EXAM 1 – AUDITING THEORY

Name: Score: 86/100

1. Which of the following is the correct order of steps in the audit process?
a. Perform test of controls
b. Develop an overall strategy for the expected conduct and scope of the audit
c. Obtain client’s written representation
d. Prepare engagement letter
e. Perform substantive tests
a. D, A, B, E, C b. D, B, C, A, E
c. D, B, A, E, C d. D, B, E, A, C

2. The audit process is

a. A special application of the scientific method of inquiry.
b. Regulated by the AICPA.
c. The only service a CPA is allowed to perform by law.
d. Performed only by CPAs.

3. Some or all of the following are planning considerations:

I. Criteria to be used.
II. Nature and extent of involvement of experts.
III. Possible sources of evidence.
IV. Type of conclusion to be used.
V. Preliminary judgment about materiality and engagement risk.
VI. Content of management letter.

Which of the foregoing are matters that need to be considered in planning an assurance
engagement?

a. All of them
b. I, II, III and V.
c. II, III, IV, VI.
d. I, III, V, VI.
4. What information should a successor auditor obtain during the inquiry of the predecessor
auditor prior to acceptance of the audit?
I. Facts that bear on the integrity of management
II. Whether statistical or non-statistical sampling was used to gather evidence
III. Disagreement with management concerning auditing procedures.
IV. The effect of the client’s internal audit function on the scope of the
independent auditor’s examination
a. I and II
b. I and III
c. I and IV
d. III and IV

5. In making a decision to accept or continue with a client, the auditor should consider
A B C D
Its own independence Yes No Yes No
Its ability to service properly Yes Yes Yes No
The integrity of the client management Yes Yes No Yes

6. The term “audit risk” refers to the risk:

a. Of legal exposure and related costs should the auditor be charged with negligence in the
conducting the audit
b. That the auditor may unknowingly fail to appropriately modify his opinion on FS that
are materially misstated
 c. That errors or irregularities may cause financial statements not to be fairly presented
d. That the auditor may fail to anticipate all circumstances which will influence his
judgment in evaluating the audit findings upon completion of the audit

7. The audit risk model is primarily

a. For planning purposes in determining how much evidence to accumulate
b. While doing test of controls
c. To determine the type of opinion to express
d. To evaluate the evidence which has been gathered

8. Inherent risk
a. Exists because all control structures are flawed in some ways
b. Is the likelihood that material misstatements exist in the financial statement of
the firm
c. Is associated with the unique characteristics of the business or industry of the client
d. Is the likelihood that the auditor will not find material misstatement

9. Control risk is
a. The probability that the auditor will render an unqualified opinion on financial
statements that are materially misstated
b. Associated with the unique characteristics of the business or industry of the client
c. The likelihood that the control structure is flawed because controls are
inadequate to prevent or detect errors in the accounts
d. The risk that auditors are willing to take that errors not detected or prevented by the
control structure will also not be detected by the auditor

10. The probability of 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 c. control risk
b. inherent risk d. detection risk

11. When planning a financial statement audit, the auditor should assess inherent risk at the
Financial statement level Account balance or transaction class level
a. Yes Yes
b. Yes No
c. No No
d. No Yes

12. 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 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.

13. PSA 300 (Revised), Planning an Audit of Financial Statements, which states that the work is to be
adequately planned, and assistants, if any, are to be properly supervised, recognizes that
a. Early appointment of the auditors is advantageous to the auditors and the client.
b. Acceptance of an audit engagement after the close of the client’s fiscal year is generally
not permissible.
c. Acceptance of an audit engagement after the close of the client’s fiscal year requires a
disclaimer of opinion.
d. Performance of substantial parts of the examination is necessary at interim dates.

14. Adequate planning of the audit work ensure that

Appropriate The work is
attention is All misstatements Potential problems completed
devoted to will be detected are identified expeditiously
 important areas
a Yes Yes Yes Yes
b No Yes No Yes
c Yes No Yes Yes
d Yes No Yes No

15. The development of a general strategy and a detailed approach for the expected nature, timing,
and extent of audit refers to:
a. Supervision c. Audit Procedures
b. Directing d. Audit Planning

16. An audit plan is a

a. A detailed plan of analytical procedures and 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.

