1Auditing Theory PRTC CHAPTER 1 1. Because an external auditor is paid a fee by a client company; he or she a) Is absolutely independent and may conduct an audit. b) May be sufficiently independent to conduct an audit. c) Is never considered to be independent. d) Must receive approval of the Securities and Exchange Commission before conducting an audit. Answer: B 2. Professional Skepticism requires that an auditor assumes that management is a) Honest, in the absence of fraud risk factors. b) Dishonest until completion of audit tests. c) Neither honest nor dishonest. d) Offering reasonable assurance of honesty. Answer: C 3. The exposure period allowed for each exposure draft of PSA to be considered by the organizations and persons to whom it is sent for comment is generally a) 120 days b) 90 days c) 60 days d) 180 days Answer: B 4. The government agency tasked by law of implementing and enforcing the regulatory policies of the national government with respect to the regulation and licensing of various professions and occupations is known as a) PRC b) BOA c) COA d) SEC Answer: A 5. An audit which has its purpose the evaluation of the economy and efficiency with which resources are employed is known as a(n) a) Financial audit b) Compliance audit c) Governmental audit d) Operational audit Answer: D 6. Which one of the following would be the most persuasive type of evidence? 2 Auditing Theory PRTC a) b) c) d) Check register Bank statement Observation of assets Inquiry with the in-house attorney Answer: C 7. The reliability of a client’s internal documentation is most affected by which of the following? a) The auditor’s independence b) Management’s motivation to misstate accounts c) The type of audit report that will be issued d) Management’s ability to understand generally accepted audit standards Answer: B 8. No person shall serve the Professional Regulatory Board of Accountancy for more than a) 3 years b) 6 years c) 9 years d) 12 years Answer: D 9. How many CPE credit units must be accumulated by a registered accounting professional within the three-year period? a) 15 credit units b) 60 credit units c) 45 credit units d) 90 credit units Answer: B 10. Based on the Code of Ethics for Professional Accountants, threats to compliance with fundamental principles arise from all of the following except: a) Self interest b) Advocacy c) The audit relationship d) Intimidation Answer: C 11. The engagement partner should be rotated after a defined period, normally no more than a) 2 years b) 3 years c) 5 years d) 7 years 3 Auditing Theory PRTC Answer: C 12. In evaluating the reasonableness of an entity’s accounting estimates, an auditor normally would be concerned about assumptions that are a) Susceptible to bias b) Consistent with prior periods c) Insensitive to variations d) Similar to industry guidelines Answer: A 13. Conclusions are typically documented by auditors in which type of working paper? a) Audit planning memo b) Audit program c) Audit memoranda d) Representation letter Answer: C 14. Which of the following types of evidence would an auditor consider to be the least reliable for an external audit? a) Representations in writing from the director of the audit client. b) A sales invoice prepared by the client. c) A sales invoice prepared by a vendor to the client. d) A bank confirmation form signed by the client’s bank. Answer: A 15. When making a client continuance decision, the auditor should evaluate client based upon which of the following? a) Client entity characteristics b) Independence risk factors c) Financial reporting issues d) All of the above Answer: D 16. a) b) c) d) Analytical procedures used in planning an audit should focus on Reducing the scope of tests of controls and substantive tests Providing assurance that potential material misstatements will be identified Enhancing the auditor’s understanding of the client’s business Assessing adequacy of the available evidence Answer: C 17. During which of the following phases of an audit is the performance of The following are examples of error.)True.)False. true d. false c. shall be rotated after every 5 years of engagement.)False.4 Auditing Theory PRTC a) b) c) d) analysis not mandatory. except . Statement 2: A two-year cooling off period shall be observed in the reengagement of the signing partner or individual auditor who was rotated. Statement 1: The independent auditors or in the case of auditing firm. a. of the regulated entities under SEC SRC Rule 68. Which of the following nonfinancial information would an auditor most likely consider in performing analytical procedures during the planning phase of an audit? a) Turnover of personnel in the accounting department b) Objectivity of audit committee members c) Square footage of selling price d) Management’s plans to repurchase stocks Answer: C 19. true b. the signing partner. Which of the following is broadest in scope? a) Audits of financial statements b) Assurance services c) Operations audit d) Review of financial statements Answer: B 20. The materiality of the misstatement b. The type of transaction effected Answer: B 2. false Answer: A CHAPTER 2 1. The level of management involved d. but rather a matter of professional judgment? Internal control evaluation phase Planning phase Substantive testing phase Completion phase Answer: C 18. What is the primary determinate in the difference between fraud and error a. The intent to deceive c.)True. 5 Auditing Theory PRTC a. Which statement is/are incorrect regarding fraud? a. Fraud involving one or more members of management or those charge with governance is referred to as “employee fraud” c. those charged with governance. stealing physical assets or intellectual property. Intentional misapplication of accounting principles relating to measurement. causing an entity to pay for goods and services not received. or third parties. The two types of fraud of intentional misstatements that are relevant to the auditor’s consideration of fraud include. presentation or disclosure d. transactions. employees. recognition. The risk of not detecting a material misstatement resulting from a fraud is higher than the risk of not detecting a material misstatement resulting from error because a. The term “fraud” refers to an intentional act by one or more individuals among management. Misrepresentation in the financial statements of events. An incorrect accounting estimate arising from oversight or misinterpretation of facts c. falsification (including forgery). classification. transaction or significant information c. The effect of fraudulent act is likely omitted in the accounting records b. Embezzling receipts. recognition. presentation or disclosure d. or alteration of accounting records or supporting documents from which the financial statements are prepared b. Fraud is ordinarily accompanied by acts specifically designed to conceal its existence and auditors do not make legal determinations of whether fraud has actually occurred c. . A mistake in the application of accounting principles relating to measurement. A mistake from gathering or processing data from which financial statements are prepared b. The auditor is responsible to detect errors but not fraud Answer: B 5. All of the above Answer: D 4. Fraud is always a result of connivance between or among employees d. or other significant information Answer: D 3. misstatements resulting from fraudulent financial reporting and misstatements resulting from misappropriation of assets. or using an entity’s assets for personal use. Misrepresentation in. classification. or intentional omission from. the financial statement events. Deception such as manipulation. Auditors make legal determinations of whether fraud has actually occurred b. involving the use of deception to obtain an unjust or illegal advantage. Fraud involving only employees of the entity is referred to as “management fraud” d. Fraudulent financial reporting least likely involve