CPA Quiz: Communication With Governance
20 questions · exam conditions
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Communication With GovernanceQuestion 1 of 20

You are the auditor of a nonissuer manufacturing company in a financial statement audit. During interim testing, you identify that the controller both sets up new vendors and approves vendor master changes, and you note two instances where vendor bank account changes were processed without independent review; management states the process is efficient and does not plan to change it. The audit is otherwise on schedule and you plan to rely on controls over disbursements. What is the auditor's responsibility in communicating this issue?

Defer communication until the final audit completion meeting because control matters are only required to be communicated at the end of the engagement.
Communicate the significant deficiency or material weakness in writing to management only, because those charged with governance are not required recipients for nonissuer internal control matters.
Communicate the significant deficiency or material weakness in writing to those charged with governance on a timely basis and also communicate it in writing to management.
Include the control issue as a critical audit matter in the auditor's report and no separate governance communication is necessary.
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CPA Quiz

CPA Quiz: Communication With Governance

Practice Communication With Governance in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Communication With Governance, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

You are the auditor of a nonissuer manufacturing company in a financial statement audit. During interim testing, you identify that the controller both sets up new vendors and approves vendor master changes, and you note two instances where vendor bank account changes were processed without independent review; management states the process is efficient and does not plan to change it. The audit is otherwise on schedule and you plan to rely on controls over disbursements. What is the auditor's responsibility in communicating this issue?

  1. Defer communication until the final audit completion meeting because control matters are only required to be communicated at the end of the engagement.
  2. Communicate the significant deficiency or material weakness in writing to management only, because those charged with governance are not required recipients for nonissuer internal control matters.
  3. Communicate the significant deficiency or material weakness in writing to those charged with governance on a timely basis and also communicate it in writing to management. (correct answer)
  4. Include the control issue as a critical audit matter in the auditor's report and no separate governance communication is necessary.
Explanation: This question tests the auditor's responsibility under AU-C 265 to communicate significant deficiencies and material weaknesses in internal control to those charged with governance in a nonissuer audit. The scenario describes a segregation of duties issue where the controller can both set up vendors and approve changes without independent review, which represents at least a significant deficiency given the lack of compensating controls and management's unwillingness to remediate. Professional standards require that significant deficiencies and material weaknesses be communicated in writing to both those charged with governance and management on a timely basis. Answer A is incorrect because control deficiencies must be communicated promptly when identified, not deferred until audit completion. Answer B is incorrect because those charged with governance must receive written communication of significant deficiencies, not just management. Answer D is incorrect because critical audit matters apply only to issuer audits, not nonissuer audits, and do not replace required governance communications. The key professional judgment is that timely written communication to both governance and management enables appropriate oversight and remediation of control deficiencies that could affect financial reporting reliability.

Question 2

You are the auditor of a nonissuer in a financial statement audit. Near the end of fieldwork, management informs you that a warehouse fire occurred after year-end but before the auditor's report date; management believes the event is immaterial and does not want to inform the board until insurance proceeds are finalized. You determine the event is a significant subsequent event requiring consideration of disclosure and potentially affects the audit timeline. What is the auditor's responsibility in communicating this issue?

  1. Communicate the subsequent event to those charged with governance promptly, including the potential financial statement disclosure implications and any effect on the planned report date. (correct answer)
  2. Avoid communicating with those charged with governance because management is responsible for subsequent event evaluation and disclosure decisions.
  3. Wait to communicate until after the financial statements are issued to avoid influencing governance's oversight role.
  4. Issue an adverse opinion immediately because any subsequent event occurring before the report date requires an adverse opinion.
Explanation: This question addresses the auditor's responsibility under AU-C 560 to communicate significant subsequent events with those charged with governance in a nonissuer audit. The warehouse fire occurring after year-end but before the auditor's report date is a Type II subsequent event requiring disclosure consideration, and management's reluctance to inform the board raises concerns about transparency. Professional standards require the auditor to communicate promptly with governance about significant subsequent events, their potential disclosure implications, and any effects on the audit timeline. Answer B is incorrect because the auditor has a responsibility to ensure governance is aware of significant matters affecting the financial statements, including subsequent events. Answer C is incorrect because waiting until after issuance would prevent governance from fulfilling their oversight role regarding financial statement disclosures. Answer D is incorrect because subsequent events do not automatically require adverse opinions; the key is appropriate disclosure or adjustment. The critical professional judgment is that timely communication about subsequent events enables governance to oversee appropriate financial statement disclosure and maintain transparency with stakeholders.

