lOMoARcPSD|12208216 Auditing Reviewer - Lecture notes 1 Accountancy (Xavier University - Ateneo de Cagayan) StuDocu is not sponsored or endorsed by any college or university Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 CHAPTER 1: REVIEW QUESTIONS-THEORETICAL Audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results thereof. (AAA) Audit Process is the sequence of different activities involved in an audit. - Pre-engagement require decision from the auditor whether or not to accept a new client or continue relationship with an existing one. It requires evaluation of the auditor’s qualification, but also the integrity of management and auditability of the client’s financial statements. Primary objective: To minimize the likelihood of being associated to a client whose management lacks integrity. - Audit planning involves the development of an overall audit strategy, audit plan and audit program. The auditor will usually obtain more detailed knowledge about the client’s business and industry. Primary Objective: To assess the different risks associated with the auditor to determine the nature, timing and extent of further audit procedures. - Consideration of internal controls involves the study and evaluation of internal controls whether it can prevent, detect or correct material misstatements in a timely manner. Primary objective: To establish a basis for reliance on internal controls in determining the nature, timing and extent of audit procedures to be performed. - Evidence- Gathering (Substantive testing) Using the information obtained in audit planning and consideration of internal controls, the auditor performs substantive test to detect material misstatements as a basis in concluding whether the entity's financial statements are presented fairly in accordance with financial reporting standards. Substantive procedures could either be analytical procedures or test of details of transactions and balances. This phase will always be performed by the auditor. Primary objective: To ascertain the degree of correspondence between the financial statements prepared by client's management and the financial reporting framework. - Completing the audit Wrap-up procedures are performed; conclusions reached are reviewed; and an overall opinion is formed during this phase. Primary objective: To assist the auditor in assessing whether the conclusion reached is consistent with evidence gathered. - Issuance of the audit report In this phase, the auditor drafts and issues the audit report which states the auditor's opinion regarding the fairness of the financial statements. Primary objective: To communicate the results of the work of the auditor to various intended users - Post-audit responsibilities After completion of the audit engagement, the auditor performs procedures to determine compliance with quality controls and to identify areas for improvement in the current and future audit engagements. Primary objective: To assess and evaluate the quality or the audit services delivered by the engagement team. PRE-ENGAGEMENT Acceptance of an engagement In making a decision whether to accept or reject an engagement, the auditor should perform the following: 1. Evaluate preconditions for an audit Preconditions of an audit is the use by management of an acceptable financial reporting framework in the preparation of the financial statements and the agreement of management and, where appropriate, those charged with governance to the premise on which an audit is conducted 2. Evaluate auditability of the prospective client. 3. Investigate the integrity of the client's management through inquiry to appropriate parties or communication with the predecessor auditor. Matters to be discussed with predecessor auditor include the following: (RID) a. The predecessor's understanding as to the Reasons for change in auditors; b. Information that might bear on the Integrity of the management; and Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 c. Disagreements between the predecessor auditor and management as to accounting principles, auditing procedures, etc. d. Note: Every time communication is made to parties other than the client, the auditor shall seek permission from the client and document the items discussed. 4. Evaluate compliance with ethical requirements, including independence. Relevant part of the Code of Ethics includes Part 1, Part 3 and Part 4A. 5. Evaluate of the firm's ability to serve the prospective client. 6. Obtain a preliminary knowledge of the client's business and industry to determine whether the auditor has the degree of competence required by the engagement. 7. Agree on the terms of the engagement and prepare an engagement letter. Continuance of an Engagement To ensure the audit firm's continuing compliance with the continuance procedures, the auditor needs to consider significant matters that have arisen during the current or previous engagements, and their implications for continuing the relationship. Agreeing the Terms of Audit Engagements The auditor and the client shall agree on the terms of engagement. The agreed terms would need to be recorded in an audit engagement letter or other suitable form of contract. It is in the interest of both client and the auditor that the auditor sends an engagement letter, preferably before the commencement of the engagement to help avoid misunderstandings with respect to the engagement. The engagement letter documents and confirms: a. Auditor's acceptance of the engagement b. Objective and scope of the audit c. Extent of auditor's responsibilities to the client d. Form of any reports Contents of engagement letter The form and content of audit engagement letters may vary for each client, but they would generally include reference to: a. The presence of audit risk b. Unrestricted access to whatever records c. The financial reporting framework used d. Objective of the audit e. The form of any reports or other communication f. Management's responsibility g. The scope of the audit The auditor may also wish to include in the letter: a. Basis in which fees are computed and any billing arrangements b. Expectation of receiving representation letter C. Acknowledgment of management of terms of agreement d. Arrangements regarding the planning of the audit e. Description of any other letters or reports When relevant, the following points could also be made: - Arrangements concerning the involvement of other auditors and experts in some aspects of the audit; - Arrangements concerning the involvement of internal auditors and other staff; -Arrangements to be made with the predecessor auditor, if any, in the case of initial audit engagement; -Any restriction of the auditor's liability when such possibility exists -A reference to any further agreements between the auditor and the client. Audit of Components When the auditor of a parent entity is also the auditor of its subsidiary, branch, or division (component), the factors that influence the decision whether to send a separate engagement letter to the component include the following: -Who appoints the component auditor; Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 -Legal requirements in relation to audit appointments; -Degree of ownership by parent; -Whether a separate auditor's report is to be issued on the component; and -Degree of independence of the component's management from the parent entity Recurring Audits On recurring audits, the auditor should consider whether circumstances require the terms of the engagement to be revised and whether there is a need to remind the client of the existing terms of the engagement. The auditor may decide not to send a new engagement letter each period. However, the following factors may make it appropriate to send a new letter: -Any indication that the client misunderstands the objective and scope of the audit. -Any revised or special terms of the engagement. -A recent change of top level management or board of directors. -A significant change in ownership. -A significant change in nature or size of the client's business. -A change in legal or regulatory requirements. -A change in financial reporting framework adopted in the preparation of the financial statements. -A change in other reporting requirements. Acceptance of a Change in Engagement Is there a reasonable justification? Yes a. Stop performing the old engagement b. Stop referring to the old engagement, except when the new engagement involves agreed-upon procedures c. Start performing the new engagement d. Issue a report based on the new engagement No a. Continue the original audit engagement b. When prohibited to continue, withdraw from the audit engagement Note: Every time withdrawal is made, the auditor should consider the necessity of communicating the reasons to appropriate level of management. Circumstances that could lead to Change in Engagement Circumstances 1. Change in circumstances affecting the need for the service 2. A misunderstanding as to the nature of the engagement originally requested 3. A restriction on the scope of the engagement (whether imposed by management or caused by circumstances) 4. Change related to information that is incorrect, incomplete or otherwise unsatisfactory 5. The auditor is unable to obtain sufficient appropriate audit evidence regarding assertions REVIEW QUESTIONS-THEORETICAL 1. Which of the following is an incorrect phrase a. Auditing is a systematic process regarding auditing? b. Auditing subjectively obtains and evaluates evidence. c. Auditing evaluates evidence regarding assertions. d. Auditing communicates results to interested users. 2. Set the following phases in proper order: I. Pre-Engagement II. Internal Controls III. Evidence-Gathering IV. Completing the Audit a. I, II, III, IV, V, VI, VI b. 1. IV, III, II, VII, V, VI V. Planning VI. Post-Audit Responsibilities VII Reporting c. IV. II, III, IV, VII, VI d. I. IV. II, III, V, VI, VI Downloaded by Larence Nova (larence.nova@yahoo.com) Justifiable? / / x x x lOMoARcPSD|12208216 3. Which of the following procedures is not required to be performed by the auditor? a. Risk assessment procedures b. Substantive procedures c. Tests of control d. Analytical procedures 4. Which of the following procedures should be performed by the auditor prior to starting an initial audit? I. Perform procedures regarding the acceptance of the client relationship and the specific audit engagement. II. Communicate with the previous auditor, where there has been a change of auditors, in compliance with relevant ethical requirements. a. I only c. Both I and II b. II only d. Neither I nor 5. Confirmation of receivable or bank balance is performed during what phase? a. Studying and evaluating internal controls phase b. Substantive testing phase c. Pre-engagement phase d. Completing the audit phase 6. Which of the following would not be a consideration of a CPA firm in deciding whether to accept a new client? a. The client's financial ability. b. The client's relations with its previous CPA firm. c. The client's standing in the business community. d. The client's probability of achieving an unqualified opinion. 7. Management's integrity affects all of the following risks except: a. Business risk b. Audit risk c. Financial reporting risk d. All of these risks are affected 8. Prior to the acceptance of an audit engagement with a client who has terminated the services of the predecessor auditor, the CPA should a. Contact the predecessor auditor without advising the prospective client and request a complete report of the circumstances leading to the termination of the engagement with an understanding that all information disclosed will be kept confidential. b. Accept the engagement without contacting the predecessor auditor since the CPA can include audit procedures to verify the reason given by the client for the termination. c. Not communicate with the predecessor auditor because this would in effect be asking the auditor to violate the confidential relationship between an auditor and the client. d. Advise the client of the intention to contact the predecessor auditor and request a permission for the contact. 9. When an independent auditor is approached to perform an audit for the first time, he or she should make inquiries of the predecessor auditor. Inquiries are necessary because the predecessor may be able to provide the successor with information that will assist the successor in determining whether a. The company rotates auditors b. The engagement should be accepted c. The predecessor's work should be used d. In the predecessor's opinion, control risk is less than high 10. Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding: a. The predecessor's evaluation of matters of continuing accounting significance b. Disagreement which the predecessor had with the client concerning auditing procedures and accounting principles c. The degree of cooperation the predecessor received concerning the inquiry of the client's legal counsel d. The predecessor's assessment of inherent risk and judgments about materiality Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 11. If the prospective client refuses to permit the predecessor to respond or limits the predecessor's response, the successor should: a. Continue to ask the predecessor auditor questions on facts that might bear on the integrity of management b. Accept the engagement but only after an equitable increase in the professional fee c. Inquire as to the reasons and consider the implications in deciding whether to accept the engagement d. Issue a disclaimer of opinion because the limited response of the predecessor auditor constitutes a significant scope limitation 12. If permission from the client to discuss its affairs with the proposed auditor is denied by the client, the predecessor auditor should: a. Keep silent of the denial b. Disclose the fact that the permission to disclosure is denied by the client c. Disclose adequately to proposed auditor all noncompliance made by the client d. Seek legal advice before responding to the proposed auditor 13. Which of the following factors would most likely cause a CPA to decide not to accept a new audit engagement? a. The CPA's lack of understanding of the prospective client's internal auditor's computer-assisted audit techniques. b. Management's disregard of its responsibility to maintain an adequate internal control environment. c. The CPA's inability to determine whether related-party transactions were consummated on terms equivalent to arm's-length transactions. d. Management's refusal to permit the CPA to perform substantive tests before the year-end. 14. In deciding whether to accept a new audit client, an auditor considers: I. Part 1 of the Code of Ethics III. Part 3 of the Code of Ethics II. Part 2 of the Code of Ethics IV. Part 4 of the Code of Ethics a. 1& IV only b. I and III only c. II and III only d. I, III, and I 15. Ultimately, the decision about whether or not an auditor is independent must be made by a. Auditor b. Client's management c. Public d. Audit committee 16. With regard to independence, which of the following statements is correct? a. Audit engagements provide assurance to a wide range of potential users; consequently, both independence in mind and independence in appearance are of particular importance. b. Only the engagement partner is required by the Code of Ethics to be independent from their assurance clients. c. In case of audits of financial statements, the Code of Ethics requires member of the assurance team, the firm but not network firms to be independent of the client. d. In case of audits of financial statements, the Code of Ethics requires the auditor to be independent from their assurance team from the start of performing procedures required by the engagement up to the issuance of the report. 17. Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements? a. The operating effectiveness of control procedures b. The existence of related-party transactions c. The complexity of the accounting system d. The adequacy of the accounting records 18. A firm has obtained information that would have caused it to decline an engagement had the information been available earlier. Actions available to the auditor would include the following, except: a. Reporting the information and its implications to the person/s who appointed b. Withdraw from the client relationship c. Withdraw from the engagement Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 d. Issue a disclaimer of opinion 19. According to PSA 210, the auditor and the client should agree on the terms of engagement. The agreed terms would need to be recorded in a(n) a. Memo placed in the permanent section of the working papers b. Client representation letter c. Engagement letter d. Comfort letter 20. Which of the following statements is/are correct? Statement 1: The auditor and the client should agree on the terms of the engagement. Such an agreement may be in the form of audit engagement letter or other suitable form of contract Statement 2: Even in those countries where the scope of the audit is established by law, an engagement letter may be informative for the client. a. Only statement 1 is correct b. Only statement 2 is correct c. Both statements are correct d. Both statements are incorrect 21. Engagement letter that documents and confirms the auditor's acceptance of the engagement would normally be sent to the client. a. Before the commencement of the engagement b. Before the auditor report is issued c. After the audit report is issued d. At the end of the fieldwork 22. An engagement letter is best described as a. A letter from the company to the auditors specifying management's expectations for completion of the audit on a timely basis and the fees. b. A letter from the auditors to company management specifying that management is responsible for the financial statements, and the auditors will issue an opinion on the financial statements. c. A letter from the auditors to company management that specifies the responsibilities of both the company and the auditors in completing the audit and the timing for its completion. d. A letter from the Board of Directors' audit committee to the auditor that indicates the auditor has been engaged to perform the audit and the fees to be paid. 23. An engagement letter is prepared with the interest(s) of a. The auditor only b. The public c. The client only d. Both the client and the auditor 24. Engagement letters are widely used in practice for: a. Professional engagements of all types b. Assurance engagements only c. Related services only d. Audits only 25. Which of the following matters is generally included in an auditor's engagement letter? a. The factors to be considered in setting preliminary judgments about materiality b. Management's vicarious liability for illegal acts committed by its employees c. Management's responsibility for the entity's compliance with laws and regulations d. The auditor's responsibility to search for significant internal control deficiencies 26. Arrangements concerning with which of the following are least likely to be included in the engagement letter? a. Fees and billing b. A predecessor auditor c. CPA investment in client securities Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 d. Other services to be provided in addition to the audit 27. An audit engagement letter least likely include: a. A reference to the inherent limitations of an audit that there is an unavoidable risk that some material misstatements may remain undiscovered b. Description of any letters or reports that the auditor expects to submit to the client c. Identification of specific audit procedures that the auditor needs to undertake d. Basis on which fees are computed and any billing arrangements 28. When a CPA is the auditor of a parent entity and also the auditor of its subsidiary, branch or division (component), which of need not be considered in deciding whether to send a separate letter to the component? a. Who appoints the auditor of the component. b. Legal requirements c. Number of reports to be prepared during the peak audit season d. Whether a separate audit report is to be issued on the component 29. Which of the following statements is/are correct? Statement 1: On recurring audits, the auditor should consider whether circumstances require the terms of the engagement to be revised and whether there is a need to remind the client of the existing terms of engagement. Statement 2: The auditor should send a new engagement letter each year to an established client. a. Only statement 1 is correct b. Both statements are correct c. Only statement 2 is correct d. Both statements are incorrect 30. On recurring audit engagements, the auditor may decide not to send a new engagement letter each period. In which of the following situations will there be no need to send a new letter? a. Revisions or special terms of the engagement b. Significant change in nature or size of client's business c. Indications of misunderstanding of the objective and scope of the audit d. Recent change of middle management and rank and file organizational structure 31. If the auditor concludes that there is reasonable justification for the change in engagement, the report to be issued would a. Include reference to the original engagement b. Be appropriate for the revised terms of the engagement c. Include reference to any procedures that may have been performed in the original form d. Not include reference to any procedures that may have been performed, particularly when the new engagement is to undertake agreed-upon procedures 32. Which of the following statements is/are correct? Statement 1: Where the terms of the engagement are changed, the auditor and the client should agree on the new terms. Statement 2: The auditor should not agree to a change of engagement when there is no reasonable justification for doing so. Statement 3: If the auditor is unable to agree to a change of the engagement and is not permitted to continue the original engagement, the auditor should withdraw and consider whether there is any obligation, either contractual or otherwise, to report to other parties, such as the board of directors or shareholders, the circumstances necessitating the withdrawal. a. Only one statement is correct c. All statements are correct b. Only two statements are correct d. All statements are incorrect 33. If a change in the type of engagement from higher to lower of assurance is not justified, the auditor should: a. Withdraw from the engagement. b. Qualify the report on the original engagement c. Continue with the revised engagement, but make explicit about the original engagement reference d. Refuse to agree to management's request on the change of engagement and continue with the original engagement. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 34. One of the first things that the auditor will do after accepting a new client is: a. Contact the client's attorney to discover legal obligations b. Communicate with the predecessor auditor. c. Study the client's internal control structure. d. Tour the client's facilities. 35. If a company's external auditor expresses an unqualified opinion as a result of the audit of the company's financial statements, readers of the audit report can assume that a. The company is financially sound and the financial statements are accurate b. The external auditor found no fraud c. Internal control is effective d All material disagreements between the company and the auditor about the application of accounting principles were resolved in the satisfaction of the external auditor.\ CHAPTER 2 : AUDIT PLANNING INTRODUCTION AND RISK ASSESSMENT PROCEDURES PLANNING AN AUDIT OF FINANCIAL STATEMENTS The primary objective of the auditor is to plan the audit so that the audit will be performed in an effective manner. However, adequate planning also leads to an efficient and timely audit engagement. The Role and Timing of Planning Planning an audit involves establishing the overall audit strategy for the engagement and developing an audit plan. Adequate planning benefits the audit of financial statements in several ways, including the following: - Appropriate attention is devoted to important areas - Potential problems are identified and resolved on a timely basis - Proper organization and management of the audit engagement leading to an effective and efficient performance - Work are properly assigned to appropriate engagement team members - Assistance in coordinating work done by other auditors and experts - Assistance in facilitating direction, supervision and review The nature and extent of planning activities will vary according to the: (SECTA) - Size and complexity of the entity - Previous Experience with the entity of key engagement team members (partner, manager, and staff-in-charge) - Changes in circumstances that occur during the audit engagement - Timing of the Appointment of the independent auditor Planning as a phase of the audit process Planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit engagement. Major Audit Planning Activities Planning is required regardless whether it is a new engagement or recurring engagement. Planning activities may differ from one client to another client but normally includes the following: 1. Obtaining an understanding of the client and its environment 2 Determining the need for experts 3. Determining the appropriateness of management use of going concern assumption 4. Establishing materiality and assessing risks 5. Assessing the possibility of non-compliance 6 Identifying related parties 7. Performing preliminary analytical procedures 8 Development of the overall audit strategy and detailed audit plan 9. Preparation of preliminary audit programs. THE OVERALL AUDIT STRATEGY AND AUDIT PLAN Overall Audit Strategy Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan. In establishing the overall audit strategy, the auditor shall: - ldentify the characteristics of the engagement that define its scope; - Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of the communications required; - Consider the factors that, in the auditor's professional judgment, are significant in directing the engagement team's efforts - Consider the results of preliminary engagement activities and, where practicable, whether knowledge gained on other engagements performed by the engagement partner for the entity is relevant - Ascertain the nature, timing and extent of resources necessary to perform the engagement Audit Plan After the overall audit strategy has been established, an audit plan can be developed to address the various matters identified in the overall audit strategy taking into account the need to achieve the audit objectives