Test Bank Chapter 4
Test Bank Chapter 4
Multiple Choice Questions
1. The International Federation of Accountants (IFAC) research
report, Rebuilding Public Confidence in Financial Reporting: An
International Perspective, has as its goal which of the
following:
A. Creating an international CPA certificateB. Examine ways of
restoring the credibility of financial reporting and corporate
disclosure from an international perspective. C. Establishing a
global code of conductD. All of the above
Answer B
2. Each of the following were themes of the investigations of
the accounting profession during the 1970s and 1980s except
for:
A. Whether low-balling to obtain audits impairs independenceB.
Whether nonaudit services impair auditor independenceC. The need
for a report on internal controlsD. The importance of developing
techniques to prevent and detect fraud
Answer A
3. The committee that first recommended that the profession
institute a voluntary program for peer review was:
A. Metcalf committeeB. Cohen committeeC. The House Subcommittee
on Oversight and Investigations D. Mintz and Morris committee
Answer A
4. The House Subcommittee on Oversight and Investigations made
its recommendations after looking into failures at:
A. ESM Government SecuritiesB. Continental Illinois National
Bank and TrustC. Penn Square BankD. All of the above
Answer D
5. During the investigations by the House Subcommittee on
Oversight and Investigations, a question that was raised was:
A. Why was fraud allowed to occur at some many companiesB. Where
was the board of directors in all these fraudsC. Where were the
auditorsD. Why did the internal controls fail in some many
frauds
Answer C
6. In its investigation of ZZZZ Best, the House Subcommittee on
Oversight and Investigations looked into:
A. Why the board of directors failed to uncover the fraud at
ZZZZ Best B. How the company was able to create 80% or more
fictitious revenueC. How the company was able to create cookie jar
reservesD. All of the above
Answer B
7. In the Lincoln Savings & Loan failure during the period
of failures at savings and loan institutions, Lincoln was charged
with:
A. Stealing $300 million from shareholdersB. Causing retirees to
lose their life savings C. Causing employees to lose their jobsD.
Engaging in a Ponzi scheme
Answer B
8. The cost to the public to clean up 1,043 failed savings and
loan institutions during the period of 1986-1995 was :
A. $152.9 billion including $123.8 billion of U.S. taxpayer
lossesB. $300 million including $123.8 million of U.S. taxpayer
lossesC. $400 billion including $152.9 billion of U.S. taxpayer
lossesD. $400 million including $152.9 billion of U.S. taxpayer
losses
Answer A
9. The accounting issues at failed savings and loan institutions
included:
A. The failure to provide adequate allowances for loan lossesB.
The failure to disclose dubious deals between the S&Ls and some
of its major customersC. The existence of inadequate controls to
prevent inadequate allowances and control for dubious dealsD. All
of the above
Answer D
10. One of the Contributions of the Treadway Commission Report
and the work of the Committee of Sponsoring Organizations (COSO)
was:
A. To establish a voluntary process for peer reviewB. To
identify red flags that might lead to fraudC. To identify the tone
at the top for management to create an ethical cultureD. All of the
above
Answer C
11. One concern in the Armadillo Foods case in the text of the
chapter is:
A. The failure of internal controlsB. Pressure to go along with
the misappropriation of assetsC. The failure of the external
auditors to catch fraudD. Pressure to meet financial analysts
earnings estimates
Answer D
12. James Doty, the chairman of the PCAOB, in his testimony
before Congress on the financial crisis of 2007-2008, admitted that
auditors should have been more vigilantnot just at Lehman Brothers,
but across the board. Which audit areas did Doty signal out for
criticism?
A. Inventories and cash flowB. Capital and operating expensesC.
Special purpose and related-party entitiesD. Valuations and
end-of-period transactions
Answer D
13. CPAs should always adhere to the rules of conduct of the
A. State board of accountancyB. AICPAC. IMAD. All of the
above
Answer A
14. The ethics rules that applies solely to those who conduct an
audit of a client entity is:
A. IndependenceB. ObjectivityC. IntegrityD. All of the above
Answer A
15. The principle of ethical behavior in the AICPA Code that
asks questions directly related to ethical courage is:
A. IndependenceB. ObjectivityC. IntegrityD. Fraud prevention
Answer C
16. The conceptual framework for the AICPA Independence
standards can best be characterized as:
A. A model to prevent fraud from occurringB. An approach to
identify threats to independenceC. An approach to identify fraud
risksD. A model to assist controllers in dealing with differences
of opinion with top management on accounting issues
Answer B
17. Impairments of independence can occur when:
A. A CPA owns a direct financial interest in a clientB. A CPA
owns a material indirect financial interest in a client C.
