1. Early appointment of the independent auditor will enable
a) A more thorough examination to be performed.
b) A proper consideration of internal control to be performed.
c) Sufficient competent evidential matter to be obtained.
d) A more efficient audit to be planned.
Answer A is incorrect because the overall scope of the audit must remain the same regardless of appointment date.
Answer B is incorrect because a proper consideration of internal control may be performed even without early appointment.
Answer C is incorrect because sufficient competent evidential matter must be obtained regardless of the appointment date.
Answer D is correct because the early appointment of the independent auditor enables the auditor to plan his/her work so that it may be done expeditiously and to determine the extent to which it can be done before the balance sheet date. Such preliminary work by the auditor permits the audit to be performed in a more efficient manner and to be completed at an early date after the year-end.
2. The primary responsibility for the adequacy of disclosure in the financial statements of a publicly held company rests with the
a) Partner assigned to the audit engagement.
b) Management of the company
c) Auditor in charge of the fieldwork.
d) Securities and Exchange Commission.
Answer A is incorrect because his/her responsibility is limited to expressing an opinion as to the fairness of the financial statements.
Answer B is correct because financial statements are the representations of management, and they have the responsibility for producing proper financial statements.
Answer C is incorrect because his/her responsibility is to gather audit evidence regarding the fairness of the financial statements.
Answer D is incorrect because its responsibility for enforcing disclosure requirements in financial statements of publicly held companies is secondary to management's primary responsibility for the representations included in the financial statements.
3. Which of the following statements best describes the phrase “Philippine Standard on Auditing”?
a) They identify the policies and procedures for the conduct of the audit.
b) They define the nature and extent of the auditor’s responsibilities.
c) They provide guidance to the auditor with respect to planning the audit and writing the audit report.
d) They set forth a measure of the quality of the performance of audit procedures.
Answer A is incorrect because Philippine Standard on Auditing (PSA) give only limited guidance as to specific policies and procedures for the conduct of the audit.
Answer B is incorrect because Philippine Standard on Auditing (PSA) gives only limited guidance as to the nature and extent of the auditor's responsibilities.
Answer C is incorrect because it only relates to the standard concerned with planning the audit and writing the audit report and not to the other standards.
Answer D is correct because Philippine Standards on Auditing (PSA) deal with measures of the quality of the performance of audit procedures. Auditing standards relate not only to the auditor's professional qualities but also to the judgment exercised by the auditor in the performance of the audit.
4. Which of the following underlies the application of Philippine Standard on Auditing (PSA), particularly the standards of fieldwork and reporting?
a) The elements of materiality and relative risk.
b) The element of internal control.
c) The element of corroborating evidence.
d) The element of reasonable assurance.
Answer A is correct because the elements of materiality and relative risk underlie the application of all the standards, particularly the standards of fieldwork and reporting.
Answer B is incorrect because internal control does not underlie all GAAS but rather deals specifically with the second fieldwork standard.
Answer C is incorrect because corroborating evidence is required to be gathered but does not underlie all GAAS. Corroborating evidence addresses the third fieldwork standard directly.
Answer D is incorrect because reasonable assurance is a basic concept of internal control which recognizes that the cost of internal control should not exceed the benefits expected to be derived.
5. Which of the following publications does not qualify as a source of generally accepted accounting principles?
a) Accounting interpretations issued by the FASB.
b) PSA Concepts Statements.
c) PICPA Practice Bulletins.
d) Statements of Financial Standards issued by the FASB
Answer A is incorrect because interpretations issued by the FASB are considered as sources of PAS.
Answer B is correct because the PAS has not issued concepts statements. The concepts statements issued by the FASB are considered "other accounting literatures" and are not sources of generally accepted accounting principles of the Philippines.
Answer C is incorrect because Practice Bulletins are considered as sources of PAS
Answer D is incorrect because FASB statements are considered sources of PAS
6. In developing a preliminary audit strategy, an auditor should consider
a) Whether the allowance for sampling risk exceeds the achieved upper precision limit.
b) Findings from substantive test performed at interim dates.
c) Whether the inquiry of the client’s attorney identifies any litigation, claims, or assessments not disclosed in the financial statements.
d) The planned assessed level of control risk.