Question 3

You are the auditor of an issuer in an integrated audit. Testing of controls over journal entries identifies that the company's system allows users with general ledger posting access to also modify the audit trail settings, and you observe that audit logs were disabled for two weeks during the year; management states it was for system maintenance. You conclude this is at least a significant deficiency and potentially a material weakness in internal control over financial reporting. Which information should the auditor prioritize in communication with governance?

  1. A detailed list of every journal entry tested and the names of individual employees involved, because governance must approve each entry to remediate the deficiency.
  2. The nature of the control deficiency, its potential impact on financial reporting and the auditor's internal control opinion, and the fact that it will be communicated in writing on a timely basis. (correct answer)
  3. A statement that no communication is required unless a material misstatement is found, because internal control issues are management's responsibility.
  4. A plan to communicate the matter only in a management letter after the Form 10-K is filed, to avoid disrupting reporting timelines.
Explanation: This question tests the auditor's responsibility under AS 1305 to communicate material weaknesses and significant deficiencies in internal control over financial reporting for an issuer. The control deficiency allowing users to modify audit trail settings and the observed disabling of audit logs represents at least a significant deficiency affecting the reliability of the control environment and potentially rising to a material weakness. PCAOB standards require timely written communication to the audit committee about the nature of control deficiencies, their potential impact on financial reporting and the internal control opinion, and management's response. Answer A is incorrect because detailed testing results and individual employee names are not required in governance communications; the focus should be on the deficiency's nature and impact. Answer C is incorrect because all material weaknesses and significant deficiencies must be communicated regardless of whether misstatements are found. Answer D is incorrect because significant deficiencies must be communicated on a timely basis, not delayed until after filing. The critical professional judgment is that prompt communication of control deficiencies enables governance oversight and timely remediation to improve internal control effectiveness.

Question 4

You are auditing an issuer. The audit committee asks whether the engagement team had any significant disagreements with management during the audit. There were disagreements about the classification of certain expenses, but management ultimately accepted the auditor's position. What is the auditor's responsibility in communicating this issue?

  1. Communicate significant disagreements with management to the audit committee, including those resolved, and describe the subject matter and how they were resolved. (correct answer)
  2. Do not communicate disagreements that were resolved because only unresolved disagreements are required to be reported.
  3. Communicate only if the disagreement resulted in a material weakness in internal control.
  4. Communicate only to the chief executive officer because the audit committee should not be involved in accounting classification disputes.
Explanation: The professional standard being tested is the auditor's responsibility to communicate with those charged with governance, specifically regarding significant issues encountered during the audit as outlined in PCAOB AS 1301 and AU-C Section 260. The key facts are that the audit involves an issuer, there were significant disagreements with management about expense classification that were ultimately resolved by management accepting the auditor's position, and the audit committee inquired about such disagreements. The correct answer aligns with authoritative guidance because auditors must communicate significant disagreements with management to the audit committee, including resolved ones, to ensure transparency and oversight of the financial reporting process, describing the subject matter and resolution method. Choice B is incorrect because guidance requires reporting both resolved and unresolved disagreements if they are significant, as per AU-C 260.A27; choice C is wrong as communication is not limited to material weaknesses in internal control but extends to significant audit issues under PCAOB standards; choice D is incorrect because the audit committee, as those charged with governance, must be informed of such disputes, not just the CEO, to fulfill their oversight role. Effective communication with governance promotes accountability and helps mitigate risks in financial reporting. Auditors should exercise professional judgment in determining the significance of disagreements, prioritizing timely and complete disclosures to support governance's decision-making and enhance audit quality.

Question 5

You are performing a financial statement audit of a nonissuer with a two-person accounting department. You identify that the same employee receives customer payments, posts to accounts receivable, and prepares the bank deposit, with no compensating controls. No misstatements were found in your substantive testing. Based on the auditor's findings, what should be communicated to those charged with governance?

