Second Pre-board Examination

Auditing
THEORIES
1. Inquiry and analytical procedures ordinarily performed during a review of a nonpublic entity's financial
statements include:
A. Analytical procedures designed to identify reportable conditions related to internal control.
B. Inquiries concerning actions taken at meetings of the stockholders and the board of directors.
C. Analytical procedures designed to test the accounting records by obtaining corroborating evidential
matter.
D. Inquiries of knowledgeable outside parties such as the client's attorneys and bankers.
2. A modification of the CPA's report on a review of the interim financial statements of a publicly-held company
would be necessitated by which of the following?
A. An uncertainty.
B. Lack of consistency.
C. Reference to another accountant.
D. Inadequate disclosure.
3. Which of the following does not result in a modification of a compilation report?
A. A lack of independence on the part of the auditors.
B. A departure from generally accepted accounting principles.
C. A lack of adequate disclosure in the financial statements.
D. A lack of consistent application of generally accepted accounting principles.
4. When a practitioner examines projected financial statements, the practitioner's report should include a
separate paragraph that:
A. Describes the limitations on the usefulness of the presentation.
B. Provides an explanation of the differences between an examination and a review.
C. States that the accountant is responsible for events and circumstances for a period not exceeding
one year after the report's date.
D. Disclaims an opinion on whether the assumptions provide a reasonable basis for the projection.
5. Under the attestation standards, in which of the following circumstances is a review report least likely to be
issued?
A. Criteria are agreed-upon or only available to specified users.
B. Established criteria exist, but other criteria are used.
C. The subject matter departs from the criteria.
D. A significant limitation on the scope of the engagement has occurred.
6. Accepting an engagement to examine an entity's financial projection most likely would be appropriate if the
projection were to be distributed to:
A. All employees who work for the entity.
B. Potential stockholders who request a prospectus or a registration statement.
C. A bank with which the entity is negotiating for a loan.
D. All stockholders of record as of the report date.
7. Which of the following is correct concerning requirements about auditor communications about fraud?
A. Fraud that involves senior management should be reported directly to the audit committee
regardless of the amount 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 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.
8. Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement
should not be accepted?
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.
9. Which of the following procedures is not performed as a part of planning an audit engagement?
A. Reviewing the working papers of the prior year.
B. Performing analytical procedures.
C. Confirmation of all major accounts.
D. Designing an audit program.
10. Which of the following statements is correct regarding the auditor's determination of materiality?
A. The planning level of materiality should normally be the larger of the amount considered for the
balance sheet versus the income statement.
B. The auditors' planning level of materiality may be disaggregated into smaller "tolerable
misstatements" for the various accounts.
C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not for
determining the planning level of materiality.
D. The amount used for the planning should equal that used for evaluation.
11. The auditors must consider materiality in planning an audit engagement. Materiality for planning purposes
is:
A. The auditors' preliminary estimate of the largest amount of misstatement that would be material to
any one of the client's financial statements.
B. The auditors' preliminary estimate of the smallest amount of misstatement that would be material to
any one of the client's financial statements.
C. The auditors' preliminary estimate of the amount of misstatement that would be material to the
client's balance sheet.
D. An amount that cannot be quantitatively stated since it depends on the nature of the item.
12. Tests for unrecorded assets typically involve tracing from:
A. Source documents to recorded journal entries.
B. Source documents to observations.
C. Recorded journal entries to documents.
D. Recorded journal entries to observations.
13. A successor auditor has accepted an engagement that was previously performed by a predecessor auditor
and, prior to accepting the engagement, has communicated with the predecessor. When the successor
believes that the predecessor has performed satisfactory previous audits, which of the following is correct?
A. A second communication is required and must include details of previous audits.
B. Ordinarily the successor auditors may be able to accept the opening balances of the current year
with a minimum of verification work.
C. Absent ongoing litigation, a predecessor must provide all working papers requested by the
predecessor.
D. The client should be informed of the need to perform a detailed audit of all opening balances.
14. The first standard of field work recognizes that early appointment of the independent auditors has many
advantages to the auditors and the client. Which of the following advantages is least likely to occur as a result
of early appointment of the auditors?