Answer A is incorrect. Any information on the achieved upper precision limit will generally be obtained after the preliminary audit strategy has been developed.
Answer B is incorrect. Any information on interim substantive tests will generally be obtained after the preliminary audit strategy has been developed.
Answer C is incorrect. Any information pertaining to attorney's letters will generally be obtained after the preliminary audit strategy has been developed.
Answer D is correct. A preliminary audit strategy may reflect (1) the planned assessed level of control risk, (2) the extent of the understanding of the internal control, (3) tests of controls that may be performed, and (4) the planned level of substantive tests to be performed
7. Inherent risk and control risk differ from detection risk in that inherent risk and control risk are
a) Elements of audit risk while detection risk is not.
b) Changed at the auditor’s discretion while detection risk is not.
c) Considered at the individual account-balance level while detection risk is not.
d) A function of the client and its environment while detection risk is not.
Answer A is incorrect. Inherent risk, control risk and detection risk are all components of audit risk.
Answer B is incorrect. Detection risk, not inherent risk and control risk, may be changed at the auditor's discretion.
Answer C is incorrect. Auditors consider all of the component risks at the account level.
Answer D is correct. Inherent risk and control risk exist independently of the audit of financial statements as functions of the client and its environment, whereas detection risk relates to the auditor's procedures and can be changed at his or her discretion.
8. As the acceptable level of detection risk decreases, the assurance directly provided from
a) Substantive test should increase.
b) Substantive test should decrease.
c) Tests of controls should increase.
d) Tests of controls should decrease.
Answer A is correct. Detection risk is restricted by the auditor's substantive tests. As the acceptable level of detection risk decreases, assurance provided by substantive tests must increase. Increased assurance can be obtained by modifying the nature, timing and/or extent of the substantive tests.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. 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.
Answer D is incorrect. 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.
9. Holding all other factors constant, decreasing the extent of substantive audit procedures for accounts payable ordinarily has what effect on audit risk?
a) Increases.
b) Decreases.
c) No effect.
d) Indeterminate.
Answer A is correct because decreasing the extent of substantive audit procedures increases detection risk, and this will increase audit risk when all other factors remain constant.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
10. Which of the following audit risk components may be assessed in nonquantitative terms?
| | Inherent Risk | Control Risk | Detection Risk |
| A | Yes | Yes | No |
| B | Yes | No | Yes |
| C | No | Yes | Yes |
| D | Yes | Yes | Yes |
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is correct because all of these risks may be assessed in quantitative terms such as percentages. They may also be assessed in nonquantitative terms such as a range from a minimum to a maximum.
11. Use the audit risk model to calculate audit risk (to the closest percent) in the following circumstance:
Control risk 40%
Inherent risk 40%
Detection risk 40%
a) 1%
b) 6%
c) 13%
d) 40%
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is correct. The requirement is to use the audit risk model to mathematically calculate audit risk (to the nearest percent). AU 312 discusses the three components of the audit risk model presented in this problem which may be viewed as
Audit risk = Inherent risk x Control risk x Detection risk in this problem
Audit risk = .40 x .40 x .40 = 6.4%
Note that a quantitative approach such as this is largely for demonstrative purposes and few would directly incorporate it into practice.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
12. The risk that an auditor will conclude, based on substantive tests, that a material misstatement does not exist in an account balance when, in fact, such error does exist is referred to as
a) Sampling risk
b) Detection risk
c) Nonsampling risk
d) Inherent risk
Answer A is incorrect. 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.
Answer B is correct. Detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion.
Answer C is incorrect. Nonsampling risk includes only those aspects of audit risk that are not due to sampling.
Answer D is incorrect. Inherent risk is the susceptibility of an assertion to a material misstatement, assuming that there are no related controls.
13. As a lower acceptable level of materiality is established, the auditor should plan more work on individual accounts to
a) Find smaller misstatements.
b) Find larger misstatements.
c) Increase the tolerable misstatement in the accounts.
d) Decrease the risk of assessing control risk too low.