  1. A significant deficiency or deficiency in internal control (as appropriate) related to segregation of duties, communicated in writing to management and those charged with governance. (correct answer)
  2. Nothing, because internal control matters are only communicated when a material misstatement is detected.
  3. Only an oral comment to the bookkeeper, because written communication is not permitted for nonissuers.
  4. A critical audit matter disclosure in the auditor's report describing the segregation-of-duties issue.
Explanation: The professional standard being tested is AU-C Section 265, which requires written communication of significant deficiencies in internal control to those charged with governance in nonissuer audits. The key facts are the lack of segregation of duties without compensating controls, despite no misstatements found. Choice A aligns with AU-C 265 by mandating communication of deficiencies based on risk potential. Choice B is incorrect because AU-C 265 requires communication regardless of misstatements; choice C is wrong as written communication is required per AU-C 265; choice D is incorrect because CAMs are PCAOB for issuers. A framework is to classify deficiencies by misstatement likelihood, then communicate accordingly. Effective governance communication drives control improvements and risk mitigation.

Question 6

You are the auditor of an issuer. During the audit, you identify that management selected an aggressive revenue recognition interpretation that is within a reasonable range but results in materially higher revenue than an alternative acceptable policy. The audit committee is considering whether to change the policy next year. Which information should the auditor prioritize in communication with governance?

  1. The significant qualitative aspects of the company's accounting practices, including why the policy is aggressive, the judgments involved, and the potential effect on comparability. (correct answer)
  2. A directive that the audit committee must choose the most conservative policy available to avoid any risk of SEC comment.
  3. No communication because the policy is acceptable and does not result in a misstatement.
  4. A recommendation to publicly disclose the matter as a critical audit matter without first discussing with the audit committee.
Explanation: The professional standard being tested is PCAOB AS 1301, which requires communication of significant qualitative aspects of accounting practices to those charged with governance in issuer audits. The key facts are the aggressive but acceptable revenue policy and the audit committee's consideration of changes. Choice A aligns with AS 1301 by prioritizing discussion of policy judgments and effects. Choice B is incorrect because AS 1301 does not mandate conservative policies; choice C is wrong as communication is required for qualitative aspects per AS 1301; choice D is incorrect because CAM disclosure follows governance discussion. A judgment framework is to evaluate policy reasonableness and bias, then communicate for governance input. Emphasizing governance communication aids in consistent and transparent accounting practices.

Question 7

You are the auditor of a nonissuer manufacturing company in a financial statement audit. During walkthroughs and testing, you identify that (1) the controller can set up new vendors and approve payments without independent review, and (2) bank reconciliations are not prepared timely and lack evidence of review; two instances of duplicate payments were noted but corrected by management. Management agrees to remediate but asks that you wait until the end of fieldwork to inform the audit committee because "it will distract them." What is the appropriate course of action for the auditor in this situation?

  1. Communicate the significant deficiencies in writing to those charged with governance on a timely basis and also communicate them to management, without waiting until the end of fieldwork. (correct answer)
  2. Defer communication until after the report release date because the deficiencies were corrected and therefore no longer require governance communication.
  3. Communicate the matters only to management because internal control communication is not required for nonissuers unless a material weakness exists.
  4. Communicate the deficiencies to the audit committee only if they result in a modified audit opinion on the financial statements.
Explanation: The professional standard being tested is AU-C Section 265, which requires auditors to communicate internal control deficiencies identified during an audit of a nonissuer to those charged with governance. The key facts are the identification of significant deficiencies in vendor setup and bank reconciliations, along with management's request to delay communication to the audit committee. Choice A aligns with AU-C 265 by requiring timely written communication to governance and also to management, ensuring transparency without delay. Choice B is incorrect because AU-C 265 mandates communication even if deficiencies are corrected, as governance needs awareness; choice C is wrong as communication to governance is required for significant deficiencies in nonissuer audits, not just material weaknesses; choice D is incorrect because AU-C 265 requires communication regardless of the audit opinion. A transferable framework is to evaluate the severity of deficiencies using indicators like potential for misstatement and compensating controls, then prioritize timely governance communication. Effective communication with governance fosters oversight and remediation, enhancing the entity's internal control environment and audit quality.