a. the auditor should consider categories of fraud risk factors relating to misstatements arising from (1) fraudulent financial reporting and (2) misappropriation of assets. The auditor’s responsibility for detecting direct-effect illegal act is similar tto the responsibility to detect fraud d. Which of the following is not a category of fraud risk factors in relation to misstatements arising from misappropriation of assests? a. Noncompliance refers to acts of omission or commission by the entity being audited which are contrary to prevailing laws and regulations b. Noncompliance includes transactions entered into by. Contact the local law enforcement office regarding potential criminal wrongdoing. Based on PSA 240 redrafted. the entity. Which of the following is usually true? a. or in the name of. The auditor’s responsibility for detecting indirect-effect illegal acts is similar to the responsibility to detect fraud Answer: C 8. It is easier for the auditor to uncover indirect-effect illegal acts than fraud c. Controls Answer: D . d. Answer: C 9. Attitudes/rationalization d. Which statement is incorrect regarding the auditor’s consideration of laws and regulations in an audit of financial statements? a.6 Auditing Theory PRTC Answer: D 6. Consider the impact of the illegal act and its relationship with the company’s management. c. Opportunities b. in a financial statement audit. by TCWG. management or employees c. Which of the following is the auditor least likely to do when aware of an illegal act? a. or on its behalf. Noncompliance includes personal misconduct of the entity’s management or employees though they are unrelated to the entity’s business activities d. It is easier for the auditor to uncover fraud than errors b. Discuss the matter with the client’s legal counsel. Obtain evidence about the potential effect of the illegal act on the financial statements. In the absence of evidence to the contrary. Pressure/incentives c. the auditor is entitled to assume the entity is in compliance with applicable laws and regulations affecting the client Answer: C 7. b. Tolerance of violations of the entity’s Code of Conduct Answer: B 13. Factors whose presence indicates that the risk of fraud is high b.In comparing management fraud with employee fraud. Reportable conditions identified during an audit Answer: B 12. An unwillingness to address identified weaknesses in internal control on a timely basis. c. b.The following are examples of circumstances that may indicate the possibility that the financial statements may contain a material misstatement resulting from fraud. The management of an entity d. Answer: C 11.Which of the following best describes what is meant by the term “fraud risk factors”? a. c. Both b and c Answer: D 14. Greater for employee fraud because of the higher crime rate among blue collar workers .The following are examples of circumstances that may indicate the possibility that the financial statements may contain a material misstatement resulting from fraud.7 Auditing Theory PRTC 10. Undue time pressures imposed by management to resolve complex or contentious issues. Frequent changes in accounting estimates that do not appear to result from changed circumstances d. Usual delays by the entity in providing requested information d. b. Those charged with governance c. particularly in connection with the auditor’s critical assessment of the audit evidence or in the resolution of potential disagreements with management. The auditor b. the auditor’s risk of failing to discover the fraud is a. Complaints by management about the conduct of the audit or management intimidation of engagement team members. except a. Accounting policies that appear to be consistent with industry norms.The primary responsible for the prevention and detection of fraud and error rests with a. except a. Factors whose presence requires modifications of planned audit procedures d. Factors whose presence often has been observed in circumstances where frauds have occurred c. Unwillingness by management to permit the auditor to meet privately with those charge with governance. d. Answer: A 16. Greater for employee fraud because of the larger number of employees in the organization d. Significant explained items on reconciliations. the appropriate level of management is a. including where a. c. Unavailability of other than photocopied or electronically transmitted documents when documents in original form are expected to exist.Communication of a misstatement resulting from fraud.The auditor may encounter exceptional circumstances that bring into question the auditors ability to continue performing the audit.The following are examples of circumstances that may indicate the possibility that the financial statements may contain a material misstatement resulting from fraud.The following are examples of circumstances that may indicate the possibility that the financial statements may contain a material misstatement resulting from fraud. The entity does not take the remedial action regarding fraud that the auditor considers necessary in the circumstances. c. or entity policy. even when the fraud is not material to the financial statements . Unsupported or unauthorized balances or transactions. Last minute adjustments that significantly affect financial results. The audit committee of board of directors d. except a. Missing documents. Documents that appear to have been altered. d. Tips or complaints to the auditor about alleged fraud. c. The lead of internal audit department Answer: B 18. Ordinarily. Greater for management fraud because of management’s ability to override existing internal controls. or suspected fraud. b. b. or error to the appropriate level of management on a timely basis is important because it enables management to take action as necessary. which is always assumed in audit. Transactions that are recorded in a complete or timely manner or are properly recorded as to amount. Answer: D 17. classification. accounting period. except a. Greater for management fraud because management are inherently smarter than employees Answer: B 15.8 Auditing Theory PRTC b. At least one level above persons who appear to be involved with the misstatement or suspected fraud c. At least equal to level of persons who appear to be involved with misstatements or suspected fraud b. c. c.Examples of the type of information that may come to the auditor’s attention that may indicate that noncompliance with laws or regulations has occurred least likely include a. d.9 Auditing Theory PRTC b. b. d. employees or government employees b. d. Payments for unspecified services or loans to consultants. All of the above Answer: D 19. Answer: B 20. Reasons supporting a conclusion that there is not a significant risk of material improper expense recognition. Payments with proper exchange control documentation. Discussions with management regarding separation of duties. Payments for goods or services made other than to the country from which the goods or services originated.PSAs require auditors to document which of the following matters related to the auditor’s consideration of material misstatements due to fraud? a. The auditor has significant concern about the competence or integrity of management or those charged with governance that affect the auditor’s ability to rely on management’s representation s. Answer: D CHAPTER 3 1) What is the management’s primary purpose of effective internal control in an organization? a) Obtaining high-quality data for making good business decisions providing reasonable assurance that the entity’s objectives are achieved b) Completion of a successful audit for the entity c) Shareholder involvement in the company’s success d) Obtaining profitability and financial strength Answer: A 2) Which of the environment? following factors Commitment to competence are included in A Yes B Yes an C No entity’s D Yes control . related parties. The auditor’s consideration