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 certificate
B. Examine ways of restoring the credibility of financial reporting and corporate
disclosure from an international perspective.
C. E s t a b l i s h i n g a g l o b a l c o d e o f c o n d u c t
D. 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.
B.
C.
D.

Whether low-balling to obtain audits impairs independence

Whether nonaudit services impair auditor independence
The need for a report on internal controls
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.
B.
C.
D.

Metcalf committee
Cohen committee
The House Subcommittee on Oversight and Investigations
Mintz and Morris committee

Answer A
4. The House Subcommittee on Oversight and Investigations made its
recommendations after looking into failures at:
A.
B.
C.
D.

ESM Government Securities

Continental Illinois National Bank and Trust
Penn Square Bank
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.
B.
C.
D.

Why was fraud allowed to occur at some many companies

Where was the board of directors in all these frauds
Where were the auditors
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.
B.
C.
D.

Why the board of directors failed to uncover the fraud at ZZZZ Best
How the company was able to create 80% or more fictitious revenue
How the company was able to create cookie jar reserves
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.
B.
C.
D.

Stealing $300 million from shareholders

Causing retirees to lose their life savings
Causing employees to lose their jobs
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.
B.
C.
D.

$152.9 billion including $123.8 billion of U.S. taxpayer losses

$300 million including $123.8 million of U.S. taxpayer losses
$400 billion including $152.9 billion of U.S. taxpayer losses
$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 losses
B. The failure to disclose dubious deals between the S&Ls and some of its major
customers

C. The existence of inadequate controls to prevent inadequate allowances and control

for dubious deals
D. 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.
B.
C.
D.

To establish a voluntary process for peer review

To identify red flags that might lead to fraud
To identify the tone at the top for management to create an ethical culture
All of the above

Answer C
11. One concern in the Armadillo Foods case in the text of the chapter is:
A.
B.
C.
D.

The failure of internal controls

Pressure to go along with the misappropriation of assets
The failure of the external auditors to catch fraud
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 vigilant
not just at Lehman Brothers, but across the board. Which audit areas did Doty
signal out for criticism?
A.
B.
C.
D.

Inventories and cash flow

Capital and operating expenses
Special purpose and related-party entities
Valuations and end-of-period transactions

Answer D
13. CPAs should always adhere to the rules of conduct of the
A.
B.
C.
D.

State board of accountancy

AICPA
IMA
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.
B.
C.
D.

Independence
Objectivity
Integrity
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.
B.
C.
D.

Independence
Objectivity
Integrity
Fraud prevention

Answer C
16. The conceptual framework for the AICPA Independence standards can best be
characterized as:
A.
B.
C.
D.

A model to prevent fraud from occurring

An approach to identify threats to independence
An approach to identify fraud risks
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.
B.
C.
D.

A CPA owns a direct financial interest in a client

A CPA owns a material indirect financial interest in a client
Immediate family members of the CPA are in violation of the independence rules
All of the above

Answer D
18. In the ESM fraud discussed in this chapter, Jose Gomez violated the
Independence standard because he:

A.
B.
C.
D.

Had loans outstanding from the client

Engaged in a business relationship with the client
Had family members who owned stock directly in the client
All of the above

Answer A
19. The SECs position on independence can best be characterized as:
A.
B.
C.
D.

Proscribing certain financial interests with the client

Proscribing certain business relationships with the client
Restricting the provision of certain nonaudit services to audit clients
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.
B.
C.
D.

The auditor may be exposed to an intimidation threat by the client

The auditor is involved in a business relationship with the client
The auditor serves in a management decision making position with the client
All of the above

Answer C
21. In the PeopleSoft case, the auditors violated what aspect of independence?
A.
B.
C.
D.

The auditor was exposed to an intimidation threat by the client

The auditor was involved in a business relationship with the client
The auditor served in a management decision making position with the client
All of the above

Answer B
22. To avoid violating independence when engaged in nonattest services for an audit
client, a CPA must:
A.
B.
C.
D.

Make all management decisions and perform all management decisions

Evaluate the adequacy and results of the services performed
Avoid being biased when providing nonattest services for the audit client
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.
B.
C.
D.

