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CPA Auditing and Attestation Aud

CPA Auditing and Attestation Aud Practice Test: Practice Test 3

Practice Test 3 for CPA Auditing and Attestation Aud: real questions and explanations from the Varsity Tutors practice-test pool.

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Question 1 of 25

While obtaining an understanding of a new client, an auditor learns that the company has experienced unusually high turnover in its senior accounting positions over the past two years. This condition most likely indicates an increased risk of:

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Question 1

While obtaining an understanding of a new client, an auditor learns that the company has experienced unusually high turnover in its senior accounting positions over the past two years. This condition most likely indicates an increased risk of:

  1. related-party transactions not being properly identified.
  2. inconsistent application of accounting policies and misstatements. (correct answer)
  3. management override of the internal audit function.
  4. failure to safeguard assets from employee theft.

Explanation: High turnover in key accounting roles disrupts continuity and institutional knowledge. This can lead to inconsistent application of accounting policies, errors in financial reporting due to lack of familiarity with company-specific issues, and a weakened control environment. New personnel may not be fully aware of historical practices or complex transactions, increasing the likelihood of misstatements.

Question 2

A firm audits an ERISA plan under Department of Labor requirements. The auditor is asked to serve as the plan’s trustee for a short period to help transition between trustees. Under DOL requirements, which situation would impair auditor independence?

  1. Serving as trustee because it is a management/decision-making role for the plan. (correct answer)
  2. Providing the trustee with audit confirmations to sign.
  3. Meeting with the trustee to discuss audit timing.
  4. Requesting trustee bank statements directly from custodians.

Explanation: The independence concept tested is DOL's prohibition on auditors holding management roles like trustee in ERISA plans. The key facts involve serving as temporary trustee during transition. Choice A aligns with DOL standards by identifying this as impairing due to the decision-making role. Choice B is incorrect because providing confirmations is a routine request, and Choices C and D are wrong as meetings and requests are standard procedures. A decision rule is to avoid any fiduciary or management positions in audited plans. This framework prevents conflicts and maintains independence.

Question 3

A practitioner is planning an audit of a nonissuer retail chain with significant cash sales and high employee turnover. The entity uses point-of-sale systems, but store managers can override prices and issue refunds without secondary approval. What risk factor should the auditor focus on when assessing fraud risks related to revenue?

  1. The existence of price overrides and refund authority at the store level that could enable concealment of cash skimming (correct answer)
  2. The need to obtain a management report on internal control over financial reporting under PCAOB standards
  3. The requirement to confirm all cash receipts with customers to support occurrence of revenue
  4. The likelihood that control risk is low because the point-of-sale system is automated

Explanation: This question tests the auditor's responsibility to assess fraud risks, particularly those related to revenue recognition, under AU-C Section 240. The key facts involve significant cash sales, high employee turnover, and the ability of store managers to override prices and issue refunds without approval, which create opportunities for fraud such as cash skimming. Focusing on the existence of price overrides and refund authority aligns with AU-C 240, as it requires considering fraud risk factors like opportunities for misappropriation of assets. Obtaining a management report on internal control (choice B) is incorrect because PCAOB standards apply to issuers, not nonissuers under AICPA rules, and confirming all cash receipts (choice C) is not required by AU-C 505, as it would be inefficient without risk basis. Assuming low control risk due to automation (choice D) ignores AU-C 315, which requires assessing risks regardless of automation if overrides exist. Auditors should evaluate fraud triangle elements—incentives, opportunities, and rationalizations—when planning. This decision-making rule helps prioritize areas where misstatements due to fraud are more likely, enhancing audit effectiveness.

Question 4

For a nonissuer entity, the auditor's responsibility for reviewing subsequent events for an audit of financial statements ordinarily is limited to the period of time:

  1. Between the balance sheet date and the date of the audit report. (correct answer)
  2. Between the balance sheet date and the date the financial statements are issued.
  3. For a reasonable period of time after the audit report is issued, not to exceed one year.
  4. Between the date of the audit report and the date the financial statements are issued.

