a substantial amount of tax work

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in the future, Sahajpreet agreed, even though he had not taken any accounting or assurance courses for many years. In performing the audit engagement, Sahajpreet obtained an engagement letter, put the financial statements together based on the clients trial balance, and attached a review engagement report. The financial statements contained a material error. Answer: a) • By cold calling and implementing a telephone campaign to get new business, Chase violated the rule of no solicitation. • Chase accepted a referral fee in the form of the flat fee for referring his clients to the car dealership. Referral fees are not permitted. • Chase accepted a commission in terms of a 1% on auto sales and leases, which is not permitted. • There is an impairment of independence in that Chase accepted a loan from a client and continued to be the client’s auditor. • Chase failed to maintain the good reputation of the profession when he accepted the loan to use for his personal use. b) • •

Anand Lee failed to conduct himself in a manner which would maintain the good reputation of the profession and its ability to serve the public interest in that he allowed users to rely on financial statements that were materially misstated. Anand Lee was associated with false and misleading information in that he knew the financial statements were materially misstated but did not do anything to correct them.

c) • •

•

Sahajpreet failed to maintain his professional competence by keeping himself informed of, and complying with, developments in professional standards in all functions in which he practiced. Sahajpreet associated himself with financial statements that were false and misleading, and he would have known this had the work been performed in accordance with the standards for review engagements. The procedures required for a review engagement were not performed. There was no documentation of analytics, discussion and enquiry to establish plausibility.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the fundamental principles of professional ethics. Section Reference: 2.1 The fundamental principles of professional ethics CPA Competency: Audit and Assurance AACSB: Analytic 70. Distinguish between independence of mind and independence in appearance. Answer: Independence is essential when complying with the ethical principles to act with integrity and objectivity. Independence of mind is the ability to act with integrity, objectivity and professional scepticism. It is the ability to make a decision that is free from bias, personal beliefs and client pressures. Independence of mind is also referred to as actual independence.

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Independence in appearance is the belief that independence of mind has been achieved. It is not enough for an auditor to be independent of mind; they must also be seen to be independent. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 71. Describe the three categories of safeguards to an auditor's independence. Answer: Safeguards are mechanisms that have been developed by the accounting profession, legislators, regulators, clients and accounting firms. The accounting profession, legislation and regulation have created a range of safeguards including education of accountants about the threats to independence, the establishment of a code of ethics, and legislation that requires that an auditor be independent. Clients can put in place appropriate mechanisms that will reduce the threat to independence. These include having appropriate corporate governance mechanisms, such as the establishment of an audit committee and establishing policies and procedures dedicated to ensuring that the financial statements are true and fair. Accounting firms also have in place a range of safeguards to ensure independence such as policies and procedures to ensure the quality of their service and providing continuing education for their staff regarding these policies and procedures. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 72. For each of the following, indicate if there is a threat to independence. If so, state the threat and a possible safeguard. a)

Ty Tomas, CPA is unaware that his audit client, James Jackets Co. makes up 20% of Ty Tomas firms revenues.

Luca Lobo goes to his assurance client, Joe’s Auto Mart to buy a used car for his daughter. Due to their business relationship, Joe offers James a vehicle below cost.

Olivia Dazzle has been auditing Fancy Dance Studio for many years. Fancy Dance Studio has been experiencing financial difficulties and has not been able to pay its audit fees for the last three years. Fancy now owes Olivia Dazzle $50,000 in assurance fees.

Robert Razo has three review engagements. One of the review engagements is done for Hugo’s Meatshop Ltd., which is 80% owned by Robert’s father-in-law, Igor Slovlog. The remaining 20% of the Meatshop is owned by Igor’s four children.

Answer:

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There is a self-interest threat in that there is the possibility of client reliance for Ty Tomas. A safeguard against this is to regularly review the assurance fees earned from each client in comparisons to total fees from all clients.

Car dealers are not in the business of selling cars below cost. The discount below cost is similar to a gift and therefore gives rise to a familiarity threat, in that Luca Lobo, the auditor has accepted a “gift” from his client. A safeguard for this is to have a firm policy whereby non trivial gifts from clients are not accepted.

This leads to a self-interest threat as significant fees outstanding are considered to be similar to a loan to the client. It could also lead to an intimidation threat by the client, in that the client could threaten to leave the firm and the auditor would be faced with a large receivable write off. A possible safeguard is to ensure all fees in arrears are collected before performing additional services to prevent any further fee dependence.

