AUDITING IN A CIS ENVIRONMENT

Bachelor of Science in Accountancy 3A and 3B

LAGUNA STATE POLYTECHNIC UNIVERSITY (LSPU) – SINILOAN CAMPUS
Quiz No. 1 Key Answers and Explanations

1. (a) The requirement is to identify the categories of financial statement assertions. Answer (a) is correct
because the professional standards establish financial statement assertions for account balances, classes of
transactions and disclosures. Answer (b) is incorrect because financial statement assertions are established
for disclosures. Answer (c) is incorrect because financial statement assertions are established for classes of
transactions. Answer (d) is incorrect because financial statement assertions are established for both classes
of transactions and disclosures.
2. (b) The requirement is to determine a likely auditor reaction to a decreased acceptable level of detection
risk. Answer (b) is correct because postponement of interim substantive tests to year-end decreases
detection risk by reducing the risk for the period subsequent to the performance of those tests; other
approaches to decreasing detection risk include changing to more effective substantive tests and increasing
their extent. Answer (a) is incorrect because increased, not reduced, substantive testing is required. Answer
(c) is incorrect because inherent risk must be considered in planning, either by itself or in combination with
control risk. Answer (d) is incorrect because tests of controls must be performed to reduce the assessed level
of control risk.
3. The requirement is to identify the risk that an auditor will conclude, based on substantive tests, that a
material error does not exist in an account balance when, in fact, such error does exist. Answer (b) is correct
because detection risk is the risk that the auditor will not detect a material misstatement that exists in an
assertion. Detection risk may be viewed in terms of two components (1) the risk that analytical procedures
and other relevant substantive tests would fail to detect misstatements equal to tolerable misstatement, and
(2) the allowable risk of incorrect acceptance for the substantive tests of details. Answer (a) is incorrect
because sampling risk arises from the possibility that, when a test of controls or a substantive test is
restricted to a sample, the auditor’s conclusions may be different from the conclusions he or she would reach
if the tests were applied in the same way to all items in the account balance or class of transactions. When
related to substantive tests sampling risk is only a part of the risk that the auditor’s substantive tests will not
detect a material misstatement. Answer (c) is incorrect because non-sampling risk includes only those
aspects of audit risk that are not due to sampling. Answer (d) is incorrect because inherent risk is the
susceptibility of an assertion to a material misstatement, assuming that there are no related controls.
4. (a) The requirement is to identify an effect of a decrease in the acceptable level of detection risk. Answer (a)
is correct because as the acceptable level of detection risk decreases, the assurance provided from
substantive tests should increase. To gain this increased assurance the auditors may (1) change the nature of
substantive tests to more effective procedures (e.g., use independent parties outside the entity rather than
those within the entity), (2) change the timing of substantive tests (e.g., perform them at year-end rather
than at an interim date), and (3) change the extent of substantive tests (e.g., take a larger sample). Answer
(b) is incorrect because the assurance provided from substantive tests increases, it does not decrease.
Answers (c) and (d) are incorrect because the acceptable level of detection risk is based largely on the
assessed levels of control risk and inherent risk. Accordingly, any tests of controls will already have been
performed.
5. (c) The requirement is to determine whether inherent risk, control risk, and detection risk may be assessed in
nonquantitative terms. Answer (c) is correct because all of these risks may be assessed in either quantitative
terms such as percentages, or nonquantitative terms such as a range from a minimum to a maximum.
6. (b) The requirement is to determine the best way for an auditor to achieve an overall audit risk level when
the audit evidence relating to control risk indicates the need to increase its assessed level. Answer (b) is
correct because a decrease in detection risk will allow the auditor to achieve an overall audit risk level
substantially the same as planned. Answer (a) is incorrect because a decrease in substantive testing will
increase, not decrease, detection risk and thereby increase audit risk. Answer (c) is incorrect because an
increase in inherent risk will also increase audit risk. Answer (d) is incorrect because there appears to be no
justification for increasing materiality levels beyond those used in planning the audit.
7. (b) The requirement is to identify the best description of what is meant by a “fraud risk factor.” Answer (b) is
correct because while fraud risk factors do not necessarily indicate the existence of fraud, they often have
been observed in circumstances where frauds have occurred. Answer (a) is incorrect because the risk of
fraud may or may not be high when a risk factor is present. Answer (c) is incorrect because the current audit
plan may in many circumstances appropriately address a fraud risk factor. Answer (d) is incorrect because a
fraud risk factor may or may not represent a material weakness.
