Practice Test 4 – Auditing Theory

Auditing Theory
CPA Reviewer
Practice Test 4
75 Multiple Choice Questions
25 True or False
With Answers and Explanations
(The Financial Statement Audit: Client Acceptance and Planning)

1. In assessing whether to accept a client for an audit engagement, an

auditor should consider the
 
I. Client’s business risk
II. Auditor’s business risk
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II

2. Which of the following factors most likely would cause an auditor to

decline a new audit engagement?
 
A. Concluding that the entity’s management probably lacks integrity.
B. An inability to perform preliminary analytical procedures before
assessing control risk.
C. An inadequate understanding of the entity’s internal control.
D. The close proximity to the end of the entity’s reporting period.
A. PSQC 1 requires a firm (including a sole practitioner) to establish
policies and procedures for the acceptance and continuance of client
relationships and specific engagements, designed to provide
reasonable assurance that it will only accept engagement if is:
Is competent to perform the engagement;
Can comply with relevant ethical requirements; and
Has considered the integrity of the client, and does not have
information to conclude that the entity’s management lacks integrity.
Answer B  is incorrect because the auditor performs analytical
procedures after accepting the engagement.
Answer C  is incorrect because the auditor obtains an understanding of
the entity’s internal control system subsequent to the acceptance of
the engagement.
Answer D  is incorrect because an auditor may accept an engagement
near or after the end of the reporting period.

3. Before accepting an engagement to audit a new client, an auditor is

required to
 
A. Obtain a copy to the client’s financial statements.
B. Prepare a memorandum setting forth the staffing requirements and
documenting the preliminary audit plan.
C. Make inquiries of the predecessor auditor after obtaining the
content of the prospective client.
D. Discuss the management representation letter with the client’s
audit committee.

C. PSA 300 (Planning an Audit of Financial Statements0 states that the

auditor shall undertake the following activities prior to starting an
initial audit:
Performing procedures required PSA 220 (Quality Control for an Audit
of Financial Statements) regarding the acceptance of the client
relationship and the specific audit engagement; and
Communicating with the predecessor auditor, where there has been a
change of auditors, in compliance with relevant ethical requirements.
Answer A  is incorrect because the entity’s annual financial statements
will be prepared after the end of its reporting period and the auditor’s
acceptance of the engagement will likely be prior to that time.
Answers B  and D  are incorrect because the procedures described will
be performed only after the acceptance of the engagement.

4. Which of the following conditions most likely would post the

greatest risk in accepting a new audit engagement?
 
A. There will be a client-imposed scope limitation.
B. The client’s financial reporting system has been in   place for 10
years.
C. The firm will have to hire an expert in one audit area.
D. Staff will need to be rescheduled to cover this new   client.

5. Which of the following circumstances would permit an independent

auditor to accept an engagement after the end of the reporting
period?
 
A. Expectation of the operating effectiveness of controls.
B. Issuance of a disclaimer of opinion as a result of inability to conduct
certain tests required by PSAs due to the timing of the acceptance of  
the engagement.
C. Remedy the limitations resulting from accepting the engagement
after   the end of the reporting period, such as those relating to the  
existence of physical inventory.
D. Receipt of an assertion from the predecessor auditor that the entity
will be able to continue as a going concern.
C. Prior to accepting a proposal audit engagement subsequent to the
end of the entity’s reporting period, the audit should determine
whether circumstances permit an audit in accordance with PSAs and
expression of an unmodified opinion. Otherwise, the auditor should
discuss with the prospective client the possibility of rendering a
qualified opinion or a disclaimer of opinion. However, in some cases,
the auditor may remedy the audit limitations such as by observing
another physical count of inventories.

Answer A  is incorrect because sufficient appropriate evidence

regarding the operating effectiveness of the entity’s internal control
during the year should be available after year-end.

Answer B  is incorrect because a disclaimer of opinion is appropriate

only if the auditor cannot resolve an issue by performing alternative
procedures.

Answer D  is incorrect because there is no need to obtain

representations regarding the prospective client’s ability to continue
as a going concern from the predecessor auditor.

6. In an audit based on Philippine Standards on Auditing (PSAs), a

successor auditor would normally become satisfied with opening
balances by
 
A. Performing analytic review procedures.
B. Reviewing the predecessor’s working papers.
C. Auditing the previous year’s working papers.
D. Interviewing client personnel.

B
7. A predecessor withdrew from the engagement after discovering
that a client’s financial statements are materially misstated that it
would not revise. If asked by the successor auditor about the
termination of the engagement, the predecessor should
 
A. Suggest that the successor auditor should obtain the client’s
consent   to discuss the reasons.
B. Indicate that there was a misunderstanding.
C. State that the audit revealed material misstatement that the client  
would not revise.
D. Suggest that the successor auditor ask the client.

8. Which of the following is not correct regarding the communications

between successor/incoming and predecessor/previous auditors?
 
A. The burden of initiating the communication rests with the
predecessor auditor.
B. The burden of initiating the communication rests with the successor
auditor.
C. The predecessor auditor may choose to provide a limited response
to a successor auditor.
D. The predecessor auditor must receive his/her former client’s
permission prior to client information to the auditor.