Immediate family members of the CPA are in violation of the
independence rulesD. All of the above
Answer D
18. In the ESM fraud discussed in this chapter, Jose Gomez
violated the Independence standard because he:
A. Had loans outstanding from the clientB. Engaged in a business
relationship with the clientC. Had family members who owned stock
directly in the clientD. All of the above
Answer A
19. The SECs position on independence can best be characterized
as:
A. Proscribing certain financial interests with the clientB.
Proscribing certain business relationships with the clientC.
Restricting the provision of certain nonaudit services to audit
clientsD. All of the above
Answer D
20. Assume the external auditor of a client entity also served
on the clients board of directors. What aspect of independence
would be violated?
A. The auditor may be exposed to an intimidation threat by the
clientB. The auditor is involved in a business relationship with
the clientC. The auditor serves in a management decision making
position with the clientD. All of the above
Answer C
21. In the PeopleSoft case, the auditors violated what aspect of
independence?
A. The auditor was exposed to an intimidation threat by the
clientB. The auditor was involved in a business relationship with
the clientC. The auditor served in a management decision making
position with the clientD. All of the above
Answer B
22. To avoid violating independence when engaged in nonattest
services for an audit client, a CPA must:
A. Make all management decisions and perform all management
decisionsB. Evaluate the adequacy and results of the services
performedC. Avoid being biased when providing nonattest services
for the audit clientD. Avoid being pressured by the client when
providing nonattest services for the audit client
Answer C
23. Each of the following is an outright restriction on
providing nonattest services for an attest client except for:
A. Tax servicesB. Financial information systems design and
implementationC. Appraisal or valuation servicesD. Internal audit
outsourcing services
Answer A
24. Under the Sarbanes-Oxley Act, the auditors responsibility
with respect to internal controls can best be stated as:
A. Develop a system of internal controls that helps to prevent
and detect fraudB. Assess whether the internal controls helps to
prevent and detect fraudC. Assess managements report on internal
controlsD. All of the above
Answer C
25. A unique aspect of the HealthSouth case discussed in the
text of this chapter is:
A. The external auditors failed to assess whether the internal
controls operated as intendedB. Top management certified that the
financial statements were accurateC. The external auditors violated
the independence standards because they were involved in a business
venture with members of top managementD. Top management hyped the
stock price to increase the value of their stock options
Answer B
26. The due care principle in the AICPA code:
A. Addresses the quality of the individual who performs
professional servicesB. Addresses the quality of services performed
by the CPAC. Addresses whether the independence standards has been
metD. All of the above
Answer B
27. Which rule of professional conduct in the AICPA code does
not apply both to internal and external accountants who are CPAs
and members of the Institute?
A. IndependenceB. IntegrityC. ObjectivityD. Due care
Answer A
28. The confidentiality standard in the AICPA code provides for
exceptions to the rule in:
A. In response to a validly issued court summonsB. To provide
information to the CPAs peer reviewersC. To defend oneself in an
ethics investigationD. All of the above
Answer D
29. A CPA who informs management of a material misstatement in
the financial statements can go to the SEC with his/her concerns
if:
A. The CPA informed the client of this matter and the client did
not inform the SEC within one business day of being informed by the
CPAB. The CPA informed the client of this matter and the client
refuses to correct the financial statementsC. The CPA informs the
client of this matter and the client fires the CPAD. All of the
above
Answer A
30. In the Fund of Funds case discussed in this chapter, the
external auditors violated which rule of conduct?
A. Due careB. The financial statements were certified as being
in conformity with GAAP when that was not the caseC. The financial
statements were certified as being in conformity with generally
accepted auditing standards when that was not the caseD.
