CPA Quiz: Misstatements And Deficiencies
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Misstatements And DeficienciesQuestion 1 of 20

In an audit of an issuer (public company), the auditor identifies a $3.2 million overstatement of revenue from bill-and-hold transactions that do not meet the criteria for revenue recognition; pretax income is $18 million and overall materiality is $1.5 million. Management refuses to correct the misstatement, which is confined to one business unit and not pervasive to the financial statements. Under PCAOB standards, what type of report modification should be considered due to the misstatement?

Unqualified opinion with an emphasis-of-matter paragraph describing the uncorrected misstatement
Qualified opinion due to a material misstatement that is not pervasive
Disclaimer of opinion due to inability to obtain sufficient appropriate audit evidence
Adverse opinion because any intentional misstatement requires an adverse opinion regardless of pervasiveness
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CPA Quiz

CPA Quiz: Misstatements And Deficiencies

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

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Question 1

In an audit of an issuer (public company), the auditor identifies a $3.2 million overstatement of revenue from bill-and-hold transactions that do not meet the criteria for revenue recognition; pretax income is $18 million and overall materiality is $1.5 million. Management refuses to correct the misstatement, which is confined to one business unit and not pervasive to the financial statements. Under PCAOB standards, what type of report modification should be considered due to the misstatement?

  1. Unqualified opinion with an emphasis-of-matter paragraph describing the uncorrected misstatement
  2. Qualified opinion due to a material misstatement that is not pervasive (correct answer)
  3. Disclaimer of opinion due to inability to obtain sufficient appropriate audit evidence
  4. Adverse opinion because any intentional misstatement requires an adverse opinion regardless of pervasiveness
Explanation: This question examines the auditor's reporting responsibilities under PCAOB standards (AS 3101) when management refuses to correct a material misstatement that is not pervasive. The key facts include a $3.2 million revenue overstatement exceeding overall materiality of $1.5 million, confined to one unit and not pervasive, with management refusing correction. Choice B is correct because AS 3101 requires a qualified opinion for material misstatements that are not pervasive, specifying a 'qualified' modification for such departures from GAAP. Choice A is incorrect as an unmodified opinion with emphasis-of-matter is not appropriate for uncorrected material misstatements per AS 3101; choice C is wrong because this is not a scope limitation leading to a disclaimer under AS 3101. Choice D is incorrect as AS 3101 does not mandate an adverse opinion for intentional misstatements unless pervasive; pervasiveness determines adverse vs. qualified. Auditors should evaluate misstatement pervasiveness and materiality to determine qualified or adverse opinions. A decision rule is to request correction and, if refused, modify the opinion based on whether the effect is material but isolated (qualified) or pervasive (adverse).

Question 2

In an audit of a nonissuer healthcare clinic, the auditor identifies a $95,000 misclassification between short-term and long-term debt. Overall materiality is $800,000; the clearly trivial threshold is $40,000. The misclassification does not affect net income but impacts the current ratio used in a lender covenant. Which action should the auditor take regarding the identified misstatement?

  1. Accumulate and evaluate the misclassification because it exceeds the clearly trivial threshold and may be qualitatively material due to covenant impact (correct answer)
  2. Do not accumulate it because it does not affect net income and therefore cannot be material
  3. Treat it as a subsequent event and address it only after obtaining the lender's waiver
  4. Communicate it only to the lender because the covenant is the lender's concern, not management's
Explanation: This question examines handling misclassifications under AICPA standards (AU-C 450). Key facts include $95,000 debt misclassification above $40,000 trivial, impacting covenant ratio without net income effect. Choice A is correct as AU-C 450 requires accumulation and qualitative evaluation, especially for covenant impacts. Choice B is incorrect because AU-C 450 considers classification material beyond net income; choice C is wrong as not a subsequent event per AU-C 560. Choice D is incorrect as AU-C 265 requires management communication. Framework: Accumulate classifications exceeding trivial and assess qualitative materiality. Decision rule: Request corrections for impacts on ratios or covenants, modifying if material and uncorrected.

Question 3

During an audit of a nonissuer wholesaler, the auditor proposes an adjustment to write down obsolete inventory by $240,000. Management records $200,000 and argues the remaining $40,000 is 'close enough.' Overall materiality is $500,000 and performance materiality is $300,000; other uncorrected misstatements total $290,000. Which factor would most likely affect the auditor's decision regarding the misstatement?