Explanation: The auditor has an active responsibility to perform audit procedures to identify subsequent events during the period from the balance sheet date up to the date of the auditor's report. After the report date, the responsibility changes from active searching to responding to information that comes to the auditor's attention.

Question 5

When planning an audit of financial statements prepared on a special purpose framework, the auditor must modify the standard engagement letter. The engagement letter should refer to:

  1. The auditor's responsibility to express an opinion on the entity's internal controls.
  2. A statement that the engagement cannot be relied upon to disclose all significant deficiencies.
  3. The expected form and content of the auditor's report, including identification of the special purpose framework. (correct answer)
  4. Management's responsibility to provide a reconciliation of the special purpose framework to GAAP.

Explanation: The engagement letter for an audit of special purpose financial statements should be tailored to the engagement. It should identify the applicable financial reporting framework and refer to the expected form and content of the auditor's report, making clear that the opinion will be on that specific framework, not GAAP.

Question 6

A bank requires a borrower to provide a report from its independent auditor on compliance with certain restrictive debt covenants. This report is to be issued in conjunction with the annual financial statement audit. The auditor's report on compliance should most appropriately be structured to do which of the following?

  1. Provide positive assurance that all debt covenants have been met.
  2. Be included as an emphasis-of-matter paragraph in the financial statement audit report.
  3. Be a separate report that provides negative assurance on compliance. (correct answer)
  4. State that the audit was not directed to obtaining knowledge of noncompliance with the covenants.

Explanation: When reporting on compliance with contractual agreements in connection with a financial statement audit, the auditor typically issues a separate report. This report provides negative assurance, stating that nothing came to the auditor's attention that caused them to believe the entity failed to comply with the specified provisions. Positive assurance would require an examination-level engagement.

Question 7

A client's fiscal year-end is December 31. The user auditor obtains a SOC 1, Type 2 report from the client's primary transaction processor that covers the period October 1 of the prior year through September 30 of the current year. To use this report as evidence supporting a low assessed level of control risk, the user auditor must:

  1. Rely on the report without further procedures, as it covers nine months of the current fiscal year.
  2. Perform procedures to obtain evidence about the intervening period from October 1 to December 31. (correct answer)
  3. Request that the service organization issue a new report covering the period through December 31.
  4. Disclaim an opinion on the financial statements due to the gap in audit evidence.

Explanation: When a service auditor's report has a period that does not coincide with the user entity's fiscal year, there is a 'gap' period (in this case, October 1 - December 31). The user auditor must perform additional procedures to obtain sufficient evidence for this intervening period. These procedures may include inquiring of management, reviewing communications from the service organization, or performing tests of user entity controls that monitor the service organization. Relying on the report as-is (A) is insufficient. Requesting a new report (C) is often not practical. A disclaimer of opinion (D) would only be appropriate if sufficient evidence cannot be obtained through other procedures.

Question 8

A client holds a significant investment in a security that is not actively traded and is valued using an internal pricing model (a Level 3 fair value measurement). Which substantive procedure would be most appropriate for the auditor to perform?

  1. Obtain the quoted market price from a national stock exchange at the balance sheet date.
  2. Confirm the value of the security with the counterparty who issued it.
  3. Evaluate the appropriateness of the valuation model and the reasonableness of the underlying assumptions. (correct answer)
  4. Compare the cost of the security to its carrying value on the balance sheet.

Explanation: Level 3 fair value measurements use unobservable inputs and are inherently subjective. The auditor's primary task is to challenge the inputs and the process used by management. This involves evaluating the valuation model to see if it is appropriate for the investment and critically assessing the reasonableness of the significant assumptions (e.g., discount rates, future cash flows) used in the model. Distractor A is impossible for a Level 3 security. Distractor B is not an independent source. Distractor D is irrelevant for a fair value measurement.

Question 9

You are performing a nonissuer audit and using data analytics to identify duplicate payments. Management provided an extract of the disbursements table, and your analytics identified many potential duplicates based on same vendor, amount, and date; however, you later learned the extract excluded manual checks processed outside the system. Which factor would most likely affect the auditor's assessment of evidence sufficiency?