 A. The auditors will be able to plan the audit work so that it may be done expeditiously.
B. The auditors will be able to complete substantive procedures prior to year-end.
C. The auditors will be able to better plan for the observation of the physical inventories.
D. The auditors will be able to perform the examination more efficiently and will be finished at an early
date after the year-end.
15. The auditors will not ordinarily initiate discussion with the audit committee concerning the:
A. Extent to which the work of internal auditors will influence the scope of the examination.
B. Extent to which change in the company's organization will influence the scope of the examination.
C. Details of potential problems which the auditors believe might cause a qualified opinion.
D. Details of the procedures which the auditors intend to apply.
16. Tests of controls do not ordinarily address:
A. By whom a control was applied.
B. How a control was applied.
C. The consistency with which a control was applied.
D. The cost effectiveness of the way a control was applied.
17. Which statement is correct concerning the relevance of various types of controls to a financial statement
audit?
A. An auditor may ordinarily ignore the consideration of controls when a substantive audit approach is
used.
B. Controls over the reliability of financial reporting are ordinarily most directly relevant to an audit, but
other controls may also be relevant.
C. Controls over safeguarding assets and liabilities are of primary importance, while controls over the
reliability of financial reporting may also be relevant.
D. All controls are ordinarily relevant to an audit.
18. When tests of controls reveal that controls are operating as anticipated, it is most likely that the assessed
level of control risk will:
A. Be less than the preliminary assessed level of control risk.
B. Equal the preliminary assessed level of control risk.
C. Equal the actual control risk.
D. Be less than the actual control risk.
19. Which of the following comes closest to outlining the auditors' responsibility for considering internal control
in all financial statement audits?
A. An understanding of the control environment, information and communication, risk assessment and
monitoring is necessary; an understanding of control activities is only necessary for areas in which the
auditor is performing tests of controls.
B. The auditor must obtain an understanding of each of the five internal control components sufficient
to assess the risks of material misstatement for the audit.
C. When tests of controls have been performed, control risk must be assessed at a level less than the
maximum.
D. An understanding of the control environment is necessary, but no understanding of the other
components is necessary unless control risk is to be assessed at a level less than the maximum.
20. Which of the following is least likely to be considered a risk assessment procedure relating to internal
control?
A. Counting marketable securities at year-end.
B. Inquiries of client personnel.
C. Inspecting documents and reports.
D. Observing the application of specific controls.
21. Which of the following is true about analytical procedures?
A. Performing analytical procedures results in the most reliable form of evidence.
B. Analytical procedures are tests of controls used to evaluate the quality of a client's internal control.
 C. Analytical procedures are used for planning, but they should not be used to obtain evidence as to
the reasonableness of specific account balances.
D. Analytical procedures are used in planning, as a substantive procedure for specific accounts, and in
the final review of the audited financial statements.
22. Which of the following is not a basic approach often used by auditors to evaluate the reasonableness of
accounting estimates?
A. Confirmation of amounts.
B. Review of management's process of development.
C. Independent development of an estimate.
D. Review of subsequent events.
23. When considering the use of management's written representations as audit evidence about the
completeness assertion, an auditor should understand that such representations:
A. Complement, but do not replace, substantive procedures designed to support the assertion.
B. Constitute sufficient evidence to support the assertion when considered in combination with a
moderate assessed level of control risk.
C. Are generally sufficient audit evidence to support the assertion regardless of the assessed level of
control risk.
D. Replace the assessed level of control risk as evidence to support the assertions.
24. During an audit engagement pertinent data are prepared and included in the audit working papers. The
working papers primarily are considered to be:
A. A client-owned record of conclusions reached by the auditors who performed the engagement.
B. Evidence supporting financial statements.
C. Support for the auditors' representations as to compliance with generally accepted auditing
standards.