Answer A is correct. A decrease in acceptable levels of materiality requires the auditor to do one or more of the following: (1) select a more effective auditing procedure, (2) perform auditing procedures closer to the balance sheet date, or (3) increase the extent of a particular auditing procedure. By increasing the extent of a procedure concerning an individual account and/or selecting a more effective procedure, the auditor will find the smaller misstatements that in aggregate might exceed his preliminary judgments about materiality. The auditor, therefore, must plan to find smaller misstatements as a lower acceptable level of materiality is established.
Answer B is incorrect. Larger misstatements must be discovered in any sampling plan regardless of materiality levels.
Answer C is incorrect. A decrease in materiality will lead to a decrease in tolerable misstatement for an account, not an increase. Tolerable misstatement is a planning concept and is related to the auditor's preliminary estimates of materiality levels in such a way that tolerable misstatement combined for the entire audit plan, does not exceed those estimates.
Answer D is incorrect. Lower levels of materiality do not require a reduction in the risk of assessing control risk too low. The risk of assessing control risk too low pertains to the planned reliance on specific internal control policies and procedures, not work on individual accounts.
14. Which of the following statements is not correct about materiality?
a) The concept of materiality recognized that some matters are important for presentation of financial statement in conformity with Philippine Accounting Standards (PAS), while other matter are not important.
b) An auditor consider materiality for planning purposes in terms of the smallest aggregate level of misstatements that could be material to any one of the financial statements.
c) Materiality judgments are made in light of surrounding circumstances and necessarily involved both quantitative and qualitative judgments.
d) 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.
Answer A is incorrect. Materiality does recognize that some matters are important for fair presentation in conformity with GAAP.
Answer B is correct because the auditor considers materiality for planning purposes in terms of the smallest, not the largest, aggregate amount of misstatement that could be material to any one of the financial statements.
Answer C is incorrect as materiality is a judgment assessed in quantitative and qualitative terms.
Answer D is incorrect because materiality is a function of the auditor's perception of user needs.
15. In considering materiality for planning purposes, an auditor believes that misstatements aggregating PHP10,000 would have a material effect on an entity’s income statement, but that misstatements would have to aggregate PHP20,000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design auditing procedures that would be expected to detect misstatements that aggregate
a) PHP10,000
b) PHP15,000
c) PHP20,000
d) PHP30,000
Answer A is correct because it will ordinarily be difficult to anticipate during the planning stage of an audit whether all misstatements will affect only one financial statement. The auditor therefore generally is required to use the lower financial statement figure for most portions of planning.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
16. Following the Professional Standards which of the following is not one of the assertions made by management in financial statements?
a) Completeness.
b) Existence or occurrence.
c) Presentation and disclosure
d) Relevance and reliability
Answer A is incorrect because completeness is a financial statement assertion.
Answer B is incorrect because existence or occurrence is a financial statement assertion.
Answer C is incorrect because presentation and disclosure is a financial statement assertion.
Answer D is correct because relevance and reliability is not included in the professional standards as assertions. AU 326 presents the five assertions as: (1) Presentation and disclosure, (2) Existence or occurrence, (3) Rights and obligations, (4) Completeness, and (5) Valuation.
17. Which of the following, if material, would be fraud as defined in Statements on Auditing Standards?
a) Errors in the application of accounting principles.
b) Errors in the accounting data underlying the financial statements.
c) Misinterpretation of facts that existed when the financial statements were prepared.
d) Misappropriation of assets.
Answer A is incorrect because an error in the application of accounting principles is an example of "errors" as defined by Statements on Auditing Standards. An error refers to an unintentional mistake.
Answer B is incorrect because an error in accounting data is an example of "errors" as defined by Statements on Auditing Standards. An error refers to an unintentional mistake.
Answer C is incorrect because a misinterpretation of facts is an example of "errors" as defined by Statements on Auditing Standards. An error refers to an unintentional mistake.
Answer D is correct because the term "fraud" refers to intentional distortions of financial statements such as deliberate misrepresentations.
18. Which of the following factors is most important concerning an auditor’s responsibility to detect errors and fraud?
a) The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles.
b) The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements.
c) The possibility that management fraud, defalcations, and the misappropriation of assets may indicate the existence of illegal acts.
d) The risks that mistake, falsifications, and omissions may cause the financial statements to contain material misstatements.