Confidentiality
Answer D
31. A common requirement/effect of the commissions and
contingent fees rule is:
A. A CPA who accepts such a payment always violates
independenceB. The CPA must disclose the acceptance of such a
payment to the clientC. A CPA is prohibited from accepting such a
form of payment when engaged in attest services for a clientD. All
of the above
Answer C
32. If a client refuses to accept an auditors report that has
been modified, the public accounting firm should withdraw from the
engagement and give its reasons in writing to the board of
directors except when: A. The auditor is unable to obtain
sufficient appropriate evidence about a suspected illegal actB. The
client fails to account for or disclose properly a material amount
connected with an illegal actC. The auditor is unable to estimate
amounts involved in an illegal actD. The auditor is unable to
observe the physical inventoryAnswer D
33. An alternative practice structure can best be described
as:
A. A form of ownership where a CPA firm owns a public company
and audits that companyB. A form of structure where a public
company provides nonattest services for a client that is also
provided with attest services by an affiliate of the public
companyC. A form of structure where a CPA firm provides nonattest
services for a client that is also provided with attest services by
a public companyD. A form of structure other than LLP and LLC
Answer B
34. A CPA can accept a contingent fee in providing tax services
for an attest client if:
A. The CPA discloses this fact to the tax clientB. The CPA
receives the permission of the client to accept such a form of
paymentC. The CPAs tax services will be reviewed by a taxing
authorityD. All of the above
Answer C
35. Objectivity may be impaired when a CPA prepares a tax return
for a client because:
A. The CPA violates the independence ruleB. The CPA violates the
integrity ruleC. The CPA serves in a tax advocacy position for the
clientD. The CPA must prepare the tax return solely based on the
information provided by the client
Answer C
36. CPAs can advertise and solicit clients as long as such
practices are:
A. Conducted in a professional mannerB. Informative about the
CPAs servicesC. Not conducted in a misleading or deceptive mannerD.
Paid for by outside parties
Answer C
37. Circular 230 applies to CPAs who:
A. Audit the financial statements of a tax clientB. Practice
before the IRSC. Practice before the SECD. All of the above
Answer B
38. Statement on Standards for Tax Services No. 1 establishes as
a basic principle of providing tax services that the CPA:
A. Must have a good faith belief that the tax return position
can be justified if challengedB. Must have a good faith belief that
the information provided by the client is accurateC. Can never
recommend a tax position to the client when it is frivolous D. All
of the above
Answer A
39. The requirement that there should be reasonable support for
a tax return position before a CPA recommends it to a client most
directly aligns with which tax standard:
A. The tax return should not be based on a frivolous positionB.
There is a realistic possibility of success if the tax position is
challengedC. It is more likely than not that the tax position will
be upheld if challengedD. Contingent fees cannot be accepted when
providing tax services for an audit client
Answer B
40. The CPA firm that became involved in tax shelter
controversies with the IRS was:
A. Ernst & YoungB. Deloitte & ToucheC.
PricewaterhouseCoopersD. KPMG
Answer D
41. The PCAOB rules prohibit auditors from:
A. Providing certain aggressive tax shelters to their public
company audit clientsB. Providing tax services to members of the
audit clients management who serve in financial reporting oversight
rolesC. Providing tax preparation and planning services for public
company executivesD. All of the above
Answer D
42. Mintz and Morris, both of whom are CPAs, became partners in
a tax preparation business in San Marcos, Texas. Which of the
following ethics standards must be followed by the two
partners?
A. Ethics laws and regulations of the Texas Board of
AccountancyB. Ethics rules of the AICPAC. Ethics rules of the Texas
Society of CPAsD. All of the above
Answer A
41. To whom does the CPA owe ultimate allegiance in carrying out
professional obligations? A. StockholdersB. Public interestC.
ClientD. Stakeholders
Answer B
42. Sarbanes-Oxley Act (SOX) sets new standards for governance
that will ultimately impact on which of the following?
A. Foreign companies listed on US exchanges onlyB. SEC
registrant companies, including foreign companies listed on USC.
NYSE listing companiesD. NASDAQ listing companies
Answer B
44.To whom do the accounting codes of professional conduct
(either the state board of public accountancy or AICPA) apply?A.
Those CPAs in public accounting only.B. Those CPAs in industry,
government, and education.C. Those CPAs in public accounting,
industry, government, and education.D. Those CPAs in public
accounting, doing auditing and taxation.