17. Audit Plan should

A B C D
Precede actions No Yes Yes No
Be flexible Yes No Yes Yes
Be cost beneficial Yes Yes Yes No

18. Which of the following is a basic tool used by the auditor to control the audit work and review
the progress of the audit?
a. Time and expense summary c. Progress flowchart
b. Engagement letter d. Audit program

19. Audit program should set out

A B C D
Nature of the procedures Yes Yes Yes No
Timing of the procedures No Yes Yes Yes
Extent of planned procedures Yes Yes No No

20. How is the audit program best be described at the beginning of audit process?
a. temporary c. confirmed
b. conclusive d. optional

21. 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 the requirements of the Code of Ethics for
Professional Accountants in the Philippines, including independence.
iii. Establish an understanding of the terms of engagement.

a. i and ii only b. ii and iii only

c. i and iii only d. i, ii, and iii

22. An accountant had begun to audit the financial statements of a nonpublic entity. Which of the
following circumstances most likely would be considered a reasonable basis for agreeing to the
entity's request to change the engagement to a compilation?
 a. The entity's management does not provide the accountant with a signed representation
letter.
b. The accountant is prohibited from corresponding with the entity's legal counsel.
c. The entity's principal creditors no longer require the entity to furnish audited
financial statements.
d. The accountant is prevented from examining the minutes of the board of directors'
meetings.

23. A successor auditor should make specific and reasonable inquiries of the predecessor auditor
regarding the predecessor's:
a. Understanding of the reasons for the change in auditors.
b. Methodology used in applying sampling techniques.
c. Opinion on subsequent events that have occurred since the balance sheet date.
d. Perception of the competency and reliance on the client's internal audit function.

24. Prior to the acceptance of an audit engagement with a client who has terminated the services of
the predecessor auditor, the CPA should
a. Contact the predecessor auditor without advising the prospective client and request a
complete report of the circumstances leading to the termination with the understanding
that all information disclosed will be kept confidential.
b. Accept the engagement without contacting the predecessor auditor since the CPA can
include audit procedures to verify the reason given by the client for the termination.
c. Not communicate with the predecessor auditor because this would, in effect, be asking
the auditor to violate the confidential relationship between auditor and client.
d. Advise the client of the intention to contact the predecessor auditor and request
permission for the contact.

25. Substantive tests are performed to obtain evidence about the effectiveness of the
i. Design of the accounting and internal control systems, that is, whether they are
suitably designed to prevent or detect and correct material misstatements.
ii. Operation of the internal controls throughout the period.
a. i only b. ii only
c. both i and ii d. neither i and ii

26. Auditors should maintain an attitude of professional skepticism. This means the auditor
assumes that management is:
a. Usually honest c. Neither honest nor dishonest
b. Usually not honest d. Honest, but biased

27. The acceptable level of detection risk is inversely related to the

a. Assurance provided by substantive tests
b. Risk of misapplying auditing procedures
c. Preliminary judgment about materiality levels
d. Risk of failing to discover material misstatements

28. 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 field work 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.

29. Which of the following about materiality is incorrect?

a. The assessment of what is material is a matter of professional judgment.
b. When planning the audit, the auditor should consider what would make the
financial statements materially misstated.
c. The assessed level of materiality should not normally be revised by the
auditor.
d. Materiality is addressed in the auditor’s report.
30. The assessment of materiality level in relation to specific account balances and classes of
transactions will enable the auditor to
a. Omit certain necessary procedures
b. Assess whether the audit opinion will be modified
c. Select audit procedures that are appropriate based on acceptable detection
risk
d. Primarily determine whether tests of controls would be performed.

31. Which of the following represents a procedure the auditor may use because plausible
relationships among financial statement balances are expected to exist?
a. attributes testing c. inherent test of control
b. enterprise risk management d. analytical review

32. The auditor notices significant fluctuations in key elements of the company's financial
statements. If management is unable to provide an acceptable explanation, the auditor should
a. Consider the matter a scope limitation.
b. Perform additional audit procedures to investigate the matter further.
c. Intensify the examination with the expectation of detecting management fraud.
d. Withdraw from the engagement.

33. The purpose of analytical procedures in 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 were approved.

34. The auditors are planning an engagement for a new client in the business that is unfamiliar to
the auditors. Which of the following would be the most useful source of information for the
auditors during the preliminary planning stage when they are trying to obtain a general
understanding of audit problems that might be encountered?
a. Client manuals of accounts and chart of accounts
b. AICPA Industry Audit Guides
c. Prior-year working papers of predecessor auditors
d. Latest annual and interim financial statements issued by the client

35. A knowledge of the business helps the auditor in carrying out the following objectives, except
a. Assessing risk and identifying problems.
b. Identifying audit areas where a specialist may be required.
c. Determining the audit opinion to be expressed.
d. Planning and performing the audit effectively and efficiently.

36. Which of the following least likely influenced the auditor’s decision to send separate
engagement letter to a component of parent entity client?
a. Legal requirements
b. Degree of ownership by parent
c. Reporting requirements of the component entity
d. Who appoints the auditor of the component

37. Which of the following is not an acceptable reason for a change of engagement from a higher to
a lower level of assurance?
a. Cost considerations
b. Restriction on the scope of the audit engagement.
c. Misunderstanding as to the nature of the engagement originally requested.
d. Audited financial statements are no longer needed because the client was able to
obtain alternative financing.

38. Which of the following is a policy that must be established to comply with the quality control
engagement performance?
 a. The firm is to be staffed by personnel who have attained and maintained the technical
standards and professional competence required to enable them to fulfill their
responsibilities.
b. There is sufficient direction, supervision, and review of work performed at all
levels to provide reasonable assurance that the work performed meets
appropriate standard of quality.
c. The firm should assign responsibility for each engagement to an engagement partner.
d. The continued adequacy and operational effectiveness of quality control policies and
procedures are to be observed.

39. The following statements relate to the auditor’s responsibility for the detection of errors and
fraud. Identify the correct statements.
i. Due to the inherent limitations of the audit, there is a possibility that material
misstatements in the financial statements may not be detected.
ii. The subsequent discovery of material misstatement of the financial information
resulting from fraud or error does not, in itself, indicate that the auditor failed to
follow the basic principles and essential procedures of an audit.
a. i only c. ii only
b. both statements are true d. both statements are false

40. Which of the following statements regarding quality control policies and procedures is
incorrect?
a. Quality control policies and procedures should be implemented at both the level of the
audit firm and on an individual audits.
b. The audit firm should implement quality control policies and procedures designed to
ensure that all audits are conducted in accordance with PSAs or relevant national
standards or practices.
c. Quality control policies are objectives and goals while quality control procedures are
steps to be taken to accomplish the policies adopted.
d. The policies and procedures adopted by individual audit firms should not vary
since there is an applicable PSA that prescribes quality control policies and
procedures that must be adopted by all auditing firms.

41. Which of the following is one of the elements of a CPA Firm’s quality control system?
a. leadership responsibilities c. Control activities (component of internal control)
b. Computer assisted auditing d. Control environment (component of internal control)
techniques (substantive testing)

42. In pursuing a CPA firms' quality control objectives, a CPA firm may maintain records indicating
which partners or employees of the CPA firm were previously employed by the CPA firm's
clients. Which quality control objective would this be most likely to satisfy?
a. Acceptance of client.
b. Supervision.
c. Independence.
d. Monitoring.

43. In pursuing its quality control objectives with respect to independence, a CPA firm may use
policies and procedures such as
a. Emphasizing independence of mental attitude in firm training programs and in
supervision and review of work.
b. Prohibiting employees from owning stock of public companies.
c. Suggesting that employees conduct their banking transactions with banks that do not
maintain accounts with client firms.
d. Assigning employees who may lack independence to research positions that do not
require participation in field audit work.

44. In connection with the element of monitoring, a CPA firm's system of quality control should
ordinarily provide for the maintenance of
a. A file of minutes of staff meetings.
 b. Updated personnel files.
c. Documentation to demonstrate compliance with its policies and procedures.
d. Documentation to demonstrate compliance with peer review directives.

45. In making a decision to accept or retain a client, the firm should consider
a. its competence
b. its ability to comply with ethical requirements
c. The integrity of the client’s management
d. All of the above

46. Quality control policies and procedures are designed to promote internal culture recognizing
that:
a. Quality is essential in performing engagements.
b. Reasonable, and not absolute, assurance can be provided by all CPA engagements.
c. The firm should always move towards the elimination of audit risk.
d. The promotion of a quality-oriented internal culture depends on clear, consistent and
frequent actions and messages from all levels of the firm’s management.

47. Monitoring of the firm’s system of quality control is performed by competent individuals and
covers
A B C D
Appropriateness of the design of quality control Yes No No Yes
Effectiveness of the operation of the quality control No Yes No Yes

48. Per PSCQ1, this refers to any individual with authority to bind the firm with respect to the
performance of a professional services engagement.
a. Professional accountant c. Staff
b. Personnel d. Partner

49. Regarding identified threats to independence, appropriate action by firm and the relevant
engagement partner includes the following, except;
a. Application of safeguards to eliminate threats to independence.
b. Application of safeguards to reduce threats to independence to an acceptable level
c. Expression of a qualified or adverse opinion on the subject matter under audit.
d. Withdrawal from the engagement.

50. In pursuing its quality control objectives with respect to acceptance of a client, a CPA firm is not
likely to
a. Make inquiries of the proposed client's legal counsel.
b. Review financial statements of the proposed client.
c. Make inquiries of previous auditors.
d. Review the personnel practices of the proposed client.