8. (b) The requirement is to identify the risk relating to material misstatement that auditors are required to
assess. Answer (b) is correct because auditors must specifically assess the risk of material misstatements due
to fraud and consider that assessment in designing the audit procedures to be performed. Answer (a) is
incorrect because while it is also required to have an assessment of the overall risk of material misstatement
(whether caused by error or fraud), there is no requirement to explicitly assess the risk of material
misstatement due to errors. Answer (c) is incorrect because the auditor need not explicitly assess the risk of
misstatement due to illegal acts. Answer (d) is incorrect because no assessment of business risk is required.
9. (a) The requirement is to determine whether audits are designed to provide reasonable assurance of
detecting misstatements due to errors, fraudulent financial reporting, and/or misappropriation of assets.
Answer (a) is correct because an audit obtains reasonable assurance that material misstatements, whether
caused by error or fraud, be detected. Fraudulent financial reporting and the misappropriation of assets are
the two major types of fraud with which an audit is relevant.
10. (d) The requirement is to identify the reply which is not a reason why auditors are unable to obtain absolute
assurance that misstatements due to fraud will be detected. Answer (d) is correct because while an auditor
must exercise professional skepticism when performing an audit, it does not represent a limitation that
makes is impossible to obtain absolute assurance. Answers (a), (b), and (c) are all incorrect because they
represent factors considered in the professional literature for providing reasonable, and not absolute
assurance.
11. (d) The requirement is to identify an auditor’s responsibility for detecting errors and fraud. Answer (d) is
correct because it is required that an auditor design the audit to provide reasonable assurance of detecting
misstatements due to errors and fraud that are material to the financial statements. Answer (a) is incorrect
because audits provide reasonable assurance of detecting material errors and fraud. Answer (b) is incorrect
because it doesn’t restrict the responsibility to material errors and fraud. Answer (c) is incorrect because it is
less precise than answer (d), which includes the responsibility on errors and fraud.
12. (c) The requirement is to identify the most likely risk factor relating to fraudulent financial reporting. Answer
(c) is correct because negative cash flows from operations may result in pressure upon management to
overstate the results of operations. Answer (a) is incorrect because one would expect a company’s top
executives to dominate management— domination by one or a few might be considered a risk factor.
Answers (b) and (d) are incorrect because large amounts of cash being processed, and small high-dollar
inventory items are more directly related to the misappropriation of assets than they are to fraudulent
financial reporting.
13. (b) The requirement is to identify the most likely fraud risk factor on an audit. Answer (b) is correct because
the possibility of improper revenue recognition is ordinarily presumed on audits. Answers (a), (c), and (d) all
represent potential risks, but risks that are not ordinarily presumed on an audit.
14. (a) The requirement is to determine the nature of the inquiries that a successor auditor should make of the
predecessor auditor prior to accepting an audit engagement. Answer (a) is correct because the inquiries
should include specific questions to management on (1) disagreements with management as to auditing
procedures and accounting principles (answer [a]), (2) facts that might bear on the integrity of management
and (3) the predecessor’s understanding as to the reasons for the change of auditors. Answers (b), (c), and
(d) are incorrect because, if made at all, they will be after the engagement has been accepted.
15. (b) The requirement is to identify the correct statement regarding a successor auditor’s inquiries of the
predecessor auditor. Answer (b) is correct because the successor should request information such as (1) facts
that might bear on the integrity of management, (2) disagreements with management as to accounting
principles, auditing procedures, or other significant matters, and (3) the predecessor’s understanding of the
reasons for the change of auditors. Answers (a), (c), and (d) all relate to matters not required to be discussed
prior to accepting an audit engagement.
16. (a) The requirement is to identify the matter generally included in an auditor’s engagement letter. Answer (a)
is correct because requirements for engagement letters, indicates that an engagement letter should include
an indication that management is responsible for identifying and ensuring that the company complies with
the laws and regulations applicable to its activities. Answer (b) is incorrect because such detailed information
on materiality is not generally included in an engagement letter. Answer (c) is incorrect because management
liability (if any) for illegal acts committed by employees is not generally included in an engagement letter.
Answer (d) is incorrect because while an auditor is required to obtain an understanding of internal control,
he or she is not required to search for significant internal control deficiencies.
17. (c) The requirement is to identify the most likely procedure during the initial planning phase of an audit.
Answer (c) is correct because during initial planning the timing of procedures will be discussed due to the
