MODULE 5

AUDIT PLANNING

PSA-BASED QUESTIONS

1. Given that an audit in accordance with generally

accepted auditing standards is influenced by the
possibility of material errors and fraud, the auditor
should conduct the audit with an attitude of
A. professional responsiveness.
B. conservative advocacy.
C. objective judgment.
D. professional skepticism.

2. With respect to errors and fraud, which of the

following should be a part of an auditor’s planning in
an audit engagement?
A. Planning to search for errors or fraud that would
have a material or immaterial effect on the
financial statements
B. Planning to discover errors or fraud that are either
material or immaterial
C. Planning to discover errors or fraud that are
material
D. Planning to consider factors affecting the risk of
material misstatements both at the financial
statement and the account balance level

3. The risk that the auditor may unknowingly fail to

appropriately modify the unqualified opinion on
financial statements that are materially misstated is
referred to as
A. audit risk.

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 B. detection risk.
C. information risk.
D. business risk.

4. The risk that financial statements are likely to be

misstated materially without regard to the
effectiveness of internal control is which type of risk?
A. Inherent risk
B. Audit risk
C. Client risk
D. Control risk

5. The type of transactions that ordinarily have a high

inherent risk because they involve management
judgment or assumptions are referred to as
A. estimation transactions.
B. nonroutine transactions.
C. routine transactions.
D. related-party transactions.

6. Inherent risk is defined as the susceptibility of an

account balance or class of transactions to error that
could be material assuming that there were no
related internal controls. Of the following conditions,
which one does not increase inherent risk?
A. The client has entered into numerous related
party transactions during the year under audit.
B. Internal control over shipping, billing, and
recording of sales revenue is weak.
C. The client has lost a major customer accounting
for approximately 30% of annual revenue.
D. The board of directors approved a substantial
bonus for the president and chief executive
officer, and also approved an attractive stock
option plan for themselves.

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7. Which of the following descriptions best describes
inherent risk?
A. Auditors fail to discover a material misstatement
in the course of their audit and do not modify
their audit opinion.
B. A company's internal control fails to identify a
material misstatement oin a timely fashion.
C. Auditing procedures fail to find a material
misstatement.
D. The possibility that a material misstatement will
occur in any given account before considering
internal control.

8. The risk that a material misstatement in an assertion

will not be prevented or detected on a timely basis by
internal control is
A. detection risk.
B. control risk.
C. inherent risk.
D. audit risk.

9. The risk that the audit will fail to uncover a material

misstatement is eliminated
A. if a client has strong internal controls.
B. if a client follows generally accepted accounting
principles (GAAP).
C. when the auditor has complied with the generally
accepted auditing standards (GAAS).
D. under no circumstances.

10. Audit risk components consist of inherent, control

and detection risks. Which of them is (are) the
dependent variable(s)?
A. Inherent risk

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 B. Control risk
C. Detection risk
D. Inherent and control risks

11. The probability that an auditor's procedures leading

to the conclusion that a material error does not exist
in an account balance when, in fact, such error does
exist is referred to as
A. prevention risk.
B. inherent risk.
C. control risk.
D. detection risk.

12. Which of the following is the best definition of

detection risk?
A. The auditor will compute audit materiality
incorrectly.
B. The auditor will fail to detect material
misstatements that exist.
C. The auditor will apply more audit procedures than
are required in the circumstances.
D. The auditor will fail to modify the audit opinion on
financial statements that are materially
misstated.
13. Which of the following is not a component of audit
risk?
A. Detection risk
B. Business risk
C. Control risk
D. Inherent risk

14. Which of the following types of risk is significantly

affected by the nature, amount and timing of
substantive auditing procedures?
A. Inherent risk

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 B. Control risk
C. Detection risk
D. Sufficiency risk

15. The understanding between the client and the

auditor as to the degree of responsibilities to be
assumed by each is normally set forth in a(an)
A. representation letter.
B. engagement letter.
C. management letter.
D. comfort letter.

16. After an auditor had been engaged to perform the

first audit for a nonpublic entity, the client requested
to change the engagement to a review. In which of
the following situations would there be a reasonable
basis for the auditor to comply with the client’s
request?
A. The client’s bank required an audit before
committing to a loan, but the client subsequently
acquired alternative financing.
B. The auditor is prohibited by the client from
corresponding with the client’s legal counsel.
C. Management refuses to sign the client
representation letter.
D. The audit is substantially complete and the
auditor determined that an unqualified opinion is
warranted but there is a disagreement concerning
the audit fee.

17. Which of the following statements is correct with

respect to obtaining an understanding with a client?
A. Auditors are not required to obtain an
understanding with their clients.

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 B. Auditors must obtain an understanding only if an
audit is to be conducted.
C. Auditors must document their understanding of
the engagement.
D. Auditors must obtain an engagement letter.

18. An engagement letter is best described as:

A. A letter from company management 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 that the
auditor has been engaged to perform the audit
and the fees to be paid.

19. The primary reason why an engagement letter is

submitted by audit firms prior to starting the work is
that it
A. clarifies the responsibilities of the management
and those of the audit firm.
B. defines the firm’s policies and procedures
regarding new clients.
C. provides an insurance policy for both the firm and
its client.

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 D. communicates the type of opinion that will be
rendered on the engagement

20. Which of the following best describes the purpose of

an engagement letter?
A. The engagement letter relieves the auditor of
some responsibility for the exercise of due care.
B. By clearly defining the nature of the engagement,
the engagement letter helps avoid and resolve
misunderstandings between the CPA and the
client regarding the precise nature of the work to
be performed and the type of report to be issued.
C. The engagement letter conveys to the
management the detailed steps to be applied in
the audit process.
D. The engagement letter should be signed by both
the client and the CPA and should be used only for
independent audits.

21. Which of the following is not included in an audit

engagement letter?
A. Objectives of the engagement
B. Representations that the financial statements
were prepared in accordance with PFRS
C. Management's responsibilities
D. A clear explanation of the services to be
performed on the engagement

22. Which of the following statements would least likely

appear in an auditor’s engagement letter?
A. The fees for our services are based on our regular
per diem rates, plus travel and other out-of-
pocket expenses.

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 B. During the course of our audit, we may observe
opportunities for economy in, or improved
controls over, your operations.
C. Our engagement is subject to the risk that
material errors, fraud, and defalcations, if they
exist, will not be detected.
D. After performing our preliminary analytical
procedures we will discuss with you the other
procedures we consider necessary to complete
the engagement.

23. Which of the following is not done during the client

selection and retention phase of planning?
A. Obtain an understanding of internal controls
B. Obtain and review financial information
C. Consider the need for special skills
D. Ensure that the firm has sufficient resources to
complete the engagement on a timely manner

24. Professional skepticism

A. neither assumes that the management is
dishonest nor of unquestioned honesty.
B. assumes that management is either dishonest or
of unquestioned honesty.
C. either assumes that management is honest or
dishonest.
D. None of the given choices is a correct statement

25. Which of the following is not required by PSA No.

315, "Consideration of Fraud in a Financial Statement
Audit"?
A. Conduct a continuing assessment of the risks of
material misstatement due to fraud throughout
the audit.

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 B. Conduct a discussion by the audit team of the
risks of material misstatement due to fraud.
C. Conduct the audit with professional skepticism,
which includes an attitude that assumes balances
are incorrect until verified by the auditor.
D. Conduct inquiries of the audit committee as to
their views about the risks of fraud and their
knowledge of any fraud or suspected fraud.

26. The primary difference between financial statement

errors and fraud is that
A. errors are intentional misstatements by
management, while fraud involves unintentional
mistakes or omissions.
B. errors are unintentional mistakes or omissions,
while fraud involves intentional misstatements.
C. there is no difference as errors and fraud have the
same meaning.
D. errors are more likely to provide an indication that
an illegal act may have occurred.

27. The risk of fraudulent financial reporting increases in

the presence of
A. incentive systems based on operating income.
B. improved control systems.
C. substantial increases in sales.
D. frequent changes in suppliers.

28. Which of the following is least likely included in an

auditor's inquiry of management while obtaining
information to identify the risks of material
misstatement due to fraud?
A. Are financial reporting operations controlled by
and limited to one location?
B. Does it have knowledge of fraud or suspect fraud?

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 C. Does it have programs to mitigate fraud risks?
D. Has it reported to the audit committee the nature
of the company's internal control?

29. Which of the following should the auditors normally

interview as part of their assessment of fraud risk?
A. Senior management
B. Audit committee
C. Various employees whose duties do not include
normal financial reporting responsibilities
D. All of the given choices

30. Which of the following characteristics most likely

would heighten an auditor’s concern about the risk of
intentional manipulation of financial statements?
A. Turnover of senior accounting personnel is low.
B. Insiders recently purchased additional shares of
the entity’s stock.
C. Management places substantial emphasis on
meeting earnings projections.
D. The rate of change in the entity’s industry is slow.

31. When planning the audit, if the auditor has no reason

to believe that noncompliance to laws and
regulations exist, he should
A. make inquiries of management regarding their
policies and their knowledge of violations, and
then rely on normal audit procedures to detect
errors, irregularities, and illegalities.
B. still include some audit procedures designed
specifically to uncover illegal acts.
C. ignore the possibility of illegal acts to occur.
D. include audit procedures which have a strong
probability of detecting illegal acts.

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32. An audit plan is a
A. detailed plan of analytical procedures and all
substantive tests to be performed in the course of
the audit.
B. document that provides an overview of the
company and a general plan for the audit work to
be accomplished, timing of the work, and other
matters of concern to the audit.
C. generic document that auditing firms have
developed to lead the process of the audit through
a systematic and logical process.
D. budget of the time that should be necessary to
complete each phase of the audit procedures.

33. What will an auditor who has been proposed for an

audit engagement usually do prior to accepting a
new client?
A. Draft the financial statements of the client as a
measure of goodwill.
B. With the permission from the prospective client,
contact the predecessor auditor to determine if
there are any disagreements between the client
and the audit firms.
C. Obtain the potential client's permission to talk to
the former auditor and review work papers.
D. Perform a peer review on the potential client in
accordance with professional standards.

34. Philippine Standards on Auditing require auditors to

assess the risk of material misstatements due to
fraud
A. for every audit.
B. for first-time audits.
C. sufficient to find any frauds which may exist.
D. whenever it would be appropriate.

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35. If, when performing analytical procedures, an auditor
observes that operating income has declined
significantly between the preceding year and the
current year, the auditor should next
A. require that the decline be disclosed in the
financial statements.
B. consider the possibility that the financial
statements may be materially misstated.
C. inform management that a qualified opinion on
the financial statements will be necessary.
D. determine management's responsibility for the
decline and discuss the issue with the audit
committee.

36. Which of the following statements best describes

materiality?
A. Materiality is typically measured as a fixed
percentage of assets.
B. Materiality is typically measured as a fixed
percentage of net income.
C. Materiality does not depend on the company
being audited, but is solely dependent on the
auditor’s discretion.
D. Materiality provides a cutoff point at which
judgment, based on the financial statements, may
be altered.

37. If the auditor sets the preliminary judgment about

materiality level at a relatively low peso amount,
A. more evidence will be required than for a high
level.
B. less evidence will be required than for a high
level.

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 C. the same amount of evidence will be required as
for a high level.
D. the amount of evidence required will not be
affected.

38. Which of the following statements is true with regard

to the relationship among audit risk, audit evidence,
and materiality?
A. The lower the inherent risk and control risk, the
lower the aggregate materiality threshold.
B. Under conditions of high inherent and control risk,
the auditor should place more emphasis on
obtaining external evidence and should reduce
reliance on internal evidence.
C. Where inherent risk is high and control risk is low,
the auditor may safely ignore inherent risk.
D. Aggregate materiality thresholds should not
change under conditions of changing risk levels.

39. Which of the following is most likely to be an overall

response to fraud risks identified in an audit?
A. Supervise members of the audit team less closely
and rely more upon judgment.
B. Use less predictable audit procedures.
C. Use only certified public accountants on the
engagement.
D. Place increased emphasis on the audit of
objective transactions rather than subjective
transactions.

40. When must an auditor perform analytical review

procedures in a financial statement audit?
A. Testing controls over financial cycles
B. Performing tests to substantiate balances

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 C. Planning the nature, timing and extent of
procedures
D. Performing tests to substantiate transactions

41. The purpose of analytical procedures during the audit

planning stage is to
A. aid in planning the observation of physical
inventory.
B. identify unusual circumstances that the auditor
may need to investigate further.
C. flag individual transactions for further review.
D. determine whether sales transactions are
approved.

42. Which of the following represents a procedure that

the auditor may use because plausible relationships
among financial statement balances are expected to
exist?
A. Attributes testing
B. Enterprise risk assessment
C. Inherent tests of control
D. Analytical review

43. The main purpose of risk assessment procedures is

to
A. Obtain 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.
B. Test the operating effectiveness of controls in
preventing, or detecting and correcting, material
misstatements at the assertion level.
C. Detect material misstatements at the assertion
level.

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 D. All of the given choices are main purposes of risk
assessment procedures.

44. Which of the following statements is incorrect

regarding obtaining an understanding of the entity
and its environment?
A. Obtaining an understanding of the entity and its
environment is an essential aspect of performing
an audit in accordance with PSAs.
B. Understanding of the entity and its environment
establishes a frame of reference within which the
auditor plans the audit and exercises professional
judgment about assessing risks of material
misstatement in the financial statements and
responding to those risks throughout the audit.
C. The auditor’s primary consideration is whether
the understanding that has been obtained is
sufficient to assess the risks of material
misstatement in the financial statements and to
design and perform further audit procedures.
D. The depth of the overall understanding that is
required by the auditor in performing the audit is
at least equal to that possessed by management
in managing the entity.

45. Which statement is incorrect regarding analytical

procedures?
A. Analytical procedures may be helpful in
identifying the existence of unusual transactions
or events, and amounts, ratios, and trends that
might indicate matters that have financial
statement and audit implications.
B. In performing analytical procedures as risk
assessment procedures, the auditor develops

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 expectations about plausible relationships that
are reasonably expected to exist.
C. When comparison of those expectations with
recorded amounts or ratios developed from
recorded amounts yields unusual or unexpected
relationships, the auditor considers those results
in identifying risks of material misstatement.
D. When such analytical procedures use data
aggregated at a high level (which is often the
situation), the results of those analytical
procedures provide a clear-cut indication about
whether a material misstatement may exist.

46. Which statement is correct regarding business risks?

A. The risk of material misstatements in the financial
statements is broader than business risk, though
it includes the latter.
B. The auditor should identify or assess all business
risks.
C. All business risks give rise to risks of material
misstatement.
D. A business risk may have an immediate
consequence for the risk of misstatement for
classes of transactions, account balances, and
disclosures at the assertion level or the financial
statements as a whole.

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47. Inquiries directed towards those charged with
governance may most likely
A. Relate to their activities concerning the design
and effectiveness of the entity’s internal control
and whether management has satisfactorily
responded to any findings from these activities.
B. Help the auditor understand the environment in
which the financial statements are prepared.
C. Relate to changes in the entity’s marketing
strategies, sales trends, or contractual
arrangements with its customers.
D. Help the auditor in evaluating the appropriateness
of the selection and application of certain
accounting policies.

48. Which statement is incorrect regarding significant

risks that require special audit consideration?
A. The auditor should determine which of the
identified risks are, in the auditor’s judgment,
require special audit consideration.
B. The auditor excludes the effect of identified
controls related to the risk to determine whether
the nature of the risk, the likely magnitude of the
potential misstatement including the possibility
that the risk may give rise to multiple
misstatements, and the likelihood of the risk
occurring are such that they require special audit
consideration.
C. Routine, non-complex transactions that are
subject to systematic processing are more likely
to give rise to significant risks because they have
higher inherent risks.
D. Significant risks are often derived from business
risks that may result in a material misstatement.

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49. The assessment of the risks of material misstatement
at the financial statement level is affected by the
auditor’s understanding of the control environment.
Weaknesses in the control environment ordinarily will
lead the auditor to
A. Have more confidence in internal control and the
reliability of audit evidence generated internally
within the entity.
B. Conduct some audit procedures at an interim date
rather than at period end.
C. Modify the nature of audit procedures to obtain
more persuasive audit evidence.
D. Decrease the number of locations to be included
in the audit scope.

50. The auditor should determine overall responses to

address the risks of material misstatement at the
financial statement level. Such responses least likely
include
A. Emphasizing to the audit team the need to
maintain professional skepticism in gathering and
evaluating audit evidence.
B. Assigning more experienced staff or those with
special skills or using experts.
C. Incorporating additional elements of
unpredictability in the selection of further audit
procedures to be performed.
D. Performing substantive procedures at an interim
date instead of at period end.

51. Which statement is incorrect regarding the nature of

further audit procedures?
A. The nature of further audit procedures refers to
their purpose and their type.

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 B. Certain audit procedures may be more
appropriate for some assertions than others.
C. The higher the auditor’s assessment of risk, the
less reliable and relevant is the audit evidence
sought by the auditor from substantive
procedures.
D. The auditor is required to obtain audit evidence
about the accuracy and completeness of
information produced by the entity’s information
system when that information is used in
performing audit procedures.

52. Which statement is incorrect regarding the extent of

further audit procedures?
A. Extent includes the quantity of a specific audit
procedure to be performed.
B. The extent of an audit procedure is determined by
the judgment of the auditor after considering the
materiality, the assessed risk, and the degree of
assurance the auditor plans to obtain.
C. The auditor ordinarily decreases the extent of
audit procedures as the risk of material
misstatement increases.
D. Increasing the extent of an audit procedure is
effective only if the audit procedure itself is
relevant to the specific risk.

53. The auditor should design and perform further audit

procedures whose nature, timing, and extent are
responsive to the assessed risks of material
misstatement at the assertion level. Which of the
following is the most important consideration in
responding to the assessed risks?
A. The nature of the audit procedures.
B. The timing of the audit procedures.

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 C. The extent of the audit procedures.
D. All of these are equally important.

54. While assessing the risk of material misstatement,

the auditors identity risks, relate risk to what could
go wrong, consider the magnitude of risks and:
A. Assess the risk of misstatements due to
noncompliance to laws and regulations.
B. Consider the complexity of the transactions
involved.
C. Consider the likelihood that the risks could result
in material misstatements.
D. Determine materiality level.

55. Which of the following would heighten an auditor’s

concern about the risk of fraudulent financial
reporting?
A. Inability to generate positive cash flows from
operations while reporting large increases in
earnings
B. Management’s lack of interest in increasing the
dividend paid on common stock
C. Large amounts of liquid assets that are easily
convertible into cash
D. Inability to borrow necessary capital without
obtaining waivers on debt covenants

56. Which of the following is least likely considered a

financial statement audit risk factor?
A. Management operating and financing decisions
are dominated by top management.
B. A new client with no prior audit history.
C. Rate of change in the entity’s industry is rapid.
D. Profitability of the entity relative to its industry is
inconsistent.

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57. Which of the following is most likely to be considered
a risk factor relating to fraudulent financial reporting?
A. Low turnover of senior management.
B. Extreme degree of competition within the
industry.
C. Capital structure including various operating
subsidiaries.
D. Sales goals in excess of any of the preceding
three years.

58. Which of the following is correct concerning

requirements about auditor’s communications about
fraud?
A. Fraud that involves senior management should be
reported directly to the audit committee
regardless of the amounts involved.
B. All fraud with a material effect on the financial
statements should be reported directly by the
auditor to the Securities and Exchange
Commission.
C. Fraud with a material effect on the financial
statements should ordinarily be disclosed by the
auditor through the use of an emphasis of a
matter paragraph added to the audit report.
D. The auditor has no responsibility to disclose fraud
outside the entity under any circumstances.

59 Which of the following factors most likely would

heighten an auditor’s concern about the risk of
fraudulent financial reporting?
A. Large amounts of liquid assets that are easily
convertible into cash.
B. Low growth and profitability as compared to other
entity’s in the same industry.

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 C. Financial management’s participation in the initial
selection of accounting principles.
D. An overly complex organizational structure
involving unusual lines of authority.

60 Which of the following is most likely to be an overall

response to fraud risks identified in an audit?
A. Only use certified public accountants on the
engagement.
B. Place increased emphasis on the audit of
objective transactions rather than subjective
transactions.
C. Supervise members of the audit team less closely
and rely more upon judgment.
D. Use less predictable audit procedures.

QUIZZERS

1. As part of audit planning, CPAs should design audit

programs for each individual audit and should include
audit steps and procedures to
A. detect and eliminate fraud.
B. increase the amount of management information
available.
C. provide assurance that the objectives of the audit
are met.
D. ensure that only material items are audited.

2. Preplanning the audit involves several key activities.

Which of the following would not be included in
preplanning an audit?
A. Investigating the client’s background

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 B. Determining the likelihood of issuing an
unqualified audit opinion on the client’s financial
statements
C. Communicating with the prospective client’s prior
auditor to inquire about any disagreements with
the client.
D. Understanding the client’s reasons for obtaining
an audit

3. During audit planning, which of the following is not a

factor that affects the auditor's judgment as to the
quantity, type, and content of working papers?
A. The auditor's preliminary assessment of control
risk
B. The auditor's preliminary evaluation of inherent
risk based on discussions with the client
C. The nature of the client’s business
D. The type of report to be issued by the auditor

4. Which one of the following is not considered a valid

source of information about the client's processes?
A. Confirmation from third-parties
B. Review of the client's budget
C. A tour of the client's plant facility
D. Management inquiry

5. The element of the audit planning process most likely

to be agreed upon with the client before the
implementation of audit strategy is the determination
of the
A. methods of statistical sampling to be used in
confirming accounts receivable.
B. pending legal matters to be included in the
inquiry of the client's attorney.

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 C. evidence to be gathered to provide a sufficient
basis for the auditor's opinion.
D. schedules and analyses to be prepared by the
client's staff.

6. Which of the following is not a component of audit

planning?
A. Observing the client's annual physical inventory
taking and making test counts of selected items
B. Making arrangements with the client concerning
the timing of audit fieldwork and use of the
client's staff in completing certain phases of the
examination
C. Obtaining an understanding of the business
D. Developing audit programs

7. R & O, CPAs, have been retained as the auditors of

City Corporation. What are R & O's responsibilities
with regards to contacting City Corporation’s
predecessor auditors?
A. If City Corporation had a disagreement with the
predecessor auditors, R & O should not contact
the predecessor auditors.
B. R & O is not required to attempt communication
with the predecessor auditors under any
circumstances.
C. R & O should attempt communications with the
predecessor auditors and ask if they had any
accounting policy disagreements with City
Corporation.
D. It would be unethical for R & O to ask the
predecessor auditors about the integrity of City
Corporation's management.

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8. An initial audit requires more audit time to complete
than a recurring audit. One of the reasons for this is
that
A. the new auditors are usually assigned to an initial
audit.
B. the predecessor auditors need to be consulted.
C. the client's business, industry, and internal control
are unfamiliar to the auditor and he needs to
carefully study them.
D. a larger proportion of customer accounts
receivable need to be confirmed on an initial
audit.

9. Prior to beginning the fieldwork on a new audit

engagement in which he does not possess industry
expertise, the CPA should
A. reduce audit risk by lowering the preliminary
levels of materiality.
B. design special substantive tests to compensate
for the lack of industry expertise.
C. engage financial experts who are familiar with the
nature of the industry.
D. obtain a knowledge of matters that relates to the
nature of the entity's business and industry.

10. Which of the following will an auditor least likely

discuss with the former auditors of a potential client
prior to acceptance of an audit engagement?
A. Integrity of the management
B. Fees charged for the services
C. Disagreements between the predecessor auditor
and the management regarding accounting
principles
D. Reasons for changing audit firms

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11. What is the most likely course of action to be taken
by an auditor in assessing management integrity?
A. Tour the plant
B. Review the minutes of the board of directors
C. Research the background and histories of officers
D. Review the bank reconciliation statements

12. An engagement letter should be written before the

start of an audit because
A. it may limit the auditor’s legal liability by
specifying the auditor’s responsibilities.
B. it specifies the client’s responsibility for preparing
schedules and making the records available to the
auditor.
C. it specifies the basis for billing the audit for the
upcoming year.
D. All of the choices given are correct

13. When a CPA is approached to perform an audit for

the first time, the CPA should make inquiries of the
predecessor auditor. This is a necessary procedure
because the predecessor may be able to provide the
successor with information that will assist the
successor in determining whether:
A. the predecessor's work should be utilized.
B. the company follows the policy of rotating its
auditors.
C. in the predecessor's opinion, internal control of
the company is satisfactory.
D. the engagement should be accepted.

14. A written understanding between the auditor and the

client concerning the auditor's responsibility for the
discovery of noncompliance to laws is usually set
forth in a(an)

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 A. client representation letter.
B. letter of audit inquiry.
C. management letter.
D. engagement letter.

15. Prior to 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 of the engagement.
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.

16. Before accepting an audit engagement, a successor

auditor should make specific inquiries of the
predecessor auditor regarding the predecessor’s

A. opinion of any subsequent events occurring since

the predecessor’s audit report was issued.
B. understanding as to the reasons for the change of
auditors.

233
 C. awareness of the consistency in the application of
PFRS between periods.
D. evaluation of all matters of continuing accounting
significance.

17. A successor auditor would most likely make specific

inquiries of the predecessor auditor regarding
A. specialized accounting principles being used by
the client’s industry.
B. the competency of the client’s internal audit staff.
C. the uncertainty inherent in applying sampling
procedures.
D. disagreements with management as to auditing
procedures.

18. Which of the following statements concerning

materiality thresholds is incorrect?
A. Aggregate materiality thresholds are a function of
the auditor's preliminary judgment concerning
audit risk.
B. In general, the more misstatements the auditor
expects, the higher should be the aggregate
materiality threshold.
C. The smallest aggregate level of errors or fraud
that could be considered material to any of the
financial statements is referred to as a
"materiality threshold."
D. Materiality thresholds may change between the
planning and review stages of the audit. These
changes may be due to quantitative and/or
qualitative factors.

19. Which of the following concepts about materiality is

incorrect?

234
 A. Materiality is directly related to the acceptable
level of detection risk.
B. Materiality does not apply if internal control is
highly effective.
C. Materiality is a matter of professional audit
judgment.
D. Materiality is more closely related to fieldwork
and reporting standards than to general
standards.

20. Which of the following would not be a source of

information about the risk of a potential new audit
client?
A. The predecessor auditor
B. Management
C. The internet
D. The new auditor’s permanent file

21. In comparing management fraud with employee

fraud, the auditor’s risk of failing to discover the
fraud is greater for:
A. employee fraud because of the larger number of
employees in the organization.
B. employee fraud because of the higher crime rate
among blue collar workers.
C. management fraud because of management’s
ability to override existing internal controls.
D. management fraud because managers are
inherently smarter than employees.

22. Management’s integrity affects all of the following

risks except:
A. enterprise risk
B. financial reporting risk
C. engagement risk

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 D. all of the above risks are affected

23. The auditor is most likely to presume that a high risk

of irregularities exists if
A. the client is a multinational company that does
business in numerous foreign countries.
B. the client does business with several related
parties.
C. inadequate segregation of duties places an
employee in a position to perpetrate and conceal
thefts.
D. inadequate employee training results in lengthy
EDP exception reports each month.

24. Which of the following audit risk components may be assessed in

non-quantitative terms?
Inherent Risk Control Risk Detection
Risk
A Yes Yes No
.
B Yes No Yes
.
C No Yes Yes
.
D Yes Yes Yes
.
25. Which of the following combinations of engagement
risk, audit risk, and materiality would lead the auditor
to most audit work?
Engagement Audit Risk Materiality
Risk
A Low High High
.
B Moderate Low Low
.

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 C Low Moderate Low
.
D High High High
.

26. Which of the following conditions justifies an

auditor’s decision of raising the materiality level?
A. Internal control over revenue and receipts cycle is
excellent.
B. Application of analytical procedures reveals a
significant increase in sales revenue in December,
the last month of the fiscal year.
C. Internal control over shipping, billing, and
recording of sales revenue is weak.
D. Study of the business reveals that the client
recently acquired a new company in an unrelated
industry.

27. Which of the following does an auditor least likely

perform in assessing audit risk?
A. Gather audit evidence in support of recorded
transactions.
B. Obtain an understanding of the client's system of
internal control.
C. Understand the economic substance of significant
transactions completed by the client.
D. Understand the entity and the industry in which it
operates.

28. Which type of risk does the management of a

company have the most control over in the short
term?
A. Inherent risk
B. Control risk
C. Detection risk

237
 D. Sufficiency risk

29. In which of the following order would the auditors

perform the following steps?
A. Determine audit risk; assess control risk;
determine detection risk; set materiality.
B. Set materiality; determine audit risk; assess
control risk; determine detection risk.
C. Set materiality; assess control risk; determine
detection risk; determine audit risk.
D. Determine audit risk; set materiality; assess
control risk; determine detection risk.

30. If the results of the auditor's tests of controls induce

the auditor to change the assessed level of control
risk for inventory from 0.2 to 0.4 and audit risk and
inherent risk remain constant, what is the effect on
the acceptable level of detection risk?
A. A change in detection risk cannot be calculated
because audit risk and inherent risk values are
not given.
B. Detection risk would increase from 0.3 to 0.6.
C. Detection risk would decrease from 0.4 to 0.2.
D. Detection risk would not change since audit risk
and inherent risk do not change.

31. Which of the following may cause the management

to intentionally understate profits?
A. Management wants to create "cookie jar"
reserves for a rainy day.
B. The company is under scrutiny by tax authorities.
C. The company is suffering a large loss and wants
to take a "big bath."
D. All of the given choices

238
32. Which of the following is true?
A. Auditors are responsible for detecting all
fraudulent financial reporting.
B. Auditors must specifically consider fraud risk from
overstating liabilities.
C. Auditors must specifically consider fraud risk from
management override of controls.
D. All of them are true

33. Why should the auditor plan more work on individual

accounts as lower acceptable levels of both audit risk
and materiality are established?
A. To find smaller errors
B. To find larger errors
C. To increase the tolerable error in the accounts
D. To decrease the risk of overreliance

34. With respect to errors and fraud, the auditor should

plan to
A. search for errors or fraud that would have a
material effect on the financial statements.
B. discover errors or fraud that would have a
material effect on the financial statements.
C. search for errors that would have a material effect
and for fraud that would have either material or
immaterial effects on the financial statements.
D. search for fraud that would have a material effect
and for errors that would have either material or
immaterial effects on the financial statements.

35. The auditor’s responsibility for identifying "direct-

effect" non-compliance to laws and regulations differs
from their responsibility for detecting
A. errors.

239
 B. indirect-effect non-compliance to laws and
regulations.
C. fraud.
D. management fraud.

36. Which of the following might be considered a "red

flag” that may indicate possible fraud in a large
manufacturing company with several subsidiaries?
A. The existence of a financial subsidiary
B. A consistent record of above average return on
investment for all subsidiaries
C. Complex sales transactions and transfers of funds
between affiliated companies
D. Use of separate bank accounts for payrolls by
each subsidiary

37. Experience has shown that certain conditions in an

organization are symptoms of possible management
fraud. Which of the following conditions would not be
considered an indicator of possible fraud?

A. Managers are regularly assuming subordinates'

duties
B. Managers are dealing in matters outside their
profit center's scope
C. Managers are not complying with corporate
directives and procedures
D. Managers are subject to formal performance
reviews on a regular basis.

38. Warning signs that cause the auditor to question

management integrity must be taken seriously and
pursued vigorously. Which of the following may lead
the auditor to suspect management dishonesty?

240
 A. The president/CEO of the client corporation has
held numerous meetings with the controller for
the purpose of discussing accounting practices
that will maximize reported profits.
B. The client has been named as a defendant in a
product liability suit.
C. The client has experienced a decrease in revenue
from increased import competition.
D. A new statutory regulation making customer
licenses more difficult to obtain may adversely
affect the client's operations.

39. Which of the following methods may be used to

commit fraudulent financial reporting?
A. Overstate revenues
B. Understate liabilities
C. Fail to provide adequate disclosure
D. Each of the given choices can be used to commit
fraudulent financial reporting

40. Which of the following internal control polices, when

absent, would increase the opportunity for fraud?
A. Appropriate segregation of duties or independent
checks
B. Job applicant screening for employees with access
to assets
C. Mandatory vacations for employees with access to
assets
D. The absence of any of the given choices increases
the opportunity for fraud

41. Whom should the auditors contact when they

suspect a fraud?
A. Senior management
B. Expected perpetrators of the fraud

241
 C. Audit committee of the board of directors
D. Either the senior management or the audit
committee

42. Analytical procedures performed in the planning

stage of an audit suggest that several accounts have
unexpected relationships. The results of these
procedures most likely would indicate that:
A. Irregularities exist among the relevant account
balances.
B. Additional tests of details are required.
C. Internal control activities are not operating
effectively.
D. The communication with the audit committee
should be revised.

43. Which of the following statements identifies a

potential weakness when comparing client data with
the industry’?
A. Industry data may not be representative of the
client’s business.
B. Other companies in the industry could use
accounting principles different from what the
client is using.
C. Data bases are comprised of data from thousands
of companies of various sizes, which may limit the
effectiveness of the comparisons.
D. All the given choices are weaknesses.

44. Which of the following statements is correct with

respect to the auditor’s use of analytical procedures?
A. Analytical procedures are time saving procedures
that auditors may employ at their discretion.

242
 B. Analytical procedures are powerful tools that are
required to be used during the planning and
testing phases of the audit.
C. Analytical procedures may be used to identify
misstatements in a client’s accounts.
D. Analytical procedures are required to be used
during the planning and completion phases of the
audit.

45. Which of the following is not an information source

for developing analytical procedures used in the
audit?
A. Relationships among financial statement
elements
B. Relationships between financial and relevant
nonfinancial data
C. Comparison of financial data with anticipated
results (e.g., budgets and forecasts)
D. Comparison of current year financial data with
projections for next year's financial results

46. Which of the following results from analytical

procedures might indicate obsolete inventory?
A. A decline in inventory turnover
B. A decline in days' sales in inventory
C. A decline in the gross margin ratio
D. An increase in operating margin

47. Auditors try to identify predictable relationships when

using analytical procedures. Which of the following
accounts would most likely yield the highest level of
evidence regarding relationships that involve
transactions?
A. Accounts payable
B. Accounts receivable

243
 C. Payroll expense
D. Advertising expense

48. Analytical procedures are performed in the following

order:
A. Calculate predictions and compare them to the
recorded amount; define a significant difference;
develop an expectation; investigate significant
differences.
B. Calculate predictions and compare them to the
recorded amount; investigate significant
differences; define a significant difference;
develop an expectation.
C. Develop an expectation; define a significant
difference; calculate predictions and compare
them to the recorded amount; investigate
significant differences.
D. Develop an expectation; calculate predictions and
compare them to the recorded amount; define a
significant difference; investigate significant
differences.

49. An auditor compares expenses as a percent of sales

to expectations. This is an example of:
A. Ratio analysis
B. Trend analysis
C. Internal control analysis
D. Vertical analysis

50. How is the audit program best described at the

beginning of the audit process?
A. Temporary
B. Conclusive
C. Confirmed
D. Optional

244
51. After discovering that a related-party transaction
exists, the auditor should be aware that the
A. substance of the transaction could be significantly
different from its form.
B. adequacy of disclosure of the transaction is
secondary to its legal form.
C. transaction is assumed to be outside the ordinary
course of business.
D. financial statements should recognize the legal
form of the transaction rather than its substance.

52. In which of the following would the auditor most

likely find information about compensation of
corporate officers?
A. Corporate charter
B. Corporate by-laws
C. Corporate minutes
D. Audit engagement letter

53. The existence of a related-party transaction may be

indicated when another entity
A. sells real estate to the corporation at a price that
is comparable to its appraised value.
B. absorbs the expenses of the corporation.
C. borrows from the corporation at a rate of interest
which equals the current market rate.
D. lends to the corporation at a rate of interest,
which equals the current market rate.

54. An auditor judges an item to be immaterial when

planning an audit. However, the auditor may still
include the item if it is subsequently determined that
A. sufficient number of staff is available.

245
 B. adverse effects related to the item are likely to
occur.
C. related evidence is reliable.
D. miscellaneous income is affected.

55. Which of the following is least likely required in an

audit?
A. Test appropriateness of journal entries and
adjustment
B. Review accounting estimates for biases
C. Evaluate the business rationale for significantly
unusual transactions
D. Make a legal determination of whether fraud has
occurred

56. Of the following procedures, which one is not

considered a part of “obtaining an understanding of
the client’s environment?”
A. Reading trade publications to gain a better
understanding of the client's industry
B. Confirming customer accounts receivable for
existence and valuation
C. Touring the client's manufacturing and
warehousing facilities to gain a clearer
understanding of the entity’s operations
D. Studying the internal controls over cash receipts
and disbursements

57. The element of the audit planning process most likely

to be agreed upon with the client before the
implementation of the audit strategy is the
determination of the
A. timing of inventory observation procedures to be
performed.

246
 B. evidence to be gathered to provide a sufficient
basis for the auditor's opinion.
C. procedures to be undertaken to discover
litigation, claims, and assessments.
D. pending legal matters to be included in the
inquiry of the client's attorney.

58. Which of the following concepts is most useful in

assessing the scope of an auditor's program relating
to various accounts?
A. Attribute sampling
B. Materiality
C. The reliability of information
D. Management fraud

59. With respect to the auditor's planning of a year-end

examination, which of the following statements is
always true?
A. An engagement proposed after the fiscal year
ends should not be accepted.
B. An inventory count must be observed at the
balance sheet date.
C. The client's audit committee should not be told of
the specific audit procedures that will be
performed.
D. It is an acceptable practice to carry out
substantial parts of the examination at interim
dates.

60. Which of the following is not a consideration in the

development of audit programs?
A. Internal control over the recording of plant asset
additions and repairs and maintenance
expenditures is found to be weak.

247
 B. The client constructed a major addition to its
central manufacturing facility during the year
under audit.
C. The client is a private university located in
Southern Philippines.
D. The members of the board of directors are elected
by the stockholders during the annual meeting.

61. An audit program provides a proof that

A. sufficient competent evidential matter is
obtained.
B. the work is adequately planned.
C. there is compliance with generally accepted
standards of reporting.
D. there is a proper study and evaluation of internal
control.

62. The principal reason for developing a written audit

program is to help assure that the
A. audit work is properly supervised.
B. audit work is properly planned and documented.
C. audit report contains only significant findings.
D. work of different auditors is properly coordinated.

63. One of the primary uses of an audit program is to

A. serve as a tool for planning, directing, and
controlling the audit work.
B. document an auditor's understanding of the
internal control.
C. provide for a standardized approach to the audit
engagement.
D. delineate the audit risk accepted by the auditor .

64. An audit program is

248
 A. the detailed plan of audit procedures to be
performed in the course of the audit.
B. an overview of the company and a general plan
for the audit work to be accomplished.
C. a generic document that auditing firms have
developed to lead the process of the audit
through a systematic and logical process.
D. a budget of the time that should be necessary to
complete each phase of the audit procedures.

65. In deciding whether to use the work of internal

auditors, external auditors must evaluate the internal
auditors'
A. objectivity and competence.
B. independence and professionalism.
C. education and certification.
D. age and gender.

66. Which of the following is not true regarding planning

in an electronic environment?
A. The definition of auditing is not changed
B. The purposes of auditing is not changed
C. The procedures used are not changed
D. Auditing standards are not changed

67. For which of the following judgments may an independent auditor

share responsibility with an entity's internal auditor who is assessed
to be both competent and objective?
Assessment of Assessment of
Inherent Risk Control Risk
A Yes Yes
.
B No No
.
C No Yes

249
 .
D No No
.

68. After studying and evaluating a client's existing

internal control, an auditor has concluded that the
policies and procedures are well-designed and
functioning as intended. Under these circumstances,
the auditor would most likely
A. perform further control tests to the extent
outlined in the audit program.
B. determine the control policies and procedures
that should prevent or detect errors and fraud.
C. set acceptable detection risk at a higher level
than would be set under conditions of weak
internal control.
D. set acceptable detection risk at a lower level than
would be set under conditions of weak internal
control.

69. Which of the following matters is generally included

in an auditor’s engagement letter?
A. Limitations of the engagement
B. Factors to be considered in establishing
preliminary judgment about materiality
C. Management’s liability for non-compliance to laws
committed by its employees
D. The auditor’s responsibility to obtain negative
assurance relating to the occurrence of non-
compliance to laws

70. Which of the following factors most likely would lead

a CPA to conclude that a potential audit engagement
should not be accepted?

250
 A. There are significant related party transactions
that management claims occurred in the ordinary
course of business.
B. Internal control activities requiring the
segregation of duties are subject to management
override.
C. Management continues to employ an inefficient
system of information technology to record
financial transactions.
D. It is unlikely that sufficient evidence is available to
support an opinion on the financial statements.

71. Which of the following is an example of fraudulent

financial reporting?
A. The company management falsifies inventory
count tags thereby overstating ending inventory
and understating cost of goods sold.
B. An employee diverts customer payments to his
personal use, concealing his actions by debiting
an expense account, thus overstating expenses.
C. An employee steals inventory and the shrinkage is
recorded in cost of goods sold.
D. An employee borrows tools from the company and
neglects to return them; the cost is reported as a
miscellaneous operating expense.

72. Which of the following statements is accurate about

“fraud risk factors” considered when conducting an
audit?
A. Factors whose presence indicates that fraud
exists.
B. Factors whose presence often have been
observed in circumstances where frauds have
occurred.

251
 C. Factors whose presence will require modification
to planned audit procedures.
D. Factors obtained during the audit which lead to
required communications with the audit
committee.

73. Which of the following is not an example of a likely

adjustment in the auditor’s overall audit approach
when significant risk is found to exist?
A. Apply increased professional skepticism about
material transactions.
B. Increase the assessed level of detection risk.
C. Assign personnel with particular skill to areas of
high risk.
D. Obtain increased evidence about the
appropriateness of management’s selection of
accounting principles.

74. Which of the following conditions identified during

the audit increases the risk of employee fraud?
A. Large amount of cash in the bank.
B. Existence of a mandatory vacation policy for
employees performing key functions.
C. Inventory items of small size, but high value.
D. Presence of reconciling items on a client prepared
year-end proof of cash.

75. Which of the following is not ordinarily considered a

factor indicative of increased financial reporting risk
when an auditor is considering a client’s risk
assessment policies?
A. Fixed monthly salaries for sales personnel
B. Implementation of a new information
system
C. Rapid growth of the organization

252
D. Corporate restructuring

253
 MODULE 5
SUGGESTED ANSWER

PSA-BASED QUESTIONS

AUDIT PLANNING
QUESTIO ANSWER SOURCE SECTION/
N CHOICE REFERENCE PARAGRAPH
NUMBER
1. D PSA 200 Sec 15 & 16
2. D PSA 200 Sec 17
3. A PSA 200 Sec 25
4. A PSA 200 Sec 25
5. A PSA 200 Sec 29
6. B PSA 200 Sec 29 & 30
7. D PSA 200 Sec 29
8. B PSA 200 Sec 29
9. D PSA 200 Sec 31
10. C PSA 200 Sec 31
11. D PSA 200 Sec 31
12. B PSA 200 Sec 31
13. B PSA 200 Sec 29 – 31
14. C PSA 200 Sec 32
15. B PSA 210 Sec 2&5
16. A PFAE Sec 19
17. C PSA 210 Sec 2&5
18. C PSA 210 Sec 5
19. A PSA 210 Sec 5
20. B PSA 210 Sec 5
21. B PSA 210 Sec 6–8
22. D PSA 210 Sec 6–8
23. A PSA 220 Sec 16
(Rev)
24. A PSA 240 Sec 2
25. C PSA 240 Sec 2, 24, 27,

254
 30

255
 MODULE 5
SUGGESTED ANSWER

PSA-BASED QUESTIONS

AUDIT PLANNING
QUESTIO ANSWER SOURCE SECTION/
N CHOICE REFERENCE PARAGRAPH
NUMBER
26. B PSA 240 Sec 5 & 6
(Rev)
27. A PSA 240 Sec 10
28. A PSA 240 Sec 34
29. D PSA 240 Sec 36 – 41
(Rev)
30. C PSA 240 Appdx 1, Sec 2
31. A PSA 250 Sec 18 – 20
32. B PSA 300 Sec 15
(Rev)
33. B PSA 300 Sec 28
34. A PSA 315 Sec 6
35. B PSA 315 Sec 10
36. D PSA 320 Sec 2
37. A PSA 320 Sec 9 & 10
38. B PSA 320 Sec 9 – 11
39. B PSA 330 Sec 4
40. C PSA 520 Sec 2
41. B PSA 520 Sec 8
42. D PSA 520 Sec 8
43. A PSA 315 Sec 6
44. D PSA 315 Sec 4&7
45. D PSA 315 Sec 10
46. D PSA 315 Sec 31 & 32
47. B PSA 315 Sec 9
48. C PSA 315 Sec 108 – 112

256
49. C PSA 330 Sec 5
50. D PSA 330 Sec 4

257
 MODULE 5
SUGGESTED ANSWER

PSA-BASED QUESTIONS

AUDIT PLANNING
QUESTIO ANSWER SOURCE SECTION/
N CHOICE REFERENCE PARAGRAPH
NUMBER
51. C PSA 330 Sec 10 & 11
52. C PSA 330 Sec 18
53. A PSA 330 Sec 18
54. C PSA 315 Sec 3
55. A
56. A
57. B
58. A
59. D
60. D

258
 MODULE 5
SUGGESTED ANSWER

QUIZZERS

AUDIT PLANNING
1. C 21. C 41. D 61. B
2. B 22. D 42. B 62. B
3. D 23. C 43. D 63. A
4. A 24. D 44. D 64. A
5. D 25. B 45. D 65. A
6. A 26. A 46. A 66. C
7. C 27. A 47. C 67. D
8. C 28. C 48. D 68. C
9. D 29. B 49. D 69. A
10. B 30. C 50. A 70. D
11. C 31. D 51. A 71. A
12. D 32. C 52. C 72. B
13. D 33. A 53. B 73. B
14. D 34. B 54. B 74. C
15. D 35. B 55. D 75. A
16. B 36. C 56. B
17. D 37. D 57. A
18. B 38. A 58. B
19. B 39. D 59. D
20. D 40. D 60. D

259