trough the efficient use of the auditor's resources. The audit plan is more detailed than the overall audit strategy in that it includes the nature, timing and extent of audit procedures to be performed by engagement team members. These procedures may be documented in an audit program The audit program shall serve as a: - Set of instructions to assistants involved in the audit; and - Means to control and record the proper execution of the work. The audit program also contains: - The audit objectives for each area; and - A time budget in which hours are budgeted for the various audit areas or procedures Changes to Planning Decisions During the Course of the Audit The overall audit plan and the audit program should be revised as necessary during the course of the audit. Planning is continuous throughout the engagement because of changes in conditions or unexpected results of audit procedures. Completion of Overall Strategy and Audit Plan The establishment of the overall audit strategy and the detailed audit plan are not necessarily discrete or sequential processes, but are closely inter- related since changes in one may result in consequential changes to the other. Also, preferably, a plan shall be initially completed prior to consideration of internal controls or performance of specific procedures. Planning documentation The auditor shall document: - the overall audit strategy - the audit plan - any significant changes made during the audit engagement to the overall strategy or audit plan, and the reasons for such changes Additional Considerations in Initial Audit Engagements After performing preliminary engagement activities, for an initial audit, the auditor may need to expand the planning activities because he/she does not ordinarily have the previous experience with the entity that is considered when planning recurring engagements. For initial audits, additional matters the auditor may consider in developing the overall audit strategy and audit plan include the following: - Arrangements to be made with the predecessor auditor to review prior years' working papers; - Any major issues discussed with management in connection with the initial selection as auditors, the communication of these matters to those charged with governance and how these matters affect the overall audit strategy and audit plan; - The planned audit procedures to obtain sufficient appropriate audit evidence regarding opening balances; and - Other procedures required by the firm's system of quality control for initial audit engagements. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 DIRECTION, SUPERVISION AND REVIEW The auditor should plan the nature, timing and extent of direction and supervision of engagement team members and review of their work. The nature, timing and extent of the direction and supervision or engagement team members and review of their work vary depending on many factors, including the - assessed risks of material misstatement; - size and complexity of the entity; - the area of audit; and - capabilities and competence of personnel performing the audit work. Considerations Specific to Smaller Entities When an audit is carried out entirely by an audit engagement partner, who may be a sole practitioner, it may be desirable to consult with other suitably-experienced auditors or the auditor's professional body. Identifying And Assessing The Risks Of Material Misstatement Through Understanding The Entity And Its Environment It is the objective of the auditor to identify and assess risks of material misstatements, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment, including the entity's internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatements. The Required Understanding of the Entity and its Environment The auditor shall obtain an understanding of the following: a. Relevant industry, regulatory, and other external factors including the applicable financial reporting framework; b. The nature of the entity, including its operations; ownership and governance structure; types of investments that the entity is making and plans to make; and the way the entity is structured and how it is financed; C. Entity's selection and application of accounting policies, including reasons for changes thereto; d. Entity's objectives and strategies and those related business risks that may result in risk of material misstatement; e. The measurement and review of the entity's financial performance; and f. Internal control (this is covered in the next chapter) RISK ASSESSMENT PROCEDURES Risk assessment procedures are audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels. Risk Assessment Procedures and Related Activities The auditor shall: a. Identify risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls that relate to the risks, and consider the classes of transactions, account balances, and disclosures in the financial statements; b. Relate the identified risks to what can go wrong at the assertion level; c. Consider whether the risks are of a magnitude that could result in a material misstatement of the financial statements; and d. Consider the likelihood that the risks could result in a material misstatement of the financial statements. The risk assessment procedures shall include the following: a. Inquiries of management, and of others within the entity who in the auditor's judgment may have information that is likely to assist in identifying risks of material misstatement due to fraud or error; b. Analytical procedures; and c. Observation and inspection. Note: Risk assessment procedures by themselves, however, do not provide sufficient appropriate audit evidence on which to base the audit opinion. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 Analytical Procedures during Planning Stage Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. Analytical procedures also encompass the investigation of identified fluctuations and relationships that are consistent with other relevant information or that differ from expected values by a significant amount. Analytical procedure is required to be performed during planning stage and overall review stage of the audit. Analytical procedures performed during audit planning is designed to: 1. Enhance the auditor's understanding of the entity's business and transactions to help plan the nature, timing, and extent of substantive auditing procedures that will be used to gather audit evidence. 2. Identify areas that may represent specific risks (such as unusual transactions and events or abnormal/significant fluctuations in amounts, ratios, or trends) that the auditor may need to investigate further AUDIT RISK AND MATERIALITY Materiality and audit risk affect the application of PSA, and are reflected in the auditor's report. The auditor must make judgments about materiality and audit risk in determining the nature, timing and extent of procedures to apply and in evaluating the results. Materiality Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. The concept of materiality recognizes that some matters, but not all, are important for fair presentation of the financial statements in conformity with PFRS. In planning the audit, the auditor makes judgments about the size of misstatements that will be considered material. These judgments provide a basis for: a. Determining the nature, timing and extent of risk assessment procedures; b. Identifying and assessing the risks of material misstatement; and C. Determining the nature, timing and extent of further audit procedures Using professional judgment, the auditor shall determine the following materiality: 1. Financial statement level materiality the smallest aggregate amount of misstatement applicable to all financial statements. 2. Assertion level materiality materiality level for individual or particular class of transactions, account balance, or disclosure where appropriate; this is also known as tolerable misstatement 3. Performance materiality amount or amounts set by the auditor at less than materiality for the financial statements as a whole, and if applicable, at less than materiality level or levels for particular classes of transactions, account balances or disclosures Audit Risk Audit risk is the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated. CHAPTER 2: REVIEW QUESTIONS-THEORETICAL 1. Which of the following statements is incorrect? a. The auditor should plan the audit so that the engagement will be performed in an effective manner. b. Planning an audit involves establishing the overall audit strategy for the engagement and developing the audit plan, in order to reduce audit risk to an acceptably low level. c. Planning involves the engagement partner and other key members of the engagement team to benefit from their experience and insight and to enhance the effectiveness and efficiency of the planning process. d. Planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins shortly after (or in connection with) the completion of the previous audit and continues until the finalization of the audit program. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 2. Which of the following statements is/are correct? Statement 1: The client should plan the audit work so that the audit will be performed in an effective manner. Statement 2: The auditor should develop and document an overall audit plan describing the scope and conduct of the audit. a. Only statement 1 is correct c. Only statement 2 is correct b. Both statements are correct d. Both statements are incorrect 3. Adequate planning of the audit work helps the auditor of accomplishing the following objectives, except: a. Ensuring that appropriate attention is devoted to important areas the audit. b. Identifying the areas that need a service of an expert c. Gathering of all corroborating audit evidence. d. The audit work is completed efficiently. 4. The auditor should plan the audit work so that the audit will be performed in an effective manner. The extent of planning will vary according to any of the following except: a Auditor's experience with the entity and knowledge of the business. b. The nature and complexity of the audit engagement c. The assessed level of control risk d. Size of the audit client. 5. The auditors plan should Succeed action Be flexible Be cost-beneficial A Yes Yes Yes B Yes Yes No C No Yes Yes D No Yes Yes 6. Which of the following statements is/are correct? Statement 1: Obtaining knowledge of the entity business is an important part of the planning the audit work. Statement 2: The auditor's knowledge of the entity's business assists in the identification of events, transactions and practices which may have a material effect on the financial statements. a. Only statement 1 is correct b. Both statements are correct. c. Only statement 2 is correct d. Both statements are incorrect 7. Which of the following statements is/are correct? Statement 1: According to PSA 300, the auditor may discuss elements of planning with those charged with governance and the entity's management. Statement 2: The audit plan sets the scope, timing and direction of the audit guides the development of the more detailed overall audit strategy. Statement 3: The overall audit strategy is more detailed than the audit plan and includes the nature, timing and extent of audit procedures to be performed engagement team members to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level. a. Only 1 statement is correct b. All statements are correct c. Only 2 statements are correct d. All statements are incorrect 8. Which of the following helps prevent misunderstandings during audit planning? a. Auditor involvement in the preparation of the client's financial records. b. Client involvement in determining specific audit planning issues. c. A preliminary meeting conference with the client to discuss fees, timing, client assistance and related issues. d. Involvement of the client's internal auditors in setting materiality levels and determining the scope of audit tests. 9. Which of the following statements is/are correct? Statement 1: The overall audit plan and the audit program should not be revised during the course of the audit. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 Statement 2: The auditor should develop and document an audit program setting out the nature, timing and extent of planned audit procedures required to implement the overall audit plan. a. Only statement 1 is correct b. Both statements are correct c. Only statement 2 is correct d. Both statements are incorrect 10. In planning the audit engagement, the auditor should consider each of the following except a. The kind of opinion (unqualified, qualified, or adverse) that is likely to be expressed. b. Matters relating to the entity's business and the industry in which operates c. The entity's accounting policies and procedures. d. Materiality level and audit risk. 11. Which of the following matters should be considered by the auditor in developing the overall audit strategy? a. Important characteristics of the entity, its business, its financial performance and its reporting requirements including changes since the date of the prior audit b. All of the choices c. Conditions requiring special attention, such as the existence of the related parties d. The setting of materiality level for audit purposes 12. In developing the overall audit strategy, the focus of the engagement team's efforts is considered. Which of the following is not appropriately classified as a factor affecting the focus of the team's efforts? a. The financial reporting framework on which the financial information to be audited has been prepared, including any need for reconciliation to another reporting framework. b. Setting materiality for planning purposes. c. Audit areas where there is a higher risk of material misstatement. d. Volume of transactions, which may determine whether it is more efficient for the auditor to rely on internal control. 