Answer C
45.Integrity is measured in terms of what is right and just.
What is a question that a CPA can ask to test decisions?A. Am I
doing what another CPA would do?B. Am I serving the interests of my
client?C. Am I protecting my self-interests?D. Have I retained my
integrity?Answer D
46.Why dont auditors prepare financial statements, as well as
audit them?A. It would take away a job from the controller of the
company.B. It would not eliminate errors in the financial
statements.C. It would be a conflict of interest and violates
ethical standards.D. It would streamline the process and be
effective.
Answer C
46.In which of the following is a CPA independent in fact and
appearance?a. The CPAs brother is the controller of the company
being audited.b. The CPA serves on the board of a non-profit with
the CFO of the company being audited.c. The CPA borrowed money for
a new car from the CEO of the company being audited.d. The CPA owes
an office building that he leases to the client.
Answer B
47.Which of the following would be an example of due care?
A. Audit documentation only supplied by the client.B. Audit
documentation is a copy of last years workpapers.C. Audit
documentation obtained by the auditor with reviews by supervisory
personnel D. Audit documentation with misapplication of GAAP.Answer
C
49.Which of the following relationships do not impair
CPA-auditor independence?A. Financial relationships with the
clientB. Business relationships with the clientC. Family
relationships whereby an immediate family member holds a
decision-making position with the clientD. Relationships where a
best friend serves in a financial reporting oversight role with the
clientAnswer D
50.Each of the following is a safeguard that helps to mitigate
threats to independence except for:
A. Safeguards created by the profession, legislation, or
regulationB. Safeguards implemented by the attest client, such as a
tone at the top. C. Safeguards developed to ensure independence
when performing nonattest services D. Safeguard implemented by the
firm, including policies and procedures to implement regulatory
requirements
Answer C
51.Which of the following is a permitted loan to a CPA from an
audit client financial institution?A. Car loan collateralized by
the carB. Credit cards with a limit greater than $25,000C. Home
mortgageD. Personal loan of less than $10,000
Answer A
52.Which case in the text of the chapter illustrates the danger
of a CPA accepting loans from an audit client?A.Tyco
InternationalB. EnronC. AdelphiaD. ESM Government SecuritiesAnswer
D53.Which of the following immediate family members or close
relatives would not have to follow the independence rules that
apply to the CPA according to Interpretation 101-1?A. CPAs spouseB.
CPAs spousal equivalentC. CPAs uncleD. CPAs dependentsAnswer
C54.Which of the following situations of a CPAs distant relatives
does not impair the CPAs independence?A. CPAs parent holds a key
position with an audit client.B. CPAs nephew is starting as a
salesperson with an audit client.C. CPAs dependent roommate owns a
material interest, and sits on the board, of an audit client.D.
CPAs sister is chief counsel for an audit client.Answer B
55.What is the maximum amount of time an audit manager or
partner may spend on nonattest services for an attest client?A. 20
hoursB. 15 hoursC. 10 hoursD. 8 hoursAnswer C56.Which of the
following services are allowed to be performed for an attest
services client by Sarbanes Oxley Act?A. Financial information
systems design and implementationB. Management functions or human
resourcesC. Internal audit outsourcing servicesD. Pension plan
auditsAnswer D
57. Which was the ethical concern exists in the PeopleSoft
case?A. Family relationships between PeopleSoft top managers and
EYB. Tax services provided for PeopleSoft top management by EYC.
Independence in appearance and fact of EY in providing services to
PeopleSoftD. Information systems design and installations services
provided for PeopleSoft by EYAnswer C
58.Which of the following is not part of standards for the
quality of work?A. Planning and supervisionB. Professional
competenceC. Professional dataD. Professional careAnswer C
59.What is the difference on contingent fees under the PCAOB
rules versus the AICPA rules?A. Both rules allow contingent fees
for an audit client if the contingency is based upon findings of
government agencies.B. The AICPA prohibits contingent fees to an
audit client.C. The PCAOB allows contingent fees for non-public
company engagements.D. The PCAOB prohibits contingent fees in tax
engagements performed for an audit client.Answer D
61.Which is not a permitted form of organization for a CPA
practice?A. Sole proprietorship with name of sole proprietorB.