  1. The number of potential duplicates identified, regardless of whether the population is complete.
  2. The completeness of the data population used for analytics, requiring reconciliation of the extract to the general ledger and inclusion of manual checks. (correct answer)
  3. Whether the analytics were performed using the auditor’s preferred scripting language.
  4. Whether management agrees with the auditor’s duplicate-payment criteria.

Explanation: This question tests AU-C Section 500, which requires sufficient evidence from analytics in nonissuer audits. The key facts include an incomplete extract excluding manual checks, impacting population completeness. Option B aligns with AU-C 520 by emphasizing reconciliation to the ledger for full populations. Option A is incorrect as AU-C 520 focuses on results after validation; Option C is wrong because AU-C 230 prioritizes relevance over tools; Option D is incorrect under AU-C 500 as agreement does not ensure completeness. Options A, C, and D overlook data gaps. A framework is to verify analytic populations against source records. Auditors should address exclusions to achieve comprehensive evidence.

Question 10

During an audit of a nonissuer construction contractor, the auditor identifies that management used an incorrect cost-to-cost percentage in applying the percentage-of-completion method, overstating contract revenue by 520,000andunderstatingcontractassetsby520,000 and understating contract assets by 520,000andunderstatingcontractassetsby520,000. Overall materiality is $600,000; the error affects a key performance metric used in management bonuses. What is the most appropriate procedure to evaluate the misstatement?

  1. Recalculate the percentage of completion using audited cost data and evaluate both the income statement and balance sheet effects in aggregate (correct answer)
  2. Test the design and implementation of controls over job costing and conclude on the misstatement based on control effectiveness
  3. Accept management’s estimate because it is within overall materiality and therefore cannot be material
  4. Postpone evaluation until the next year’s audit to determine whether the revenue reverses

Explanation: This question evaluates procedures for assessing misstatements in revenue recognition under the percentage-of-completion method per AICPA standards (AU-C 450 and AU-C 540). Key facts include a 520,000overstatementofrevenueandunderstatementofassetsduetoincorrectpercentage,below520,000 overstatement of revenue and understatement of assets due to incorrect percentage, below 520,000overstatementofrevenueandunderstatementofassetsduetoincorrectpercentage,below600,000 materiality but affecting bonuses. Choice A is correct as AU-C 450 requires recalculating using audited data and evaluating effects on both income and balance sheet in aggregate. Choice B is incorrect because AU-C 330 emphasizes substantive procedures for misstatements, not just controls; choice C is wrong as AU-C 450 prohibits accepting misstatements solely for being below materiality. Choice D is incorrect as evaluation cannot be postponed per AU-C 450. Framework: Use audited inputs to verify estimates and assess multi-statement impacts. Decision rule: Consider qualitative factors like incentive effects when evaluating estimate misstatements.

Question 11

When planning to use internal auditors to provide direct assistance on an audit of a nonissuer, the external auditor is required to obtain which of the following?

  1. A written agreement from management authorizing the internal auditors to follow the external auditor's instructions.
  2. A written agreement from the internal auditors acknowledging they will follow the external auditor's instructions. (correct answer)
  3. Approval from those charged with governance for the use of internal auditors in this capacity.
  4. A representation from the chief audit executive that the internal audit function complies with The IIA's Professional Practice Framework.

Explanation: AU-C 610 requires the external auditor to obtain written agreements from both management and the internal auditors when using internal auditors for direct assistance. The agreement from the internal auditors must acknowledge that they will follow the external auditor's instructions and maintain the confidentiality of information obtained during the audit.

Question 12

During planning, an auditor determines that the valuation of a client's level 3 financial instruments represents a significant risk due to the complexity of the valuation model and the subjectivity of the inputs used. Auditing standards require specific procedures when addressing significant risks.

When designing the audit response for a significant risk, the auditor must perform which of the following?

  1. Rely solely on the work of a management-engaged specialist.
  2. Perform substantive procedures that are specifically responsive to that risk. (correct answer)
  3. Test the related internal controls, regardless of the planned reliance on them.
  4. Lower performance materiality for all financial statement line items.