9. The auditor may accept or continue an audit engagement only

when the basis upon which it is to be performed has been agreed,
through
 
I. Establishing whether the preconditions for an audit are present.
II. Confirming that there is a common understanding between the
auditor   and management and, where appropriate, those charged
with   governance of the terms of the audit engagement.
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II

C. As defined in PSA 210 (Agreeing the Terms of Audit

Engagement), “preconditions for an audit” refers to:
A) The use by management of an acceptable financial reporting
framework in the preparation of the financial statements; and
B) The agreement of management and, where appropriate those
charged with governance to the premise on which an audit is
concluded.

The auditor establishes whether the preconditions for an audit are

present by:

1) Determining whether the financial reporting framework to be

applied in the preparation of the financial statements is acceptable;
and
2) Obtaining management’s agreement that it acknowledges and
understands its responsibilities that are fundamental to the conduct of
an audit in accordance with PSAs.

10. An audit is conducted on the premise that management and,

where appropriate, those charged with governance, have acknowledge
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?
 
A. The preparation of financial statements in accordance with relevant
pronouncements issued by the   AASC.
B. The establishment and maintenance of an adequate internal control
system that is necessary to   enable the preparation of financial
statements that are free from material misstatements,   whether due to
fraud or error.
C. To provide the auditor with access to all information that is relevant
to the preparation of the   financial statements such as records,
documentation, and other matters.
D. To provide the auditor with unrestricted access to persons within
the entity from which the auditor   determines it necessary to obtain
audit evidence.

 
A. Management is responsible for the preparation of the financial
statements in accordance with the applicable financial reporting
framework, including where relevant their fair presentation.

11. The auditor shall agree the terms of the audit engagement with
management or those charged with governance, as appropriate. The
agreed terms shall be recorded in a/an
 
A. Engagement letter
B. Letter of audit inquiry
C. Management representation letter
D. Confirmation letter

A. The standard states that it is in the interests of both the entity and
the auditor that the auditor sends an audit engagement letter before
the commencement of the audit to help avoid misunderstandings with
respect to the audit.
The engagement letter shall include:

A) The objective and scope of the audit of the financial statements;

B) The responsibilities of the auditor;
C) The responsibilities of the of management;
D) Identification of the applicable financial reporting framework for
the preparation of the financial statements; and
E) Reference to the expected form and content of any reports to be
issued by the auditor and a statement that there may be
circumstances in which a report may differ from its expected form and
content.

12. The following matters are generally included in an auditor’s

engagement letter, except
 
A. The factors to be considered in determining the overall materiality.
B. The fact that because of the test nature and other inherent
limitations   of an audit, together with the inherent limitations of
internal control,   there is an unavoidable risk that even some material
misstatements   may remain undiscovered.
C. The scope of the audit.
D. Management’s responsibility for the financial statements.

13. The following are usually included in an auditor’s engagement

letter, except
 
A. List of audit procedures to be used in inventory   observation.
B. The financial statements are the responsibility of the   company’s
management.
C. A reference to PFRS.
D. A reference to PSAs.

14. Which of the following statements would least likely appear in an

auditor’s engagement letter?
 
A. Our audit will be made with the objective of our expressing an
opinion on the   financial statements.
B. We remind you that the responsibility for the preparation of
financial statements   including adequate disclosure is that of the
management of the entity.
C. After performing our preliminary analytical procedures, we will
discuss with you   the other procedures we consider necessary to
complete the engagement.
D. Our fees, which will be billed as work progresses, are based on the
time required   by the individuals assigned to the engagement plus
out-of-pocket expenses.

15. An auditor is required to establish an understanding with a client

regarding the services to be performed for each engagement. This
understanding generally includes
 
A. The auditor’s responsibility to apply the concept of materiality in
planning and   performing the audit.
B. Management’s responsibility for providing the auditor with an
assessment of the   risk of material misstatement due to fraud.
C. 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.
D. Management’s responsibility for errors and the illegal activities of
employees that   may cause material misstatement.

C. An auditor’s engagement letter shall include, among other things,

the auditor’s responsibility to communicate to those charged with
governance of the client significant internal control deficiencies that
may be discovered during the audit.

Answer A  is incorrect because determining materiality in planning and

performing an audit is a responsibility that the auditor is not required
to share with the client.
Answer B  is incorrect because the auditor assesses the risk of material
misstatement.
Answer D  is incorrect because management is not responsible for the
errors and illegal activities of employees.

16. An auditor’s engagement letter most likely will include

A. A request for permission to contact the client’s lawyer for assistance
in   identifying litigation, claims, and assessments.
B. A reminder that management is responsible for illegal acts
committed   by employees.
C. The auditor’s preliminary assessment of the risk factors relating to  
misstatements arising from fraudulent financial reporting.
D. Management’s acknowledgment of its responsibility for such
internal   control as it determines is necessary to enable the
preparation of   financial statements that are free from material
misstatement.

D. Among the matters addressed in an engagement letter is

management’s responsibility for:

A) The preparation and fair preparation of the financial statements in

accordance with Philippine Financial Reporting Standards; and
B) Such internal control as it determines is necessary to enable the
preparation of financial statements that are free from material
misstatement, whether due to fraud or error.

Answer A  is incorrect because management is responsible for

adopting policies and procedures to identify, evaluate, and account for
litigation, claims, and assessments.

Answer B  is incorrect because management is responsible for ensuring

that the entity’s operations are conducted in accordance with laws and
regulations. However, it is not responsible for illegal acts of employees
that are unrelated to the entity’s business activity.
Answer C  is incorrect because an auditor submits an engagement
letter before the commencement of the audit. Prior to performing
procedures, the auditor does not assess the risk factors relating to
misstatements that may arise from fraudulent financial reporting.

17. The auditor of a parent entity is also the auditor of its component.
Which of the following factors may influence the auditor’s decision
whether to send a separate engagement letter to the entity’s
component?
 
A. Whether a separate auditor’s report is to be issued on the
component.
B. The component’s management does not accept its responsibilities
that   are fundamental to the conduct of an audit.
C. The financial reporting framework used by the component is  
unacceptable.
D. The preconditions for an audit of the component’s financial  
statements are not present.
A. The following factors may influence the auditor’s decision whether
to send a separate audit engagement letter to the component:
1) Who appoints the component auditor;
2) Whether a separate auditor’s report is to be issued on the
component;
3) Legal requirements in relation to audit appointments;
4) Degree of ownership by parent; and
5) Degree of independence of the component management from the
parent entity.

18. On recurring audits, the auditor may decide not to send a new
engagement letter each period. Which of the following factors may
make it appropriate to send a new engagement letter?
  A B C D

Any revised or special terms of the audit

Yes No Yes No
engagement

A recent change of senior management Yes No No No

A change in legal or regulatory

Yes Yes Yes Yes
requirements

A significant change in nature or size of the

Yes Yes Yes Yes
entity’s business

A. According to the standard, the following factors may make it

appropriate to revise the terms of the audit engagement or to remind
the entity of existing terms:
-Any indication that the entity misunderstands the objective and
scope of   the audit.
-Any revised or special terms of the audit engagement.
-A recent change of senior management.
-A significant change in ownership.
-A significant change in nature or size of the entity’s business.
-A change in legal or regulatory requirements.
-A change in the preparation of the financial data statements.

19. The auditor shall not agree to a request from the entity to change
the terms of the audit engagement or to change the audit
engagement to an engagement that conveys a lower level of
assurance when there is no reasonable justification for doing so.
Which of the following may be considered reasonable justifications for
the change in the audit engagement?
 
I. A change in circumstances affecting the need for the service.
II. A misunderstanding as to the nature of an audit as originally
requested.
III. A restriction on the scope of the engagement, whether imposed by
management or caused by   other circumstances.
 
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III

A. PSA 210 states that a change in circumstances that affects the

entity’s requirements or a misunderstanding concerning the nature of
the service originally requested may be considered a reasonable basis
for requesting a change in the audit engagement.

A restriction on the scope of the audit would not be considered a

reasonable justification for the change. For example, a change would
not be considered reasonable if the auditor is unable to obtain
sufficient appropriate audit evidence regarding receivables and client
requests that the audit engagement be changed to a review
engagement to avoid a qualified opinion or a disclaimer of opinion.
20. Before the completion of the audit engagement, an auditor is
requested to change the engagement to one that provides a lower
level of assurance. If the auditor concludes that there is a reasonable
justification for the change in engagement, the report to be issued
would be
 
A. Be that appropriate for the revised terms of engagement.
B. Include reference to the original engagement.
C. Include reference to any procedures that may have been performed
in   the original engagement.
D. Not include reference to any procedures that may have been  
performed, particularly when the new engagement is to undertake  
agreed-upon procedures.

A. PSA 210 states that if the auditor concludes that there is reasonable
justification to change the engagement the if the audit work
performed complies with the PSAs applicable to the changed
engagement, the report issued would be that appropriate for the
revised terms of engagement.  In order to avoid confusing the reader,
the report would not include reference to:

a) The original engagement; or

b) Any procedures that may have been performed in the original
engagement, except  where the engagement is changed to an
engagement to undertake agreed-upon procedures and thus,
reference to the procedures performed is a normal part of the report.

21. 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
 
A. Insist on continuing the original engagement.
B. Express a qualified opinion.
C. Express an adverse opinion.
D. Withdraw from the engagement.

D. Under PSA 210, 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.

22. Planning an audit involves

 
I. Establishing the overall audit strategy for the engagement.
II. Developing an audit plan.
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II

23. Which of the following activities should be performed by the

auditor at the beginning of the current audit engagement?
 
I. Perform procedures regarding the continuance of the client
relationship and the specific audit engagement.
II. Evaluate compliance with relevant ethical requirements, including
independence.
III. Establish an understanding of the terms of the engagement.
 
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III

24. Initial audit planning involves the following matters, except

 
A. Identifying the client’s reason for the engagement.
B. Schedule engagement staff and auditor’s experts.
C. Develop an overall audit strategy.
D. Request that bank balances be confirmed.

25. Adequate planning helps to ensure that

  A B C D

Appropriate attention is devoted to

No Yes Yes No
important areas of the audit

Potential problems are identified and

Yes Yes No No
resolved on a timely basis

The audit engagement is properly organized

Yes Yes No No
and managed

B. The benefits of adequate planning include the following:

-Helping the auditor to devote appropriate attention to important

areas of the audit.
-Helping the auditor identify and resolve potential problems on a
timely basis.
-Helping the auditor properly organize and manage the audit
engagement so that it is   performed in an effective and efficient
manner.
-Assisting in the selection of engagement team members with
appropriate levels of   capabilities and competence to respond to
anticipated risks, and the proper   assignment of work to them.
-Facilitating the direction and supervision of engagement team
members and the   review of their work.
-Assisting, where applicable, in coordination of work done by auditors
of components   and experts.

26. Which of the following statements concerning audit planning

is incorrect?
 
A. Planning is discrete phase of an audit.
B. Planning is a continual and iterative process.
C. In a recurring audit, planning often begins shortly after (or in  
connection with) the completion of the previous audit and continues  
until the completion of the current audit engagement.
D. In planning an audit, the auditor considers the timing of certain  
planning activities and audit procedures that are to be completed  
prior to the performance of further audit procedures.

A. The standard states, “Planning is not a discrete phase of an audit,

but rather a continual and iterative process that begins shortly after
(or in connection with) the completion of the previous audit and
continues until the completion of the current audit engagement.
Planning, however, includes consideration of the timing of certain
activities and audit procedures that need to be completed prior to the
performance of further audit procedures.”

27. 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.

D. The auditor is required to have or obtain a sufficient knowledge of

the client’s business and industry to identify and understand the
events, transactions, and practices that, in the auditor’s judgment, may
have a significant effect on the financial statements.

28. Which of the following is the least likely procedure to be formed in

planning a financial statement audit?
 
A. Selecting a sample of sales invoices for comparison with shipping
documents.
B. Coordinating the assistance of entity personnel in data preparation.
C. Reading the current year’s interim financial statements.
D. Discussing the matters that may affect the audit with firm personnel
responsible for non-audit services to the entity.

A. Selecting a sample of sales invoices for comparison with shipping

documents is a substantive test procedure. Substantive tests are
performed to accumulate sufficient appropriate audit evidence, not to
plan the audit.
Answers B, C,  and D  are planning procedures.

29. The establishment of an overall audit strategy involves

 
I. Determining the characteristics of the engagement that define its
scope.
II. Ascertain the reporting objectives of the engagement to plan the
timing of the   audit and the nature of the communications required.
III. Considering the important factors that will determine the focus of
the engagement   team’s effort.
 
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III

 
D. PSA 300 (Planning an Audit of Financial Statements) requires the
auditor to 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 is required to:
A) Identify the characteristics of the engagement that define its scope;
B) Ascertain the reporting objectives of the engagement to plan the
timing of the audit   and the nature of the communications required;
C) Consider the factors that, in the auditor’s professional judgment,
are significant in   directing the engagement team’s efforts;
D) Consider the results of preliminary engagement activities and,
where applicable,   whether knowledge gained on other engagements
performed by the   engagement partner for the entity is relevant; and
D) Ascertain the nature, timing and extent of resources necessary to
perform the   engagement.

30. Which of the following should be included in the audit plan?

 
I. The nature, timing and extent of planned risk assessment
procedures.
II. The nature, timing and extent of planned further audit procedures
at the assertion level.
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II

C. The audit plan shall include a description of:

A) The nature, timing and extent of planned risk   assessment

procedures, as determined under PSA 315   (Identifying and Assessing
the Risks of Material   Misstatement through Understanding the Entity
and   its Environment)
B) The nature, timing and extent of planned further audit   procedures
at the assertion level, as determined under PSA   330 (The Auditor’s
Response to Assessed Risks).

31. Which of the following matters would an auditor least likely

consider when setting the direction of the audit?
 
A. The selection of the engagement team and the assignment of audit
work   to the team members.
B. The engagement budget which includes consideration of the  
appropriate amount of time to allot for areas   where there may   be
higher risks of material misstatement.
C. The availability of client personnel and data.
D. The manner in which the auditor emphasizes to engagement team  
members the need to maintain a   questioning mind and to exercise  
professional skepticism in the gathering and evaluation of audit
evidence.

C. The availability of client personnel and data s a matter to consider

when establishing the scope  of the audit.
32. Which of the following matters would an auditor most likely
consider when establishing the scope of the audit?
 
A. The expected audit coverage, including the number and locations of
the entity’s components to be included.
B. The entity’s timetable for reporting, such as at interim and final
stages.
C. The discussion with the entity’s management concerning the  
communications on the status of audit work throughout the  
engagement and the expected deliverables resulting from the audit  
procedures.
D. Audit areas where there is a higher risk of material misstatement.

A. Answers B  and C  are matters to consider when determining the

reporting objectives of the engagement, the timing of the audit, and
the nature of communications required.
Answer D is a matter to consider when setting the director of the
audit.

33. In the planning stage of an audit engagement, the auditor is

required to perform audit procedures to obtain an understanding of
the entity and its environment, including its internal control. These
procedures are called
 
A. Risk assessment procedures
B. Substantive tests
C. Tests of controls
D. Dual-purpose tests

A. The audit procedures to obtain an understanding of the entity and

its environment, including its internal control are referred to as “risk
assessment procedures” because some of the information obtained
through these procedures may be used as audit evidence to support
assessments of the risks of material misstatement.

34. In planning the audit engagement, the auditor should consider

each of the following, except
 
A. The type of opinion that is likely to be expressed.
B. The entity’s accounting policies and procedures.
C. Matters relating to the entity’s policies and procedures.
D. Materiality level and audit risk.

A. The nature of the report expected to be issued (e.g., a report on

consolidated financial statements) should be considered in planning
an audit engagement. The type  of opinion to be rendered is
determined after the performance of audit procedures.

35. Audit programs are modified to suit the circumstances of particular

engagements. A complete audit program usually should be developed
 
A. When the engagement letter is prepared.
B. After obtaining an understanding of the control environment and  
control activities component of the entity’s internal control.
C. After the auditor has obtained an understanding of the entity and
its   environment, including its internal control and assessed the risks
of   material misstatement.
D. Prior to beginning the actual audit work.

C. Only after obtaining knowledge of the entity and its environment,

including its internal control and assessing the risks of material
misstatement can the auditor determine the nature, timing, and extent
of substantive tests of financial statement assertions.
36. In designing written audit programs, an auditor should establish
specific audit objectives that relate primarily to the
 
A. Selected audit techniques.
B. Cost-benefit of gathering audit evidence.
C. Timing of audit procedures.
D. Financial statement assertions.

C. Only after obtaining knowledge of the entity and its environment,

including its internal control and assessing the risks of material
misstatement can the auditor determine the nature, timing, and extent
of substantive tests of financial statement assertions.

37. An audit program should be designed for each individual audit

and should incorporate steps and procedures to
 
A. Detect and eliminate fraud of any type.
B. Gather sufficient amount of management information   available.
C. Provide assurance that the objectives of the audit are   satisfied.
D. Ensure that only material items are audited.

C. A written audit program sets forth, in reasonable detail, the specific
audit procedures that in the auditor’s judgment are necessary to
satisfy the specific audit objectives.

38. Which of the following is an aspect of scheduling and controlling

the audit engagement?
 
A. Including in the engagement letter an estimate of the minimum and
maximum audit fee.
B. Writing a conclusion in individual working papers indicating how
the results of the audit will affect the auditor’s report.
C. Performing audit work only after the entity’s books have been
closed for the period under audit.
D. Including in the audit program a column for budgeted and actual
time.

D. The audit program/plan serves as a set of instruction to assistants

involved in the audit and as a means to control and record the proper
execution of the work.
By including a column for estimated and actual time for each audit
step, the audit program can be a useful tool for controlling and
scheduling the audit work.

39. In connection with the planning phase of an audit engagement,

which of the following statements is always correct?
 
A. Final staffing decisions must be made prior to completion of the  
planning stage.
B. Observation of inventory count should be performed at year-end.
C. A portion of the audit of a continuing audit client can be performed
at   interim dates.
D. An engagement should not be accepted after the client’s financial  
year-end.

40. The auditor shall undertake which of the following activities prior
to starting an initial audit?
 
I. Performing procedures required by PSA 220 (Quality Control for an
Audit of Financial Statements) regarding the acceptance of the client
relationship and the   specific audit engagement.
II. Communicating with the predecessor auditor, where there has been
a change of auditors, in compliance with relevant ethical requirements.
 
A. I only
B. II only
C. Either I or II
D. Both I and II

41. Before accepting an audit engagement, a proposed

(successor/incoming) auditor should make inquiries of the previous
(predecessor) auditor regarding the previous auditors
 
A. Evaluation of all matters of continuing accounting significance.
B. Understanding as to the reasons for the change of auditors.
C. Awareness of the consistency in the application of PAS/PFRS
between   period.
D. Opinion on any subsequent events occurring since the previous  
auditor’s report was issued.

B. The standard requires the proposed auditor to communicate

directly with the previous auditor before accepting the engagement.
The proposed auditor should initiate the communication although
both must obtain client permission to communicate. The proposed
auditor should inquire about reasons for the change in auditors,
disagreements with managements concerning accounting principles
and auditing procedures, and facts bearing on the integrity of the
entity’s management.

42. The auditor is required to determine three different levels of

materiality: (1) materiality for the financial statements as a whole, (2)
performance materiality, and (3)
 
A. Overall materiality
B. Planning materiality
C. General materiality
D. Specific materiality

D. The auditor is required to determine three different levels of

materiality. These are:
A) Materiality for the financial statements as a whole (also   called
overall materiality, general materiality, or tolerable   misstatement)
B) Performance materiality (also called planning materiality or  
scoping materiality)
C) Materiality applied to specific classes of transactions, account  
balances or disclosures (also called specific materiality or   individual
materiality)

43. What materiality level would be considered by the auditor to

determine whether the proposed adjustments are significant or not?
 
A. Overall materiality
B. Scoping materiality
C. Specific materiality
D. Performance materiality

A. AASC Bulleting, Series 001 of 2010 states, “Materiality for the

financial statements as a whole (hereinafter referred to as the “overall
materiality”) is the materiality determined at the overall financial
statement level. This materiality level helps the auditor determine
whether the proposed audit adjustments are significant or not. If the
audit adjustments exceed this level, the auditor may need to adjust the
financial statements.”

44. What materiality level is used by the auditor in determining line

items in the financial statements are to be tested?
 
A. Overall materiality
B. Performance materiality
C. Specific materiality
D. Individual materiality

B. Performance materiality, calculated as a certain percentage of

overall materiality, is used in scoping of financial statement line items
to be tested by the auditor. This will ensure that significant accounts in
the financial statements are covered by audit testing.

45.   is the amount set by the auditor for particular classes of

transactions, account balances or disclosures for which misstatements,
well though lower than overall materiality could reasonably be
expected to influence the economic decisions of users of the financial
statements.
 
A. Performance materiality
B. Planning materiality
C. Specific materiality
D. General materiality

46. Which of the required materiality levels is calculated by multiplying

a certain percentage by the appropriate benchmark which is either an
element or component of an entity’s financial statements?
 
A. Overall materiality
B. Planning materiality
C. Scoping materiality
D. Specific materiality
A

47. Which of the following factors are normally considered by the

auditor in determining the appropriate benchmark for the purpose of
calculating overall materiality?
 