  1. Whether the remaining uncorrected $40,000 exceeds overall materiality by itself
  2. Whether the aggregate of uncorrected misstatements, including the remaining $40,000, exceeds performance materiality and/or indicates bias in management's judgments (correct answer)
  3. Whether the client agrees to strengthen inventory controls, because that eliminates the need to evaluate remaining uncorrected misstatements
  4. Whether the adjustment was proposed by the auditor, because auditor-proposed adjustments are not included in the evaluation of misstatements
Explanation: This question evaluates factors in assessing partial adjustments under AICPA standards (AU-C 450). Key facts include $40,000 uncorrected after partial write-down, aggregating with $290,000 others near $300,000 performance materiality, suggesting bias. Choice B is correct as AU-C 450 requires aggregate evaluation and consideration of bias patterns. Choice A is incorrect because AU-C 450 evaluates aggregates, not isolation; choice C is wrong as controls do not negate misstatement evaluation. Choice D is incorrect as AU-C 450 includes all proposed adjustments. Framework: Aggregate uncorrected items and probe for bias. Decision rule: Request full corrections if aggregates approach materiality or indicate bias.

Question 4

During an audit of a nonissuer technology company, the auditor finds that management omitted required related-party disclosures for transactions totaling $2.5 million with an entity controlled by the CEO. The dollar amounts were recorded correctly, and overall materiality is $1.2 million based on pretax income. What type of report modification should be considered due to the misstatement if management refuses to add the disclosures and the omission is material but not pervasive?

  1. Qualified opinion due to a material departure from the applicable financial reporting framework (inadequate disclosure) (correct answer)
  2. Unmodified opinion because disclosure omissions do not affect the numbers in the financial statements
  3. Disclaimer of opinion because the auditor cannot obtain evidence about the related-party transactions
  4. Adverse opinion because any related-party disclosure omission is considered pervasive by definition
Explanation: This question assesses reporting for disclosure omissions under AICPA standards (AU-C 705). Key facts include omitted related-party disclosures for $2.5 million transactions, material but not pervasive, exceeding $1.2 million materiality. Choice A is correct as AU-C 705 requires qualified opinions for material, non-pervasive departures like inadequate disclosures. Choice B is incorrect because AU-C 450 considers disclosure omissions misstatements; choice C is wrong as evidence was obtained per AU-C 705. Choice D is incorrect as AU-C 705 reserves adverse for pervasive effects. Framework: Evaluate disclosure materiality and pervasiveness for opinion type. Decision rule: Qualify for material but isolated disclosure failures if uncorrected.

Question 5

During an audit of a nonissuer manufacturing company, the auditor identifies several uncorrected misstatements that are individually immaterial but in aggregate exceed overall materiality. Management argues that because each item is small, no adjustment is required. Which action should the auditor take regarding the identified misstatements under AICPA auditing standards?

  1. Evaluate the aggregate effect of uncorrected misstatements on the financial statements and request adjustment; if not corrected and material, consider modifying the opinion (correct answer)
  2. Accept management's position because aggregation is not permitted; only individual misstatements are evaluated
  3. Address the issue by increasing control testing next year rather than proposing adjustments in the current year
  4. Issue an adverse opinion automatically because any aggregate misstatement above materiality is presumed pervasive
Explanation: This question examines aggregation of misstatements under AICPA standards (AU-C 450). Key facts include multiple individually immaterial misstatements aggregating above materiality, with management refusing adjustment. Choice A is correct as AU-C 450 requires aggregate evaluation, correction requests, and modification if material. Choice B is incorrect because AU-C 450 mandates aggregation; choice C is wrong as current adjustments are needed. Choice D is incorrect as adverse requires pervasiveness per AU-C 705. Framework: Accumulate and assess misstatements in totality. Decision rule: Modify opinions if aggregate uncorrected misstatements are material.

Question 6

In an audit of an issuer, the auditor identifies multiple misstatements in the tax provision resulting in a net $2.4 million understatement of income tax expense; overall materiality is $2.0 million. Management proposes recording only $0.6 million, asserting the remainder is 'immaterial.' Based on the circumstances, which response is most appropriate for the discovered misstatement under PCAOB standards?