Explanation: According to auditing standards (e.g., AU-C 330), when an auditor has determined that a significant risk exists, the auditor must design and perform substantive procedures that are specifically responsive to that assessed risk. While testing controls or engaging a specialist might be part of the response, the core requirement is to perform specifically tailored substantive procedures.

Question 13

An auditor is most concerned with the completeness assertion for long-term debt. Which substantive procedure would be most effective in addressing this concern?

  1. Examining bond indentures to identify any restrictive covenants.
  2. Recomputing interest expense based on stated interest rates and average outstanding balances.
  3. Confirming the outstanding balance of known loans with lenders.
  4. Reviewing the minutes of board of directors' meetings for authorization of new debt. (correct answer)

Explanation: The completeness assertion for debt is concerned with whether all debt obligations have been recorded. Significant new borrowings typically require authorization from the board of directors. Therefore, reviewing the minutes of board meetings is a very effective procedure for identifying potential unrecorded debt. Distractor A addresses presentation and disclosure. Distractor B is an analytical procedure that might indirectly indicate unrecorded debt but is less direct than reviewing minutes. Distractor C tests the existence and accuracy of known debt, not completeness.

Question 14

A CPA is engaged to audit the financial statements of a nonissuer retailer under AICPA GAAS. During the audit, management restricts the auditor from confirming accounts receivable and the auditor cannot perform alternative procedures to obtain sufficient appropriate evidence for a balance that is material and pervasive. No other issues are noted. Under these circumstances, what should the auditor conclude regarding the audit opinion?

  1. Adverse opinion because the limitation indicates fraud
  2. Qualified opinion due to a material misstatement
  3. Unmodified opinion because management representations compensate for the limitation
  4. Disclaimer of opinion due to a scope limitation (correct answer)

Explanation: This question tests audit opinion modifications under AICPA GAAS for nonissuers due to scope limitations. The key facts involve management's restriction on confirming material and pervasive accounts receivable, with no alternative procedures possible and no other issues. A disclaimer of opinion is required per AU-C 705 when a scope limitation prevents sufficient evidence and effects are material and pervasive. A qualified opinion applies to non-pervasive limitations, an unmodified opinion is incorrect as representations do not substitute for evidence, and an adverse opinion is for GAAP departures, not scope issues. The distractors confuse scope limitations with misstatement or fraud responses. Auditors evaluate scope limitations by materiality and pervasiveness to choose qualified or disclaimer. This approach promotes obtaining alternative evidence where possible to avoid modifications.

Question 15

A new, complex accounting standard for revenue recognition has become mandatory for all companies in the client's industry. The client, a construction company using long-term percentage-of-completion contracts, has just adopted the new standard.

When planning the audit, the auditor's assessment of this external regulatory change should result in an increased focus on:

  1. The segregation of duties within the payroll processing department.
  2. The physical existence of construction equipment on job sites.
  3. The collectibility of retainage receivables from customers.
  4. The risk of misapplication of the new accounting principles and the adequacy of related disclosures. (correct answer)

Explanation: The mandatory adoption of a new, complex accounting standard represents a significant risk. For a construction company, changes to revenue recognition rules are particularly high-risk due to the nature of long-term contracts. There is a substantial risk that management may misunderstand, misapply, or incorrectly implement the new standard, or fail to provide the required disclosures. The auditor must plan specific procedures to address these risks.

Question 16

You are performing an audit of a nonissuer manufacturer and plan to use sampling to test depreciation expense by examining additions to property, plant, and equipment (PP&E) for proper capitalization and start dates. The PP&E addition population is 420 items totaling $12.5 million, and the entity has inconsistent documentation for smaller tools and equipment. The auditor wants to reduce the risk of missing large misstatements while still covering the full population. Which sampling method should the auditor use?