Question 8

You are the auditor of an issuer in an integrated audit of financial statements and internal control over financial reporting. Midway through fieldwork, management restricts access to certain contract files supporting a new revenue stream, citing confidentiality with a strategic partner, and proposes providing only summary schedules instead. This restriction affects planned substantive procedures and could limit evidence. What is the appropriate course of action for the auditor in this situation?

  1. Accept management's summary schedules as sufficient appropriate audit evidence because the restriction relates to confidential information and proceed without further communication.
  2. Communicate the scope limitation to the audit committee promptly and discuss its potential effect on the audit and the auditor's report, while seeking to obtain the underlying evidence. (correct answer)
  3. Communicate the restriction only to management because the audit committee is not involved in audit scope decisions unless a misstatement is identified.
  4. Automatically withdraw from the engagement without communicating with the audit committee because any restriction by management requires withdrawal for issuers.
Explanation: This question addresses the auditor's responsibility under AS 1301 when management imposes scope limitations during an integrated audit of an issuer. The restriction on access to contract files supporting a new revenue stream constitutes a scope limitation that could affect the auditor's ability to obtain sufficient appropriate audit evidence for both the financial statement and internal control opinions. PCAOB standards require prompt communication with the audit committee about scope limitations, their potential effects on the audit, and possible implications for the auditor's report. Answer A is incorrect because accepting summary schedules without the underlying evidence would violate the auditor's responsibility to obtain sufficient appropriate audit evidence. Answer C is incorrect because the audit committee must be informed of scope limitations that could affect the audit opinions, not just management. Answer D is incorrect because automatic withdrawal is not required; the auditor should first communicate with governance and attempt to resolve the limitation. The critical professional judgment is that governance must be promptly informed of scope limitations to fulfill their oversight responsibilities and help resolve issues that could affect audit quality and reporting.

Question 9

You are engaged to perform a financial statement compilation for a nonissuer closely held retailer, and management asks you to help "clean up" the books by proposing journal entries and also to speak directly with the two-member board about the company's weak cash controls. You become aware that the bookkeeper both receives cash and performs the bank reconciliation, and there is no evidence of fraud but the risk is elevated. Based on the accountant's findings, what should be communicated to those charged with governance?

  1. Nothing, because compilation engagements never involve any communication with those charged with governance about internal control matters.
  2. Only a statement that the accountant will provide assurance on internal controls as part of the compilation due to the elevated risk.
  3. If the accountant chooses to communicate, the communication should clearly state the lack of assurance in a compilation and describe the observed control weakness without implying an audit or review was performed. (correct answer)
  4. A written communication to the audit committee describing significant deficiencies identified during tests of controls performed as part of the compilation.
Explanation: This question addresses communication considerations in a compilation engagement under AR-C 80 for a nonissuer. While compilations provide no assurance and have no requirement to communicate control matters, the accountant may choose to communicate observed issues when specifically requested by management or governance. The key is that any communication must clearly state the lack of assurance provided in a compilation and avoid implying that audit or review procedures were performed. Answer A is incorrect because while not required, accountants may communicate matters that come to their attention if they choose to do so. Answer B is incorrect because compilations provide no assurance on any aspect, including internal controls. Answer D is incorrect because compilations do not involve tests of controls or identification of significant deficiencies in the audit sense. The critical professional judgment is that if choosing to communicate in a compilation, the accountant must be clear about the engagement's limitations and avoid creating misunderstanding about the level of service provided.

Question 10

You are the auditor of an issuer. During the audit, you identify that management consulted with a different accounting firm on a contentious accounting issue and is selectively sharing only the favorable portions of that consultation. The audit committee is unaware of the consultation. Based on the auditor's findings, what should be communicated to those charged with governance?

  1. The existence of management's consultation on a significant accounting matter, the auditor's concerns about completeness and transparency, and the potential implications for financial reporting and audit evidence. (correct answer)
  2. Nothing, because consultations with other firms are privileged and cannot be discussed with the audit committee.
  3. Only the final accounting conclusion, without mentioning the consultation, to avoid creating tension between management and the audit committee.
  4. Communicate directly to the SEC staff because any consultation indicates potential fraud.
Explanation: The professional standard being tested is PCAOB AS 1301, which requires communication of significant accounting consultations and related concerns to those charged with governance in issuer audits. The key facts are management's selective sharing of the consultation and the audit committee's unawareness. Choice A aligns with AS 1301 by mandating discussion of the consultation and transparency issues. Choice B is incorrect because AS 1301 allows discussion of consultations; choice C is wrong as full context is required per AS 1301; choice D is incorrect because consultations do not automatically indicate fraud. A rule is to evaluate consultation completeness, then communicate risks to governance. Effective communication promotes fair financial reporting and audit evidence integrity.

Question 11

You are conducting a financial statement audit of a nonissuer construction contractor. You discover that the chief executive officer directed accounting staff to record revenue on an unapproved change order to meet a bonus target; management proposes to reverse it next period. The company has a board of directors that meets quarterly. Based on the auditor's findings, what should be communicated to those charged with governance?

  1. The fraud involving senior management and its implications for the audit, including the need for governance oversight, communicated timely to those charged with governance. (correct answer)
  2. Only the quantitative amount of the misstatement, because qualitative aspects of fraud are not required communications.
  3. Only to management because governance communication is unnecessary when management intends to reverse the entry in a future period.
  4. To the company's customers because they may have been affected by the unapproved change order.
Explanation: The professional standard being tested is AU-C Section 260, which requires communication of fraud involving senior management to those charged with governance in nonissuer audits. The key facts are the CEO's directive to record unapproved revenue, indicating fraud, and the proposal to reverse it later. Choice A aligns with AU-C 260 by mandating timely communication of fraud and its audit implications to governance. Choice B is incorrect because AU-C 260 requires both quantitative and qualitative fraud aspects; choice C is wrong as governance communication is required per AU-C 260; choice D is incorrect because AU-C 260 limits communication to governance, not external parties. A judgment framework is to assess fraud indicators like intent and materiality, then escalate to governance for oversight. Emphasizing governance communication deters fraud and strengthens internal accountability.

Question 12

You are the auditor of a nonissuer in a financial statement audit. During the audit, you learn that the chief financial officer offered your senior associate tickets to a major sporting event shortly before year-end fieldwork, and the associate initially accepted but later returned them after discussing with the engagement partner. There is no evidence of misstatement, but the situation raises concerns about independence and ethics. What is the appropriate course of action for the auditor in this situation?

  1. Document the matter internally but do not communicate it to those charged with governance because it was resolved and did not affect audit procedures.
  2. Communicate to those charged with governance the relevant independence considerations and safeguards applied, and document the communication and conclusions. (correct answer)
  3. Immediately issue a disclaimer of opinion because any offer of gifts automatically impairs independence, regardless of safeguards.
  4. Communicate the matter only to the company's legal counsel because ethical matters are outside the scope of auditor-governance communications.
Explanation: This question addresses the auditor's responsibility under AU-C 260 to communicate independence matters with those charged with governance in a nonissuer audit. The acceptance and subsequent return of valuable gifts from client management raises independence concerns that, while ultimately resolved through appropriate safeguards, require communication to governance. Professional standards require communication of relevant independence considerations and safeguards applied when circumstances arise that could reasonably be thought to bear on independence. Answer A is incorrect because resolved independence matters still require communication when they could reasonably affect perceptions of auditor objectivity. Answer C is incorrect because the gift was returned and appropriate safeguards were applied; this does not automatically impair independence or require a disclaimer. Answer D is incorrect because independence matters are within the scope of required auditor communications with governance, not limited to legal counsel. The critical professional judgment is that transparent communication about independence considerations, even when resolved, maintains trust and enables governance to fulfill their oversight role regarding auditor independence.

Question 13

You are auditing a nonissuer technology company. The company has a venture capital representative on the board who is also negotiating to purchase additional shares. During the audit, you learn confidential information that could affect valuation, and the representative asks you privately for details before the board meeting. Which factor is most critical for the auditor to discuss with governance?

  1. Maintaining confidentiality and appropriate communication channels, and ensuring communications are made to those charged with governance as a body (or through authorized governance processes) rather than selectively to an individual for personal use. (correct answer)
  2. Providing the requested details to the representative because board members are always entitled to all audit information individually.
  3. Withholding all information from the board because confidentiality prevents any governance communication.
  4. Reporting the request as a critical audit matter in the auditor's report to ensure equal access by all investors.
Explanation: The professional standard being tested is AU-C Section 260, which emphasizes maintaining confidentiality and communicating with governance as a body in nonissuer audits. The key facts are the board representative's private request for confidential information potentially for personal gain. Choice A aligns with AU-C 260 by requiring communication through proper channels to preserve confidentiality. Choice B is incorrect because AU-C 260 prohibits selective disclosure; choice C is wrong as governance communication is required; choice D is incorrect because CAMs are not applicable. A framework is to assess requests against confidentiality rules, then direct to governance body. Governance communication ensures equitable information access and ethical practices.

Question 14

You are auditing an issuer. The engagement team identified a significant deficiency in controls over financial reporting close to year-end, but management remediated it before year-end and asserts it no longer exists. The audit committee asks whether it still needs to be communicated. What is the auditor's responsibility in communicating this issue?

  1. Communicate the significant deficiency to the audit committee, including that it was identified during the audit and describing management's remediation and the auditor's understanding of its status. (correct answer)
  2. Do not communicate because the deficiency was remediated before year-end and therefore is irrelevant to governance.
  3. Communicate only if the deficiency results in a restatement of previously issued financial statements.
  4. Communicate only to management because the audit committee's role is limited to approving fees and auditor appointment.
Explanation: The professional standard being tested is PCAOB AS 2201, which requires communication of significant deficiencies in ICFR to the audit committee in issuer audits, even if remediated. The key facts are the late-year significant deficiency remediated before year-end and the audit committee's inquiry. Choice A aligns with AS 2201 by mandating communication including remediation status. Choice B is incorrect because AS 2201 requires communication of identified deficiencies; choice C is wrong as communication is not limited to restatements; choice D is incorrect because AS 2201 assigns ICFR oversight to the audit committee. A decision rule is to report all identified deficiencies, noting status. Governance communication ensures ongoing ICFR monitoring and effectiveness.

Question 15

During the audit of a nonissuer, an auditor identifies a new significant risk related to a complex derivative valuation that was not contemplated during the initial planning stages.

What is the auditor's responsibility regarding communication of this newly identified risk to those charged with governance?

  1. Wait until the audit is complete and include the matter in the final management letter.
  2. Communicate the new risk and the planned responsive audit approach on a timely basis. (correct answer)
  3. Only communicate the risk if it results in the discovery of a material misstatement.
  4. Discuss the matter with management only, as it is an operational risk.
Explanation: The correct answer is B. Auditing standards require that the auditor communicate with those charged with governance on a timely basis throughout the audit. When a new significant risk is identified, the auditor should communicate this development and the corresponding changes to the audit plan to ensure governance is appropriately informed. A is incorrect because delaying communication of a significant risk until the end of the audit would not be considered timely. C is incorrect because the communication requirement relates to the risk itself, not whether it has already resulted in a misstatement. D is incorrect because significant risks, especially those affecting financial reporting, are a key area of interest and oversight for those charged with governance.

Question 16

An auditor is required to communicate certain matters to those charged with governance. Which of the following matters is an auditor most likely to communicate only to the appropriate level of management and not to those charged with governance?

  1. The auditor's views on significant qualitative aspects of the entity's accounting policies.
  2. A disagreement with management over a valuation method that has a material effect on the financial statements.
  3. An internal control deficiency that is neither a material weakness nor a significant deficiency. (correct answer)
  4. Significant difficulties encountered during the audit, such as unreasonable delays in providing information.
Explanation: The correct answer is C. Internal control deficiencies that are of a lesser severity than a significant deficiency (often called 'other control deficiencies') are typically communicated to the appropriate level of management but are not required to be communicated to those charged with governance. A, B, and D are all examples of 'significant findings from the audit' that auditing standards (AU-C 260) explicitly require the auditor to communicate to those charged with governance.

Question 17

An auditor is conducting an integrated audit of an issuer subject to PCAOB standards. The auditor identifies a deficiency that, while not a material weakness, is considered a significant deficiency. What is the auditor's communication requirement?

  1. Communicate the deficiency to management orally and document it in the workpapers.
  2. Report the deficiency directly to the SEC, as it relates to an issuer.
  3. Communicate the deficiency in writing to the audit committee prior to the issuance of the auditor's report. (correct answer)
  4. Communicate the deficiency to management in writing, but no communication to the audit committee is required.
Explanation: The correct answer is C. Under PCAOB Auditing Standard 1301, Communications with Audit Committees, the auditor must communicate all significant deficiencies and material weaknesses in writing to the audit committee. This communication must occur prior to the issuance of the auditor's report on the financial statements. A is incorrect because the communication must be in writing. B is incorrect as deficiencies are reported to the audit committee, not directly to the SEC in this manner. D is incorrect because significant deficiencies must be communicated to the audit committee (those charged with governance for an issuer).

Question 18

During the audit of a private company, an auditor identifies three internal control deficiencies: (1) a clerk occasionally makes minor pricing errors on sales invoices that are immaterial individually and in the aggregate, (2) the accounts payable supervisor can add new vendors and approve payments to them, and (3) the CFO can post journal entries to the general ledger without any independent review.

Which of these deficiencies is the auditor required to communicate in writing to those charged with governance?

  1. Only the CFO's ability to post journal entries without review.
  2. The lack of segregation of duties in accounts payable and the CFO's ability to post journal entries. (correct answer)
  3. All three identified deficiencies.
  4. Only the lack of segregation of duties in accounts payable.
Explanation: The correct answer is B. The auditor must communicate significant deficiencies and material weaknesses. The lack of segregation of duties in accounts payable (item 2) creates an opportunity for fraudulent payments and would likely be considered at least a significant deficiency. The CFO's ability to post journal entries without review (item 3) is a classic example of a risk of management override and would also be considered at least a significant deficiency, if not a material weakness. The minor pricing errors (item 1) would likely be classified as a control deficiency to be discussed with management but not communicated to governance. A and D are incorrect because both items 2 and 3 represent significant risks that merit the attention of those charged with governance. C is incorrect because the minor pricing errors are likely not severe enough to be considered a significant deficiency.

Question 19

An auditor is planning the audit of a technology company that has entered into several complex, multi-element revenue arrangements. During the planning phase, the auditor forms a preliminary view that management's application of the revenue recognition criteria may be inappropriate for certain contracts.

How should the auditor address this matter in the initial communications with the company's audit committee?

  1. Communicate a formal disagreement with management and threaten to issue a qualified opinion.
  2. Discuss the auditor's preliminary views on these significant and critical accounting policies and practices. (correct answer)
  3. Wait until substantive testing is complete before raising any potential accounting issues.
  4. Refuse to communicate any preliminary views to avoid appearing biased before the audit procedures are complete.
Explanation: The correct answer is B. Auditing standards encourage early communication of significant matters. Discussing preliminary views on critical accounting policies, especially in high-risk areas like revenue recognition, provides an opportunity for a robust dialogue with the audit committee early in the process. This is a key part of communicating the planned scope and approach to significant risks. A is incorrect because it is too confrontational for a preliminary view during the planning stage. C and D are incorrect because delaying communication of such a significant potential issue would be a disservice to the audit committee and contrary to the principle of timely, two-way communication.

Question 20

During an audit, the auditor concludes that management has chosen an accounting principle for recognizing revenue that, while permitted under GAAP, is less preferable than an available alternative. The chosen principle has a material positive effect on reported net income. Management is unwilling to change its method.

What is the auditor's most appropriate communication to those charged with governance regarding this matter?

  1. Inform them that an adverse opinion will be issued because the financial statements are not fairly presented.
  2. Withdraw from the engagement due to an irresolvable conflict with management.
  3. Communicate the auditor's concerns about the qualitative aspects of this significant accounting practice. (correct answer)
  4. Insist that management include a footnote disclosing the auditor's preference for the alternative principle.
Explanation: The correct answer is C. The auditor is required to communicate with those charged with governance about their views on the qualitative aspects of the entity's significant accounting practices, including the selection of accounting principles. Even if a principle is acceptable under GAAP, the auditor can and should discuss why an alternative may be more appropriate or less aggressive. This provides the governance body with important context for their oversight role. A is incorrect because a choice between two acceptable GAAP principles does not warrant an adverse opinion. B is incorrect as this situation is a disagreement, but not necessarily one that requires withdrawal. D is incorrect because the auditor cannot insist on specific footnote wording prepared by management, although they would evaluate the adequacy of the existing disclosures.