13. Which of the following is least likely considered by the CPA when he makes an overall audit plan? a. The nature and timing of reports and other communication with the entity that are expected under the engagement b. Identification of complex accounting areas including those involving accounting estimates c. The effect of information technology on the audit d. The content of the representation letters. 14. With respect to planning an audit, which of the following statements is always true? a. An inventory count must be observed at year-end. b. An engagement should not be accepted after the client's year-end. c. Final staffing decisions must be made prior to completion of the planning stage. d. It is acceptable to perform a portion of the audit of a continuing client at interim dates. 15. Which of the following procedures would an auditor most likely perform in planning an audit of financial statements? a. Inquiring of the client's legal counsel concerning pending litigation. b. Comparing the financial statements to anticipated results. c. Examining computer generated exception reports to verify the effectiveness of internal controls. d. Searching for unauthorized transactions that may aid in detecting unrecorded liabilities. 16. This serves as the set of instructions to assistants involved in the audit and as a means to control and record the proper execution of the work of the personnel involved in the service. a. Audit procedures b. Audit program c. Audit plan d. Audit risk model 17. The auditor should design the written audit program, so that: Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 a. All material transactions will be selected for substantive testing. b. Substantive tests prior to the balance sheet date will be minimized. c. The audit procedures selected will achieve specific audit objectives. d. Each account balance will be tested under either tests of controls or tests of transactions. 18. In designing audit programs, an auditor should establish specific audit objectives that related primarily to the. a. Selected audit techniques b. Financial statement assertions c. Timing of audit procedures. d. Cost-benefit gathering evidence 19. The auditor should document the overall audit strategy and the audit plan, including significant changes made during the audit engagement. Which of the following statements on documentation is incorrect? a. Documentation of the overall audit strategy may be made in the form of a memorandum that contains key decisions regarding the overall scope, timing and conduct of the audit. b. The auditor may use standard audit programs or audit completion checklists, but such programs and checklists need to be tailored to the particular client. c. The auditor's documentation of any significant changes to the originally planned overall audit strategy and to the detailed audit plan need not include the reasons for the significant changes. d. The form and extent of documentation depend on such matters as the size and complexity of the entity, materiality, the extent of other documentation, and the circumstances of the specific engagement. 20. Audit procedures may be classified as risk assessment procedures and further audit procedures. Which of the following best describes risk assessment procedures? a. These procedures are used detect material misstatements at the assertion level. b. These procedures include tests of details of classes of transactions, account balances, and disclosures and analytical procedures. c. These procedures test the operating effectiveness of controls in preventing detecting and correcting, material misstatements at the assertion level. d. These are procedures for obtaining an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement at the financial statement and assertion levels. 21. The audit program should contain the following, except: a. Audit objective b. Set of planned audit procedures c. Time budget for the various audit areas d. The combined assessed level of inherent and control risk 22. Which of the following procedures is not performed as a part of planning an audit engagement? a. Reviewing working papers of the prior year. c. Designing an audit program b. Performing analytical procedures d. Test of controls 23. Cost-benefit considerations are part of audit planning. In relation to this, which of the following audit procedures is usually the least costly to perform? a. Tests of balances b. Analytical procedures c. Tests of transactions d. Tests of controls 24. Analytical procedures are required: ï‚· ï‚· ï‚· As a risk assessment procedure performed during planning As a substantive test procedure during evidence gathering As an overall review at audit completion A Yes Yes No B Yes Yes Yes 25. Analytical procedures used in planning an audit should focus on a. Reducing the scope of tests of controls and substantive tests Downloaded by Larence Nova (larence.nova@yahoo.com) C Yes No No D Yes No Yes lOMoARcPSD|12208216 b. Providing assurance that potential misstatements will be identified. c. Enhancing the auditor's understanding of the client's business. d. Assuming the adequacy of the available evidential matter. 26. Which of the following procedures would an auditor least likely perform planning a financial statement audit? a. Coordinating the assistance of personnel in data preparation. b. Discussing matters that may affect the audit with firm personnel responsible for non-audit services to the entity. c. Selecting a sample of vendor's invoices for comparison to receiving report d. Reading the current year's interim financial statements. 27. Audit risk has three components: inherent risk, control risk and detection risk. Which of the following statements is correct? a. Detection risk is a function of the efficiency of an audit procedure. b. Cash is more susceptible to theft than an inventory of coal because it has a greater inherent risk. c. The risk that material misstatement will not prevent or detected on a timely basis by internal control can be reduced to a zero by effective controls. d. The existing levels of inherent risk, control risk and detection risk can be changed at the discretion of the auditor. 28. Some accounts balances, such as those for retirement benefits and finance lease, are the results of complex calculations. The susceptibility to material misstatements in these types of accounts is referred to as a. Audit risk b. Control risk c. Detection risk d. Inherent risk 29. Inherent risk and control risk differ from detection risk in that inherent risk and control risk area are: a. Elements of audit risk while detection risk is not. b. Changes at the auditor's discretion while detection risk is not. c. Functions of the client and its environment while detection risk is not d. Considered at the individual account balance level while detection risk is not. 30. Which of the following statements is not correct about materiality? a. The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important. b. An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements. c. Materiality judgments are made in light of surrounding circumstanced and necessarily involve both quantitative and qualitative judgments. d. An auditor's consideration of materiality is influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements. 31. There is an inverse relationship that exist between the acceptable level of detection risk and the a. Risk of failing to discover material misstatement b. Preliminary judgments about materiality levels c. Assurance provided by substantive tests d. Risk of misapplying audit process 32. In considering materiality for planning purposes, Ash, auditor believes that misstatements aggregating P60, 000 would have material effect on an entity's income statement, but that misstatements would have to aggregate P40, 000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design auditing procedures that would be expected to detect misstatements that aggregate: a. P40, 000 b. P50, 000 c. P60, 000 d. P100, 000 Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 33. Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality? a. The anticipated sample size of the planned substantive tests. b. The entity's annualized interim financial statements. c. The results of the internal control questionnaire d. The contents of the management representation letter. 34. Which of the statements is/are correct? Statement 1: Planning involves developing an overall strategy for the expected and scope of the audit. Statement 2: involves directing the efforts of assistants who are involved in accomplishing the objectives of the audit and determining whether those objectives were accomplished. a. Only statement 1 is correct b. Both statements are correct c. Only statement 2 is correct d. Both statements are incorrect 35. In performing an audit of financial statements, the auditor should obtain a sufficient knowledge of a client's business and industry to a. Develop an attitude of professional skepticism concerning management's financial statement assertions. b. Make constructive suggestions concerning improvements to the client's internal control. c. Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated. d. Understand the events and transactions that may have an effect on the client's financial statements CHAPTER 3: REVIEW QUESTIONS-THEORETICAL 1. It is the process designed and effected by those charged with governance, management, and other personnel to provide reasonable assurance about the achievement of the entity's objectives. a. Internal auditing b. Business strategy c. Internal control d. Accounting process. 2 Internal controls are not designed to provide reasonable assurance that a. The recorded accountability for assets is compared with the existing assets at reasonable intervals b. Access to assets is permitted only in accordance with management's authorization c. Transactions are authorization executed in accordance with management's d. Irregularities will be eliminated 3. This is a basic concept of internal control which recognizes that the cost of internal control should not exceed the benefits expected to be derived from it: a. Management by exception. b. Limited liability c. Management responsibility d. Reasonable assurance 4. An internal control system that is working effectively a. Eliminates risk and potential loss of to the entity b. Cannot be circumvented by management c. Reduces the need for management the review exception reports on a day-to-day basis d. Is unaffected by changing circumstances and conditions encountered by the entity 5. Which of the following is an example of an inherent limitation in a client's internal control system? a. The effectiveness of procedures depends on the segregation of employee duties. b. Procedures are designed to assure the execution and recording of transactions in accordance with management's authorization. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 c. In the performance of most control procedures, there are possibilities of errors arising from mistakes in judgment. d. Procedures for handling large numbers of transactions are processed by information technology (IT) equipment. 6. Which of the following statements best describes "control environment? a. Policies and procedures that help ensure that management directives are carried out. b. The system for transferring information from transaction processing systems to the general ledger or the financial reporting system. c. 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. d. This includes the governance and management functions and the attitudes, awareness, and actions of those charged with governance and management concerning the entity's internal control and its importance to the entity. 7. Which of the following considered control environment elements? Commitment to Competence Detection Risk a. Yes No b. Yes Yes c. No No d. No No Organizational Structure Yes Yes No Yes 8. An entity's risk assessment process includes how management: ï‚· ï‚· ï‚· A Identifies risk Yes Assess significance and likelihood of occurrence of these identified risks Decides upon actions to manage these risks Yes B Yes Yes No C No Yes Yes D Yes Yes No No 9. Risks can arise or change due to circumstances such as the following except: a. There is a change in the regulatory or operating environment (.e. a new law has been passed which prohibits the use of a chemical which is a main ingredient of the company's major product). b. New employees have been hired by the company. c. The company switched from manual information systems to a computerized system. d. The accounting and financial reporting framework has remained stable for the past five years, and no new pronouncements have been made. 10. As part of a periodic planning exercise, Cedric Naranjo Company discovers that a political dispute may interfere with the company's supply sources. This is an example of: a. Control environment b. Risk assessment c. Control activities d. Monitoring of controls 11. Control activities constitute one of the five components of internal control. Which of the following is not included in this internal control component? a. Segregation of duties c. An internal audit function b. Performance reviews d. Authorization 12. Control activities are the policies and procedures that help ensure that management directives are carried out. These include activities relating authorization, performance reviews, information processing, physical controls and segregation of duties. There is proper segregation of duties when an individual who a. Authorizes a transaction records it. b. Maintains custody of an asset has access to the accounting records for the asset c. Authorizes transaction maintains custody of the asset that resulted from the transaction. d. Records a transaction do not compare the accounting record of the asset with the asset itself. 13. Under PSA 315, monitoring of controls is an internal control component that involves a process of assessing the quality of internal control performance over time. It involves assessing the design and operation of controls on a timely Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 basis and taking necessary corrective actions. Monitoring of controls is accomplished through ongoing monitoring activities, separate evaluations, or a combination of the two. An entity's ongoing monitoring activities often include a. Periodic reporting by the entity's internal auditors about the functioning of internal control b. The audit of the annual financial statements c. Periodic audits by the audit committee d. Reviewing the purchasing account 14. The primary purpose of the auditor's consideration of internal control is to provide a basis for a. Determining whether procedures and records that are concerned with the safeguarding of assets are reliable. b. Constructive suggestions to clients concerning deficiencies in internal control. c. Determining the nature, timing and extent of audit tests to be applied d. The expression of an opinion. 15. Which of the following statements concerning the relevance of various types of controls to a financial statement audit is correct? a. All controls are ordinarily relevant to a financial statement audit. b. Controls over the reliability of assets and liabilities are of primary importance, while controls over the reliability of financial reporting may also be relevant. c. Controls over the reliability of financial reporting are ordinarily most directly relevant to a financial statement audit, but other controls may also be relevant. d. An auditor may ordinarily ignore a consideration of controls when a substantive audit approach is taken. 16. PSA 315 Redrafted requires the auditor to obtain an understanding of the client's internal controls a. For every audit b. For first-time audits c. Whenever it would be appropriate d. Sufficient to find any frauds which may exist 17. When obtaining knowledge about an entity's internal control, it is important for the auditor to of its employees because their competence bears directly and importantly upon the a. Cost-benefit relationship of internal control b. Comparison of recorded accountability with assets c. Achievement of the objectives of internal control d. Timing of substantive tests to be performed 18. Obtaining an understanding of internal control involves: A B C ï‚· Evaluating the design of a control Yes Yes Yes ï‚· Determining whether the control has been implemented Yes Yes No ï‚· Testing the effectiveness of a control Yes No Yes consider the competence D No Yes Yes 19. The primary objective of procedures performed to obtain an understanding of internal control is to provide an auditor with a. Information necessary to prepare flowcharts. b. Evidence to use in reducing detection risk. c. Knowledge necessary to plan the audit. d. A basis for modifying test of controls. 20. To obtain an understanding of the relevant policies and procedures of internal control, the auditor performs all of the following except: a. Make inquiries b. Make observations c. Design substantive tests d. Inspect documents and records 21. After obtaining an understanding of an entity's internal control, an auditor may assess control risk at the maximum level for some assertions because the auditor a. Believes the internal control policies and procedures are unlikely to be effective. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 b. Determines that the pertinent internal control components are not well documented. c. Performs tests of controls to restrict detection risk to an acceptable level. d. Identifies internal control policies and procedures that are likely to prevent material misstatements. 22. After obtaining an understanding of internal control and assessing control risk, an auditor decided to perform tests of controls. The auditor most likely decided that a. Additional evidence to support a further reduction in control risk is not available. b. It would be efficient to perform tests of controls that would result in a reduction in planned substantive tests. c. An increase in the assessed level of control risk is justified for certain financial statement assertions, d. There were many internal control weaknesses that could allow errors to enter the accounting system. 23. Information about segregation of duties ordinarily is best obtained by a. Performing test of transactions that corroborate management's financial statements assertions. b. Developing audit objectives that reduce control risk. c. Observing employees as they apply specific controls. d. Obtaining a flowchart of activities performed by entity personnel. 24. In conducting an audit in accordance with PSAs, the auditor is required to identify and assess the risks of material misstatement at the financial statements level, and at the assertion level for classes of transactions, account balances, and disclosure. Some of these risks, in the auditor's judgment, require special audit consideration, such as those that involve fraud or complex transactions. Such risks are called a. Business risks c. Audit risks b. Significant risks d. Material risks 25. The auditor's primary objective in obtaining an understanding of the client's control over the purchasing function is to a. Investigate the recording of unusual transactions regarding raw materials. b. Determine the reliability of financial reporting by the purchasing function. c. Observe the annual physical count. d. Ascertain that raw material paid for are on hand. 26. When obtaining an understanding of an entity's internal control, an auditor should concentrate on the substance of controls rather than their form because: a. The controls may be operating effectively but may not be documented. b. Management may establish appropriate controls but not act on them. c. The controls may be so inappropriate that no reliance is contemplated by the auditor. d. Management may implement controls with costs in excess of benefits. 27. When obtaining an understanding of the accounting and internal the accounting control system the auditor may trace a few transactions through the accounting system. This technique is: a. Reperformance b. Control test c. Walk-through d. Validity test 28. Control risk assessment procedures include all of the following, except a. Inspection of documents b. Confirmation of bank balances c. Observation of procedures d. Inquiry of client personnel 29. Evidence of the performance of control risk assessment procedures includes all of the following, except: a. Flowcharts b. Questionnaires c. Lead schedule d. Memoranda 30. Which of the following statements regarding auditor documentation of the client's internal control structure is correct? a. Documentation must include flowcharts. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 b. Documentation must include procedural write-ups. c. No documentation is necessary although it is desirable. d. No one particular form of documentation is necessary, and the extent of documentation may vary. 31. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that: a. Specified controls requiring segregation of duties may be circumvented by collusion. b. Tests of controls may fail to identify controls relevant to assertions. c. Material misstatement may exist in the financial statements. d. Entity policies may be circumvented by senior management. 32. An auditor may decide to assess control risk at the maximum level certain assertions because the auditor believes a. Evaluating the effectiveness of policies and procedures is inefficient. b. Sufficient evidential matter to support the assertions is likely to be available. c. More emphasis on tests of controls than substantive tests is warranted. d. Considering the relationship of assertions to specific account balances is more efficient. 33. An auditor's flowchart of a client's accounting system is a diagrammatic representation that depicts the auditor's a. Assessment of control environment's effectiveness b. Identification of weaknesses in the system c. Understanding of the system d. Assessment of control risk 34. Which of the following statements is true? a. Tests of controls are necessary if the auditor plans to use the primarily substantive approach. b. Tests of controls are necessary if the auditor plans to assess the level of control risk at maximum. c. The auditor can simultaneously obtain an understanding of internal control and perform tests of controls. d. After performing tests of controls, the auditor will always assess control risk at maximum. 35. After documenting internal control in an audit engagement, the auditor may perform tests on: a. Those controls that the auditor plans to rely on. b. Those controls that were reviewed (selected on a random basis). c. Those controls in which deficiencies or weaknesses were identified. d. Those controls that have a material effect on the balances in the 36. In a financial statement audit, the auditor is required to perform test of controls when I. The auditor's risk assessment includes expectation of the operating effectiveness of controls. II. When substantive procedures alone do not provide sufficient appropriate audit evidence at the assertion level. a. I only. b. Either I or II c. II only d. Neither I nor II 37. Tests of controls are used to test whether controls are: a. Properly incorporated in the financial statements b. Placed in operation or implemented c. Properly documented by the client d. Operating effectively 38. Tests of controls may include the following, except: a. Reperformance of internal control procedures b. Inquiries about, and observation of, internal controls which leave no audit trail c. Inspection of documentary support to transactions evidencing authorization d. Analytical procedures involving comparison of operating expenses budget amount 39. An auditor intends to perform test of controls on a client’s control procedures that leaves no audit trail of documentary evidence. The auditor most likely will test the procedure by a. Inquiry and inspection Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 b. Inquiry and observation c. Confirmation and reperformance d. Analytical procedures and confirmation 40. Which of the following is the auditor's purpose of further testing internal control procedures? a. Provide a basis for reducing the assessed level of control risk below that which resulted from the auditor's initial understanding of internal control. b. Reduce the risk that errors or fraud which are not prevented or reduce detected by internal control are not detected by the independent audit c. Provide assurance that transactions are executed in accordance with management's authorization and access to assets is limited by a proper segregation of functions. d. Provide assurance that transactions are recorded as necessary to permit the preparation of the financial statements in accordance with PERS 41. Which of the following is not a characteristic of the lower control risk approach? a. The auditor usually plans to place considerable reliance on the controls. b. The auditor plans to perform extensive tests of controls. c. Control risk is usually assessed at maximum level. d. Substantive tests are usually restricted. 42. A control that reduces the risk that an existing or potential control weakness will result in a failure to meet a control objective is referred to as a. Compensating control b. Non-routine control c. Conditional control d. Offset control 43. When a compensating control exists, a weakness in the system: a. Is no longer a concern because the potential for misstatement has been sufficiently reduced. b. Is reduced but it is not removed; therefore, it is still of concern to the auditor. c. Could cause a material loss, so it must be tested using substantive procedures. d. Is magnified and must be removed from the sampling process and examined in its entity. 44. If no changes have occurred since the controls were last tested, a CPA should a. Rely on the prior year audit's assessment of internal controls and use this assessment in the current year. b. Test the operating effectiveness of such controls at least once in every fourth audit c. Rely entirely on the performance of substantive audit procedures. d. Test the operating effectiveness of such controls at least once in every third audit 45. Regardless of the assessed level of control risk, an auditor would perform some a. Test of controls to determine the operating effectiveness of internal control policies b. Analytical procedures to verify the design of internal control procedures c. Substantive test to restrict detection risk for significant classes of transactions d. Dual-purpose test to evaluate both the risk of monetary misstatement and preliminary control risk CHAPTER 4: REVIEW QUESTIONS-THEORETICAL Problem 4-1: Introduction 1. The transaction cycles approach leads to efficient processing of large number of transactions because a. Transaction cycles are easy to understand. b. Transaction cycles are easier to computerize. c. The transaction cycle approach represents natural order of the business. d. A large number of transactions within a given cycle can be categorized into a relatively small number of distinct types. 2. What is the major difference between the revenue and the expenditure cycle? a. The revenue cycle includes marketing activities; the expenditure cycle does not. b. In the revenue cycle, cash is received; in the expenditure cycle cash paid out. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 c. The expenditure cycle includes paying employees. d. The revenue cycle includes the activity of obtaining funds from investors. 3. The business owners obtain financing from outside investors, which result to an inflow of cash into the company. This transaction is considered to be part of which cycle? a. Revenue cycle c. Production cycle b. Payroll cycle d. Financing cycle 4. The basic "give and take functions of a business have been grouped into transaction cycles. The cycle that includes the events of hiring employees and paying them is known as the a. Human resources cycle c. Expenditure cycle b. Financing cycle d. Revenue cycle 5. The transaction cycles relate to one another and interface with this to generate information for both management and external parties. a. General ledger and reporting system c. Human resources cycle b. Accounting information systems d. Computer processor Problem 4-2: Revenue and Receipt Cycle/Order to Cash (OTC) 1. Which of the following business function is associated with the revenue/receipt cycle? a. Resources are held, used or transformed. b. Obligations are paid to vendors and employees. c. Capital funds are received from investors and creditors. d. Resources are distributed to outsiders in exchange for promises of future payments. 2. Which of the following is not normally considered a step in the credit sales functions? a. Approving credit b. Accepting customer orders c. Shipping the sales orders d. Acquiring goods to fill the order 3. Which of the following is not typically included in the sales and collection cycle? a. Bad debt expense. b. Sales returns and allowances. c. Allowance for uncollectible accounts. d. Cash credits from the cash disbursement journal. 4. The overall objective in the audit of the sales and collection cycle is to evaluate whether a. The sales account and the accounts receivable account are free of errors. b. The sales account and the accounts receivable are free of material errors c. The account balances affected by the cycle are fairly presented in accordance with GAAP. d. The sales account and the accounts receivable account are presented fairly in accordance with GAAP. 5. The internal controls surrounding the revenue cycle provide the organization with several assurances that include all of the following except the a. Approval of all credit sales transactions after they are processed. b. Accurate recording, shipping, and billing of all valid sales transactions. c. Proper authorization of all sales and sales return and allowance transactions. d. Proper safeguarding of finished goods inventories while in stock and during the shipment process. 6. The internal control objectives of the revenue cycle include all of the following except a. Revenue cycle transactions are properly executed. b. Transactions relating to revenue are properly recorded. c. Appropriate goods are ordered so that sales can be made. d. Custody over assets resulting from the revenue cycle is properly maintained Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 7. Which of the following control procedures would most likely assure that access to shipping, billing, inventory control, and accounting records is restricted to personnel authorized by management? a. Segregate responsibilities for authorization, execution and recording and prenumber and control custody of documents b. Establish cash receipts function in a centralized location and require daily reconciliation of cash receipts records with deposit slips. c. Establish policy and procedures manuals, organization charts, and supporting documentation d. Periodically substantiate and evaluate recorded account balances. 8. Before goods are shipped on account, a properly authorized person must a. Approve credit b. Prepare the sales invoice c. Approve the journal entry d. Verify that the unit price is accurate 9. In a credit merchandising organization, the best place to vest credit approval is in: a. Accounts receivable department. b. Sales department. c. A completely separate department. d. The cashier area where receipts will eventually be sent. 10. To achieve good internal control, which department should perform the activities of matching shipping documents with sales orders and preparing daily summaries? a. Billing department c. Credit department b. Shipping department. d. Sales order department 11. Which of the following control procedures may prevent the failure to bill customers for some shipments? a. Each shipment should be supported by a pre-numbered sales invoice that is accounted for. b. Each sales order should be approved by authorized personnel. c. Sales journal entries should be reconciled to daily sales summaries. d. Each sales invoice should be supported by a shipping document. 12. Which of the following control procedures could prevent or detect errors or frauds arising from shipments made to unauthorized parties? a. Document policies and procedures for scheduling shipments. b. Establish procedures for reviewing and approving prices and sales terms before sale. c. Prenumber bills of lading and assure that related billings are made on a periodic basis. d. Prepare and periodically update lists of authorized customers. 13. Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense t high bad debt write-offs? a. Employees responsible for authorizing bad debt write-offs are denied access to cash. b. Employees involved in the credit granting are separated from sales function c. Shipping documents and sales invoices are matched by an employee who does not have authority to write-off bad debts. d. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit 14. The use of pre-numbered invoices, then accounting for their numeric sequence, meets primarily the a. Completeness assertion b. Rights and obligations assertion c. Valuation or allocation assertion d. Existence or occurrence assertion 15. Which of the following controls most likely would assure that all billed sales are correctly posted to the account's receivable ledger? a. Each shipment on credit is supported a prenumbered sales invoice. b. Each sales invoice is supported by prenumbered shipping document Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 c. Daily sales summaries are compared to daily postings to the accounts receivable ledger. d. The accounts receivable ledger is reconciled daily to the control account in the general ledger. 16. To achieve control when there is no billing department, the billing function should be performed by the a. Accounting department b. Shipping department c. Sales department d. Credit and collection department 17. The person who opens the mail commonly prepares a remittance advice when a customer fails to return one with a payment. Consequently, mail should be opened by the a. Credit manager b. Sales manager c. Receptionist d. Accounts receivable clerk 18. Which of the following is an effective internal control over accounts receivable? a. Balances in the subsidiary accounts receivable ledger should be c reconciled to the general ledger control account once a year, preferably at year-end. b. Responsibility for approval of the write-off of uncollectible accounts receivable should be assigned to the cashier. c. The billing function should be assigned to persons other than those responsible for maintaining accounts receivable subsidiary records. d. Only persons who handle cash receipts should be responsible for the preparation of documents that reduce accounts receivable balances. 19. Which of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mail room? a. The cashier endorses the checks. b. The cashier prepares the daily deposit. c. The cashier makes the daily deposit at a local bank d. The cashier posts the receipts to the accounts receivable subsidiary ledger. 20. Which of the following would best protect a company that wishes to prevent lapping? a. Having customers send payments directly to the company's bank b. Segregating duties so that accounting has no access to an incoming mail c. Requesting that customers checks be made payable to the company and be addressed to the treasurer d. Segregating duties so that no employee has access both to checks from customers and to currency from daily cash receipts 21. Which of the following is not a universal rule for achieving control over cash? a. Separate the cash-handling and record-keeping functions. b. Decentralize the receiving of cash as much as possible. c. Deposit each day's cash receipts by the end of the day. d. Have bank reconciliation's performed by employees who do not handle cash. 22. Which of the following fraudulent activities most likely could be perpetrated due to lack of effective control in the revenue cycle? a. The failure to prepare shipping documents may cause an overstatement of inventory balances b. Authorization of credit memos by personnel who receives cash may permit the misappropriation of cash. c. Fictitious transactions may be recorded that may cause an understatement of revenues and overstatement of receivables. d. Claims received from customers for goods returned may be intentionally recorded in other customer's accounts. 23. Assuming cash receipts from credit sales have been misappropriated, which of the following is likely to conceal the misappropriation and unlikely to be detected? a. Understating the sales journal b. Overstating the accounts receivable control account Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 c. Overstating the accounts receivable subsidiary ledger d. Overstating the cash receipts journal 24. Which of the following control procedures will likely prevent the concealment of a cash shortage that was perpetrated by improperly writing off a trade accounts receivable? a. Write-offs must be approved by the cashier. b. Write-offs must be authorized by the field sales representatives. c. Write-offs must be supported by an aging schedule showing that only receivables months overdue have been written off. d. Write-offs must be approved by a responsible officer after reviewing credit department recommendations and supporting evidence. 25. During the review of a small owner-managed company's internal controls the auditor discovers that the accounts receivable clerk approves credit memos and has access to cash. Which of the following controls would offer this deficiency? a. The owner reviews errors in billings to customers and postings to subsidiary records. b. The owner reviews credit memos after they are recorded. c. The controller reconciles the detailed receivables records to the general ledger. d. The controller reviews the monthly bank statement directly and reconciles the checking accounts. 