Answer A is incorrect. The susceptibility of the accounting records to intentional manipulations, alterations, and the misapplication of accounting principles are examples of factors that may influence the auditor's consideration of risk of material misstatement. This answer is incorrect because it is incomplete.
Answer B is incorrect. The probability that unreasonable accounting estimates result from unintentional bias or intentional attempts to misstate the financial statements is an example of a factor that may influence the auditor's consideration of risk of material misstatements in the financial statements. This answer is incorrect because it is incomplete.
Answer C is incorrect. The possibility that management fraud, defalcations, and the misappropriation of assets indicating the existence of illegal acts is one factor the auditor can use to assess the risk of management misrepresentation in the financial statements. Answer C is incorrect because it is incomplete.
Answer D is correct. The auditor should assess the risk that errors and fraud (which include mistakes, falsifications and omissions) may cause the financial statements to contain material misstatements.
19. What assurance does the auditor provide that errors, fraud, and direct effect illegal acts that are material to the financial statements will be detected?
| | Errors | Fraud | Direct effects illegal acts |
| A | Limited | Negative | Limited |
| B | Limited | Limited | Reasonable |
| C | Reasonable | Limited | Limited |
| D | Reasonable | Reasonable | Reasonable |
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is correct. AU 316 requires the auditor to design the audit to provide reasonable assurance of detecting material errors, fraud and direct effect illegal acts.
20. The independent auditor’s plan for an examination in accordance with generally accepted auditing standards is influenced by the possibility of material misstatements. The auditor will therefore conduct the examination with an attitude of
a) Professional skepticism.
b) Subjective mistrust.
c) Objective indifference.
d) Professional responsiveness.
Answer A is correct because the auditor should plan and perform the audit with an attitude of professional skepticism, recognizing that the application of auditing procedures may produce evidential matter indicating the possibility of errors or fraud.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
21. Which of the following statements best describes the auditor’s responsibility regarding the detection of material errors and fraud?
a) The auditor is responsible for the failure to detect material errors and fraud only when such failure results from the nonapplication of generally accepted accounting principles.
b) Auditing procedures may or may not need to be extended if the auditor’s analysis indicates the existence of fraud risk factors.
c) The auditor is responsible for the failure to detect material errors and fraud only when the auditor fails to confirm receivables or observed inventories.
d) Extended auditing procedures are required to detect unrecorded transactions even if there is no evidence that material errors and fraud may exist.
Answer A is incorrect. The auditor should design the audit to provide reasonable assurance of detecting errors and fraud that is material to the financial statements. This responsibility for detection is not limited to circumstances arising from the nonapplication of generally accepted accounting principles.
Answer B is correct. When fraud risk factors exist, the auditor should consider whether already designed procedures adequately consider the existence of fraud. When they do not, audit procedures must be extended.
Answer C is incorrect. The auditor may be held responsible for failures to detect misstatements due to errors and fraud because of inadequate planning, performance or judgment. Not confirming receivables or not observing inventories are only two of the many possible situations in which the auditor may be held responsible for a failure to detect associated errors and fraud.
Answer D is incorrect. The extended auditing procedures are necessary when normal procedures indicate evidence that misstatements due to errors and fraud may exist, not when there is no such evidence.
22. Which of the following is an example of fraudulent financial reporting?
a) Company management improperly records as revenue the proceeds of a loan.
b) The treasurer diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses.
c) An employee steals inventory and the “shrinkage” is recorded in cost of goods sold.
d) An employee bills his company for products not received, using the name of a fictitious supplier.
Answer A is correct because fraudulent financial reporting involves intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users and improperly recording the revenue results in such misstatements.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
23. Which of the following is correct concerning a “fraud risk factor?”
a) Its presence indicates that the risk of fraud is high.
b) It has been observed in circumstances where frauds have occurred.
c) It requires modification of planned audit procedures.
d) It is also a material weakness in internal control.
Answer A is incorrect because the risk of fraud may or may not be high when a risk factor is present.