of the risk of material misstatement resulting from fraud and the results of audit tests indicate a significant risk of material and pervasive fraud c. Procedures performed to obtain information necessary to identify and assess the risks of material fraud. Unauthorized transactions or improperly recorded transactions. Results of the internal auditor’s procedures performed to address the risk of management override of controls. physical custody and access to asset Answer: C 7) Which of the following would be considered to be an application control in an information system? a) Controls over system software acquisition b) Controls pertaining to system access security c) Controls pertaining to the follow-up of exception reports d) Control pertaining to application systems maintenance Answer: C 8) Which of the following would require auditing through the computer rather than auditing around the computer? a) These are small volumes of input/output data b) The internal controls are not embedded in the computer system . rests with a) Internal auditors. the completion of a questionnaire is most closely associated with which of the following? a) Separation of duties b) Understanding the system c) Flowchart accuracy d) Tests of controls Answer: B 5) The primary responsibility for designing. recording. c) The external auditor. and the tone of internal control typically originates. Answer: D 6) Segregation of duties deals with the segregation of which functions? a) Recording and physical custody of assets b) Authorizing and recording assets c) Authorizing. implementing and maintaining internal control. d) The management/TCWG.1 0 Auditing Theory PRTC Integrity and ethical values Organizational structure Human resources policies and procedures Answer: D Yes No Yes No Yes No Yes Yes Yes Yes Yes Yes 3) Which of the following elements is not a part of an entity’s control? a) Control risk b) Control activities c) The accounting system d) The control environment Answer: A 4) In an auditor’s consideration of internal control. recording and physical custody of assets d) Authorizing. b) The CFO. record. and equity. revenue from the award credits is recognized at the point of sale Answer: C 9) Control environment component of internal control a) Consists of policies and procedures that help ensure that management directives are carried out. . accompanied by a detailed chart of accounts. liabilities. Answer: B 10) Controls that enhance the reliability of the financial statements may be classified as prevention controls and detection controls. Which of the following is primarily a detection control? a) Separation of duties between recording cash receipts and depositing cash b) Bank accounts are reconciled monthly by persons independent of cash recording and cash custody c) The human resources department authorizes the hiring of only those persons for accounting positions that meet the written job requirements specified by the corporate controller d) An accounting manual. process. and report entity transactions (as well as events and conditions) and to maintain accountability for the related assets. awareness. b) Includes the governance and management functions and the attitudes. c) Is the entity’s process for identifying business risks relevant to financial reporting objectives and deciding about actions to address those risks and the results thereof.1 1 Auditing Theory PRTC c) The system is complex and includes key parts of the accounting system d) The system was audited with computer-assisted audit techniques (CAATs) in the previous years. c) Cost of internal control procedures should not exceed the benefits expected to be derived from the control. carefully and clearly describes each of type of transaction affecting the entity Answer: B 11) When considering internal control. and actions of those charged with governance and management concerning the entity’s internal control and its importance in the entity. an auditor must be aware of the concept of reasonable assurance which recognizes that a) Employment of competent personnel provides assurance that the objectives of internal control will be achieved. d) Consists of the procedures and record established to initiate. b) Establishment and maintenance of internal control is an important responsibility of the management and not of the auditor. and the extent of documentation may vary. promoting operational efficiency. b) Documentation must include procedural write-ups. c) No documentation is necessary although it is desirable. Answer: B 15) Which of the following statements about auditor documentation of the client’s internal controls is correct? a) Documentation must include flowcharts. Answer: B 13) PSAs require the auditor to obtain an understanding of the entity’s internal control structure a) For first time audit clients. c) Provide a basis for suggestions to the client for improving the accounting system. d) No one particular form of documentation is necessary. d) Taking plant and operational tours. a) The control environment b) Audit testing of processes and controls c) Designs and operations of controls . d) Sufficient to find any frauds that may exist. checking the accuracy and reliability of accounting data. d) Provide a method for safeguarding assets. b) Making inquiries of banks and attorneys. which of the following factors is considered pervasive and creates both an attitude and culture that affects the client’s reporting system. c) Reviewing system flowcharts. the process of recording transactions. Answer: C 12) An auditor obtains evidence of the internal control over the accounting system by all of the following except: a) Walkthroughs of the accounting system. the process of making estimates and adjustments. Answer: B 14) When auditing a company. c) Whenever the auditor wishes or sees necessary. and encouraging adherence to prescribed managerial policies. Answer: D 16) When assessing the client. the auditor should obtain an understanding of internal control sufficient to: a) Provide reasonable protection against client fraud and defalcations by client employees.1 2 Auditing Theory PRTC d) Segregation of incompatible functions is necessary to ascertain that the control procedures are effective. b) Assess control risk. b) For every audit. d) An individual authorizing a transaction maintain acustody of the asset that results from a transaction. c) An individual recording a transaction not compare the accounting record of the asset with the asset. the auditor should obtain knowledge about the internal control’s Design Implementation Operating Effectiveness a) Yes Yes Yes b) Yes Yes No c) Yes No No d) No No Yes Answer: B 20) A secondary purpose of the auditor’s consideration of internal control is to provide a) A basis for constructive suggestions about improvements in internal control structure. Answer: B 19) When obtaining understanding of the entity’s control. b) An individual authorizing a transaction records it. c) An assurance that the records and documents have been maintained in accordance with existing company policies and procedures. d) A basis for the determination of the resultant extent of the tests to which auditing procedures are to be restricted. b) Management is dominated by one individual.1 3 Auditing Theory PRTC d) Inherent and control risk Answer: A 17) A proper segregation of duties requires a) An individual maintaining custody of an asset be entitled to access the accounting records for the asset. Answer: A CHAPTER 4 . c) Accurate management job descriptions delineate specific duties. d) The audit committee actually overseas the financial reporting process. Answer: C 18) Management philosophy and operating style most likely would have a significant influence on an entity’s control environment when a) The internal auditor reports directly to management. b) A basis for assessing control risk. 2009 Answer: C 2. Which is false? a. December 31. The professional accountant should be honest and truthful when marketing professional services c. Fixed fees c. Integrity Answer: D 3. Which of the following threats to compliance with the fundamental principles may occur as a result of the financial principles may occur as a result of the financial or other interests of a professional accountant of an immediate or close family member? a. Contingent fees b. June 30. Objectivity b. Professional behavior c. 2008 d. Familiarity Answer: A 4. qualifications possessed or experience gained. When marketing professional services. The Code of Ethics for Professional Accountants in the Philippines is applicable to professional services performed in the Philippines on or after a. Self-interest b. Advocacy d. The following statements relate to the provisions of the Code of Ethics that deal with the professional accountant’s marketing of professional services. the professional accountant should not make exaggerated claims for services offered. Predetermined fees d. Commissions Answer: A 5.1 4 Auditing Theory PRTC 1. 