  1. Accept management's partial correction because it reduces the net misstatement below overall materiality without further evaluation
  2. Evaluate whether the uncorrected portion remains material individually or in aggregate and, if so, request full correction and consider opinion modification if uncorrected (correct answer)
  3. Rely on the company's internal audit function to determine the remaining amount to record and discontinue substantive testing
  4. Wait until after issuance to determine whether the company restates and then decide whether to reissue the report
Explanation: This question tests responses to partial corrections of misstatements under PCAOB standards (AS 2810). Key facts include a $2.4 million net misstatement with only $0.6 million corrected, exceeding $2.0 million materiality. Choice B is correct as AS 2810 requires evaluating remaining uncorrected amounts individually and in aggregate, requesting full correction, and considering modification if material. Choice A is incorrect because AS 2810 does not allow acceptance without evaluation; choice C is wrong as internal audit cannot substitute for auditor judgment per AS 2605. Choice D is incorrect as evaluation occurs pre-issuance per AS 2810. Framework: Assess partial corrections for completeness and aggregate remaining effects. Decision rule: If uncorrected portions are material, modify opinions accordingly.

Question 7

During an audit of an issuer, the auditor identifies an uncorrected $900,000 understatement of warranty liability; overall materiality is $5 million. However, the understatement causes the company to report positive operating income rather than a slight operating loss in one reportable segment, and segment results are prominently disclosed in MD&A. Under PCAOB standards, which factor would most likely affect the auditor's decision regarding the misstatement?

  1. Whether the misstatement is below overall materiality, because segment disclosures are excluded from the auditor's evaluation
  2. Whether the misstatement affects a segment trend or turns a segment loss into income, which may be qualitatively material to users (correct answer)
  3. Whether the misstatement can be corrected by management after the audit report date without informing the auditor
  4. Whether the misstatement relates to an estimate, because estimates are not considered misstatements under PCAOB standards
Explanation: This question tests qualitative factors in misstatement evaluation under PCAOB standards (AS 2810). Key facts include $900,000 understatement below $5 million materiality but altering segment loss to income in disclosures. Choice B is correct as AS 2810 considers qualitative impacts like segment trends material to users. Choice A is incorrect because AS 2810 includes segment disclosures in evaluations; choice C is wrong as post-report corrections require auditor involvement per AS 3905. Choice D is incorrect as AS 2810 treats estimate misstatements similarly. Framework: Consider user-specific qualitative effects like segment impacts. Decision rule: Escalate misstatements affecting key disclosures despite quantitative immateriality.

Question 8

During an audit of a nonissuer manufacturing company, the auditor identifies an uncorrected misstatement: inventory is overstated by $420,000 due to a pricing file error, increasing pretax income by the same amount. Overall materiality is $500,000 and performance materiality is $300,000; the misstatement is not pervasive but turns a small loss into a small profit and affects a debt covenant based on minimum net income. Under AICPA auditing standards, which factor would most likely affect the auditor's decision regarding the misstatement?

  1. Whether the misstatement exceeds overall materiality, because items below overall materiality are presumed clearly trivial and need not be accumulated
  2. Whether the misstatement changes a loss into income or affects compliance with regulatory or contractual requirements, even if it is below overall materiality (correct answer)
  3. Whether management agrees to remediate the pricing file control deficiency, because control remediation eliminates the need to evaluate the misstatement
  4. Whether the misstatement would have been detected in interim testing, because only interim misstatements require evaluation for aggregation
Explanation: This question tests the evaluation of uncorrected misstatements under AICPA auditing standards (AU-C 450), focusing on qualitative factors that may render a misstatement material despite being below quantitative thresholds. The key facts are that the $420,000 inventory overstatement is below overall materiality of $500,000 but turns a loss into a profit and affects a debt covenant based on net income. Choice B is correct because AU-C 450 requires auditors to consider qualitative aspects, such as impacts on earnings trends or compliance with contractual requirements, which could make the misstatement material even if quantitatively immaterial. Choice A is incorrect as AU-C 450 does not presume misstatements below overall materiality are clearly trivial; accumulation and qualitative evaluation are still required. Choice C is wrong because control remediation does not eliminate the need to evaluate misstatements per AU-C 450, and choice D is incorrect as all misstatements, not just interim ones, must be accumulated under AU-C 450. A transferable framework is to accumulate misstatements exceeding the trivial threshold and assess them quantitatively in aggregate while applying qualitative factors like effects on key metrics or covenants. Professional judgment requires requesting correction for qualitatively material items and considering opinion modification if management refuses.

Question 9

In an audit of an issuer, the auditor identifies an error in the consolidation process that omits a small foreign subsidiary, understating total assets by 2% and revenue by 1%. Overall materiality is based on pretax income, and the quantitative effect on income is below materiality; however, the omission affects required geographic disclosures and could influence investors' risk assessment. Which factor would most likely affect the auditor's decision regarding the misstatement?