D. A record to be used as a basis for the following year's engagement.
25. The permanent file section of the working papers that is kept for each audit client most likely contains:
A. Review notes pertaining to questions and comments regarding the audit work performed.
B. A schedule of time spent on the engagement by each individual auditor.
C. Correspondence with the client's legal counsel concerning pending litigation.
D. Narrative descriptions of the client's accounting procedures and controls.
26. An auditor performs analytical procedures that involve comparing the gross margins of various divisional
operations with those of other divisions and with the individual division's performance in previous years. The
auditor notes a significant increase in the gross margin at one division. The auditor does some preliminary
investigation and also notes that there were no changes in products, production methods, or divisional
management during the year. Based on the above information, the most likely cause of the increase in gross
margin would be:
A. An increase in the number of competitors selling similar products.
B. A decrease in the number of suppliers of the material used in manufacturing the product.
C. An overstatement of year-end inventory.
D. An understatement of year-end accounts receivable.
27. If all other factors specified in an attributes sampling plan remain constant, decreasing the tolerable rate
and increasing the estimated population deviation rate would have what effect on sample size?
A. Increase.
B. Remain the same.
C. Decrease.
D. Indeterminate, depends upon exact change being made.
28. In performing a test of a control last year the auditors specified a tolerable deviation rate of X percent.
This year the auditors have specified a tolerable rate of less than X percent. Assuming that all other factors
remain the same, which of the following is true regarding the relationship between this year's sample size
compared to last year's sample size?
 A. This year's sample is larger than last year's sample.
B. This year's sample is smaller than last year's sample.
C. This year's sample is equal to last year's sample.
D. This year's sample is indeterminate in relation to last year's sample.
29. When the auditors have chosen to test a control, what relationship will the tolerable rate normally have
when compared to the expected rate of deviations in the sample?
A. Exceed.
B. Equal.
C. Be less than.
D. Indefinite.
30. An audit basically consists of having the auditor form an opinion regarding management's financial
statement assertions. The auditor therefore develops general and specific program steps to apply to the
accounts and transactions. In a particular case, s/he might do this by:
A. Tracing sales invoices to shipping documents to tests the completeness of reported sales.
B. Tracing shipping documents to sales invoices to test the occurrence of reported sales.
C. Tracing sales invoices to shipping documents to test the occurrence of reported sales.
D. Tracing sales invoices to shipping documents to test the completeness of recorded accounts
receivable.
31. Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective
internal controls in the revenue cycle?
A. Merchandise received is not promptly reconciled to the outstanding purchase order file.
B. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market
value.
C. The write-off of receivables by personnel who receive cash permits the misappropriation of cash.
D. Fictitious transactions are recorded that cause an understatement of revenue and overstatement of
receivables.
32. An audit program for the examination of the retained earnings account should include a step that requires
verification of the:
A. Market value used to charge retained earnings to account for a two-for-one stock split.
B. Approval of the adjustment to the beginning balance as a result of a write-down of an account
receivable.
C. Authorization for both cash and stock dividends.
D. Gain or loss resulting from disposition of treasury shares.
33. Material loss contingencies should be recorded in the financial statements if available information indicates
it is probable that a loss had been sustained prior to the balance sheet date and the amount of such loss can
be reasonably estimated. These considerations will affect the audit report as follows:
A. If a loss has been recorded in accordance with these criteria, the auditor may issue an unqualified
opinion but is required to point out the contingency in an explanatory paragraph of the report.
B. If a loss meets these criteria but is disclosed in the financial statement notes rather than being
recorded therein, the auditor may issue an unqualified opinion, but is required to point out the
contingency in an explanatory paragraph of the report.
C. If a loss meets these criteria but is disclosed in the financial statement notes rather than being
recorded therein, the auditor may issue an unqualified opinion, but should consider adding an
explanatory paragraph as a means of emphasizing the disclosure.
D. If a loss is probable but the amount cannot be reasonably estimated and is disclosed in the notes to
the financial statements rather than being recorded therein, the auditor may issue an unqualified
opinion.
34. In planning an operational audit, an on-site survey could assist with all of the following, except:
A. Obtaining auditee comments and suggestions on control problems.
B. Obtaining preliminary information on internal control.
 C. Identifying areas for audit emphasis.
D. Evaluating the effectiveness of the internal control.
35. The completeness of computer-generated sales figures can be tested by comparing the number of items
listed on the daily sales report with the number of items billed on the actual invoices. This process uses:
A. Self-checking numbers.
B. Control totals.
C. Validity tests.
D. Process tracing data.

PROBLEMS
Problem 1
NAKABASBASSIT LABORATORIES holds a valuable patent (No. 112170) on a device that prevents certain types
of air pollution. NAKABASBASSIT does not manufacture or sell the products and processes it develops; it
conducts research and develops products which it patents, and then assigns the patents to manufacturers on a
royalty basis. The history of Patent No. 112170 is as follows:
Date Activity Cost
2005-2006 Research conducted to develop device P1,259,100
Jan. 2007 Design and construction of a prototype 262,800
Mar. 2007 Testing of models 126,000
Jan. 2008 Legal and other fees to process patent application; patent granted
June 2008 186,150
Nov. 2009 Engineering activity necessary to advance the design of the device
to the manufacturing stage 244,500
April 2011 Research aimed at modifying the design of the patented device 129,000
May 2015 Legal fees paid in a successful patent infringement suit against a
competitor 102,000
NAKABASBASSIT assumed a useful life of 17 years when it received the initial device patent. On
January 1, 2013, it revised its useful life estimate downward to 5 remaining years. Amortization is computed
for a full year if the cost is incurred prior to July 1 and no amortization for the year if the cost is incurred after
June 30. NAKABASBASSIT’s reporting date is December 31, 2015.
Compute the carrying value of Patent No. 112170 on each of the following dates:
36. December 31, 2008
A. P180,675 B. P186,150 C. P293,788 D. P175,200
37. December 31, 2012
A. P223,200 B. P52,560 C. P131,400 D. P122,640
38. December 31, 2015
A. P120,560 B. P78,840 C. P52,560 D. P98,550

KABASSITAN COMPANY has provided information on intangible assets as follows:

 A patent was purchased from Valenzuela Company for P4,000,000 on January 1, 2014. KABASSITAN
estimates the remaining useful life of the patent to be 10 years. The patent was carried in Valenzuela’s
accounting records at a net book value of P4,000,000 when Valenzuela sold it to KABASSITAN.
 During 2015, a franchise was purchased from Delco Company for P960,000. The contract which runs for
10 years provides that 5% of revenue from the franchise must be paid to Delco. Revenue from the
franchise for 2015 was P5,000,000. KABASSITAN takes a full year amortization in the year of purchase.
 The following research and development costs were incurred by KABASSITAN in 2015:
Materials and equipment P284,000
Personnel 378,000
Indirect costs 204,000
P866,000
 KABASSITAN estimates that these costs will be recouped by December 31, 2018. The materials and
equipment purchased have no alternative uses.
 On January 1, 2015, because of recent events in the field, KABASSITAN estimates that the remaining life
of the patent purchased on January 1, 2014 is only 5 years from January 1, 2015.
39. What is the total carrying value of KABASSITAN’s intangible assets on December 31, 2015?
A. P3,744,000 B. P4,864,000 C. P2,880,000 D. P3,681,500
40. As a result of the facts above, compute the total amount of charges against income for the year ended
December 31, 2015?
A. P2,428,000 B. P1,932,000 C. P1,648,000 D. P1,116,000

Problem 3
BINABASSIT CO. was organized at the beginning of the current year. The following shareholders’ equity
accounts are included in the entity’s year-end trial balance.
Preference share capital, P100 par, authorized 100,000 shares,
issued and outstanding, 66,000 shares P6,600,000
Preference share capital subscribed, 6,000 shares 600,000
Share premium – preference 240,000
Subscriptions receivable – preference 360,000
Ordinary share capital, P10 par value, authorized 200,000 shares,
issued and outstanding, 72,000 shares 720,000
Ordinary share capital subscribed, 72,000 shares 720,000
Share premium – ordinary 2,850,000
Subscriptions receivable – ordinary 1,080,000
The following current year transactions relate to BINABASSIT Co.’s shareholders’ equity:
 Immediately after BINABASSIT Co. was organized, it received subscriptions to 60,000 preference shares.
Subscriptions to ordinary shares were also received on the same date.