  1. Monetary-unit sampling for the PP&E additions because it provides higher selection probability for larger recorded amounts while still allowing selection across the population (correct answer)
  2. Block selection of the last two months of additions because it is a representative period and easier to audit
  3. Haphazard selection restricted to items under $5,000 because smaller items are more likely to be misstated
  4. Select only items with missing documentation and ignore documented items because sampling should focus exclusively on exceptions

Explanation: AU-C 530 recognizes monetary-unit sampling (MUS) as particularly effective for substantive testing when the auditor wants higher selection probability for larger recorded amounts while maintaining coverage of the entire population. The key facts are that PP&E additions vary significantly in size, the auditor wants to reduce risk of missing large misstatements, and full population coverage is desired. Answer A correctly identifies MUS as the optimal method because it automatically gives larger items higher selection probability while still allowing any item to be selected. Answer B violates random selection principles and may not be representative, Answer C inappropriately biases selection toward small items contrary to the stated objective, and Answer D violates the fundamental principle that sampling requires selection from the defined population. The professional judgment framework is: when testing populations with high variability and concern about large misstatements, MUS provides optimal coverage by probability-weighting selection by recorded amount.

Question 17

A software-as-a-service (SaaS) company has a material estimate for deferred implementation revenue. The auditor notes that the key assumption in the estimate is the average length of a customer relationship. Which audit procedure would be most effective for evaluating the reasonableness of this assumption?

  1. Confirming contract terms with a sample of new customers.
  2. Analyzing historical customer attrition (churn) data and comparing it to industry benchmarks. (correct answer)
  3. Inquiring with the head of sales about their expectations for future customer retention.
  4. Recalculating the amortization of deferred revenue based on management's assumed customer life.

Explanation: The correct answer is B. To test the reasonableness of the estimated customer life, the auditor should analyze the company's own historical data on customer retention and attrition. Comparing this internal data to external industry benchmarks provides corroborating evidence and helps identify potential bias in management's assumption. A confirms contract terms, not the length of the relationship. C is inquiry, which is not sufficient on its own. D tests the mathematical calculation but does not test the reasonableness of the underlying assumption (the customer life).

Question 18

An auditor for a manufacturing company uses a data analytic to perform a three-way match of purchase orders, receiving reports, and vendor invoices. The output contains a list of 200 instances where the quantity on the vendor's invoice is 10% greater than the quantity recorded on the associated receiving report.

This output should lead the auditor to design further tests that are primarily focused on the risk of:

  1. Understatement of accounts payable and expenses.
  2. Overstatement of expenses and inventory. (correct answer)
  3. Improper cutoff of purchase transactions at year-end.
  4. Failure to take advantage of purchase discounts.

Explanation: If the company is paying invoices for quantities greater than what was actually received, it is likely overstating the related expense (if used immediately) or inventory (if placed in stock). This relates to the occurrence assertion for expenses and the existence assertion for inventory. The company may be paying for goods it never received.

Question 19

The accountant's standard report on a review of a nonissuer's financial statements should state that a review is substantially less in scope than:

  1. A compilation.
  2. An audit. (correct answer)
  3. An examination.
  4. An agreed-upon procedures engagement.

Explanation: A standard review report explicitly includes a paragraph describing the nature of a review. This paragraph states that a review consists principally of inquiries and analytical procedures and is substantially less in scope than an audit, the objective of which is the expression of an opinion. Accordingly, no such opinion is expressed.

Question 20

An auditor is designing a substantive test of details using a nonstatistical sampling plan for accounts receivable. Which of the following combinations of factors would lead to the largest required sample size?

  1. High assessed risk of material misstatement, high tolerable misstatement.
  2. Low assessed risk of material misstatement, low tolerable misstatement.
  3. High assessed risk of material misstatement, low tolerable misstatement. (correct answer)
  4. Low assessed risk of material misstatement, high tolerable misstatement.

Explanation: Sample size has a direct relationship with the assessed risk of material misstatement (a higher risk requires more evidence, hence a larger sample) and an inverse relationship with tolerable misstatement (a lower tolerable misstatement requires more precision, hence a larger sample). Therefore, the combination of high assessed risk and low tolerable misstatement will result in the largest sample size.

Question 21

An issuer manufacturing company is audited under PCAOB standards, including an audit of internal control over financial reporting. The auditor identifies a control deficiency where management’s compliance monitoring over environmental regulations is not designed to identify violations that could lead to material remediation liabilities, and a recent violation has occurred. Management argues the control is “operational” and not relevant to internal control over financial reporting. Which compliance reporting action should the auditor take?