  1. Whether the omission affects disclosures about significant operating segments or geographic information that users consider important, even if income effects are below materiality (correct answer)
  2. Whether the omitted subsidiary is profitable, because only profitable components affect materiality
  3. Whether the company has an effective consolidation control, because an effective control eliminates the need to evaluate the misstatement
  4. Whether the misstatement reverses in the next period, because self-correcting misstatements are excluded under PCAOB standards
Explanation: This question tests qualitative factors for consolidation errors under PCAOB standards (AS 2810). Key facts include omission understating assets/revenue below materiality but affecting geographic disclosures and risk assessment. Choice A is correct as AS 2810 considers qualitative user impacts like omitted disclosures material. Choice B is incorrect because AS 2810 evaluates all components; choice C is wrong as controls do not negate evaluation. Choice D is incorrect as AS 2810 does not exclude self-correcting items. Framework: Assess omissions for disclosure and user decision impacts. Decision rule: Escalate if qualitative factors indicate materiality despite quantitative immateriality.

Question 10

In an audit of a nonissuer professional services firm, the auditor identifies an unrecorded $380,000 contingent liability that is probable and reasonably estimable. Overall materiality is $450,000; the liability would reduce pretax income from $520,000 to $140,000. Management refuses to record the accrual but offers to add a disclosure only. What type of report modification should be considered due to the misstatement?

  1. Unmodified opinion because disclosure of a probable loss contingency is an acceptable substitute for accrual
  2. Qualified opinion because the financial statements are materially misstated due to failure to record a required accrual, assuming not pervasive (correct answer)
  3. Disclaimer of opinion because the auditor lacks sufficient appropriate evidence about the contingency
  4. Adverse opinion because any failure to accrue a probable loss contingency is automatically pervasive
Explanation: This question assesses reporting for unaccrued contingencies under AICPA standards (AU-C 705 and AU-C 501). Key facts include unrecorded $380,000 probable liability, material as it reduces income significantly, with disclosure offered instead. Choice B is correct as AU-C 705 requires qualified opinions for material, non-pervasive failures to accrue per ASC 450. Choice A is incorrect because ASC 450 mandates accrual for probable losses, not just disclosure; choice C is wrong as evidence exists. Choice D is incorrect as not automatically pervasive per AU-C 705. Framework: Distinguish accrual vs. disclosure requirements for contingencies. Decision rule: Qualify for material accrual failures if not pervasive.

Question 11

In an audit of a nonissuer nonprofit organization, the auditor identifies that management incorrectly classified $600,000 of donor-restricted contributions as without donor restrictions, affecting net asset classes and required disclosures. Overall materiality is $750,000, but the misclassification affects compliance with donor restrictions and board monitoring. Which action should the auditor take regarding the identified misstatement?

  1. Request correction of the net asset classification and related disclosures and evaluate qualitative materiality; if uncorrected and material, modify the opinion (correct answer)
  2. Do not propose an adjustment because the misstatement is below overall materiality and does not affect total net assets
  3. Communicate the misstatement only to the donors because donor restrictions are not within the auditor's communication responsibilities
  4. Treat the issue as a subsequent event and address it only if donors request a refund after year-end
Explanation: This question tests handling classification misstatements in nonprofits under AICPA standards (AU-C 450). Key facts include $600,000 misclassification below $750,000 materiality but affecting restrictions and monitoring. Choice A is correct as AU-C 450 requires correction requests and modification for material uncorrected classifications. Choice B is incorrect because AU-C 450 considers qualitative impacts; choice C is wrong as auditor communicates to governance per AU-C 265. Choice D is incorrect as not a subsequent event per AU-C 560. Framework: Evaluate classifications qualitatively for user impacts. Decision rule: Modify for material restriction misclassifications if uncorrected.

Question 12

In an audit of a nonissuer manufacturer, the auditor identifies a misstatement in accrued payroll of $70,000 due to an error in the year-end accrual model. The auditor also notes a pattern of prior-year adjustments that increased income, suggesting potential management bias. Overall materiality is $600,000 and clearly trivial is $30,000. Which factor would most likely affect the auditor's decision regarding the misstatement?