 During the year, subscriptions were received for an additional 12,000 preference shares at a price of P120
per share.
 Cash payments were received from subscribers at frequent intervals for several months after subscription.
The company’s policy is to issue share certificates only upon full payment of the share subscription.
 Also during the current year, BINABASSIT Co. issued 24,000 ordinary shares in exchange for a tract of land
with a fair value of P690,000.
41. What is the total subscription price of the ordinary shares originally subscribed?
A. P4,290,000 B. P3,840,000 C. P3,600,000 D. P4,050,000
42. How much was collected from the subscribers of preference shares?
A. P1,440,000 B. P5,640,000 C. P7,440,000 D. P7,080,000
43. The company’s statement of financial position at the end of the current year should report contributed
capital of
Preference Ordinary
A. P7,440,000 P4,290,000
B. 7,080,000 3,210,000
C. 6,480,000 2,490,000
D. 6,840,000 360,000

The following shareholders’ equity accounts are included in the statement of financial position of
BINABASSITAN CO. on December 31, 2014.
Preference share capital, 8%, P100 par (200,000 shares authorized,
60,000 shares issued and outstanding) P6,000,000
Ordinary share capital, P5 par (2,000,000 shares authorized,
600,000 shares issued and outstanding) 3,000,000
 Share premium 3,750,000
Retained earnings 3,500,000
Total P16,250,000
During 2015, BINABASSITAN took part in the following transactions concerning equity.
1. Paid the annual 2014 P8 per share dividend on preference shares and a P2 per share dividend on
ordinary shares. These dividends had been declared on December 31, 2014.
2. Purchased 81,000 shares of its own outstanding ordinary shares for P40 per share.
3. Reissued 21,000 treasury shares for land valued at P900,000.
4. Issued 15,000 preference shares at P105 per share.
5. Declared a 10% stock dividend on the outstanding ordinary shares when the shares are selling for P45
per share.
6. Issued the stock dividend.
7. Declared the annual 2015 P8 per share dividend on preference shares and the P2 per share dividend on
ordinary shares. These dividends are payable in 2016.
8. Reported net income of P9,900,000 for the current year.
Questions:
44. What is the retained earnings balance (before appropriation for treasury shares) on December 31, 2015?
A. P9,182,000 B. P718,000 C. P6,782,000 D. P11,000,000
45. What amount should be reported as total shareholders’ equity on December 31, 2015?
A. P25,997,000 B. P23,597,000 C. P21,197,000 D. P14,415,000

Problem 4
On January 1, 2014, BASSIT MFG. CO. began construction of a building to be used as its office headquarters.
The building was completed on June 30, 2015.
Expenditures on the project were as follows:
January 3, 2014 P2,500,000
March 31, 2014 3,000,000
June 30, 2014 4,000,000
October 31, 2014 3,000,000
January 31, 2015 1,500,000
March 31, 2015 2,500,000
May 31, 2015 3,000,000
On January 3, 2014, the company obtained a P5 million construction loan with a 10% interest rate. The loan
was outstanding all of 2014 and 2015. The company’s other interest-bearing debts included a long-term note
of P25 million with an 8% interest rate, and a mortgage of P15 million on another building with an interest
rate of 6%. Both debts were outstanding during all of 2014 and 2015. The company’s fiscal year-end is
December.
46. What is the amount of capitalizable interest in 2014?
A. P3,400,000 B. P1,043,750 C. P663,125 D. P500,000
47. What is the amount of capitalizable interest in 2015?
A. P630,625 B. P654,663 C. P361,707 D. P799,663
48. What amount of interest should be expensed in 2014?
A. P2,736,875 B. P2,356,250 C. P2,900,000 D. P 0
49. What amount of interest should be expensed in 2015?
A. P2,769,375 B. P3,038,293 C. P2,600,337 D. P2,745,337
50. What is the total cost of the building (including the interest capitalized in 2014 and 2015)?
A. P24,600,000 B. P20,817,788 C. P20,905,457 D. P20,630,625

“Inca ken coton, sika a nasadut. Utubem dagiti daldalanna, ket sumiribca”
Dagiti Proverbio 6:6
~ End of Examination ~