2009 b. June 30. Advertising and publicity are generally unacceptable d. a self-interest threat to compliance with the principle of professional behavior may be created b. When a professional accountant in public practice solicits new work through advertising or other forms of marketing. Self-review c. Which of the following fundamental ethical principles requires a professional accountant to be straightforward and honest in all professional and business relationships? a. 2008 c. . These are fees calculated on a predetermined basis relating to the outcome or result of a transaction or the result of the work performed a. Professional competence and due care d. December 31. To any third party that lost money or suffered damages from investing in the audited company d. normally no more than a. Self interest b. that he is to. A former partner of the firm being a director or officer of the client or an employee in a position to exert direct and significant influence over the subject matter of the engagement Answer: A 8. Long association of senior personnel with the assurance client c. 7 years . Intimidation Answer: C 10. Advocacy c. When an auditor is sued for negligence in the performance of an audit. threats to compliance with fundamental principles arise from all of the following except: a. to what parties does the contributory negligence defense apply? a. Based on the Code of Ethics for Professional Accountants. or may. Promoting shares in a listed entity when that entity is a financial statement audit client b. 5 years d. Self-review threat d. Familiarity threat Answer: B 7. A member of the engagement team having a close or immediate family relationship with a director or officer of the client d. Only to the parties having a contractual relationship with the auditor b. excepts a. The following are examples of circumstances that may create familiarity threats.The engagement partner should be rotated after a pre-defined period. Self-interest threat c. The audit relationship d. Which of the following threats to independence is created when a member of the assurance team participates in the assurance engagement while knowing. join the assurance client sometime in the future? a. Only to those third parties that the auditor could reasonably have known would have relied on the audited financial statements Answer: A 9. To any third party that relied on the audited financial statements c. or having reason to believe. 2 years b. 3 years c. Intimidation threat b.1 5 Auditing Theory PRTC Answer: C 6. Adjusting entries b. Extortion d.Which of the following is an example of a common type of financial reporting fraud? a.Which of the following statements best describes an auditor’s responsibility regarding misstatements? a. Unusual entries d. Closing entries c. Excluding a contingent liability that has been settled Answer: C . Embezzlement/Defalcation c.1 6 Auditing Theory PRTC Answer: C 11. An auditor’s failure to detect a material misstatement resulting from fraud is an indication of noncompliance with the requirements of the Philippine Standards on Auditing Answer: A 12.What type of fraud occurs if an employee obtains financial benefit through intimidation? a.There is a high risk as well as a history. An auditor should obtain reasonable assurance that the financial statements taken as a whole are free from material misstatements. Agreement between two or more persons to commit a criminal act Answer: B 15. Theft of assets covered up by manipulation of accounting records d. Conspiracy b. Misappropriation of assets that have been entrusted to one’s care b. Larceny Answer: C 13. All of the above Answer: D 14. Theft of assets c. whether caused by fraud or error. Capitalizing major overhauls to operating equipment b.Which of the following constitutes the fraud of larceny? a. An auditor should obtain absolute assurance that material misstatements in the financial statements will be detected. Deferring service revenue until it is delivered to customers c. b. An auditor is responsible to detect material errors but has no responsibility to detect material fraud that is concealed through employee collusion or management override of internal control d. that fraud is instituted through which of the following? a. c. Recording sales for inventory sold with the right to return d. Answer: C 19. An audit cannot be expected to detect noncompliance with all laws and regulations b. c.According to professional audit standards.Which statement(s) is(are) incorrect regarding the auditor’s responsibility to consider fraud and error in an audit of financial statements? a. In planning the audit. The auditor is not and cannot be held responsible for the prevention of fraud and error being the primary responsibility of both the management and those charged with governance b. Fraud training courses from actual corporate fraud ex-criminals b. the auditor should discuss with other members pf the audit team the susceptibility of the entity to material statements in the financial statements resulting from fraud or error and exercise professional skepticism (the best method to detect method) d.Which of the following is the incorrect about the auditor’s responsibility of evaluation noncompliance by the entity to laws and regulations? a. requires considerations of the implications for the integrity of managements or employees. Actively search for all errors in the financial statements Answer: A 17. Noncompliance refers to acts of omissions or commission by the entity being audited which are contrary to prevailing laws or regulations. Understand and properly apply Generally Accepted Accounting Standards c. Noncompliance includes personal misconduct of entity management or employee though they are unrelated to the entity’s business activities d. The auditor should design audit programs that will provide reasonable assurance that material errors and fraud will be detected in the ordinary course of the examination . Use professional skepticism b. Circulating a survey to the client company employees for completion d.1 7 Auditing Theory PRTC 16.What is the best method an auditor may use to detect fraud in the financial statements of clients? a. Detection of noncompliance. When planning and performing audit procedures and evaluating and reporting the results thereof. Conducting a brainstorming meeting with the members of the audit team c. the auditor should consider the risk of misstatements in the financial statements resulting from fraud c. Brainstorm with the client to find the type of fraud occurring d. how might an understanding of the nature if fraud that may occur in the client organization best be identified by the audit firm? a. Discussions with other CPA firms Answer: B 18. regardless of materiality. Oral and in writing Answer: D CHAPTER 5 1 The principal reason for an independent auditor to gather and evaluate audit evidence is to a Form an opinion