Tax services
Financial information systems design and implementation
Appraisal or valuation services
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.
B.
C.
D.

Develop a system of internal controls that helps to prevent and detect fraud
Assess whether the internal controls helps to prevent and detect fraud
Assess managements report on internal controls
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
intended
B. Top management certified that the financial statements were accurate
C. The external auditors violated the independence standards because they were
involved in a business venture with members of top management
D. 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.
B.
C.
D.

Addresses the quality of the individual who performs professional services

Addresses the quality of services performed by the CPA
Addresses whether the independence standards has been met
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. Independence
B. Integrity
C. Objectivity

D. Due care
Answer A
28. The confidentiality standard in the AICPA code provides for exceptions to the rule
in:
A.
B.
C.
D.

In response to a validly issued court summons

To provide information to the CPAs peer reviewers
To defend oneself in an ethics investigation
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 CPA
B. The CPA informed the client of this matter and the client refuses to correct the
financial statements
C. The CPA informs the client of this matter and the client fires the CPA
D. 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 care
B. The financial statements were certified as being in conformity with GAAP when
that was not the case
C. The financial statements were certified as being in conformity with generally
accepted auditing standards when that was not the case
D. 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 independence
B. The CPA must disclose the acceptance of such a payment to the client
C. A CPA is prohibited from accepting such a form of payment when engaged in
attest services for a client
D. 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 act
B. The client fails to account for or disclose properly a material amount connected
with an illegal act
C. The auditor is unable to estimate amounts involved in an illegal act
D. The auditor is unable to observe the physical inventory
Answer 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
company
B. 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
company
C. A form of structure where a CPA firm provides nonattest services for a client that
is also provided with attest services by a public company
D. 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.
B.
C.
D.

The CPA discloses this fact to the tax client

The CPA receives the permission of the client to accept such a form of payment
The CPAs tax services will be reviewed by a taxing authority
All of the above

Answer C
35. Objectivity may be impaired when a CPA prepares a tax return for a client
because:
A.
B.
C.
D.

The CPA violates the independence rule

The CPA violates the integrity rule
The CPA serves in a tax advocacy position for the client
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.
B.
C.
D.

Conducted in a professional manner

Informative about the CPAs services
Not conducted in a misleading or deceptive manner
Paid for by outside parties

Answer C
37. Circular 230 applies to CPAs who:
A.
B.
C.
D.

Audit the financial statements of a tax client

Practice before the IRS
Practice before the SEC
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
challenged
B. Must have a good faith belief that the information provided by the client is
accurate
C. 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.
B.
C.
D.

The tax return should not be based on a frivolous position

There is a realistic possibility of success if the tax position is challenged
It is more likely than not that the tax position will be upheld if challenged
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.
B.
C.
D.

Ernst & Young

Deloitte & Touche
PricewaterhouseCoopers
KPMG

Answer D
41. The PCAOB rules prohibit auditors from:
A. Providing certain aggressive tax shelters to their public company audit clients
B. Providing tax services to members of the audit clients management who serve in
financial reporting oversight roles
C. Providing tax preparation and planning services for public company executives
D. 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.
B.
C.
D.

Ethics laws and regulations of the Texas Board of Accountancy

Ethics rules of the AICPA
Ethics rules of the Texas Society of CPAs
All of the above

Answer A
41. To whom does the CPA owe ultimate allegiance in carrying out professional
obligations?
A. Stockholders
B. Public interest
C. Client
D. Stakeholders
Answer B
42. Sarbanes-Oxley Act (SOX) sets new standards for governance that will ultimately
impact on which of the following?
A.
B.
C.
D.

Foreign companies listed on US exchanges only

SEC registrant companies, including foreign companies listed on US
NYSE listing companies
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.
B.
C.
D.

Those CPAs in public accounting only.

Those CPAs in industry, government, and education.
Those CPAs in public accounting, industry, government, and education.
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.
B.
C.
D.

Am I doing what another CPA would do?

Am I serving the interests of my client?
Am I protecting my self-interests?
Have I retained my integrity?

Answer D
46. Why dont auditors prepare financial statements, as well as audit them?
A.
B.
C.
D.

It would take away a job from the controller of the company.

It would not eliminate errors in the financial statements.
It would be a conflict of interest and violates ethical standards.
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 client
B. Business relationships with the client
C. Family relationships whereby an immediate family member holds a decisionmaking position with the client
D. Relationships where a best friend serves in a financial reporting oversight role
with the client
Answer 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 regulation
B. 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.
B.
C.
D.

Car loan collateralized by the car

Credit cards with a limit greater than $25,000
Home mortgage
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.
B.
C.
D.

Tyco International
Enron
Adelphia
ESM Government Securities

Answer D
53. 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.
B.
C.
D.

CPAs spouse
CPAs spousal equivalent
CPAs uncle
CPAs dependents

Answer C
54. 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.
B.
C.
D.

20 hours
15 hours
10 hours
8 hours

Answer C
56. 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 implementation
B. Management functions or human resources
C. Internal audit outsourcing services
D. Pension plan audits

Answer D
57. Which was the ethical concern exists in the PeopleSoft case?
A.
B.
C.
D.

Family relationships between PeopleSoft top managers and EY

Tax services provided for PeopleSoft top management by EY
Independence in appearance and fact of EY in providing services to PeopleSoft
Information systems design and installations services provided for PeopleSoft by
EY

Answer C
58. Which of the following is not part of standards for the quality of work?
A.
B.
C.
D.

Planning and supervision

Professional competence
Professional data
Professional care

Answer 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.
B.
C.
D.

Sole proprietorship with name of sole proprietor

Limited liability partnership
Professional corporation
Corporation

Answer D
63. Which tax service is still permitted by the PCAOB for audit clients following the
KPMG tax shelter case?

A.
B.
C.
D.

Aggressive tax shelter for audit clients

Auditing of deferred taxes
Tax services to audit client management or family members
Tax services for a contingent fee

Answer B
64. What ethical rules are violated when a CPA auditing a client provides inside
information about the client to a friend?
A.
B.
C.
D.

Independence and objectivity

Objectivity and due care
Due care and confidentiality
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.
B.
C.
D.

Proper accounting for line costs

Proper accounting for advertising costs
Proper accounting for special purpose entities
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 Securities

B. PeopleSoft
C. Fund of Funds
D. 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 lawyers
B. Whether a company can record revenue before it is shipped to the customer
C. Whether a company can record revenue before the revenue recognition rules are
met
D. All of the above
Answer D
69. The question that arises in the First Community Church case is whether:
A.
B.
C.
D.

The financial statements have been materially misstated

There has been a misappropriation of assets
The auditors lacked independence
All of the above

Answer B
70. In the Lee & Han, LLC case, Barbara Strom should:
A.
B.
C.
D.

Report the situation to SEC under the Dodd-Frank Act.

Change the audit workpapers to not reflect the market decline in inventory
Discuss the matter with Kate Boller
Report the situation to the firms oversight or similar committee.

Answer D
71. In the Gee Wiz case, the main ethical issue was:
A.
B.
C.
D.

Independence of David in providing tax services to an audit client

Confidentiality in disclosing sensitive information about a client of the CPA firm
Integrity in providing tax services to an audit client through her own entity
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.
B.
C.
D.

Report her findings to Kwami, her supervisor

Talk to the agencys board of directors
Examine more evidence to support her finding
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.
B.
C.
D.

Inventory
Contractual allowance
Sales returns
All of the above

Answer B
74. The main ethical issue in Healthcare Fraud case is:
A.
B.
C.
D.

Maintaining two sets of accounting books.

Inflating healthcare costs submitted to Medicare.
Outsourcing operations to a firm known for maximizing expense reimbursements.
All of the above.

Answer B
75. PricewaterhouseCoopers was investigated by the SEC for independence violations
due to:
A.
B.
C.
D.

Reporting systems that relied on self-reporting of violations

Ownership of client stock
Investments by PwC professionals in bank accounts of audit clients
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.