  1. Whether the misstatement is below performance materiality, because misstatements below performance materiality are excluded from evaluation
  2. Whether the misstatement, together with other misstatements, indicates a pattern of bias in management's estimates or judgments (correct answer)
  3. Whether the misstatement can be corrected by the auditor posting an entry directly to the general ledger
  4. Whether the misstatement relates to payroll, because payroll accrual errors are considered clearly trivial by nature
Explanation: This question tests factors affecting misstatement decisions under AICPA standards (AU-C 450). Key facts include $70,000 accrual error above $30,000 trivial, with pattern suggesting bias. Choice B is correct as AU-C 450 requires considering aggregate effects and bias patterns. Choice A is incorrect because AU-C 450 evaluates beyond performance materiality; choice C is wrong as auditors cannot post entries per AU-C 450. Choice D is incorrect as no such triviality by nature in AU-C 450. Framework: Probe patterns in misstatements for bias indicators. Decision rule: Escalate if aggregates or patterns suggest material misstatement risk.

Question 13

In an audit of an issuer, the auditor finds that management capitalized $1.1 million of routine maintenance costs as fixed assets, increasing operating income; overall materiality is $2.0 million. The misstatement is below materiality but increases earnings per share enough to meet analysts' consensus and affects management's earnings-based compensation. Under PCAOB standards, which factor would most likely affect the auditor's decision regarding the misstatement?

  1. Whether the misstatement is below overall materiality, because PCAOB standards prohibit considering qualitative factors
  2. Whether the misstatement enables the company to meet earnings expectations or compensation thresholds, which may be qualitatively material (correct answer)
  3. Whether the misstatement can be corrected through improvements to internal control over financial reporting without proposing an adjustment
  4. Whether the misstatement relates to a noncash account, because only cash misstatements are considered material under PCAOB standards
Explanation: This question tests qualitative materiality considerations under PCAOB standards (AS 2810) for misstatements below quantitative thresholds. Key facts involve $1.1 million improper capitalization below $2.0 million materiality but enabling meeting earnings expectations and compensation thresholds. Choice B is correct because AS 2810 requires evaluating qualitative factors like impacts on expectations or incentives, potentially making it material. Choice A is incorrect as AS 2810 explicitly includes qualitative factors, not prohibiting them; choice C is wrong because control improvements do not substitute for correcting misstatements per AS 2810. Choice D is incorrect as AS 2810 applies to all accounts, not just cash. Framework: Assess misstatements quantitatively first, then apply qualitative lenses like motivational impacts. Decision rule: Escalate qualitatively material items for correction, considering opinion effects if uncorrected.

Question 14

During an audit of a nonissuer real estate company, the auditor finds that depreciation expense is understated by $150,000 due to an incorrect useful life. Overall materiality is $1.0 million and the clearly trivial threshold is $50,000. Management agrees to correct the current-year depreciation but refuses to restate prior-year comparative amounts presented for consistency. Which action should the auditor take regarding the identified misstatement?

  1. Evaluate whether the prior-year comparative amounts are materially misstated and, if so, request correction or consider modifying the opinion on the current-year statements that include comparatives (correct answer)
  2. Accept management's correction because only current-year amounts are within the scope of the audit when comparatives are presented
  3. Issue a disclaimer of opinion because refusal to adjust comparatives is a scope limitation
  4. Communicate the matter only to the predecessor auditor because comparatives relate to the prior year
Explanation: This question examines handling comparative misstatements under AICPA standards (AU-C 450 and AU-C 708). Key facts include $150,000 understatement above $50,000 trivial, with refusal to restate comparatives. Choice A is correct as AU-C 708 requires evaluating material comparative misstatements and modifying if uncorrected. Choice B is incorrect because AU-C 708 includes comparatives in scope; choice C is wrong as not a scope limitation per AU-C 705. Choice D is incorrect as current auditor responsibility per AU-C 708. Framework: Assess comparatives for material errors and request restatements. Decision rule: Modify current opinions if material comparative misstatements persist.

Question 15

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 $520,000 and understating contract assets by $520,000. 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 $520,000 overstatement of revenue and understatement of assets due to incorrect percentage, below $600,000 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 16

During an audit of a nonissuer, an auditor identifies a material misstatement in the valuation of inventory. Management corrects the error in the accounting records to the auditor's satisfaction. What is the auditor's next step regarding this corrected misstatement?