on the financial statements. Answer: D 4 The independent auditor’s responsibility in a regular audit is to express opinion on the financial statements. d Comparable data about competitors (benchmarking). In writing c. observation. The auditor’s opinion: a Helps the company adopt sound accounting principles b Assists the company in maintaining adequate and effective system of accounts c Helps management safeguard the company assets d Helps establish the credibility of the financial statements Answer: D . In the case of the financial statement audit of listed entities. c Evaluate management. d Adjustments to the financial statements that are not reflected in formal journal entries.Firms are required to establish policies and procedures relating to independence communications with audit committees. Answer: D 3 Other information that the auditor may use as audit evidence least likely includes a Minutes of meetings. d Evaluate internal control. b Confirmation from third parties. b Detect fraud. Oral or in writing d. c Information obtained by the auditor from such audit procedures as inquiry. or others charged with governance of the client. Oral b. b The general and subsidiary ledgers. Answer: A 2 Accounting records least likely include a The record of initial entries and supporting entries. and inspection. c Worksheets and spreadsheets supporting cost allocations. such communication should be a.1 8 Auditing Theory PRTC Answer: B 20. d Unrestricted access to whatever records. he or she should ordinarily a Perform the audit with increased professional skepticism.1 9 Auditing Theory PRTC 5 Which of the following is not included in an engagement letter? a Restriction on cash balances. c The auditor’s judgment that misstaments are probable on certain balances. b The company’s financial statements. lines of credit by similar arrangements b Accessibility to all financial reports c Client imposed limitation in the scope d Limitation in the scope of examination as imposed by the circumstances Answer: A 6 The form and content of audit engagement letters may vary for each client. c The form of any reports or other communication of results of the engagement. Answer: C 8 Which of the following factors most likely would influence an auditor’s determination of the auditability of the entity’s financial statements? a The complexity of the accounting system b The existence of related party transactions c The adequacy of accounting records d The operating effectiveness of control procedures Answer: C 9 The extent of procedures is affected mostly by which of the following factors? a The sheer volume of procedures to be applied by the auditor. b The time of the year in which the client takes a physical inventory in the warehouse. Answer: C 10 An “integrated audit” includes an audit of a The company’s internal controls. Answer: B 7 If the auditor believes that an understanding with the client has not been established. d Modify the scope of the audit to reflect an increased risk of material misstatement due to fraud. b Assess the control risk at the maximum level and perform a primarily substantive audit. documentation and other information requested in connection with the audit. . but they would generally include reference to the following. d The availability of the client’s staff or near the balance sheet date. except: a The objective of the audit of financial statements b Auditor’s responsibility for the financial statements. c Decline to accept or perform the audit. after the auditor has evaluated the client’s internal control and estimated the amount of time required for the audit c When a new client is accepted by the auditor d At the conclusion of the fieldwork. . just prior to signing the audit report Answer: C 13 For which engagements are engagement letters required? a All engagements b Audit engagements only c Assurance engagements only d All engagements except the preparation of income tax returns Answer: A 14 Which of the following is least likely to be considered a risk assessment procedure? a Analytical procedures b Confirmation of ending accounts receivable c Inspection of documents d Observation of performance of certain accounting procedures Answer: B 15 Which of the following will an auditor most likely discuss with the former auditors of a potential client prior to acceptance? a Integrity of management b Reasons for changing audit firms c Disagreements with management regarding accounting principles d All of the above must be discussed Answer: D 16 If permission from client to discuss its affairs with the proposed auditor is denied by the client. the predecessor auditor should a Keep silent of the denial. Both A and B. Answer: D 11 The auditor’s opinion a Guarantees the credibility of the financial statements b Is an assurance as to the future viability of the entity c Certifies the correctness of the financial statements d Is not an assurance as to the efficiency with which the management has conducted the affairs of the entity Answer: D 12 When should an auditor obtain an engagement letter? a Whenever a prospective client offers to hire the audit firm b During the interim audit period. b Disclose the fact that the permission to disclose is denied by the client.2 0 Auditing Theory PRTC c d The company’s compliance with its rules and processes. Which of the following statements concerning evidence is correct? a) Appropriate evidence supporting management’s assertions should be . the auditor would most likely increase the a Extent of tests of controls. Seek legal advice before responding to the proposed auditor. d Level of inherent risk. Answer: B 19 When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective . c Extent of test of details. d Neither A nor B. b Further audit procedures (test of controls and substantive procedures). and thus its sufficiency and appropriateness. c Both A and B. assuming no internal control. Answer: B 17 The auditor obtains audit evidence to daw reasonable conclusions on which to base the audit opinion by performing a Risk assessment procedures. Answer: C 18 Which of the following statements is not true? a Inherent risk is inversely related to detection risk. c Inherent risk is the susceptibility of the financial statements to material error. b Level of detection risk. b Inherent risk is inversely related to evidence. to support the audit opinion d The matter of difficulty or expense involved is a valid basis for omitting an audit procedure for which there is no alternative. d Inherent risk is the auditor’s assessment of the likelihood that errors exceeding a tolerable amount exist in a segment before considering the effectiveness of internal controls. Answer: D CHAPTER 6 1.2 1 Auditing Theory PRTC c d Disclose adequately to proposed auditor all noncompliance made by the client. Answer: C 20 Which statement is incorrect regarding audit evidence? a The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion b Accounting records alone do not provide sufficient audit evidence c The auditor uses professional judgments and professional skepticism in evaluating the quantity and quality of audit evidence. Audit documentation may be recorded on paper or on electronic or other media. Which of the following audit procedures is used extensively throughout the audit and often is complementary to performing the audit procedures? a) Inspection b) Observation c) Inquiry d) Confirmation Answer: C 4. except a) Audit programs b) Analyses c) Control manuals d) Issues memoranda Answer: C . b) An effective internal control structure contributes little to the reliability of the evidence created within the entity. Which statement is incorrect regarding inspection as an audit procedure? a) Inspection consists of examining records or documents or physical examination of assets b) Inspection of tangible assets may provide reliable audit evidence with respect to their existence and about the entity’s rights and obligations on the