Limited liability partnershipC. Professional corporationD.
Corporation Answer D
63.Which tax service is still permitted by the PCAOB for audit
clients following the KPMG tax shelter case?A. Aggressive tax
shelter for audit clientsB. Auditing of deferred taxesC. Tax
services to audit client management or family membersD. Tax
services for a contingent feeAnswer B
64. What ethical rules are violated when a CPA auditing a client
provides inside information about the client to a friend?
A. Independence and objectivityB. Objectivity and due careC. Due
care and confidentialityD. Confidentiality and integrity
Answer D
65. Which statement is correct with respect to a CPAs ethical
obligation to return client books and records and CPA work
papers:
A. Client-provided records in the custody or control of the CPA
should be returned to the client at the clients request.B. CPA work
papers should be given to the client at the end of each audit.C.
CPA work product never has to be turned over to the client.D. All
of the above
Answer A
Case Questions
66. The AOL case described in the text focused mainly on:
A. Proper accounting for line costsB. Proper accounting for
advertising costsC. Proper accounting for special purpose
entitiesD. All of the above
Answer B
67. The ethical issue raised in the Beauda Medical Center case
is similar to that in:
A. ESM Government SecuritiesB. PeopleSoftC. Fund of FundsD.
Enron
Answer C
68. The revenue recognition issue in the Family Games case
is:
A. Whether a company can record revenue before it is signed-off
by the lawyersB. Whether a company can record revenue before it is
shipped to the customerC. Whether a company can record revenue
before the revenue recognition rules are metD. All of the above
Answer D
69. The question that arises in the First Community Church case
is whether:
A. The financial statements have been materially misstatedB.
There has been a misappropriation of assetsC. The auditors lacked
independenceD. All of the above
Answer B
70. In the Lee & Han, LLC case, Barbara Strom should:
A. Report the situation to SEC under the Dodd-Frank Act.B.
Change the audit workpapers to not reflect the market decline in
inventoryC. Discuss the matter with Kate BollerD. Report the
situation to the firms oversight or similar committee.
Answer D
71. In the Gee Wiz case, the main ethical issue was:
A. Independence of David in providing tax services to an audit
client B. Confidentiality in disclosing sensitive information about
a client of the CPA firmC. Integrity in providing tax services to
an audit client through her own entityD. Whistleblowing on a
client
Answer C
72. In the Family Outreach case, Yimei finds three accounts all
using the same documentation and amounts. Being skeptical, Yimei
should consider doing all but:
A. Report her findings to Kwami, her supervisor B. Talk to the
agencys board of directorsC. Examine more evidence to support her
findingD. Check to see if the accounts were in the prior years
workpapers
Answer B
73. In the HealthSouth case, the auditors failed to meet their
ethical and professional obligations because they failed to uncover
fraud in which account?
A. InventoryB. Contractual allowanceC. Sales returnsD. All of
the above
Answer B
74. The main ethical issue in Healthcare Fraud case is:
A. Maintaining two sets of accounting books.B. Inflating
healthcare costs submitted to Medicare.C. Outsourcing operations to
a firm known for maximizing expense reimbursements.D. All of the
above.
Answer B
75. PricewaterhouseCoopers was investigated by the SEC for
independence violations due to:
A. Reporting systems that relied on self-reporting of
violationsB. Ownership of client stockC. Investments by PwC
professionals in bank accounts of audit clientsD. All of the
above
Answer D
Essay Questions
1. Explain how the Principles of the AICPA Code of Professional
Conduct establish standards of behavior for CPAs that are similar
to those discussed in chapters 1 and 2.2. Describe each of the
investigations of the accounting profession during the 1970s and
1980s. Given the passage of the Sarbanes-Oxley Act in 2002, do you
think these investigations helped to pave the way for SOX
improvements?3. What are the major threats to independence
addressed by the AICPA Conceptual Framework for Independence
Standards and how can CPAs/CPA firms mitigate such threats?4. What
are the similarities and differences in the application of the
rules of professional conduct in the AICPA with respect to internal
accountants who are CPAs and CPA-external auditors?5. What steps
should an auditor take when she suspects illegal acts have occurred
at a client entity?6. Under what circumstances do you think it
would be acceptable for a CPA to blow the whistle on financial
wrongdoing by a client? What steps should the CPA take before
carrying through with the whistle-blowing action?7. Describe the
steps to be taken by a staff accountant who has been told by
his/her supervisor to accelerate the recording of revenue into a
period earlier than which it should be recognized under GAAP.8.