26. Defective merchandise returned by customers should be presented to a. Inventory control personnel b. Receiving personnel c. Purchasing personnel d. Sales personnel 27. Sales invoices may be recorded in the incorrect accounting period. A computer comparison of the invoice date with the accounting period when the goods were shipped relates to the a. Valuation or allocation assertion. b. Completeness assertion c. Existence or occurrence assertion. d. Existence or occurrence assertion and to the completeness assertion 28. The purpose of tests of controls over shipping is to determine whether a. Shipments are billed b. Billed goods have been shipped c. Credit is approved before goods are shipped d. Shipping department personnel are competent 29. The purpose of tests of controls over billing is to determine whether a. Shipments are billed b. Billed goods have been shipped c. Credit is approved before goods are billed d. Billing department personnel are competent 30. To determine whether internal control operates effectively to minimize errors of failure to invoice a shipment, the auditor would select a sample of transactions from the population represented by the a. Sales invoice b. Bill of lading file. c. Customer order file d. Subsidiary customer accounts ledger 31. Tracing copies of sales invoice to shipping documents provides evidence that a. Shipments were billed b. Billed sales were shipped c. Shipments were recorded as receivables d. Debits to accounts receivable were for sales shipped Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 32. Tracing shipping documents to sales invoices provides evidence that a. Shipments were recorded as sales b. Recorded sales were shipped c. Invoiced sales were shipped d. Shipments were billed 33. To test for recorded sales for which there were no actual shipments, the auditor traces from the a. Bill of lading to the sales journal b. Sales journal to the bill of lading c. Sales journal to the accounts receivable subsidiary ledger d. Bill of lading to the supporting customer order and sales order 34. To test for the possibility of a shipment to a fictitious customer, the auditor traces from the a. Sales journal to the accounts receivable ledger b. Accounts receivable ledger to the bill of lading c. Credit authorization to the bill of lading d. Bill of lading to the credit authorization 35. From the standpoint of good internal control, the credit manager should be responsible to the a. Treasurer b. Sales manager c. Controller d. Customer-service manager Problem 4-3: Expenditure and Disbursement Cycle 1. Which of the following functions is not common to the expenditure/disbursement cycle? a. Obligations to vendors are paid. b. Resources are held, used or transformed c. Resources are acquired from vendors in exchange for obligations to pay. d. Resources are acquired from employees in exchange for obligations to pay. 2. The primary audit objective regarding the purchasing of materials by the client is to a. Observe the annual physical count. b. Ascertain that materials paid for are on hand. c. Investigate the recording of unusual transactions regarding materials. d. Determine the reliability of financial reporting by the purchasing function. 3. A request by an authorized employee for goods or services is made on the a. Debit memo b. Purchase requisition c. Purchase order d. Acquisition transaction file 4 Which of the following is a primary function of the purchasing department? a. Authorizing the of goods b. Reducing expenditures for goods acquired c. Verifying the propriety of goods of a specified quality d. Ensuring the acquisition of goods of a specified quality 5. If internal control is well-designed, employees in the same department most likely would approve purchase orders and also a. Inspect goods upon receipt b. Negotiate terms with vendors c. Authorize requisition of goods d. Reconcile the open invoice file Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 6. The authority to accept incoming goods in receiving should be based on a(n) a. Bill of lading b. Materials requisitions c. Vendor's invoice d. Approved purchase order 7. Internal control is improved when the quantity of merchandise ordered is omitted from the copy of the purchase order sent to the a. Department that initiated the requisition b. Accounts payable department i c. Receiving department d. Purchasing agent 8. When goods are received, the receiving clerk should match the goods with the a. Purchase order and requisition b. Vendor's invoice and the receiving report c. Vendor's shipping document and the purchase order d. Receiving report and the vendor's shipping documents 9 The accounts payable department receives a purchase order form to accomplish all of the following, except a. Comparing invoice price to purchase order price b. Comparing quantity ordered to quantity purchased c. Ensuring that the purchase had been properly authorized d. Ensuring that the goods had been received by the party requesting the goods 10. Matching the suppliers' invoice, the purchase order, and the receiving report normally should be the responsibility of the a. Treasury function b. Receiving department. c. Accounting function. d. Purchasing department 11. Accounts payable department usually has responsibility for verifying the propriety of acquisitions by comparing the details on the a. Vendor's invoice and the receiving report b. Vendor's invoice and the purchase requisition c. Purchase order, receiving report, and vendor's invoice d. Purchase requisition, purchase order, and receiving report 12. What is the reason for ensuring that every copy of a vendor's invoice has a receiving report? a. To ascertain that merchandise billed by the vendor was received by the company b. To ascertain that merchandise received by the company was billed by the vendor c. To ascertain that a check was prepared for every invoice d. To ascertain that the invoice was correctly prepared 13. Which of the following is the most effective control procedure to detect vouchers that were prepared for the payment of goods that were not received? a. Match the purchase order, receiving report and vendor's invoice for each voucher in accounts payable department b. Compare goods received with goods requisitioned in receiving department c. Verify vouchers for accuracy and approval in internal audit department d. Count goods upon receipt in the storeroom 14. Which of the following controls is not usually performed in the vouchers payable department? a. Approving vouchers for payment by having an authorized employee sign the vouchers b. Accounting for unused prenumbered purchase orders and receiving reports c. Matching the vendor's invoice with the related receiving report d. Indicating the asset and expense accounts to be debited Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 15. Which of the following controls is not usually performed in the treasurer's department? a. Verifying the accuracy of checks and vouchers b. Controlling the mailing of checks to vendors c. Approving vendor's invoices for payment d. Cancelling payment vouchers when paid 16. When processing and recording cash disbursements, it is important to have a method of cancelling the supporting documents to prevent their reuse at support for another check at a later time. A common method is to a. Transfer the possession of the documents to a bank vault such as a safety deposit box b. Move the documents to a permanent off-site facility warehouse. c. Write the check number on the supporting documents d. Shred the documents so that they can't be reused 17. For good internal control, the person who should sign checks is the a. Person preparing the checks b. Purchasing agent c. Accounts payable clerk. d. Treasurer 18. Operating control of the check-signing machine normally should be the responsibility of the a. General accounting b. Treasury function c. Internal audit function d. Legal counsel 19. The mailing of disbursement checks and remittance advices should be controlled by the employee who a. Signed the checks last b. Approved the vouchers for payment c. Matched the receiving reports, purchase orders, and vendor invoices d. Verified the mathematical accuracy of the vouchers and remittance advices 20. The procedure that would discourage the resubmission of vendor invoices after they have been paid is a. A requirement for double endorsement of checks. b. The cancellation of vouchers by accounting personnel. c. The cancellation of vouchers by treasurer personnel. d. The mailing of payments directly to payees by accounting personnel. 21. Which of the following is a standard control over cash disbursements? a. Checks should be signed by the controller and at least one other employee of the company. b. Checks should be sequentially numbered and the numerical sequence should be accounted for by the person preparing bank reconciliations c. Checks and supporting documents should be marked "paid" immediately after the check returned with the bank statement. d. Checks should be sent directly to the payee by the employee who prepares documents that authorize check preparation. 22. Which of the following would prevent a paid disbursement from being paid a second time? a. Individuals responsible for signing checks should prepare vouchers. b. The official signing the check should cancel the supporting documents. c. Disbursements should be approved by at least two responsible officials. d. The disbursement date should be within a few days of the date the voucher is presented for payment. 23. The receipt of goods and services in the normal course of business represents the date clients normally recognize a. Liability b. Warranty c. Income d. Expenses Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 24. The internal control objective to determine that existing acquisition transactions are recorded" satisfies the objective of a. Validity: b. Authorization c. Valuation d. Completeness 25. The internal control which requires "examination of supporting documentation before signing of checks by an authorized person satisfies the objective of a. Validity b. Valuation and allocation c. Completeness d. Posting and summarization 26. Which of these functions is not a test of acquisitions? a. Recognizing the liability b. Receiving goods and services c. Processing purchase orders d. Processing cash disbursements 27. How can an auditor test to determine whether Receiving Department procedures are applied properly? a. Review procedures manuals b. Test a sample of receiving documents c. Interview Receiving department personnel d. Observe receiving procedures on a surprise basis 28. An auditor performs a test to determine whether all merchandise for which of the client was billed was received. The population for this test consists all a. Merchandise received b. Cancelled checks c. Vendor's invoices d. Receiving reports 29. In assessing control risk for purchases, an auditor vouches a sample t entries in the voucher register to the supporting documents. What assertion would this test of controls most likely support? a. Completeness b. Existence or occurrence c. Valuation or allocation d. Rights and obligations 30. An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursement journal. The purpose of this substantive audit procedure most likely was to a. Identify unusually large purchases that should be investigated further. b. Verify that the cash disbursements were for goods actually received c. Test whether payments were for goods actually ordered. d. Determine that purchases were properly recorded. Problem 4-4: Human resources and payroll. 1. Which of the following departments most likely would approve changes in pay rates and deductions from employee salaries? a. Payroll c. Controller b. Treasurer d. Personnel 2. For appropriate segregation of duties, journalizing and posting payroll transactions should be assigned to a. Payroll accounting c. General accounting b. Treasury department d. Timekeeping department 3. Which of the following is not a common activity within personnel and payroll? Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 a. Initiating terminations b. Preparing and recording payroll c. Distributing paychecks to employees. d. Preparing and updating personnel records 4. Which of the following best describes proper internal control over payroll a. The preparation of the payroll must be under the control of the personnel department. b. The confidentiality of employee payroll data should be carefully protected to prevent fraud. c. The duties of hiring, payroll computation, and payment to employees should be segregated d. The payment of cash checks to employees should be replaced with payment by checks 5. The proper use of pre-numbered termination notice forms by the payroll department should provide assurance that all a. Personnel files are kept up to date. b. Terminated employees are removed from the payroll. c. Employees who have not been terminated receive their payroll checks. d. Uncashed payroll checks were issued to employees who have not been terminated. 6. The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the a. Human resources function from the controllership function b. Administrative controls from the internal accounting controls c Authorization of transactions from the custody of related assets d. Operational responsibility from the record keeping responsibility 7. Which of the following procedures is most likely to ensure that employee job time tickets are accurate? a. Check the employee check cards against the job time tickets. b. Approve the payroll voucher in the accounts payable department. c. Keep employment information in the human resources department. d. Make sure that the number of hours per week on each employee's job time ticket is 49. 8. To minimize the opportunities for fraud, unclaimed cash payroll should be a. Held by the controller b. Held by the payroll custodian c. Deposited in a safe deposit box d. Deposited in a special bank account 9. In the weekly computer run to prepare payroll checks, a check was printed for an employee who had been terminated the previous week. Which of the following control procedures, if properly utilized, would have been most effective in preventing the error or assuring prompt detection? a. Use of a check digit for employee numbers b. Use of a header label for the payroll input sheet c. A control total for hours worked, prepared from time cards collected by the timekeeping department d. Requiring the treasurer's office to account for the numbers of the pre numbered checks issued to the computer department for the processing of the payroll 10. Which of the following control procedures could best prevent direct labor from being charged to manufacturing overhead? a. Comparison of daily journal entries with factory labor summary. b. Examination of routing tickets from finished goods on delivery. c. Reconciliation of work in process inventory with cost records. d. Recomputation of direct labor based on inspection of time cards. 