  1. Evaluate whether the deficiency represents a material weakness in internal control over financial reporting and report accordingly if it could result in a material misstatement (correct answer)
  2. Ignore the deficiency because environmental compliance controls are never relevant to internal control over financial reporting
  3. Report the deficiency only in a separate compliance report because PCAOB standards prohibit including control findings in internal control reporting
  4. Test only substantive environmental expenditures and issue an unmodified internal control opinion if year-end balances agree to the ledger

Explanation: This question tests PCAOB AS 2201 on internal control over financial reporting (ICFR), including controls over compliance that affect financial reporting. The key facts are the deficient monitoring of environmental regulations, potential material liabilities, and a recent violation, despite management's claim it's operational. Choice A is correct as AS 2201 requires evaluating deficiencies for material weakness if they could lead to material misstatements, including compliance-related controls. Choice B is incorrect because compliance controls can be relevant to ICFR if they impact liabilities per AS 2201; choice C is wrong as control findings are included in ICFR reporting under AS 2201; choice D is incorrect because substantive testing does not substitute for control evaluations per AS 2201. A judgment framework is to assess if deficiencies prevent detection of material misstatements, classifying severity accordingly. Auditors should integrate compliance risks into ICFR assessments for comprehensive reporting.

Question 22

In an audit of a nonissuer under AICPA auditing standards, the auditor assesses a high risk of material misstatement for inventory valuation due to volatile commodity prices and a history of slow-moving items. The client’s perpetual records are unreliable, and management performed a year-end reserve calculation using a new spreadsheet model that lacks documented review. Overall materiality is 900,000,andinventoryis900,000, and inventory is 900,000,andinventoryis6.5 million. Which substantive procedure would be most effective given the assessed risk?

  1. Perform tests of controls over the spreadsheet model’s change management and rely on those controls to reduce substantive testing.
  2. Obtain management representations that the reserve is adequate and reduce further audit work because the reserve is an estimate.
  3. Select a sample of inventory items and recalculate lower of cost or net realizable value using recent sales prices/subsequent sales, aged inventory reports, and current replacement costs; also develop an independent expectation of the reserve and compare to management’s estimate. (correct answer)
  4. Limit testing to items with recorded value above $900,000 because amounts below overall materiality are not subject to substantive testing.

Explanation: This question assesses the auditor's substantive response to high risk of material misstatement in inventory valuation under AICPA auditing standards. The scenario presents multiple risk factors: volatile commodity prices, history of slow-moving items, unreliable perpetual records, and a new unreviewed spreadsheet model for reserve calculations, with inventory at 6.5millionagainst6.5 million against 6.5millionagainst900,000 materiality. AU-C 330 requires the auditor to design substantive procedures responsive to assessed risks, and for significant risks, substantive procedures alone must be performed. Option C correctly prescribes recalculating lower of cost or net realizable value using external evidence (recent sales prices, subsequent sales, replacement costs) and developing an independent expectation of the reserve. Option A inappropriately attempts to rely on controls over a new, unreviewed model; Option B improperly relies solely on management representations for a significant estimate; Option D misapplies materiality by limiting testing to individual items above overall materiality. The transferable principle is that high-risk estimates require independent recalculation using external evidence, not reliance on management's models or representations alone.

Question 23

You are auditing a nonissuer with a portfolio of corporate bonds measured at fair value. At year-end, market volatility increased and bid-ask spreads widened; management selected the midpoint price from a pricing service without evaluating whether it represents an exit price. Internal controls do not require assessing market activity levels. In the context of fair value measurement, which procedure is most appropriate?

  1. Evaluate whether the market is active for the securities, assess the appropriateness of using midpoint pricing, and test fair value by corroborating prices to observable inputs and considering valuation adjustments when warranted (correct answer)
  2. Confirm fair value with the bond issuers because they can validate the exit price
  3. Use the prior-year fair value as the best evidence because volatility makes current pricing unreliable
  4. Perform only inquiry of management about their pricing policy and accept it if consistently applied

Explanation: AU-C Section 540 requires evaluating pricing appropriateness in volatile markets for fair value. The midpoint pricing without assessing market activity, amid widened spreads and weak controls, risks inaccurate exit prices. Assessing market activity, midpoint use, and corroborating prices aligns with AU-C 540 by ensuring reliable measurements. Choice B is incorrect because issuer confirmations are not market-based per AU-C 500. Choice C is incorrect as prior-year values ignore current conditions under AU-C 540, and choice D is incorrect because inquiry alone is insufficient evidence per AU-C 330. Auditors should test pricing adjustments in inactive markets. This decision rule promotes fair value accuracy through input validation.

Question 24

You are auditing a nonissuer hospitality company. The company has recurring losses, negative operating cash flows, and a $6 million loan due in 7 months; the lender has provided a written indication it will consider refinancing but has not issued a commitment letter. Management’s forecast assumes refinancing occurs and also assumes a 20% increase in occupancy without signed group bookings. Based on the financial conditions, what should the auditor consider in evaluating going concern?

  1. Whether management’s assumptions are supported by persuasive evidence (such as a refinancing commitment and corroborating occupancy data) and whether substantial doubt remains after considering management’s plans. (correct answer)
  2. Whether the auditor can omit evaluating management’s forecast because the lender expressed willingness to consider refinancing.
  3. Whether to issue an adverse opinion solely because the company has a loan due within 12 months.
  4. Whether to communicate the issue only to the company’s bank because it is the primary user affected by refinancing risk.

Explanation: The concept tested is the auditor's consideration of going concern under AU-C 570 for nonissuers, focusing on evaluating management's assumptions and plans with sufficient evidence. Key facts include recurring losses, negative cash flows, a near-term loan maturity with only a noncommittal lender indication, and an unsupported occupancy increase assumption. Choice A is correct as it requires assessing assumption supportability and determining if doubt remains, per AU-C 570's evidence-based approach. Choice B is incorrect because auditors cannot omit forecast evaluations even with lender willingness, and choice C is wrong as adverse opinions are not automatic for debt maturities. Choice D is incorrect since communication should include those charged with governance, not just the bank. A decision rule is to test key forecast inputs for reasonableness using corroborative data like commitments or historical trends. Professional judgment involves sensitivity analysis to assess how changes in assumptions impact going concern conclusions.

Question 25

In the planning phase of an audit of a nonissuer manufacturer, the auditor notes that inventory is stored at multiple third-party logistics warehouses and the entity implemented a cycle-count program this year. The cycle counts are performed by warehouse staff, and management reviews exception reports monthly but does not perform periodic independent test counts. Which planning procedure is most appropriate?

  1. Plan to observe inventory counts (or perform alternative procedures) at selected locations and evaluate the design and implementation of controls over cycle counts and exception follow-up. (correct answer)
  2. Wait until the completion phase to decide whether to observe counts, because inventory observation is an execution-phase procedure only.
  3. Rely on the third-party logistics provider’s operational reports as a substitute for audit evidence without assessing their relevance and reliability.
  4. Perform an integrated audit of internal control over financial reporting because inventory is significant and stored offsite.

Explanation: This question addresses audit planning for inventory held at third-party locations and the auditor's responsibilities under AU-C 501 regarding audit evidence for inventory. The key facts are that inventory is stored at multiple third-party warehouses, the entity uses cycle counts performed by warehouse staff, and management reviews exceptions but doesn't perform independent test counts. The correct answer A properly plans to observe inventory counts (or perform alternative procedures) and evaluate controls over the cycle count program, which aligns with AU-C 501's requirements for obtaining sufficient appropriate audit evidence about inventory existence and condition. Answer B incorrectly treats inventory observation as only an execution-phase procedure when planning for observation is required; Answer C inappropriately relies on third-party reports without assessing their reliability as required by AU-C 500; Answer D incorrectly requires an integrated audit for a nonissuer. The professional framework requires auditors to plan procedures for inventory held by third parties, including considering observation, alternative procedures, and evaluation of the entity's count programs. When inventory is significant and held offsite, auditors must plan appropriate procedures during the planning phase to ensure sufficient appropriate audit evidence can be obtained.