Evaluate the ethics of tax standards in the Statements on Standards
for Tax Services with respect to the ethics standards discussed in
chapters 1 and 2.9. How do the PCAOB rules attempt to strengthen
the obligations of a CPA to be independent of clients and perform
services objectively?10. Rosie Mintz, CPA, has just started her own
tax preparation firm. Describe the ethics standards of behavior of
the accounting profession that apply to Rosies performance of
professional services.11. Steve Morris, CPA, performs audits for
nonpublic clients. Describe the independence obligations of Steve
that apply to the performance of professional services for audit
clients.12. A young man by the name of Mr. Hicks works at an
accounting firm which has a written ethics code of conduct. The
code specifically outlines the duties and obligations that every
employee must follow without question. One of rules states that
every accountant should not lie under any circumstances.
Last week Mr. Hicks sent out a finalized tax return to the Wrong
client. The Wrong client called Mr. Hicks and informed him that he
was sending the tax return back to him overnight. Meanwhile the
Right client called Mr. Hicks and wanted to know where the tax
return was. Mr. Hicks told the Right client that he sent it to the
wrong address and he will send out the return the next day. The
Right client was irritated and called the partner of the firm.
The partner scolded Mr. Hicks and wanted to know why he told the
client he sent the return to the wrong address. The partner said he
should have told the client that the return was in the 2nd partner
review or some other excuse to cover up the mistake. Mr. Hicks
explained that the ethics code of conduct specifically states that
he should not lie under any circumstances and he was just following
his ethical duty. The partner grinned and told Mr. Hicks that the
next time this happens, he should consult with the partner
first.
Using the ethical decision making model and ethical theories,
justify the positions of either the partner, Mr. Hicks or an
alternative solution.
Ans:Hicks has attempted to be honest with the Right client but
in an awkward way. It sounds like the return was sent to an
incorrect address, not another client. Hicks should have spoken to
the partner to get some advice before responding to the Right
client. He has not exercised due care in his actions. Perhaps Hicks
was trying to follow deontology and rights of the Right client.
However, the way in which he went about it was short-sighted at
least from the firms point of view. In this case the ends do not
justify the means. Mistakes of this kind should be dealt at the
partner level.
Utilitarianism can be used to support the partners position in
that the benefits of deceiving the Right client for a short while,
including holding on to the client and saving the firms reputation,
far outweigh the costs of deceiving the client. One might argue
this is a situation of no harm, no foul. However, this Act
Utilitarian approach fails to recognize the utilitarian rule that
clients should never be deceived.
13. Sarah is an audit senior with Childs, Maxwell and Weaver,
LLP. Sarah specializes in auditing loan loss reserve for financial
institution clients. This current year she has noticed that two of
her financial institution clients in town have written loans off to
a loan customer, Mr. T (fictional name to protect the guilty). Mr.
T is well known in town as a highly successful real estate
developer and businessman with many different business dealings. As
Sarah is auditing her third financial institution client in town,
she notices that the bank has loans of $3.5 million outstanding to
Mr. T. The current loan loss reserve could not cover the losses on
Mr. Ts loans. Sarah has recommended a significant increase to the
loan loss reserve account. The client will not discuss increasing
the loan loss reserve. Ms. Childs, senior partner on the audit,
wants to know how the audit firm can justify the increase loan loss
reserve account. What can and should Sarah disclose about Mr.
T?
Ans: This short case is about confidentiality and particularly
what is learned from one audit that could affect another audit. In
the Fund of Funds case in the chapter, the judged ruled an auditor
must use information obtained about one client in the audit of
another ostensibly to protect the public interest with regard to
the second client. Sarah should discuss the matter with Ms. Childs.
The best solution would be for Sarah to dig deeper to gather as
much evidence as possible about the collectibility of the loan to
Mr. T so if it has to be written down, the evidence supports it.
There would be no reason to inform the third financial institution
client about Mr. Ts problems with the other two, and to do so would
violate the confidentiality obligation of CPAs.