11. In the audit of the following types of profit-oriented enterprises, which one would the auditor be most likely to place special emphasis on testing the internal controls over proper classification of payroll transactions? a. A service organization b. A wholesaling organization c. A retailing organization d. A manufacturing organization Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 12. Which of the following procedures is most effective in providing reasonable assurance that payroll checks are distributed only to bona fide employees? a. An employee independent of payroll preparation compares endorsements on canceled payroll checks with employee signatures in personnel records b. All changes in pay rates and deductions are reviewed and approved by a responsible official independent of payroll preparation and distribution, c. All unclaimed paychecks are returned to an employee independent of payroll preparation and distribution. d. All personnel and payroll records and documents are prenumbered and physically protected from unauthorized access. 13. Which of the following statements best explains why the accuracy of payroll calculations and of payroll account distribution is critical to auditor? a. Employees will complain to management if their paychecks do not reflect wages or salaries earned. b. Payroll is paid in cash, an account that is highly susceptible to frauds. c. Auditing standards require that tests of cash and payroll be coordinated d. Payroll impacts several statement of financial position and statement of comprehensive income accounts 14. Test of controls over personnel and payroll focus on the preparation distribution, and recording of earned salaries and wages. Which of the following is the primary source from which tests of personnel and payroll are derived? a. Payroll register b. Employee earnings record c. Time records d. Labor distribution summary 15. On a surprise basis, an auditor may elect to distribute paychecks to employees personally. What is the primary purpose of this audit procedure? a. To assure that no extra payroll checks are prepared and distributed b. To test whether all paid employees exist c. To assure that paychecks are not distributed to an employee absent on the day the auditor distributes checks. d. To test the procedures for distributing paychecks Problem 4-5: Production Cycle 1. The objectives of the internal structure for a production cycle are to provide assurance that transactions are properly executed and recorded, and that a. Production orders are pre-numbered and signed by a supervisor b. Independent internal verification of activity reports is established c. Custody of work in process and of finished goods is properly maintained d. Transfers to finished goods are documented by a completed production report and a quality control report. 2. Which of the following policies is an internal control weakness related to the acquisition of factory equipment? a. Depreciation policies are reviewed only once a year b. Advance executive approvals are required for equipment acquisitions c. Acquisitions are to be made through and approved by the department in need of the equipment d. Variances between authorized equipment expenditures and actual costs are to be immediately reported to management 3. When perpetual inventory records are maintained in quantities and in peso, and internal control procedures over inventory are deficient, the auditor would probably a. Have to disclaim an opinion on the income statement that year b. Increase the extent of tests for unrecorded liabilities at the end of the year c. Want the client to schedule the physical inventory count at the end of the year d. Insist that the client perform physical counts of inventory items several times during the year 4. An auditor's tests of a client's cost accounting system are designed primarily to determine that a. Physical inventories substantially agree with book inventories Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 b. The system complies with generally accepted accounting principles and functions as planned c. Costs have been assigned properly to finished goods, work in process, and cost of goods sold d. Quantities on hand have been computed based on acceptable methods that reasonably approximate actual quantities on hand 5. An auditor has accounted for a sequence of inventory tags and is now going to trace information on a representative number of tags to the physical Inventory sheets. The purpose of this procedure is to obtain assurance that a. The final inventory is valued at cost b. All inventory represented by an inventory tag is bona fide c. Inventory sheets do not include untagged inventory items d. All inventory represented by an inventory tag is listed on the inventory sheets 6. When verifying debits to a manufacturing company's perpetual inventory records, an auditor would be most interested in testing a sample of purchase a. Orders: b. Invoices. c. Approvals d. Requisitions 7. The physical count of inventory of a retailer was higher than shown by the perpetual records. Which of the following could explain the difference? a. Inventory items had been counted, but the tags placed on the items had not been taken off the items and added to the inventory accumulation sheets. b. Credit memos for several items returned by customers had not been recorded. c. No journal entry had been made on the retailer's books for several items returned to its suppliers. d. An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had not been reflected in the perpetual records 8. For several years, a client's physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be deficiencies in internal control that led to the failure to record some a. Cash purchases b. Sales discounts c. Sales returns received d. Purchases returned to vendors 9. A client's physical count of inventories was higher than the inventory quantities per the perpetual records. This situation could be the result of the failure to record a. Sales b. Purchases c. Sales discounts d. Purchase returns 10. An auditor would be most likely to learn of slow-moving inventory through a. Inquiry of sales personnel b. Inquiry of stores personnel c. Physical observation of inventory d. Review of perpetual inventory records Problem 4-6: Investing and Financing Cycle 1. A company holds bearer bonds as a short-term investment. Responsibility for custody of these bonds and submission of coupons for periodic interest collections probably should be delegated to the a. Chief Accountant c. Internal Auditor b. Cashier d. Treasurer 2. A company has additional funds to invest. The Board of Directors decided to purchase marketable securities and assigned the future purchase and sale decisions to a responsible financial executive. The best person(s) to make periodic reviews of the investment activity should be a. An investment committee of the Board of Directors. Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 b. The chief operating officer. c. The corporate controller. d. The treasurer. 3. Which of the following is a responsibility that should not be assigned to only one employee? a. Access to securities in the company's safe deposit box b. Custodianship of tools and small equipment c. Custodianship of the cash working fund d. Reconciliation of bank statements 4. In reviewing and evaluating internal control over marketable securities auditor would be specially concerned about: a. Recording of stock investments by the controller. b. Approval of stock investment purchases by the Board of Directors. c. Access to stock certificates by the corporate treasurer. d. Access to stock certificates by the controller. 5. When no independent stock transfer agents are employed and the corporation issues its own stocks and maintains stock records, canceled stock certificates should a. Not be defaced but segregated from other stock certificates and retained in a canceled certificates file. b. Be destroyed to prevent fraudulent reissuance c. Be defaced and sent to the secretary of state, d. Be defaced to prevent reissuance and attached to their corresponding stubs. Purpose of Financial Statement Audit A financial statement audit aims to determine whether the financial statements are prepared in accordance with the appropriate financial reporting framework. Financial Statement Assertions 1. Existence or Occurence 2. Completeness 3. Rights and Obligations 4. Measurement and Allocation 5. Presentation and Disclosure Audit Process 1. Pre-engagement activities 2. Audit planning and Evaluation of Internal Control 3. Evidence Gathering 4. Reporting Pre-engagement activities 1. Client's business reputation 2. Changes in client's ownership or management 3. Client's reporting practices 4. Audit team considerations Audit Planning Obtaining an understanding of the client, its business, industry and accounting policies; Obtaining understanding of the client's internal control system; Assessing materiality and audit risk; Identifying audit objectives; Determining whether reliance can be placed on certain controls in the system; Determining the nature, extent and timing of substantive tests to be performed; and designing and finalizing the audit program Evidence-Gathering or Audit Documentation Evidence gathered must both be sufficient and competent. a. Confirmation b. Physical count and observation c. Inquiry d. Documentation e. Comparisons Downloaded by Larence Nova (larence.nova@yahoo.com) lOMoARcPSD|12208216 f. Recalculations g. Mechanical tests of data Reporting Determination of the audit report appropriate in the circumstances 1. An audit is conducted on the premise that management and, where appropriate, those charged with governance, have acknowledged and understand that they have responsibilities that are fundamental to the conduct of an audit in accordance with PSAs. Which of the following is not one of those responsibilities? - The preparation of financial statements in accordance with relevant pronouncements issued by the AASC. 2. Which of the following matters would an auditor most likely consider when establishing the scope of the audit? - The expected audit coverage, including the number and locations of the entity’s components to be included. 3. Which of the following is the least likely procedure to be performed in planning a financial statement audit? - Selecting a sample of sales invoices for comparison with shipping documents. 4. In using the work of an expert, an auditor referred to the work of an expert’s findings in the auditor’s report. This is an appropriate reporting practice if the - Auditor, as a result of the expert’s work, issues a report that contains a modified opinion. 5. Which of the following statements concerning audit planning is incorrect? - Planning is a discrete phase of an audit. 6. An auditor is required to establish an understanding with client regarding the services to be performed for each engagement. This understanding generally includes - The auditor’s responsibility for ensuring that those charged with governance are aware of any significant deficiencies in internal control that may come to the auditor’s attention. 7. The auditor’s risk assessment procedures - By themselves, do not provide sufficient appropriate audit evidence on which to base the audit opinion. 8. There is an inverse relationship that exists between the acceptable level of detection risk and the - Assurance provided by substantive tests. 9. Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would - Decrease detection risk. 10. A basic premise underlying analytical procedures is that - Plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. 11. An entity’s internal control system contains manual elements and often contains automated elements. Manual elements in internal control may be less reliable that automated elements because - Manual control elements can be more easily bypassed, ignored, or overridden and they are also more prone to simple errors and mistakes. 12. Inherent risk is ________ related to detection risk and ________ related to the amount of audit evidence - Inversely, directly 13. Which of the following is not an objective of the revenue/receipt cycle? - Received goods are counted and inspected for quality. 14. Which of the following is an essential control procedure to ensure the accuracy of the recorded inventory quantities? - Establishing a cutoff for goods received and shipped. 15. The following controls are appropriate for property, plant and equipment (PPE), except - Disposal of fully depreciated PPE items. 16. Which of the following questions is most likely to be included by an auditor on an internal control questionnaire for notes payable? - Are direct borrowings on notes payable authorized by the board of directors? 17. Organization independence in the processing of payroll can be achieved by segregating the functions of authorizations, record-keeping, and custody of assets. Which one of the following functional separations is not required for internal control purposes? - Separation of payroll preparation and maintenance of year-todate records. Downloaded by Larence Nova (larence.nova@yahoo.com)