I. Components of the entity’s financial statements
II. Laws and regulations
III. Nature of the entity
 
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III

D. The following factors are normally considered in choosing the

appropriate benchmark:
-Components if the entity’s financial statements
-Focus of the users of the financial statements
-Nature of the entity
-Ownership structure of the entity
-Volatility of the benchmark identified
-Laws and regulations (e.g., SEC)

48. Which of the following statements concerning materiality is not

correct?
 
A. When establishing the overall audit strategy, the auditor shall
determine materiality for the financial statements as a whole.
B. If, in the specific circumstances of the entity, there is one or more
particular classes   of transactions, account balances or disclosures for
which misstatements of lesser   amounts than materiality for the
financial statements as a whole could   reasonably be   expected to
influence the economic decisions of users taken on the basis of the
financial   statements, the auditor shall also determine the materiality
level or levels to those   particular classes of transactions, account
balances or disclosures.
C. Determining materiality involves the exercise of professional
judgment.
D. The materiality level for the financial statements as a whole
determined in the planning   stage of the audit should not be affected
by changes in the circumstances of the   engagement.

D. PSA 320 (Materiality in Planning and Performing an Audit) states

that materiality for the financial statements as a whole (and, if
applicable, the materiality level or levels for particular classes of
transactions, account balances or disclosures) may need to be revised
as a result of:

-A change in circumstances that occurred during the audit (e.g., a  

decision to dispose of a major part of the entity’s business);

-New information; or

-A change in the auditor’s understanding of the entity and its  

operations as a result of performing further audit procedures.

49. Which of the following would an auditor most likely use in

determining a preliminary judgment about materiality?
 
A. The contest of the management representation letter.
B. The anticipated sample size of the planned substantive   tests.
C. The entity’s annualized interim financial statements.
D. The results of internal control questionnaire.
C. The measurement of a preliminary materiality level usually relates to
an annual figure (e.g., net income).

50. An auditor shall consider materiality when

 
I. Determining the nature, timing, and extent of audit   procedures.
II. Evaluating the effect of misstatements.
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II

C. The auditor considers materiality when determining the nature,

timing, and extent of audit procedures and evaluating the effect of
misstatements.

51. It is an appraisal activity established within an entity. Its functions

include, among other things, examining, evaluating, and monitoring
the adequacy and effectiveness of the accounting and internal control
systems.
 
A. External auditing
B. Internal auditing
C. Governmental auditing
D. Internal control

52. Which is not a similarity between and internal auditors?

 
A. Both consider materiality and risk in their work.
B. Both use similar methodologies in performing their work.
C. Both must be competent.
D. Both must be independent of the company.

53. The external auditor should obtain a sufficient understanding of

the internal audit function because
 
A. The understanding of the internal audit function is an important
substantive test to   be performed by the external auditor.
B. The audit programs, working papers, and reports of internal
auditors may often be   used as a substitute for the work of the
external auditor’s staff.
C. The procedures performed by the internal audit staff may eliminate
the external   auditor’s need for considering internal control.
D. The work performed by internal auditors may be a factor in
determining the   nature, timing, and extent of the external auditor’s
procedures.

D. The standard requires the external auditor to obtain a sufficient

understanding of internal audit activities to identify and assess the
risks of material misstatement in the financial statements and to
design and perform further audit procedures. Thus, an internal audit
function is one of many factors that influence the nature, timing, and
extent of the external auditor’s procedures.

54. Internal auditing can affect the scope of the external auditor’s
audit of financial statements by
 
A. Decreasing the external auditor’s need to perform detailed   tests.
B. Eliminating the need to observe the physical inventory taking.
C. Allowing the external auditor to limit his/her audit to the  
performance of substantive test procedures.
D. Limiting direct testing by the external auditor to management  
assertions not directly tested by internal auditing.

55. Which of the following is an incorrect statement concerning the

relationship of the internal auditor and the scope of the external audit
of an entity’s financial statements?
 
A. The external auditor is not required to give consideration to the
internal audit   function beyond obtaining a sufficient understanding
to identify and assess the   risks of material misstatement of the
financial statements and to design and   perform further audit
procedures.
B. The internal auditors may determine the extent to which audit
procedures should   be employed by the external auditor.
C.  Under certain circumstances, the internal auditors may assist the
external auditor   in performing substantive tests and tests of controls.
D. The nature, timing, and extent of the external auditor’s substantive
tests may be   affected by the work of internal auditors.

B. The standard categorically states that the external auditor has sole
responsibility for the audit opinion expressed, and that responsibility is
not reduced by any use made of internal auditing. All judgments
relating to the audit of an entity’s financial statements are those of the
external auditor.

56. In determining whether the work of the internal auditors is likely to

be adequate for purposes of the audit, the external auditor shall
evacuate the internal auditor’s
 
A. Efficiency and experience
B. Independence and review skills
C. Training and supervisory skills
D. Competence and objectivity

D. The external auditor shall evaluate:

A) The objectivity of the internal audit function;

B) The technical competence of the internal auditors;
C) Whether the works of the internal auditors is likely to   be carried
out with due professional care; and
D) Whether there is likely to be effective communication   between the
internal auditors and the external   auditor.

57. In assessing the technical competence of an internal auditor, an

external auditor most likely would obtain information about the
 
A. Quality of working paper documentation, reports, and
recommendations.
B. Organizational level to which the internal auditor reports.
C. Influence of management on the internal auditor reports.
D. Influence of management on the internal auditor’s duties.
E. Entity’s commitment to integrity and ethical values.

A. Is assessing the competence of an internal auditor, the external

auditor should consider factors, such as the following:

-Educational level and professional experience

-Professional certification and continuing education
-Audit policies, programs, and procedure
-Audit policies, programs, and procedures
-Supervision and review of the internal auditor’s activities.
-Departmental practices regarding assignments
-Quality of working paper documentation, reports, and
recommendations
-Evaluation of the internal auditor’s performance
-Answers B, C,  and D  are incorrect because they all relate
to objectivity rather   than technical competence.

58. Which of the following is a false statement about the use of the

internal auditor’s work by the external auditor?
 
A. The PSAs do not allow the external auditor to use the work of the  
internal auditor.
B. PSAs do not allow the external auditor to substitute the work of the
internal auditor for the work of the external auditor in critical
judgments.
C. The PSAs state that, when specific work of the internal auditor is to
be used, it   should be evaluated and tested.
D. PSAs state that, when considering whether to use the work of the
internal   auditor, the external auditor should consider the internal
auditor’s   competence and objectivity.

59. The coordination of activities between internal and external

auditors
 
A. Eliminates duplication of audit reports.
B. Includes the exchange of audit reports and management   letters.
C. Prevents external auditors from having access to the   programs
used by internal auditors.
D. Prohibits the internal auditor from using the same audit  
techniques as external auditors and vice versa.
B. Coordination of internal and external audit efforts helps to ensure
adequate audit coverage and to minimize duplication of audit efforts.
Coordination involves:

-Meetings at appropriate intervals during the period to   discuss

matters of mutual interest.
-Access to each other’s audit programs and working   papers.
-Exchange of audit reports and management letters.

60. Which of the following are included in the activities of the internal
audit function?
 
I. Monitoring of internal control.
II. Examination of financial and operating information.
III. Review of operating activities.
 
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III

D. The activities of the internal audit function may include one or

more of the following:

-Monitoring of internal control.

-Examination of financial and operating information.
-Review of operating activities.
-Review of compliance with laws and regulations.
-Risk management.
-Governance

61.    is an individual or organization possessing expertise in a field

other than accounting or auditing, whose work in that field is used by
the auditor to assist the auditor in obtaining sufficient appropriate
audit evidence.
 
A. Auditor’s expert
B. Management’s expert
C. Expert
D. Specialist

62.   is an individual or organization possessing expertise in a field

other than accounting or auditing, whose work in that field is used by
the entity to assist the entity in preparing the financial statements.
 
A. Auditor’s expert
B. Management’s expert
C. Expert
D. Specialist

63. When planning to use the work of an expert, the auditor should
evaluate the expert’s
 
I. Professional competence
II. Objectivity
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II
C

64. Which of the statements is correct concerning the auditor’s use of

the work of an expert?
 
A. The auditor is required to perform substantive test procedures to  
verify the expert’s assumptions and findings.
B. The auditor should obtain an understanding of the methods and  
assumptions used by the expert.
C. The entity should not have an understanding of the nature of work
to   be performed by the expert.
D. The expert should not have an understanding of the auditor’s  
corroborative use of the expert’s findings.

B. The expert is responsible for the appropriateness and

reasonableness of assumptions and methods used. Because the
auditor does not have the same expertise, he/she is not in the position
to challenge the expert’s methods and assumptions. However, the
standard states that the auditor will need to obtain an understanding
of the assumptions and methods used and to consider his/her
knowledge of the entity’s business and the results of other procedures.

Answer A  is incorrect because, if the expert’s findings corroborate the

financial statement assertions being considered, the auditor may
reasonably conclude that sufficient appropriate evidence has been
obtained.

Answers C  and D  are incorrect because the auditor, the entity, and the
expert should have an understanding about the nature, scope, and
objective of the work to be performed.
65. Which of the following is not an expert upon whose work an
auditor may rely?
 
A. An actuary.
B. An individual with expertise in complex modeling for   the purpose
of valuing financial instruments.
C. An expert in taxation law.
D. An individual with expertise in applying methods of   accounting for
deferred income tax.

66. If the results of the expert’s work do not provide sufficient

appropriate audit evidence or are not consistent with other audit
evidence, the auditor should

A. Report the matter to the appropriate regulatory agency of   the

government.
B. Resolve the matter.
C. Withdraw from the engagement.
D. Express an unmodified opinion with reference to the work of   the
expert.

B. If the results of the expert’s work do not provide sufficient

appropriate audit evidence or are not consistent with other audit
evidence, the auditor should resolve the matter.  The auditor may need
to discuss the matter with the entity and the expert, apply additional
audit procedures, possibly engage another expert, or modify the
auditor’s report.

67. When issuing an unmodified auditor’s report, the auditor

 
A. May refer to the work of an expert.
B. Should refer to the work of an expert to indicate a   division of
responsibility.
C. Should include in the auditor’s report the identity of   the expert
and the extent of the expert’s involvement.
D. Should not refer to the expert’s work.

D. The standard prohibits the auditor to refer to the expert’s work

when issuing an unmodified auditor’s report because such a reference
might be misunderstood to be a qualification of the auditor’s opinion
or a division of responsibility, neither of which is intended.

68. Is using the work of an expert, an auditor referred to the expert’s

findings in the auditor’s report. This is an appropriate reporting
practice if the
 
A. Auditor, as a result of the expert’s work, decides to indicate a
division of responsibility with the expert.
B. Expert is aware that his/her work will be used to evaluate the
assertions in the financial statements.
C. Auditor, as a result of the expert’s work, issues a report that
contains a modified opinion.
D. Auditor, as a result of the expert’s work, adds an emphasis-of-
matter paragraph his/her unmodified auditor’s report.

C. An auditor shall not refer to the expert’s work in an auditor’s report
containing an unmodified opinion. However, if as a result of the
expert’s work, the auditor decides to express a modified opinion, it
may be appropriate—in explaining the nature of the modification—to
refer to or describe the expert’s work.

69. As used in PSA 600, Special Consideration – Audits of Group

Financial Statements (Including the Work of Component Auditors),    is
an entity or business activity for which group or component
management prepares financial information that should be included in
the group financial statements.
 
A. Component
B. Group
C. Significant component
D. Group management

70. As used in PSA 600, financial statements that include the financial
information of more than one component are called
 
A. Component financial statements
B. Group financial statements
C. Consolidated financial statements
D. Common financial statements

71. The    is the partner or other person in the firm who is responsible
for the group audit engagement and its performance, and for the
auditor’s report on the group financial statements that is issued on
behalf of the firm.
 
A. Engagement partner
B. Component engagement partner
C. Principal auditor
D. Group engagement partner
D

72. The group engagement team shall obtain an understanding that is

sufficient to
 
I. Confirm or revise its initial identification of components that are
likely to be significant.
II. Assess the risks of material misstatement of the group financial
statements, whether due to fraud or error.
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II

73. If the group engagement team plans to request a component

auditor to perform work on the financial information of a component,
the group engagement team shall obtain an understanding of
 
I. Whether the component auditor understands and will comply with
the ethical requirements that are relevant to the group audit and, in
particular, is independent.
II. The component auditor’s professional competence.
 
A. I only
B. II only
C. Both I and II
D. Neither I nor II
C

74. Which of the following statements concerning group audits

is incorrect?
 
A. The group engagement team has the responsibility to establish an  
overall group audit strategy and audit plan.
B. The group engagement team shall determine as a whole when  
establishing the overall group audit strategy.
C. The component engagement partner shall review the overall group
audit strategy and group audit plan.
D. The group engagement partner shall agree on the terms of the
group   audit engagement in accordance with PSA 210.

75. An auditor who, at the request of the group engagement team,

perform work on financial information related to a component for the
group audit is a
 
A. Group auditor
B. Component auditor
C. Component engagement team
D. Group engagement team

TRUE OR FALSE

1. Inherent risk is a measure of the auditor’s assessment of the

possibility that there are material misstatements in an account before
considering the effectiveness of the client’s internal control.

True

2. Acceptable audit risk is a measure of the auditor’s willingness to

accept that the financial statements do not contain material
misstatements after the audit is completed and a modified opinion has
been expressed.

False

3. The purpose of an engagement letter is to document the terms of

the engagement.

True

4. Early appointment of the independent auditor will enable a more

thorough examination to be performed.

False

5. Related party transactions may be indicated when another entity

has had a distributor relationship with the company for 10 years.

False

6. During audit planning, the auditor uses analytical procedures

primarily to understand the client’s business and industry and to
indicate possible misstatements.
True

7. Increased fraud risk could also result in higher inherent risk, lower
control risk, and lower detection risk.

False

8. A properly planned and performed audit may fail to detect a

material misstatement resulting from fraud because an audit is
planned and performed to provide reasonable assurance of detecting
material misstatements caused by errors but not by fraud.

False

9. 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.

True

10. Comparison of recorded amounts of major disbursements with

appropriate invoices a typical analytical procedure.

False

11. Analytical procedures are required for planning, substantive

testing, and overall review of the financial statements.

False
12. In assessing the competence of an internal auditor, an
independent CPA most likely would obtain information about the
quality of the auditor’s work.

True

13. The successor auditor has the responsibility to initiate contact with
the predecessor auditor to ask about the client before the
engagement is accepted; the predecessor has no responsibility to
initiate this contact, even when aware of matters bearing on the
integrity of management.

True

14. Materiality and audit risk are considered throughout the audit.

True

15. Analytical procedures are seldom used for planning an audit

engagement because they are substantive test procedures.

False

16. A predecessor auditor is required to attempt to initiate

communication with the successor auditor prior to the successor’s
acceptance of the engagement.

False

17. Audits of financial statements are designed to obtain reasonable

assurance of detecting material misstatements due to errors and fraud.
True

18. All uncorrected misstatements that are below the amount of

materiality established in the planning stage of the audit will always be
evaluated as immaterial.

False

19. If the prospective client refuses to allow the predecessor auditor to

communicate with the successor auditor, the successor auditor should
have reservations about accepting the proposed audit engagement.

True

20. A written understanding between the auditor and the client

concerning the auditor’s responsibility for the discovery of illegal acts
is usually set forth in letter of audit inquiry.

False

21. When a company has changed auditors, the predecessor auditor

has no responsibility to initiate contact with the successor auditor,
even when the predecessor is aware of matters bearing on the
integrity of management.

True

22. An example of fraudulent financial reporting is when an employee

diverts customer payments to his personal use, concealing his actions
by debiting an expense account, thus overstating expenses.
False

23. Generally, the external auditor may rely on the work of an internal
auditor if the internal auditor is competent and objective.

True

24. An independent auditor might consider the procedures performed

by the internal auditors because they are employees whose work must
be reviewed during substantive testing.

False

25. An auditor obtains knowledge about a new client’s business and its
industry in order to maintain professional skepticism concerning
management’s financial statement assertions.

False