assets c) Inspection of individual inventory items ordinarily accompanies the observation of inventory counting d) Some documents represent direct audit evidence of the existence of of an asset Answer: B 3. Answer: D 2.2 2 Auditing Theory PRTC convincing rather than merely persuasive. c) The cost of obtaining evidence is not an important consideration to an auditor in deciding what evidence should be obtained d) A client’s accounting records cannot be considered sufficient audit evidence to support the financial statements. No deletions of of audit documentation are allowed after the a) Client’s year end b) Documentation completion date c) Last date of significant fieldwork d) Report release date Answer: B 5. Example of audit documentation include the following. An exception in a test of control indicates the misstatements of the . The auditor notice notices significant fluctuations in key elements of the company’s financial systems.2 3 Auditing Theory PRTC 6. b) Confirmation of balances of accounts receivable c) Comparison of signatures on checks to a list of authorized signers d) Flowcharting of the client’s receipt system Answer: B 11. the auditor should a) Consider the matter a scope of limitation b) Perform additional audit procedures to investigate the matter further c) Intensify the examination with the expectation of detecting management fraud d) Withdraw from the engagement Answer: B 7. If management is unable to provide acceptable explanation. The preliminary use of the analytical review procedures by the auditor is a) Required to identify heightened risk b) Optional in accordance with the auditor’s judgment c) Only used when other planning procedures cannot be applied d) Used to assist the auditor in documenting internal control Answer: A 9. Which of the following is the best example of a substantive test? a) Examining a sample of cash disbursement to test whether expenses have been properly approved. Which of the following methods is considered the best combination in obtaining audit evidence assuming documentary evidence is available to the auditor? a) Inspection and reperformance b) Inquiry and inspection c) Inquiry and analytical procedure d) Observation and inquiry Answer: B 8. Which of the following is ordinarily designed to detect possible material misstatements on the financial statements? a) Test of controls b) Analytical procedures c) Computer controls d) Post audit work paper review Answer: B 10. Which assertion are auditors most concerned regarding the audit of asset accounts? a) Completeness b) Existence c) Accuracy d) Proper period Answer: B 15. a) b) c) d) Which of the following statements relate to the ownership assertion? Inventory listings are accurately included in the inventory accounts Inventory excludes items billed to customers Inventory is properly classified as current assets Inventory is properly stated at cost Answer: B 16. The strongest criticism of the reliability of audit evidence that the auditor physically observes is that a) The client may conceal items from the auditor b) The auditor may not be qualified to evaluate the items he is observing c) Such evidence is too costly in relation to its reliability d) The observation must occur at a specific time.2 4 Auditing Theory PRTC a) b) c) d) The amount The likelihood The amount. which is often too difficult to . Which is clearly a test of control? a) Confirmation to a customer of an accounts receivable balance b) Examination of a sample of purchase order records for electronic authenticated authorization c) Observing the controller’s use of the company owned equipment d) Sending a letter to the client’s attorney to determine a litigation that is pending between the plaintiff and the defendant Answer: B 13. likelihood . A procedure that would least likely to be used by an auditor in performing test of control is a) Inspection b) Reperformance c) Observation d) Recalculation Answer: D 14. and classification The amount and the classification Answer: B 12. Theoretically. d) Whether or not the client reports to the Securities and Exchange Commission. Objective and unbiased. Answer: D 19. Consistent with the audit objectives. which of the following would not have an effect on the amount of audit evidence gathered by the auditor? a) The type of opinion to be issued. and convincing. b) Obtaining and examining evidential matter. Most of the independent auditor’s work in formulating an opinion on financial statements consists of a) Studying and evaluating internal control.2 5 Auditing Theory PRTC arrange Answer: B 17. Which of the following statements about existence (testing is from the accounting records to the supporting audit evidence) and completeness (testing is from the supporting evidence to the accounting records) assertions is not true? a) The existence and completeness assertions emphasize different audit concerns b) Existence deals with overstatements and completeness deals with understatements c) Existence deals with understatements and completeness deals with overstatements d) The completeness assertion deals with unrecorded transactions Answer: C 18. d) Comparing recorded accountability with assets. Answer: D CHAPTER 7 1. Answer: B 20. Factual. a) b) c) d) Audit information is usually considered relevant when it is Derived through valid statistical sampling. c) Examining cash transactions. A risk of material misstatement is . b) The auditor’s evaluation of internal control. adequate. c) The types of audit evidence available to the auditor. and IV d. requires special audit consideration. taking account of relevant controls that the auditor intends to test. a risk that may relate to the inaccurate or incomplete recording of routine and significant classes of transactions or account balances. relate risk to what could go wrong.2 6 Auditing Theory PRTC a. The following are examples of conditions and events that may indicate the existence of risks of material misstatement. and by considering the classes of transactions. and II Answer: B 3. III. and disclosures in the financial statements IV. II. IV. Consider the likelihood of misstatement. and I c. and potentially affect many assertions that could be considered material. b. III. High degree of complex regulation Answer: A . in the auditor’s judgment. and IV b. a. I. b. Consider the likelihood that the risks could result in material misstatements d. The risk that relate pervasively to the financial statements as a whole. III. Pending litigation and contingent liabilities c. Consider the complexity of the transactions involved c. c. the risk that the financial statements are materially misstated prior to audit. Determine the most logical order of assessing the risks of material misstatements as indicated in PSA 315? I. While assessing the risks of material misstatement auditors identify risks. Answer: C 2. d. the characteristics of which often permit highly automated processing with little or no manual intervention. III. III. II. Determine materiality levels Answer: C 4. and evaluate whether they relate more pervasively to the financial statements as a whole and potentially affect many assertions. an identified and assessed risk of material misstatement that. Application of new accounting pronouncements d. Operations in regions that are economically stable b. and whether the potential misstatement is of a magnitude that could result in a material misstatement. Identify the risks throughout the process of obtaining an understanding of the entity and its environment. account balances. including relevant controls that relate to the risks. Relate the identified risks to what can go wrong at the assertion level. II. Assess the identified risks (if it is a significant risk). I. Assess the risk of misstatement due to illegal acts. consider the magnitude of risk and a. including the possibility of multiple misstatements. IV. except a. I. II. V. except a. IV. Whether the risk involves significant