This is a familiarity threat in that family members of the auditor own shares of the company under audit. It is also a self-interest threat in that his wife owns shares in the entity. There is no appropriate safeguard in this situation. Robert should resign from the engagement immediately.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 73. The five key threats to auditor independence are self-interest, self-review, advocacy, familiarity, and intimidation threats. Provide an example of each threat and suggest a safeguard against each identified threat. Answer: This is only a suggested answer and student responses may vary. Threat Self-interest threat

Example An audit firm relies on the fees from a client.

Self-review threat

An assurance team audits records that were prepared by a colleague in their firm on behalf of the client.

Advocacy Threat

An auditor represents an audit client in a legal case.

Safeguard Regular review of assurance and other fees earned from each client compared with total fees from all assurance clients. When providing non-audit services, ensuring that the client is responsible for overseeing and guiding that work and making any final decisions regarding the outcomes of that work. Policies and procedures prohibiting the representation of clients in any disputes or legal matters.

Ethics, Legal Liability, and Client Acceptance

Familiarity threat

An auditor has a family member involved in the preparation of the accounting information subject to audit.

Intimidation threat

A client threatens to dismiss the audit firm.

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Procedures when assigning staff to assurance clients ensuring no close personal relationships exist between assurance team members and client personnel. Avoidance of fee dependence.

Bloomcode: Application Difficulty: Medium Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 74. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

To ensure independence of prospective and continuing clients, an audit firm must review the threats to independence, and make certain that safeguards are put in place to limit or remove those threats.

The final stage in the client acceptance and continuance decision process involves assessing independence threats.

By signing the engagement letter, management is not necessarily considered to be responsible for the financial statements.

To successfully sue an auditor, a plaintiff must only prove that a duty of care was owed by the auditor.

Answer: a) Agree. An audit firm should always assess independence before the client acceptance or continuance decision is made. b)

Disagree. The final stage in the client acceptance and continuance decision process involves the preparation of an engagement letter. An engagement letter is prepared by an auditor and acknowledged by a client before the commencement of an audit.

Disagree. Management is considered to be responsible for the financial statements and acknowledges this responsibility when they sign the engagement letter.

Disagree. To successfully sue an auditor, a plaintiff must prove not only that a duty of care was owed by the auditor, but also that there was a breach of that duty, and a loss was suffered as a result of that breach. To establish that an auditor owes them a duty of care, a third party must now establish that the auditor was aware that the third party was going to use the financial statements and that the users relied on the financial statements for the purpose they were prepared.

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Bloomcode: Application Difficulty: Medium Learning Objective: Define and assess auditor independence. Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.3 Independence Section Reference: 2.5 Legal liability Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 75. Simean & Co, a firm of CPA’s, issued an unqualified audit report for its client, Xiing Manufacturing Corporation, a footwear manufacturer in Asia. Xiing Manufacturing, listed its head office in Toronto, Ontario, and its shares were traded on a Canadian Stock Exchange. Besides the shareholders, Simean & Co. knew the company was in the process of refinancing a significant bank loan coming due, and the bank was anxious to see the year end results. After an unqualified audit report was issued, the regulator of the stock exchange halted the trading of the shares after allegations of management fraud came to light. As a result, the share price plummeted and the company went out of business. Required: (a) To whom did Simean & Co. owe a duty of care? (b) What must the bank demonstrate to establish negligence? (c) What are the defences available to Simean & Co? Answer: a) The auditor owes a duty of care to the client, Xiing Manufacturing, as established when the engagement letter is signed. The auditor also owes a duty of care to third parties. However, this duty is usually limited to fraud or gross negligence unless the auditor has actual knowledge that the third party will rely on the statements. In this case, the bank is a known user and therefore the auditor owes the bank a duty of care. The auditor would not owe a duty of care to all known users unless fraud or gross negligence is established. There is nothing to suggest that this is the case. (b) There are four requirements for negligence to be established: 1. Simean & Co. owed the bank a duty of care. 2. There was a breach of that duty (such as failure to follow generally accepted auditing standards). 3. There must be proof that damage resulted. 4. There must be a reasonably proximate connection between the breach of duty and the resulting damage. (c) The auditor can deny that the plaintiff has established the necessary conditions to recover damages by asserting the following:

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There was no legal duty of care to the plaintiff. There was no breach of that duty (such as failure to follow generally accepted auditing standards). No damage resulted. There was no reasonably proximate connection between the breach of duty and the resulting damage.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 76. Categorize each of the following items as either a factor that relates to contract law or tort law. 1. auditor failed to take reasonable care in the performance of the audit 2. auditor fails to live up to their responsibility implicit in agreeing to act as the auditor and explicit in the engagement letter 3. the work was below the standard that may be reasonably expected from a designated public accountant 4. the injured party must prove that the auditor’s carelessness or unintentional behaviour caused harm and therefore breached the duty of care 5. a client can sue the auditor for breach of contract Answer: Contract Law 2. auditor fails to live up to their responsibility implicit in agreeing to act as the auditor and explicit in the engagement letter 5. a client can sue the auditor for breach of contract

Tort Law 1. auditor failed to take reasonable care in the performance of the audit 3. the work was below the standard that may be reasonably expected from a designated public accountant 4. the injured party must prove that the auditor’s carelessness or unintentional behaviour caused harm and therefore breached the duty of care

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

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77. Explain the purpose and major contents of an engagement letter between the auditor and their client. Answer: The engagement letter is a form of contract between an auditor and their client. Its purpose is to set out the terms of the audit engagement, to avoid any misunderstandings between the auditor and their client. The letter confirms the obligations of the client and the auditor. It also includes an explanation of the scope of the audit, the timing of the completion of various aspects of the audit, an overview of the client's responsibility for the preparation of the financial statements, the requirement that the auditor have access to all information required, independence considerations and fees. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 78. Independence is considered one of the key characteristics of auditors. Explain why auditor independence is so important to the effectiveness of an audit and explain the various threats to an auditor's independence. Answer: Answers may vary. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence. Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 79. Audit committees have been widely recommended as being an important mechanism for enhancing the external auditor's independence. What are the important characteristics of audit committees and discuss why these characteristics are considered so important to a committee's effective and efficient operation. Answer: Answers may vary. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic 80. The key difficulty for third parties in legal action against auditors has been establishing that a duty of care was owed to them by their auditor. Explain the development of the relevant legal principles relating to an auditor's duty of care to third parties with reference to specific case law. Answer: Answers may vary. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement. Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

CASE QUESTION

81. Amelia Vadilia is a junior auditor working on the audit of Activia Linens Company. Amelia performed an inventory count where she noticed an unusually large amount of green fabric for use in manufacturing Activia products. When she inquired with the warehouse manager about why the quantity of green fabric was disproportionate with other colors the manager replied by saying “that green fabric products never sells and has been sitting there as long as I can remember”. When Amelia looked over the inventory ledger, she noticed these materials were accounted for and totaled $220,000. Because the materials were recognized in the accounting records and the reasonable explanation provided by the warehouse manager, Amelia did not see a need for further inquiries. She documented her work in the audit file and proceeded to seek the advice of the manager on the audit, Michael Visco. Michael commented, “Activia is long-standing client, always pays their fees on time, and has never had any inventory issues in the past. They will obviously use the green fabric in production at some point, so I would suggest removing any notes of the mater in the audit file and continue working on other audit areas.” Amelia did not feel great about this discussion with her manager and did not know how to proceed knowing there is likely an inventory obsolescence issue. Required: a) Did Amelia use professional skepticism in her decision-making process? Explain all instances where Amelia did and did not apply professional skepticism during her audit of Activia Linens Company. b) Discuss the ethical dilemma presented to Amelia by identifying each step of the ethical dilemma framework. Answer: Students responses may vary. a) Amelia used professional skepticism both initially when she saw the green fabric, first noticing that it appeared disproportionate from the rest of the fabric colors, and then when following up by asking the warehouse manager for an explanation. She gathered evidence to support a possible inventory obsolescence issue by tracing the green fabric to the inventory ledger and establishing the $220,000 recorded value. Amelia did a great job exercising her professional skepticism from the onset of her inventory count. b) The application of the framework for ethical dilemmas for Amelia can be summarized as follows: 1. Identify the ethical dilemma: Amelia is being told by her audit manager to remove the evidence of Amelia uncovering the inventory obsolescence issue from the audit file, and forget it ever happened. Amelia feels uneasy about the situation knowing there is likely a misstatement in inventory. 2. Determine who is affected: Activia management and the external users of its financial statements such as banks and investors will be the key parties affected by the possible inventory misstatement. Should the misstatement prove to be material to the users, there can be a significant impact on Amelia, Michael, and their accounting firm. 3. Identify the likely alternatives available: - Amelia can take Michael’s recommendation and remove the documentation from the file and ignore the issue, or - Amelia can highlight the possible impact of the issue to Michael and ask him to reconsider, or

