CPA Practice Test 14
10 free CPA practice questions in the real exam format, covering the official content areas, with an explanation for every answer.
Question 1 of 10
Performing Further Procedures and Obtaining EvidenceEngagement File — Larkspur Medical Equipment, Inc.
To: Audit senior From: Simon Ortlieb, engagement manager Date: February 20, Year 3 Re: Larkspur — receivables sample evaluation
Larkspur Medical Equipment, Inc. is a nonissuer; we audit its December 31, Year 2 financial statements under GAAS. We used monetary-unit sampling (MUS) to test the existence and valuation of gross accounts receivable through confirmation and alternative procedures. Plan: recorded gross receivables $8,400,000; sampling interval $40,000; 210 sampling units selected; tolerable misstatement $252,000; risk of incorrect acceptance 5%. Overall materiality is $420,000 and performance materiality is $315,000. The allowance for credit losses ($310,000) was tested separately and is not part of this sample. Please (1) project the misstatement, (2) compute the upper misstatement limit, (3) conclude, and (4) classify the control deficiencies identified.
| Item | Book value | Audited value | Notes |
|---|---|---|---|
| 1 | $12,000 | $9,000 | Invoiced at the prior price list; price master change was not reviewed |
| 2 | $64,000 | $58,000 | Freight billed twice; the billing review was skipped for that invoice batch |
| 3 | $5,000 | $4,000 | Quantity keyed incorrectly on the invoice |
| 4 | $22,000 | $0 | Goods returned December 18; credit memo not posted until January 9, Year 3 |
| 5 | $10,000 | $10,000 | Customer confirmed $7,500; its $2,500 payment was mailed December 30 and received January 3, Year 3 |
Items with a book value of $40,000 or more equal or exceed the sampling interval (top stratum).
| Number of misstatements | Reliability factor | Incremental change |
|---|---|---|
| 0 | 3.00 | — |
| 1 | 4.75 | 1.75 |
| 2 | 6.30 | 1.55 |
| 3 | 7.76 | 1.46 |
| 4 | 9.16 | 1.40 |
Firm method: Upper misstatement limit = projected misstatement + basic precision + incremental allowance for sampling risk. Basic precision = the zero-misstatement factor × sampling interval. For items below the interval, rank projected misstatements from largest to smallest and multiply each by (its incremental change − 1). Top-stratum misstatements are included at their actual amount, with no allowance for sampling risk.
| No. | Deficiency | Reasonable possibility of misstatement? | Potential magnitude |
|---|---|---|---|
| D1 | Price master file changes are not reviewed (item 1) | Yes | Up to $38,000 |
| D2 | No backup for the returns clerk; credit memos for December returns were not posted (item 4); no other control detects unposted returns | Yes | Up to $520,000 |
| D3 | Sales manager released 3 of 40 tested orders over the credit limit without credit approval | Yes | Up to $340,000 in the allowance |
| D4 | The CFO can post and approve her own journal entries; no one reviews them | Yes | Up to $90,000 |
| D5 | Billing review skipped for one batch (item 2); a weekly supervisor review of billing exceptions, tested and effective, detects batch errors over $10,000 | Yes | Up to $9,000 |
Summary of AU-C 530, AU-C 450 and AU-C 265, with firm guidance (paraphrased)
AU-C 530: The auditor projects misstatements found in the sample to the population and considers sampling risk. If the projected misstatement plus the allowance for sampling risk exceeds tolerable misstatement, the sample does not provide a reasonable basis for conclusions about the population.
AU-C 450: The auditor accumulates misstatements identified during the audit, other than clearly trivial ones, communicates them on a timely basis to management, and requests that management correct them.
AU-C 265: A significant deficiency is less severe than a material weakness yet important enough to merit the attention of those charged with governance. A material weakness is a deficiency, or combination of deficiencies, for which there is a reasonable possibility that a material misstatement will not be prevented, or detected and corrected, on a timely basis.
Firm guidance: Classify as a material weakness when there is a reasonable possibility of a misstatement at or above overall materiality. Otherwise, classify as a significant deficiency when the potential misstatement exceeds performance materiality or the deficiency involves the control environment or antifraud controls (for example, review of management's journal entries). Classify all other deficiencies as deficiencies.
Step 1 — Projected misstatement. Using the Sample Results tab, enter the total projected misstatement of gross accounts receivable (overstatement).