Answer B is correct because AU 316 suggests that while fraud risk factors do not necessarily indicate the existence of fraud, they often have been observed in circumstances where frauds have occurred.
Answer C is incorrect because the current audit program 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 in internal control; see AU 325 for information on reportable conditions and material weaknesses in internal control.
24. Which of the following is correct concerning requirements about auditor communications about fraud?
a) All fraud that causes a material misstatement of the financial statements should be reported directly to the audit committee.
b) Fraud that causes an immaterial misstatement of the financial statements need not be reported to the audit committee.
c) Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission.
d) The auditor has no responsibility to disclose fraud outside the entity under any circumstances.
Answer A is correct because all fraud involving senior management and all other material fraud should be reported directly to the audit committee.
Answer B is incorrect because fraud resulting in an immaterial misstatement of the financial statements with which management is involved must be communicated to the audit committee.
Answer C is incorrect because auditors are only required to report fraud to the Securities and Exchange Commission under particular circumstances.
Answer D is incorrect because under certain circumstances auditors must disclose fraud outside the entity. AU 316 provides information on the CPA's responsibility relating to fraud.
25. Professional skepticism, when exercised during the consideration of the risk of misstatement due to fraud:
a) Should only be exercised during the planning stage of the audit.
b) Is based on the notion that the client is dishonest.
c) Is an attitude that includes a questioning mind.
d) Ordinarily includes the use of an outside expert in most audits.
Answer A is incorrect because professional skepticism is exercised during all stages of the audit.
Answer B is incorrect because the auditor does not assume that the client is either honest or dishonest.
Answer C is correct because AU 230 defines professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence.
Answer D is incorrect because no outside expert is ordinarily consulted relating to the professional skepticism requirement.
26. Which of the following is not a likely response when an auditor has determined that a misstatement is, or may be, the result of fraud, and has determined that the effect on the financial statements may be material?
a) Consider the implications for other aspects of the audit.
b) Discuss the matter and approach to further investigation with an appropriate level of management.
c) Attempt to obtain additional evidential matter to determine whether material fraud has occurred or is likely to have occurred.
d) Suggest that the client contact a local law enforcement authority to report the possible fraud.
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is correct because in most circumstances of fraud it is unlikely that a CPA would suggest to a client that a local law enforcement authority be contacted.
27. In which of the following circumstances is it least likely that the auditor will have a responsibility to disclose a fraudulent act to parties other than the client’s senior management and its audit committee?
a) In response to a successor auditor.
b) To comply with legal and regulatory requirements.
c) In response to question raised by an analyst who follow the stock of the company.
d) To a funding agency in accordance with requirement for audit of entities that received governmental financial assistance.
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is correct because an auditor will not ordinarily disclose a fraudulent act in response to a question raised by an analyst.
Answer D is incorrect. Refer to the correct answer explanation.
28. Which of the following is a risk factor relating to the misappropriation of assets?
a) Large amounts of cash on hand.
b) High turnover of legal counsel.
c) Inability to generate positive cash flows from operations.
d) Overly complex organizational structure involving numerous legal entities.
Answer A is correct because the existence of large amounts of cash on hand may lead to the misappropriation of assets.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is incorrect. Refer to the correct answer explanation.
29. Which of the following is not typically a characteristic of fraud?
a) Collusion.
b) Concealment.
c) Falsified documentation.
d) Unintentional.
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is correct because fraud is intentional, not unintentional
30. Which of the following statements is correct concerning fraud risk factors that an auditor considers when performing a financial statement audit?
a) They can easily be ranked in order of importance.
b) They must considered individually, and not in combination, when conducting an audit.
c) They must be combined into models before they are effective in identifying the existence of fraud.
d) Their existence in an audit does not necessarily indicate the existence of fraud.
Answer A is incorrect. Refer to the correct answer explanation.
Answer B is incorrect. Refer to the correct answer explanation.
Answer C is incorrect. Refer to the correct answer explanation.
Answer D is correct because AU 316 makes clear that while fraud risk factors do not necessarily indicate the existence of fraud, they often have been observed in circumstances where frauds have occurred.
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