need for client assistance with many of these procedures. Answer (a) is incorrect because the timing of audit
procedures will occur subsequent to the initial planning stage of an audit. Answer (b) is incorrect because the
evaluation of reasonableness of the client’s accounting estimates will occur after planning. Answer (d) is
incorrect because the inquiry of a client’s attorney will occur subsequently to initial planning.
18. (c) The requirement is to identify the item for which the generally accepted auditing standards do not require
documentation. Answer (c) is correct because while a CPA fi rm will include an engagement letter in the
working papers, it will not detail the auditor’s planned fieldwork. Answer (a) is incorrect because it requires a
written audit plan. Answer (b) is incorrect because it requires that the working papers document the
agreement or reconciliation of the accounting records with the financial statements. Answer (d) is incorrect
because it requires the auditor to document the assessment of the risks of material misstatement.
19. (b) The requirement is to identify form(s) of documentation of the understanding obtained with a client.
Answer (b) is correct because the professional standards require that an auditor document the
understanding through a written communication with the client. Answer (a) is incorrect because an oral
communication is not sufficient. Answer (c) is incorrect because the communication should be in writing.
Answer (d) is incorrect because the understanding is not documented in a completely detailed audit plan—a
term of questionable meaning.
20. (a) The requirement is to identify the statement that is always true with respect to planning an audit. Answer
(a) is correct because it is acceptable for an auditor to perform a certain portion of the audit at an interim
date; for example, performing a portion of planning prior to year-end is always acceptable for a continuing
client. Also, when a new client has engaged an auditor prior to year-end, a portion of the audit may be
conducted prior to year-end. Answer (b) is incorrect because an engagement may be accepted after the
client’s year-end. Answer (c) is incorrect because alternative procedures may be possible when an inventory
count was not observed at year-end. Answer (d) is incorrect because final staffing decisions need not be
made prior to completion of the planning stage of an audit.
21. (d) The requirement is to determine what specific audit objectives are addressed when designing an audit
plan. Answer (d) is correct because in obtaining evidence in support of financial statement assertions, the
auditor develops specific audit objectives in the light of those assertions. Answers (a), (b), and (c) are all
incorrect because these replies do not relate specifically to the audit objectives as do the financial statement
assertions.
22. (c) The requirement is to determine whether a successor auditor should request a new client to authorize the
predecessor auditor to allow a review of the predecessor’s engagement letter, working papers, or both.
Answer (c) is correct because it is advisable that a successor auditor request to be allowed to review the
predecessor’s working papers.
23. (a) The requirement is to identify the reply that is not a component of an entity’s internal control. Answer (a)
is correct because while auditors assess control risk as a part of their consideration of internal control, it is
not a component of an entity’s internal control. Answers (b), (c), and (d) are incorrect because the control
environment, risk assessment, control activities, information and communication, and monitoring are the
five components of an entity’s internal control.
24. (d) The requirement is to identify the meaning of the concept of reasonable assurance. Answer (d) is correct
because reasonable assurance recognizes that the cost of internal control should not exceed the benefits
expected to be derived.
25. (d) The requirement is to determine which of the factors listed are included in an entity’s control
environment. Answer (d) is correct because the audit committee, integrity and ethical values, and
organization structure are all included.
26. (b) The requirement is to identify the functions that should be segregated for effective internal control.
Answer (b) is correct because authorizing transactions, recording transactions, and maintaining custody of
assets should be segregated.

27-31. I—Integrity and ethical values C—Commitment to competence H—Human resource policies and practices
A—Assignment of authority and responsibility M—Management’s philosophy and operating style B—Board
of directors or audit committee participation O—Organizational structure.

32-36. Relationship among inherent risk, control risk, and detection risk. Inherent risk and control risk differ from
detection risk in that they exist independently of the audit, whereas detection risk relates to the effectiveness of
the auditor’s procedures. A number of questions are asked concerning the relationship among the three risks.
Although the auditor may make either separate or combined assessments of inherent risk and control risk, you
may find the audit risk formula that separates the risks helpful for such questions. Accordingly, if any risk
increases another must decrease to hold audit risk at certain level. Therefore, when a question asks for the
relationship between control risk and detection risk, for example, you would reply that it is inverse. Stated
otherwise, if control risk (or inherent risk) increases, detection risk must decrease.