Certified Public Accountant Case Studies & Practical Application 3 — Questions and Answers
Question 1: A CPA's audit client has a going concern issue. Management prepares a plan that includes refinancing existing debt and cutting costs. What is the auditor's responsibility regarding this plan?
- Accept the plan at face value if management provides it in writing
- Evaluate whether it is probable that the plan will be effectively implemented and will mitigate the going concern doubt (Correct answer)
- Issue a qualified opinion automatically whenever going concern doubt exists
- Refer the matter to a specialist without forming an independent conclusion
Correct answer: Evaluate whether it is probable that the plan will be effectively implemented and will mitigate the going concern doubt
AU-C 570 requires the auditor to independently evaluate the feasibility and likelihood of management's mitigating plans, not simply accept them.
Question 2: A client uses the percentage-of-completion method for a long-term construction contract. In Year 2, the estimated total cost increases significantly, making the contract a loss contract. What must be done?
- Spread the additional costs over the remaining contract years
- Recognize the entire anticipated loss immediately in Year 2 (Correct answer)
- Defer recognition until the contract is complete
- Reclassify the contract to the completed-contract method
Correct answer: Recognize the entire anticipated loss immediately in Year 2
Under ASC 606 and longstanding GAAP, the full expected loss on a loss contract must be recognized immediately in the period the loss becomes evident.
Question 3: A sole proprietor earned $180,000 in net self-employment income. Approximately how much self-employment tax is owed, and what portion is deductible for income tax purposes?
- $25,434 total; none deductible
- $25,434 total; 50% ($12,717) deductible above the line (Correct answer)
- $22,014 total; 50% deductible above the line
- $25,434 total; fully deductible as a business expense on Schedule C
Correct answer: $25,434 total; 50% ($12,717) deductible above the line
SE tax is 15.3% on 92.35% of net SE income; one-half of the SE tax paid is deductible as an above-the-line adjustment on Form 1040.
Question 4: During fieldwork, an auditor identifies that a client's controller has both check-signing authority and bank reconciliation responsibility. What control weakness does this represent?
- Inadequate documentation
- Lack of segregation of duties creating a fraud risk (Correct answer)
- Insufficient IT general controls
- Absence of a whistleblower policy
Correct answer: Lack of segregation of duties creating a fraud risk
Combining custody of assets (check signing) with recordkeeping (reconciliation) eliminates a key compensating control and creates opportunity for undetected fraud.
Question 5: A calendar-year C corporation has taxable income of $500,000. A shareholder-employee receives a salary of $800,000, which the IRS deems $300,000 to be unreasonable compensation. What is the tax consequence?
- The $300,000 excess is reclassified as a dividend, non-deductible by the corporation (Correct answer)
- The entire $800,000 salary is disallowed
- The $300,000 is deductible but subject to a 20% penalty tax
- No adjustment is required if the board approved the salary
Correct answer: The $300,000 excess is reclassified as a dividend, non-deductible by the corporation
Unreasonable compensation is reclassified as a nondeductible dividend, increasing the corporation's taxable income by $300,000.
Question 6: A CPA reviews a client's deferred tax accounts and finds a deferred tax asset of $400,000 related to net operating loss carryforwards. The client has had three consecutive years of losses. What must the CPA evaluate?
- Whether the NOL carryforward period has expired
- Whether a valuation allowance is needed because realization is not more likely than not (Correct answer)
- Whether the deferred tax asset should be reclassified as a current asset
- Whether to restate prior-year financial statements for the NOL
Correct answer: Whether a valuation allowance is needed because realization is not more likely than not
Under ASC 740, a valuation allowance must be established if it is more likely than not that some or all of a deferred tax asset will not be realized.
Question 7: A CPA firm is engaged to perform a review of a nonpublic company's financial statements. The controller asks if the CPA can skip analytical procedures since the company's data is well-organized. What is the correct response?
- Agree, since analytical procedures are optional in a review
- Decline, because analytical procedures are required and are the primary basis for review-level assurance (Correct answer)
- Agree, but supplement with additional inquiry procedures
- Escalate the engagement to an audit to compensate
Correct answer: Decline, because analytical procedures are required and are the primary basis for review-level assurance
AR-C 90 requires analytical procedures as a mandatory procedure for a review engagement; they cannot be omitted at management's request.
Certified Public Accountant Case Studies & Practical Application 3
A CPA's audit client has a going concern issue.
Management prepares a plan that includes refinancing existing debt and cutting costs.
What is the auditor's responsibility regarding this plan?