  1. Exclude the misstatement from the summary of uncorrected misstatements communicated to those charged with governance.
  2. Modify the audit opinion to reflect that the initial financial statements were materially misstated.
  3. Perform additional audit procedures to ensure the correction was properly made and there are no other related misstatements. (correct answer)
  4. Insist that management disclose the original misstatement and subsequent correction in the notes to the financial statements.
Explanation: The correct answer is C. When management corrects an identified misstatement, the auditor's responsibility is to perform audit procedures to determine that the correction has been properly made and to consider whether other similar misstatements might exist. The auditor needs to be satisfied with the adjustment. A is incorrect because while it's excluded from the uncorrected summary, it's still often communicated as part of the summary of all misstatements found. B is incorrect because a corrected misstatement does not require a modified opinion. The opinion is on the final, corrected financial statements. D is incorrect as disclosure of the correction is not typically required unless it is so significant it would be considered an error correction under accounting standards, which is a management decision.

Question 17

An auditor uses audit sampling to test the valuation of accounts receivable. The auditor finds a $5,000 overstatement in a sample of $100,000 from a total population of $2,000,000. What is the projected misstatement for the population?

  1. $5,000
  2. $25,000
  3. $100,000 (correct answer)
  4. $2,000,000
Explanation: The correct answer is C. The auditor projects the misstatement found in the sample to the entire population. The misstatement rate in the sample is $5,000 / $100,000 = 5%. Applying this rate to the total population gives a projected misstatement of 5% * $2,000,000 = $100,000. This is the auditor's best estimate of the misstatement in the population. A is the known misstatement in the sample, not the projected misstatement. B and D are incorrect calculations.

Question 18

An auditor determines that the aggregate of uncorrected misstatements is material to the financial statements. After communicating this to management, management refuses to make any corrections. The auditor's next step should be to:

  1. Immediately withdraw from the engagement without further communication.
  2. Issue a standard unmodified audit opinion but describe the misstatements in an other-matter paragraph.
  3. Communicate the uncorrected misstatements to those charged with governance and consider the implications for the auditor's report. (correct answer)
  4. Report management's refusal to the appropriate regulatory agency.
Explanation: The correct answer is C. When management refuses to correct material misstatements, the auditor must inform those charged with governance (e.g., the audit committee). This communication allows governance to take action. The auditor will then evaluate the final outcome to determine the effect on the audit report, which will likely be a qualified or adverse opinion. A is incorrect because withdrawal is a step of last resort and further communication is required. B is incorrect because a material misstatement requires a qualified or adverse opinion, not an unmodified opinion. D is incorrect as reporting to an external agency is not the immediate next step and is only done under specific circumstances.

Question 19

During the evaluation of audit results, an auditor discovered that several misstatements in different accounts, while individually immaterial, all resulted in an increase to reported net income. This situation would most likely lead the auditor to:

  1. Disregard the misstatements since their net effect is likely to be immaterial.
  2. Conclude that the financial statements are materially misstated without further work.
  3. Consider the possibility of management bias and the potential for fraud. (correct answer)
  4. Assume these are normal, recurring errors that do not require further consideration.
Explanation: The correct answer is C. A systematic pattern of misstatements, even if individually small, that all push earnings in one direction is a strong indicator of management bias. This bias may be an attempt to manage earnings, which increases the risk of material misstatement due to fraud. The auditor must heighten professional skepticism and consider the implications. A is incorrect because the pattern itself is a significant qualitative factor. B is an overreaction; further investigation is needed before concluding the statements are materially misstated. D is incorrect as a one-sided pattern of errors should not be dismissed as normal.

Question 20

An auditor is evaluating a client's allowance for doubtful accounts. The auditor's independent estimate of the required allowance is a range from $200,000 to $250,000. Management has recorded an allowance of $180,000. How should the auditor quantify the misstatement?

  1. There is no misstatement because management's estimate is reasonably close to the auditor's range.
  2. The misstatement is $20,000, the difference between management's estimate and the low end of the auditor's range. (correct answer)
  3. The misstatement is $70,000, the difference between management's estimate and the high end of the auditor's range.
  4. The misstatement is $45,000, the difference between management's estimate and the midpoint of the auditor's range.
Explanation: The correct answer is B. When an auditor develops a range of reasonable estimates and management's recorded estimate falls outside that range, the misstatement is, at a minimum, the difference between the recorded amount and the nearest point in the auditor's range. In this case, management's recorded amount of $180,000 is below the auditor's reasonable range of $200,000 to $250,000. Therefore, the known misstatement is $200,000 - $180,000 = $20,000. This amount represents an understatement of the allowance (and thus an overstatement of net receivables and income).