transactions that are outside the normal course of business for the entity. Which of the following conditions and events least likely indicate the existence of risks of material misstatements? a. IV. and III only d. b. b. Inquiries into the entity’s operations or financial results by regulatory or government bodies. III. Weaknesses in internal control. Accounting measurements that involve simple processes c. Significant amount of routing or systematic transactions d. II. timing. c. Whether the risk is a risk of fraud II. The following events and conditions indicate the existence of risks of material misstatement. b. d. Expanding into new locations c. III. requires specific attention.2 7 Auditing Theory PRTC 5. I. Operations that are subject to a low degree of complex regulation. especially those measurements involving a wide range of measurement uncertainty VI. Installation of significant new IT systems related to financial reporting. IV. therefore. accounting or other developments and. especially those not addressed by management. Answer: D 7. and V only c. and IV only b. and VI Answer: D 9. Changes in the supply chain. II. II. III. Consistency of the entity’s IT strategy and its business strategies. d. and extent are responsive to the assessed risks of material . Whether the risk is related to recent significant economic. The auditor should design and perform further audit procedures whose nature. Having personnel with appropriate accounting and financial reporting skills. I. or that otherwise appear to be unusual. III. Whether the risk involves significant transactions with related parties V. The complexity of transactions. a. The degree of subjectivity in the measurement of financial information related to the risk. the auditor shall consider at least the following: I. I. I. II. Constraints on the availability of capital and credit Answer: D 6. In exercising judgment as to which risks are significant risks. Which of the following conditions and events may most likely indicate the existence of risks of material misstatements? a. Changes in key personnel including departure of key executives. Answer: D 8. Obtain an understanding of the entity and its environment.2 8 Auditing Theory PRTC misstatement at the assertion level.Reasons to evaluate internal control would not include a. Procedures to obtain an understanding of internal control 2. including its internal control. material misstatement at the assertion level. The timing refers to when audit procedures are performed or the period or date to which the audit evidence applies c. All of the above Answer: C 14. The frequency and effectiveness of the controls c. The effectiveness and efficiency of controls b. Which three are substantive tests? 1. Test of controls . and extent of further audit procedures? a. timing. The nature of the audit procedures b. The extent of the audit procedures c. All of the above Answer: D 11. Extent includes the quantity of a specific audit procedure to be performed. Formulating constructive suggestions for improvements Answer: C 12. Which of the following is the most important consideration in responding to the assessed risks? a. Detect material misstatements at the assertion level d. All of these are equally important Answer: A 10. The implementation and efficiency Answer: C 13. or detecting and correcting. Test the operating effectiveness of controls in preventing. These issues are: a. Basis for planning b. The nature of further audit procedures refers to their purpose and their type b.The main purpose of substantive procedures is to a. d. The timing of audit procedures d.Shown below (1 through 5) are the five types of test which auditors use to determine whether financial statements are fairly stated. to assess the risks of material misstatement at the financial statement and assertion levels. timing. b.Which statement is/are correct regarding the nature. The design and utilization of the controls d. and extent of substantive procedures c.An auditor should consider two key issues when obtaining an understanding of a client’s internal controls. c. Basis for type of opinion to be rendered d. Determining the nature. c. 2. Test of transactions 4. Procedures manual Answer: D 17. d. Test of controls b. Determine whether procedures and records correcting the safeguarding of assets are reliable. Examine documents and records.2 9 Auditing Theory PRTC a. b. Answer: C 16. Walk through d.The following are the different techniques in documenting the auditors’ understanding of the client’s internal control system. b. d. except a. Ascertain whether the opportunities to allow any person to both perpetrate and conceal fraud are minimized. Documentation must include narrative memoranda c. Analytical procedure Answer: C 19. 1. c. 2. Observe client activities and operations.Which of the following is not useful for obtaining an understanding of internal controls? a. 3. and the extent of documentation may vary Answer: D 18. 3. Narrative memorandum b. Flowchart d. No documentation is necessary although it is desirable d. No one particular form of documentation is necessary. Questionnaires c. b.Which of the following statements regarding auditor documentation of the client’s internal control structure is correct? a. 4.Tracing transactions through the system to determine whether procedures are being applied as prescribed a. Tests of details of balances 3 5 5 4 Answer: B 15. . Make inquiries of the client’s personnel. and and and and 3. Analytical procedures 5. Read industry trade magazines. 2. Inspection c.An auditor uses the knowledge provided by the understanding of internal control and the assessed level of control risk primarily to a. Documentation must include flowcharts b. 3. timing. Preliminary estimates of materiality levels. Audit sampling c. Answer: D . Analytical procedures b. c. Tests of controls Answer: B 2. Answer: D CHAPTER 8 1. Such responses least likely include a. b. Eliminate the risk of nonsampling errors c. Minimize the failure to detect errors and irregularities b. Emphasizing to the audit team the need to maintain professional scepticism in gathering and evaluating audit evidence b. Efficiency of the audit. Effectiveness of the audit. Substantive testing d. The risk of incorrect acceptance and the likelihood of assessing control risk too low relate to the: a.The auditor should determine overall responses to address the risks of material misstatement at the financial statement level. Reduce the level of audit risk and materiality to a relatively low amount d. Answer: D 20. Performing substantive procedures at an interim date instead of at the period end.3 0 Auditing Theory PRTC c. d. d. It involves the application of audit procedures to less than 100 percent of items within a population of audit relevance such that all sampling units have a chance of selection a. Mathematically measures sampling risk Answer: D 3. and extent of substantive test for financial statement assertions. d. c. An advantage of statistical sampling over nonstatistical sampling is that statistical sampling helps an auditor to a. Modify the initial assessments of inherent risk and preliminary judgments about materiality levels. Assigning more experienced staff or those with special skills or using experts. Allowable risk of tolerable misstatement. Determine the nature. Incorporating additional elements of unpredictability in the selection of further audit procedures to be performed. Nature and cause of deviations. The calculated audit amounts are approximately proportional to the client's book amounts. Estimating populations whose records consist of quantities. d. Eliminate the need to use judgment in determining appropriate sample sizes. an auditor should consider the likely rate of deviations. Decrease sample size Increase sample size d. Population size. d. Answer: A 7. c. No Yes d. b. Tolerable deviation rate. Can more easily convert the sample into a dual-purpose test useful