ACCT 250 – Principles of Auditing
Spring 2023, S1& S2
Handout 5B – Midterm I additional practice questions
MCQs:
1. Ethical behavior is considered to be a cornerstone for trust in everyday life as well as in
business practices. Ethics are
A) beliefs that we have about our own behaviour.
B) a set of moral principles or values.
C) rules in society that help us to do the right thing.
D) laws that govern how businesses should behave.
Answer: B
2. The underlying reason for a high level of professional conduct, such as exemplified in a code
of conduct, for any profession is
A) the need for public confidence in the quality of service of the profession.
B) that it provides a safeguard to keep unscrupulous people out.
C) that it is required by federal legislation.
D) that it allows licensing agencies to have a standard to measure deficient performance.
Answer: A
3. A public accountant would be facing an ethical dilemma when deciding whether or not to
A) overlook a material overstatement of revenues to maintain a good client relationship.
B) overlook a non-material error in the financial statements.
C) accept an invitation from the client to go golfing in order to maintain a good client
relationship.
D) participate in a charitable activity organized by the client.
Answer: A
4. In which of the following circumstances would a public accountant be bound by ethics to
refrain from disclosing any confidential information obtained during the course of a professional
engagement?
A) The public accountant is issued a subpoena that orders the public accountant to present
confidential information.
B) A major shareholder of a client company seeks accounting information from the public
accountant after management declined to disclose the requested information.
C) Confidential client information is made available as part of a practice inspection of the public
accountant's practice.
D) An inquiry by a disciplinary body of a provincial institute requests confidential client
information.
Answer: B
5. The components of the risk of misstatement are:
A) Inherent Risk, Control Risk, Detection Risk
B) Inherent Risk, Control Risk
C) Inherent Risk
D) Control Risk, Detection Risk
Answer: B
6. Which of the following is not an assertion relating to purchases?
A) Accuracy
B) Existence
C) Cut-off
D) Classification
Answer: B
7. Audit documentation should be sufficient to allow which individual to understand the audit
work performed, the evidence obtained, and the significant conclusions?
A) A certified public accountant
B) A partner in a CPA firm
C) An experienced auditor
D) The controller at the company being audited
Answer: C
8. Which type of a procedure is the review of a vendor’s invoice by the auditor to establish
occurrence of a transaction?
A) Analytical procedure
B) Inquiry
C) Inspection
D) Re-performance
Answer: C
9. The auditor of Smith Electronics wish to limit the audit risk of material misstatement in the
test of accounts receivable to 5%. They believe that inherent risk is 100% and there is a 40% risk
that material misstatement could have bypassed the client’s system of internal control. What is
the maximum detection risk the auditors should specify in their substantive procedures of
accounts receivable?
A) 5%
B) 12.5%
C) 42.7%
D) 60%
Answer: B
10. Frankinfurter Limited decided that it wanted to improve earnings. To do this, they
understated their expenses by omitting unpaid expenses from the accrued liabilities account at
year end. Which management assertion has been violated?
A) rights and obligations
B) completeness
C) existence
D) disclosure
Answer: B
11. XYZ Brick Company decided to inflate sales by recording fictitious sales. Several nonexistent clients were created, and the sales were added into the sales journal throughout the year.
The general transaction related assertion affected with these actions is
A) posting and summarization
B) completeness
C) accuracy
D) occurrence
Answer: D
12. Radio Supplies Limited sells parts and components to organizations that repair radios and
other forms of audio equipment. They have many parts on their inventory listing at cost that were
purchased up to fifteen years ago. Some of these parts have not seen any movement in the last
ten years. The general account balance-related assertion affected by this activity is
A) accuracy
B) existence
C) valuation and allocation
D) completeness
Answer: C
Short Answer:
1. ISA 210 Agreeing the Terms of Audit Engagements requires auditors to agree the terms of an
engagement with those charged with governance and formalize these in an engagement letter.
Required:
(a) Identify and explain TWO factors which would indicate that an engagement letter for an
existing audit client should be revised.
Solution:
Engagement letters for recurring/existing clients should be revised if any of the following factors
are present:
 Any indication that the entity misunderstands the objective and scope of the audit, as this
misunderstanding would need to be clarified.
 Any revised or special terms of the audit engagement, as these would require inclusion in
the engagement letter.
 A recent change of senior management or significant change in ownership. The letter is
signed by a director on behalf of those charged with governance. If there have been
significant changes in management they need to be made aware of what the audit
engagement letter includes.
 A significant change in nature or size of the entity’s business. The approach taken by the
auditor may need to change to reflect the change in the entity and this should be clarified
in the engagement letter.
 A change in legal or regulatory requirements. The engagement letter is a contract; hence
if legal or regulatory changes occur, then the contract could be out of date.
 A change in the financial reporting framework adopted in the preparation of the financial
statements. The engagement letter clarifies the role of auditors and those charged with
governance, it identifies the reporting framework of the financial statements and if this
changes, then the letter requires updating.
 A change in other reporting requirements. Other reporting requirements may be stipulated
in the engagement letter; hence if these change, the letter should be updated.
2. FineFoods Inc. is an existing audit client of Hastings & Co. FineFoods’ new finance director
has read about review engagements and is interested in the possibility of Hastings & Co
undertaking these in the future instead of an audit. However, he is unsure how these
engagements differ from an external audit and how much assurance would be gained from this
type of engagement.
Required:
(a) Explain the purpose of review engagements and how these differ from external audits; and
(b) Describe the level of assurance provided by external audits and review engagements.
Solution:
(a) Review engagements
Review engagements are often undertaken as an alternative to an audit, and involve a practitioner
reviewing financial data, such as six‐monthly figures. This would involve the practitioner
undertaking procedures to state whether anything has come to their attention which causes the
practitioner to believe that the financial data is not in accordance with the financial reporting
framework.
A review engagement differs to an external audit in that the procedures undertaken are not nearly
as comprehensive as those in an audit, with procedures such as analytical review and enquiry
used extensively. In addition, the practitioner does not need to comply with ISAs as these only
relate to external audits.
(b) Levels of assurance
External audit
This provides comfort that the financial statements present fairly in all material respects (or are
true and fair) and are free of material misstatements. A high but not absolute level of assurance is
provided. This is known as reasonable assurance.
Review engagements
The practitioner gathers sufficient evidence to be satisfied that the subject matter is plausible. In
this case negative assurance is given whereby the practitioner confirms that nothing has come to
their attention which indicates that the subject matter contains material misstatements.
3. You are an audit manager of Buffon & Co, and you have just been assigned the audit of
Maldini Co (Maldini). The audit engagement partner who is responsible for the audit of Maldini,
a listed company, has been in place for approximately eight years and her son has just been
offered a role with Maldini as a sales manager. This role would entitle him to shares in Maldini
as part of his remuneration package.
Maldini’s board of directors is considering establishing an internal audit function, and the
finance director has asked Buffon & Co about the differences in the role of internal audit and
external audit. If the internal audit function is established, the directors have suggested that they
may wish to outsource this to Buffon & Co.
The finance director has suggested to the board that if Buffon & Co is appointed as internal as
well as external auditors, then fees should be renegotiated with at least 20% of all internal and
external audit fees being based on the profit after tax of the company as this will align the
interests of Buffon & Co and Maldini.
From a review of the information above, your audit assistant has highlighted some of the
potential situations which may affect the independence of the auditor in respect of the audit of
Maldini.
(1) Audit partner has been in the position for eight years
(2) Maldini has asked for advice regarding role of internal audit
(3) Maldini has asked Buffon & Co to carry out internal audit work
(4) Fees will be based on 20% of profit after tax
Required:
(a) For each of the situations, identify the ethical threat, and a safeguard to mitigate the risk to an
acceptable level.
(b) Is there any other situation which would warrant your attention?
Solution:
(a)
Situation
Audit partner has been in
the position for eight years
Threat
Familiarity
Safeguard
Engagement Partner should be changed
as partner rotation should be every 5
years for a non-financial sector client.
Advice may be provided as long as
auditors don’t get involved in
managerial tasks or assume managerial
role/decision making.
Maldini has asked for
advice regarding role of
internal audit
None
Maldini has asked Buffon &
Co to carry out internal
audit work
Self-review
Decline the engagement because the
threat would be too great to safeguard
against.
Fees will be based on 20%
of profit after tax
Self interest
Cannot accept contingent fees,
communicate with TCWG that audit
fees need to be reflective to time, skill
and experience of audit team.
(b) The engagement partner’s son has been offered a role with Maldini as a sales manager,
entitling him to shares in Maldini as part of his remuneration package. This poses a familiarity
threat due to immediate family personal relationship, and a self-interest threat, because there is a
direct financial interest of the auditor’s family member in the company. This matter should be
disclosed in the audit file, and the engagement partner should be removed from the audit team.