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- Amelia can discuss the issue with the firm’s managing partner in charge, or - Amelia can ask to be removed from the audit entirely. 4. Decide on the appropriate action: Amelia should first request that Michael further investigate the inventory issue by highlighting its impact/importance, and if he does not agree, Amelia should push the matter to the managing partner of the firm. Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the fundamental principles of professional ethics. Learning Objective: Describe professional judgement and professional skepticism. Section Reference: 2.1 The fundamental principles of professional ethics Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 82. The CPL Audit Committee has a policy of changing audit firms every five years to ensure that they receive fresh approaches from different audit firms. Accordingly, the CPL Board has asked Ginger & Paprika LLP to replace its previous audit firm. CPL is a manufacturer and distributor of wire ropes, industrial cables, and rigging cables and has a reputation for its ability to fill special orders and to ship across Canada from its Thunder Bay facility on time and at competitive prices. They have a reputation among their customers for going the extra mile and have kept a loyal customer base for over a century. Curtis Sanza, a new partner at Ginger & Paprika LLP, a growing CPA firm in northern Ontario, is excited about CPL becoming a potential new client. The previous week he met with the Canadian President of CPL, Jinyi Gu. Curtis Sanza quickly decided that Jinyi Gu was a man of integrity and his frank and open opinions would make it a pleasure to deal with him. He also appeared to have a competent management team in place. Curtis also wanted to make an impression on his new firm by bringing in several new clients in the next year or two, as a good portion of his future compensation will be derived from new business. He is also aware that any negligence on his part during the client acceptance phase would reflect on his professional judgment and open the firm to possible litigation. The senior partner, Walter Peters, has invited Curtis Sanza to join him in his office to discuss CPL. Required: a) You are Walter Peters, the Senior Partner at Ginger & Paprika LLP. What would be on your “checklist” of client acceptance questions? Prepare an exhaustive inventory of all the questions you would ask Jack before deciding to accept or reject CPL. b) The firm recently lost a lawsuit and has parted ways with the partner-in-charge of the aggrieved client. What can Walter Peters do to avoid litigation? Answer:

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The first step involves the assessment of client integrity. When assessing client integrity, the auditor will consider the following questions: 1. 2. 3. 4.

What is the reputation of the client, its management, directors, and key stakeholders? What are the reasons provided for switching audit firms (client acceptance decision)? What is the client’s attitude to risk exposure and management? What is the client’s attitude to the implementation and maintenance of adequate internal controls to mitigate (minimize) identified risks? 5. To what extent is the client’s interpretation of accounting rules appropriate? 6. To what extent is the client willing to allow the auditor full access to information required to form their opinion? 7. What is the client’s attitude to audit fees and its willingness to pay a fair amount for the work completed? Here is a possible checklist of questions with regard to the firm’s possible existing prohibitions that would preclude the firm or any staff member from performing the engagement: 8. We would ask about the prohibitions listed below: A. B. C. D. E. F. G. H. I. J. K. L. M.

Financial interests in entity. Loans and guarantees to/from client. Close business relationships with client. Family and personal relationships with client. Future or recent employment with entity serving as officer, director, or company secretary of client. Provision of non-assurance services such as corporate finance or legal services that involve dispute resolution. Performance of management functions for the client. Making journal entries or accounting classifications without first obtaining management’s approval. Acceptance of gifts or hospitality from client (other than clearly insignificant). Fee quote that is considerably less than market price for the engagement. Provision of legal services. Preparation of source documentation. Provision of corporate finance services.

Are we satisfied there are no significant “threats” to independence? Address each of the following threats in relation to the firm and any member of the engagement team: A. Self-interest (i.e., where loss of client fees would be material). B. Self-review (i.e., the nature and extent of bookkeeping services required or where a judgment from a previous engagement needs to be evaluated in reaching conclusions). C. Advocacy (i.e., acting as an advocate on behalf of client in litigation or in share promotion). D. Familiarity (i.e., being too sympathetic to the client’s interests). E. Intimidation (i.e., being deterred from acting objectively and exercising professional scepticism).

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Walter Peters would also ask about whether there are any safeguards to reduce the above threat(s) to independence identified to an acceptable level. b)

One of the ways that an auditor can avoid litigation is to follow up on any significant weaknesses in the client’s internal control procedures in a previous year’s audit. There are a number of ways that an auditor can avoid litigation. These include: A. B. C. D. E.

hiring competent staff training staff and updating their knowledge regularly ensuring compliance with ethical regulations ensuring compliance with auditing regulations implementing policies and procedures that ensure: – appropriate procedures are followed when accepting a new client – appropriate staff are allocated to clients – ethical and independence issues are identified and dealt with on a timely basis – all work is fully documented – adequate and appropriate evidence is gathered before forming an opinion F. meeting with a client’s audit committee to discuss any significant issues identified as part of the audit G. Following up on any significant weaknesses in the client’s internal control procedures in a previous year’s audit. Bloomcode: Application Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties. Learning Objective: Identify the factors to consider in the client acceptance or continuance decision. Section Reference: 2.5 Legal liability Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

CHAPTER 3 AUDIT PLANNING l CHAPTER LEARNING OBJECTIVES 1. Identify the different phases of an audit. The phases of an audit include risk assessment, risk response, and reporting. During the risk assessment phase, an auditor will gain an understanding of their client in order to make an informed risk assessment, develop an audit strategy, and set their planning materiality. During the risk response phase, an auditor will execute their detailed testing of account balances and transactions. The final phase of every audit involves reviewing all of the evidence gathered throughout the audit and arriving at a conclusion regarding the fair presentation of the client’s financial statements. The auditor will then write an audit report that reflects their opinion based upon their findings. 2. Explain the process used in gaining an understanding of the client. An auditor will gain an understanding of their client to aid in the risk identification process. This process involves consideration of issues at the entity level, the industry level, and the broader economic level. At the entity level, an auditor will identify the client’s major customers, suppliers, and stakeholders (that is, banks, shareholders, and employees). The auditor will also determine whether their client is an importer or exporter, who the client’s competitors are, what the client’s capacity is to adapt to changes in technology, and what the nature of any warranties provided to customers is. At the industry level, an auditor is interested in their client’s position within its industry. At the economic level, an auditor will assess how well positioned the client is to cope with current and changing government policy and economic conditions. 3. Explain how related parties can impact risk. Related parties include parent companies, subsidiaries, joint ventures, associates, company management, and close family members of key management. Since related parties are not independent of each other, these transactions may not be in the normal course of business. This increases the risk of material misstatement and may impact the overall financial results. Therefore, related party transactions require some specific consideration throughout the audit and specific procedures should be performed and documented. 4. Evaluate fraud risk. Fraud is an intentional act through the use of deception to obtain an unjust or illegal advantage. The two kinds of fraud are financial reporting fraud and misappropriation of assets. There are a number of techniques the auditor uses to assess the risk of fraud. The audit file must document the fraud risk assessment and procedures performed to support that assessment. 5. Explain the going concern assumption.

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The responsibility for preventing and detecting fraud rests with those charged with governance at the client as well as the auditors.

The auditor should not ask management and those charged with governance if they are aware of a known fraud or suspect there has been fraud.

Elvie Lee explained to her friend how application controls work: “Application controls are designed to prevent and detect a material misstatement in the financial statements.”

Answer: a) Disagree. It is the responsibility of the auditor to ensure that related parties are identified and appropriately disclosed, in line with relevant accounting standards. According to the CPA Handbook, related parties include parent companies, subsidiaries, joint ventures, associates, company management, and close family members of key management. Since related parties are not independent of each other, these transactions may not be in the normal course of business. This not only increases the susceptibility of the financial statements to material misstatement due to fraud or error, it may also impact the overall financial statement results. Therefore, financial statement users need sufficient information to assess the impact of these transactions on the financial statements overall. b)

Agree. Adopting an attitude of professional scepticism implies that auditors must remain independent of their client, maintain a questioning attitude, and search thoroughly for corroborating evidence to validate information provided by the client. Auditors must not assume that their past experience with client management and staff is indicative of the current risk of fraud.

Disagree. The responsibility for preventing and detecting fraud rests with those charged with governance at the client. It is the responsibility of the auditor to assess the risk of fraud and the effectiveness of the client's attempts to prevent and detect fraud through their internal control system.

Disagree. The auditor should ask management and those charged with governance these key questions. If the company being audited has an internal audit department, the internal auditors should also be asked this question. The results of these inquiries should be documented.

Agree. These controls are designed to prevent and/or detect a material misstatement in the financial statements by ensuring all transactions are recorded only once and rejected transactions are identified and corrected. Application controls impact on the procedures used for data entry, data processing and output, or reporting. They include reconciliations between input and output data and automated checks on data entered to ensure accuracy.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how related parties can impact risk. Learning Objective: Evaluate fraud risk. Learning Objective: Appraise corporate governance. Learning Objective: Evaluate how a client’s information technology (IT) can affect risk. Section Reference: 3.3 Related parties Section Reference: 3.4 Fraud risk Section Reference: 3.7 Corporate governance

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Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic 67. What is fraud and what are some of the red flags that can alert auditors to the possibility that a fraud may have occurred? Answer: Fraud is an intentional act to obtain an unjust or illegal advantage through the use of deception. An auditor can use red flags to alert them to the possibility that a fraud may have occurred. These red flags include: a high turnover of key employees, key finance personnel refusing to take leave, overly dominant management, poor compensation practices, inadequate training programs, a complex business structure, no (or ineffective) internal auditing staff, a high turnover of auditors, unusual transactions, and weak internal controls. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk. Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic 68. Bill Dodds was the accounts payable manager of Big Build Property Management Ltd. Bill started with the company as a bookkeeper and worked up to his current management position. He was promoted due to his dedication to the company and his reliability – he often worked evenings and weekends, rarely called in sick, and he never took holidays. Despite making a good wage, Bill enjoyed living large, and the majority of his paycheque went to pay for his luxury car and designer clothes. As Bill was living paycheque to paycheque he was disappointed he did not have a “nest egg” set aside for retirement or emergency purposes. Big Build Property Management had a history of profitability. To reward its employees, the company had established a bonus scheme for meeting profit targets. It was a shock to all employees when at the end of 2022, the company announced it had had the worst year in the company’s history. The losses were significant and the company planned significant lay-offs in an attempt to turn this situation around. As a result, the accounting department was reduced by 35%, and the remaining staff was asked to do more. Bill found not only was he managing an unhappy accounts payable group, he was also now signing cheques, processing payables, and reconciling the bank account. This meant Bill was required to work even more without any pay increase or bonus in sight. For the first time in his career at Big Build, Bill was unhappy. While he was fearful further lay-offs may be coming, he also felt unappreciated and after all of his hard work, he was unhappy he was being asked to do more. Required: Discuss the incentives, opportunities, and rationalizations to commit fraud in this case. Answers: Incentives and Pressures — While few employees would take the opportunity to commit fraud, adding an element of pressure could sway an honest worker. Pressure may come from the individual’s personal life. In this case, the following incentives/pressures exist: • Management has a focus on the need to reach target profits.

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• There are falling profits at the company. • Bill also lives paycheque to paycheque and likes to live large. With the fear of losing his job, he may feel pressure to commit fraud to maintain his standard of living. Opportunity — This is where there is an opportunity to perpetrate a fraud due to weak or nonexistent internal controls. • Bill rarely called in sick, and never took holidays. This makes it easier to cover up any fraud that could be taking place. • Lack of segregation of duties. Bill now processes accounts payable, signs cheques, and performs the bank reconciliation. As a result he can make fraudulent payments to himself and cover them up. • With fewer staff now in place to perform the work required, there is likely less focus on internal controls and more focus on getting the job done. Again there is evidence of this with the lack of segregation of duties in the accounting department. This would make it easier to commit fraud and cover it up. Rationalization — This is when fraudsters justify their actions to themselves. In this case as Bill is being asked to do more for the same remuneration, he may have an attitude of ”I deserve more money” and “they owe it to me.” Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk. Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic 69. What should auditors do if there are risk factors that indicate that the going concern assumption is at risk? Answer: If the auditor identifies risk factors that indicate that the going concern assumption is in doubt, they will undertake procedures to gather evidence regarding each risk factor. For example, if a client has lost a number of key, long-standing personnel, an auditor may assess the quality of the remaining staff and the likelihood that the client will be able to hire suitable replacements in the near future. If the auditor believes there is an unresolved going concern issue outstanding, an assessment is made of the appropriateness of management disclosures in the notes to the financial statements regarding that issue. An auditor will assess the process used by management to evaluate the extent of the going concern risk. If a company has a history of losses and difficulties, an auditor will expect management to take a great deal of time and care in their going concern assessment. Once the auditor has an understanding of the process used by management, which may include the careful preparation of detailed cash flow projections and budgets, they will assess the adequacy of that process and conduct additional procedures if necessary. Bloomcode: Application Difficulty: Medium Learning Objective: Explain the going concern assumption. Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

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70. CAS 540 indicates that the higher the estimation uncertainty, the higher the risk of material misstatement and the greater the audit effort. What causes the increase in estimation uncertainty? Provide an example of an accounting estimate with high estimation uncertainty and explain why the level of uncertainty in your example is considered to be high. Answer: An estimate would be considered as having low estimation uncertainty when a simple model and objective data is used to establish the estimate. High estimation uncertainty would exist when a complex valuation model is applied along with subjective and future-looking assumptions. Examples will vary. Bloomcode: Application Difficulty: Medium Learning Objective: Explain how estimates can impact risk. Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 71. CAS 300 Planning an Audit of Financial Statements requires that auditors plan their audits. Why is planning such an important stage of every audit? Explain the various aspects of the preliminary risk identification process. Answer: Answers may vary. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit. Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic 72. When gaining an understanding of their clients, auditors consider the particular information technology risks faced by their clients. Explain the particular risks associated with information technology and discuss the main controls that companies can have in place to mitigate these risks. Answer: Answers may vary. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client. Learning Objective: Evaluate how a client’s information technology (IT) can affect risk. Section Reference: 3.2 Gaining an understanding of the client Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic 73. Corporate governance is the rules, systems, and processes within companies used to guide and control them. Why are auditors concerned with the corporate governance structures of their clients and what is the current status of corporate governance regulation in Canada? Answer: Answers may vary. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Appraise corporate governance. Section Reference: 3.7 Corporate governance CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 74. Last year the review of Lethbridge Broadcasting did not go well for Bossy & Bossier CPAs. In an attempt to meet budget, Mike Bossy, the auditor-in-charge, left out the review of closing procedures. His Group Partner’s review notes were professional but his annual review commentary was not as complimentary. Mike was not convinced that he was at fault and felt that according to his firm’s mandate, as spelled out in the engagement letter, it was the client’s responsibility to ensure the adequacy of closing procedures. This year the firm will be starting the audit of a new broadcasting client and the partner is planning the risk assessment procedures. His partner’s review note reads: “Ensure that Mike Bossy gains a detailed knowledge of the Quebecor Media broadcasting operations at the entity level.” Required: a) Comment on the partner’s Lethbridge Broadcasting concerns and explain how the closing process is supposed to work. b) Discuss the entity-level audit procedures Mike will have to follow in order to gain an understanding of Quebecor Media operations and why these entity-level procedures are important. Answer: a) Although the closing procedures are the responsibility of the client, the auditor has a responsibility to ensure that material misstatements do not occur. Reviewing closing procedures is important because from an audit perspective there is a risk that the client's closing procedures are inadequate. Discussion on Mike Bossy’s and his firm’s responsibilities: (i) Auditors are concerned that transactions and events have been recorded in the correct accounting period. Although this is the responsibility of those charged with governance, it is the responsibility of the auditors to ensure that their client has applied its closing procedures appropriately. (ii) If an auditor determines that the client's closing procedures are weak, an auditor will plan on spending more time conducting detailed testing around year end. (iii) There are a number of ways that Mike Bossy can assess the adequacy of the client's closing procedures. checking the accuracy of accrual calculations around year end. look at earnings trends to assess whether the reported income is in line with similar periods in prior years. trace transactions recorded close to year end to source documentation and confirm that all transactions are recorded in the appropriate accounting period. b)

Knowledge about the entity is gained through interviews with client personnel, including those charged with governance. Mike Bossy will ask questions about what the client does, how the client functions, the ownership structure of the client, and its sources of financing. Procedures to gain understanding of client: Major customers are identified so that the auditor may consider whether those customers have a good reputation, are on good terms with the client (that is, likely to remain a

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customer in future), and are likely to pay the client on a timely basis. Dissatisfied customers may withhold payment, which affects the allowance for doubtful accounts and the client's cash flow, or decide not to purchase from the client in the future, which can affect the going concern assumption. If a client has only one or a few customers, this risk is increased. The auditor also considers the terms of any long-term contracts between their client and their client's customers. Major suppliers are identified to determine whether they are reputable and supply quality goods on a timely basis and payment on a timely basis. If the client is having trouble paying its suppliers, it may have trouble sourcing goods as suppliers may refuse to transact with a company that does not pay on time. The client's capacity to adapt to changes in technology and other trends is assessed. If the client is not well positioned to adjust to such changes, it risks falling behind competitors and losing market share, which in the longer term can affect the going concern assumption. The nature of any warranties provided to customers is assessed. If the client provides warranties on products sold, the auditor needs to assess the likelihood that goods will be returned and the risk the client has underprovided for that rate of return (adequacy of the warranty provision). The terms of discounts given by the client to its customers and received by the client from its suppliers are reviewed. An assessment is made of the client's bargaining power with its customers and suppliers to determine whether discounting policies are putting profit margins at risk, which may place the future viability of the client at risk. An assessment is made of the client's reputation with its customers, suppliers, employees, shareholders, and the wider community. A company with a poor reputation places future profits at risk. It is also not in the best interests of the auditor to be associated with a client that has a poor reputation. An understanding is gained of client operations. The auditor will note where the client operates, the number of locations it operates in, and the dispersion of these locations. The more spread out the client's operations are, the harder it is for the client to effectively control and coordinate its operations, increasing the risk of errors in the financial statements. The auditor will need to visit locations where the risk of material misstatement is greatest to assess the processes and procedures at each site. If the client has operations interprovincial or overseas, the auditor may plan for a visit to those sites by staff from affiliated offices at those locations where risk is greatest. For example, an auditor is more likely to visit client operations if the client opens a new, large site, or if the business is located in a country where there is a high rate of inflation or where there is a high risk of theft. An understanding is gained of the nature of employment contracts and the client's relations with its employees. The auditor will consider how a client pays its employees, the mix of wages and bonuses, the level of unionization among the workforce, and the attitude of staff to their employer. The more complex a payroll system, the more likely that errors can occur. When staff are unhappy, there is greater risk of industrial action, such as strikes, which disrupt client operations. The client's sources of financing are reviewed. An assessment is made of a client's debt sources, the reliability of future sources of financing, the structure of debt, and the reliance on debt versus equity financing. An auditor assesses whether their client is meeting interest

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payments on funds borrowed and repaying funds raised when they are due. If the client does not meet the conditions of a debt covenant, the borrower may recall the debt, placing the client's liquidity position at risk, and increasing the risk that the client may not be able to continue as a going concern. The client's ownership structure is assessed. The auditor is interested in the amount of debt funding relative to equity, the use of different forms of shares, and the differing rights of shareholder groups. The client's dividend policy and its ability to meet dividend payments out of operating cash flow are also of interest. Bloomcode: Application Difficulty: Medium Learning Objective: Explain the process used in gaining an understanding of the client. Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results. Section Reference: 3.2 Gaining an understanding of the client Section Reference 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

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CHAPTER 4 AUDIT PLANNING ll CHAPTER LEARNING OBJECTIVES 1. Evaluate audit risk. Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. The three components of audit risk are inherent risk, control risk, and detection risk. 2. Explain and apply the concept of materiality. Information is considered to be material if it impacts the decision-making process of users of the financial statements. 3. Describe how an auditor determines the audit strategy. The audit strategy is a key component of the risk assessment phase of the audit. It sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan. An audit strategy will depend on the auditor’s preliminary inherent and control risk assessment. 4. Outline how clients measure performance. By understanding how a client measures its own performance, an auditor can plan the audit to take into consideration areas where the client may be under pressure to achieve certain outcomes. 5. Summarize how an auditor uses analytical procedures when planning an audit. Analytical procedures are conducted at the risk assessment phase of the audit to identify unusual fluctuations, help identify risks, help when gaining an understanding of a client, identify the accounts at risk of material misstatement, and reduce audit risk by concentrating audit effort where the risk of material misstatement is greatest. There are many processes that can be used when conducting analytical procedures. The processes discussed in this chapter include simple comparisons, trend analysis, common-size analysis, and ratio analysis.