for substantive testing. c. b. Answer: D 8. but not book values. Yes Yes b. Provide an objective basis for quantitatively evaluating sample risk. Increase sample size Decrease sample size c.3 1 Auditing Theory PRTC 4. Afford greater assurance than a nonstatistical sample of equal size. the allowable risk of assessing control risk too low. and the: a. Decrease sample size Decrease sample size Answer: C 6. d. No No c. The use of the ratio estimation sampling technique is most effective when: a. Risk of incorrect acceptance. A relatively small number of differences exist in the population. In determining the sample size for a test of controls. Increase sample size Increase sample size b. Yes No Answer: A 5. How would increases in tolerable misstatement and assessed level of control risk affect the sample size in a substantive test of details? Increase in tolerable Increase in assessed misstatement level of control risk a. . An advantage of using statistical over nonstatistical sampling methods in tests of controls is that the statistical methods: a. c. Large overstatement differences and large understatement differences exist in the population. b. Which of the following factors is (are) considered in determining the sample size for a test of controls? Expected Tolerable deviation rate deviation rate a. c. Does not support the auditor's planned assessed level of control risk when the true operating effectiveness of internal control justifies such an assessment. c. d. d. b. b. Answer: C 12. Variables sampling. Stop-or-go sampling. There is an inverse relationship between the expected population deviation rate and the sample size. Answer: A 11. Which of the following statements is correct concerning statistical sampling in tests of controls? a. d. Answer: B 10. Contains misstatements that could be material to the financial statements when aggregated with misstatements in other account balances or transactions classes.Which of the following courses of action would an auditor most likely follow in planning a sample of cash disbursements if the auditor is aware of several unusually large cash disbursements? a. Random-number sampling. b. Does not support the tolerable error for some or all of management's assertions.3 2 Auditing Theory PRTC Answer: A 9. Attribute sampling. an auditor considers detection risk and the sample size.Which of the following sampling methods would be used to estimate a numerical measurement of a population. such as a dollar value? a. Increase the sample size to reduce the effect of the unusually large disbursements. the sample size should increase proportionately.The likelihood of assessing control risk too high is the risk that the sample selected to test controls: a. Stratify the cash disbursements population so that the unusually large disbursements are selected. In determining tolerable rate. Set the tolerable rate of deviation at a lower level than originally planned. As the population size increases. Deviations from specific control activities at a given rate ordinarily result in misstatements at a lower rate. Contains proportionately fewer monetary errors or deviations from prescribed internal controls than exist in the balance or class as a whole. b. c. c. . Inclusion of zero and negative balances generally does not require special design considerations. Yes No d. c.As a result of sampling procedures applied as tests of controls. d. an auditor incorrectly assesses control risk lower than appropriate. c. b. The most likely explanation for this situation is that: a. Answer: B 13. d.The sample size of a test of controls varies inversely with: Expected population Tolerable deviation rate rate a. but the deviation rate in the population is less than the tolerable rate. but the deviation rate in the population exceeds the tolerable rate. An estimate of the standard deviation of the population's recorded amounts is not required. No Yes Answer: D 15. Selecting accounts receivable for confirmation of account balances. The deviation rates of both the auditor's sample and the population is less than the tolerable rate. Yes Yes b. Continue to draw new samples until all the unusually large disbursements appear in the sample. b.For which of the following audit tests would an auditor most likely use attribute sampling? a. Answer: C 16. Any amount that is individually significant is automatically identified and selected. Inspecting employee time cards for proper approval by supervisors. d. No No c. The deviation rates of both the auditor's sample and the population exceed the tolerable rate. The auditor rarely needs the assistance of a computer program to design an efficient sample. The deviation rate in the auditor's sample is less than the tolerable rate. c. Making an independent estimate of the amount of a LIFO inventory. The deviation rate in the auditor's sample exceeds the tolerable rate.3 3 Auditing Theory PRTC d.Which of the following most likely would be an advantage in using classical variables sampling rather than probability-proportional-to-size (PPS) sampling? a. Examining invoices in support of the valuation of fixed asset additions. Answer: D 14. . b. What is an auditor's evaluation of a statistical sample for attributes when a test of 50 documents results in3 deviations if tolerable rate is 7%. Identify whether inventory items are properly priced. b. Represents a dollar amount that is material. and the allowance for sampling risk is 2%. Estimate whether the dollar amount of inventory is reasonable. Upper deviation rate (8%) was more than the percentage of errors in the sample (3.An auditor examining inventory most likely would use variables sampling rather than attributes sampling to: a. c.000 sales invoices processed during the year. Expected deviation rate (7%) was more than the percentage of errors in the sample (3. If a random number matches a voided voucher. that voucher ordinarily would be replaced by another voucher in the random sample if the voided voucher: a.An auditor desired to test credit approval on 10. the expected population deviation rate is 5%. The auditor estimated from previous experience that about 2 1/2% of the sales invoices lacked approval. b. Indicates a deviation from the prescribed activity. Has been properly voided.An auditor is selecting vouchers for testing an entity's internal control activities related to the proper approval of vouchers before checks are prepared. Determine whether discounts for inventory are properly recorded. Answer: D 20. Answer: A 18. The auditor is matching random numbers with voucher numbers to determine which vouchers to inspect. The auditor designed a statistical sample that would provide 1% risk of assessing control risk too low (99% confidence) that not more than 7% of the sales invoices lacked approval. the auditor decided to increase the level of the preliminary assessment of control risk because the: a. d.5%). . The auditor then determined the upper deviation rate to be 8%. c. d. Expected deviation rate (2. Cannot be located in the voucher file.3 4 Auditing Theory PRTC Answer: C 17. In the evaluation of this sample.5%). c. A sample of 200 invoices was examined and 7 of them were lacking approval.5%) was less than the tolerable rate (7%). b. Answer: B 19. Discover whether misstatements exist in inventory records. d. Tolerable rate (7%) was less than the upper deviation rate (8%). c. Modify the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate. Answer: D . Accept the sample results as support for the planned assessed level of control risk because the tolerable rate less the allowance for sampling risk equals the expected population deviation rate. d. Modify the planned assessed level of control risk because the tolerable rate plus the allowance for sampling risk exceeds the expected population deviation rate.3 5 Auditing Theory PRTC a. b. Accept the sample results as support for the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate.