Oni n

ANSWER KEY
UNIT III
141
1. d 36. b 71. C 106. b
. d
2. C 37. b 72. c 107. d
142 THE FINANCIAL STATEMENTS AUDIT
. a
143
3. d 38. b 73. d 108. a
. b
144 1. Audit engagement letters generally include reference to the following except
4. d 39. d 74. b 109. b c
.
a. objective of the audit of financial statements.
145
5. b 40. b 75. d 110. a b. management's responsibility for the financial statements.
. a
146 c. scope of the audit.
6. C 41. a 76. b 111. c d
. d. identification of the audit team members.
147
7. a 42. a 77. d 112. b
. b
148 2. When a professional accountant is the auditor of a parent entity and also the
8. d 43. b 78. b 113. C a
. auditor of its subsidiary, branch or division (component),which of the following
149 factors need not be considered in deciding whether to send the separate
9. d 44. C 79. d 114. a a
. engagement letter tothe
theauditor
component?
a. Who appoints of the component.
10 150
d 45. C 80. a 115. d d
. .
11 151 b. Whether a separate audit report is to be issued on the
b 46. d 81. a 116. d c component.
c. Legal requirements.
. .
12 152
b 47. C 82. d, 117. a c
. . d. Number of reports to be prepared during the peak audit
13 153 season.
d 48. a 83. d 118. d
. . a
14 154
a 49. a 84. a 119. d C 3. On recurring audits, the auditor mnay decide not to send a new
. .
15 155 engagement letter each period. In which of the following situations will there
d 50. d 85. a 120. a b a. Revision of special terms of the engagement.
. . be no need to send a new letter?
b. Significant change in nature or size of the client's business.
16 156
d 51. b 86. b 121. d b
. .
17 157
d 52. b 87. a 122. b d c. Recent change of middle management and rank and file
. .
18 158 organization structure.
d 53. C 88. c 123. a C d. Indications of misunderstanding of the objective and scope of the
. .
19 159 audit.
d 54. d 89. C 124. d
. . b
20 160
C 55. b 90. C 125. C d
. .
21 161
b 56. a 91. d 126. C b
. .
22 . 11-48 III-1
b 57. a 92. d 127. d 162
. c
 The Financial Statements Audit
Unit II1
for the auditor to change the engagement to one which provides a [Link] of the following is not one of the three main reasons why the
lower level of assurance? auditor should properly plan engagements?
a. Restrictions on the scope of the a. To help keep audit costs reasonable.
engagement,whether imposed by management or b. To avoid misunderstandings with the client.
caused by circumstances. c. To enable the auditor to obtain sufficient
b. Misunderstanding as to the nature of an audit or
competent evidence.
related service originally requested.
d. To enable proper on-the-job training of employees.
C. Recent changes in senior management, board of directors
or ownership. 8. One of the major parts of audit planning is preplanning. Which of
d. Change in circumstances affecting the need for the service. the following is not involved during the preplanning phase?
a. Deciding whether to accept or continue this client.
5. For initial engagements, the auditor should obtain
sufficient appropriate audit evidence for the following b. Obtaining information about client's legal obligations.
except c. Selecting staff for the engagement.
a. that the opening balances do not contain misstatement d. Obtaining an engagement letter.
that materially affect the current period's financial
statements. 9. Which of the following would not be a consideration of a CPA firm
b. that the prior period's closing balances have been in deciding whether to accept a new client?
correctly brought forward to the current period, or, when a. Client's probability of achieving an unqualified opinion.
appropriate,have been restated. b. Client's financial ability.
c. that appropriate accounting policies are consistently c. Client's relation with its previous CPA firm.
applied or changes in accounting policies have been d. Client's standing in the business community.
properly accounted for or adequately disclosed.
d. that the client has informed the predecessor auditor of [Link] client is changing auditors, PSA requires
his appointment as the new auditor. communication between predecessor and successor auditors.
The burden of initiating the communication rests with the
6. Before accepting an engagement to audit a new client, an a. predecessor.
auditor is required to b. client.
a. make inquiries of the predecessor auditor after obtaining c. successor.
the consent of the prospective client. d. SEC.
b. obtain the prospective client's signature to the
engagement letter. [Link] purpose of an engagement letter is to
c. prepare a memorandum setting forth the staffing a. reduce the terms to writing in order to
requirements and documenting the preliminary audit minimize misunderstandings.
plan.
b. reduce the CPA firm's responsibility to external users of
d. discuss the management representation letter with
the audited financial statements.
the prospective client's audit committee.

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 The Financial Statements Audit
Unit Ill
c. satisfy the Statuteof Frauds which requires that contracts for [Link] preliminary audit arrangements have been made, an
professional services must be in wvriting to be enforceable.
d. notify the audit staff of an upcoming engagement so that engagement confirmation letter should be sent to the [Link] letter
personnel scheduling can be facilitated. usually would not include
a. a reference to the auditor's responsibility for the detection of
[Link] engagement letter will do one, some, or all of the following: errors or irregularities.
1. State whether the CPA will perform audit, review, or b. an estimation of the time to be spent on the audit work by
compilation services. audit staff and management.
2. State whether the CPA will perform tax or management c. a statement that management advisory services would be
advisory or other services. made available upon request.
3. State any restriction to be imposed on the CPA's work. d. a statement that a management letter will be issued outlining
4. Identify deadlines for completing the work. comments and suggestions as to any procedures requiring the
5. State the amount and type of work to be done by client's client's attention.
personnel in generating auditor's workpapers.
6. State the CPA's fees for the engagement.
[Link] appointment of the independent auditor will enable
7. Inform the client that the CPA does not have responsibility for
a. a more thorough examination to be performed.
detecting fraud.
b. a proper study and evaluation of internal control to be
performed.
The engagement letter will do
C. sufficient competent evidential matter to be obtained.
a. numbers 1,2,4, and 6.
b. numbers 1,2,3,4, and 6. d. a more efficient examination to be planned.
c. numbers 1,3,5, and 7.
d. all seven of the above stated items. 16. In an audit situation, communication between the successor and
predecessor auditors should be
[Link] engagement letter a. authorized in an engagement letter.
a. does affect the CPA firm's responsibility to external users of b. acknowledged in a representation letter.
audited financial statements. c. either written or oral.
b. can affect legal responsibilities to the client. d. written and included in the working papers.
c. can be used to alter the auditor's responsibilities under the
standards on auditing. [Link] of the following topics is not normally included in an
d. is useful only if it is an engagement, but has no effect for engagement letter?
review or compilation services. a. The auditors' preliminary assessment of internal control.
b. The auditors' estimate of the fee for the engagement.
C. Limitations on the scope of the engagement.
d. A description of responsibility for the detection of freud.

111-4 III-5
 The Financial Statements Audit
Unit Ill

111-4 III-5
Unit III
The Financial Statemnents Audit

[Link] arrangements agreed to by the auditors and the client should be

reduced to writing by the auditors. The best place to set forth these arrangements is in [Link] accepting an audit engagement, a successor auditor should make specific
a. a memorandum to be placed in the permanent section of the auditing inquiries of the predecessor auditor regarding the predecessor's
working papers.
a. Awareness of the consistency in the application of financial reporting
b. an engagement letter.
standards between periods.
C. a client representation letter.
b. Evaluation of all matters of continuing accounting
d. a confirmation letter attached to the constructive services letter.
significance.
C. Opinion of any subsequent events occurring since the
19. Which statement is correct relating to a potential successor auditor's responsibility
predecessor's audit report was issued.
for communicating with the predecessor auditors in connection with a prospective new
d. Understanding as to the reasons for the change of auditors.
audit client?
a. The successor auditors have no responsibility to contact the predecessor 22. An auditor who has been invited to submit a proposal for an audit engagement is
auditors.
a
b. The successor auditors should obtain permission from the prospective a. predecessor auditor.
client to contact the predecessor auditors. b. successor auditor.
c. The successor auditors should contact the predecessors regardless C. principal auditor.
of whether the prospective client authorizes contact. d. interim auditor.
d. The successor auditors need not contact the predecessors if the
successors are aware of all available relevant facts. 23. Legacy Commercial Inc. engages the services of Mr. C. Dimalanta,CPA, to make a
project study on the expanded food vending operations of the corporation with the
20. An auditor who accepts an audit engagement and does not possess the industry corresponding staffing and compensation package for its executive staff. Dimalanta,
expertise of the business entity, should however,has primarily auditing expertise and only in general merchandising operations.
a. engage financial experts familiar with the nature of the business Mr. Dimalanta may properly
entity.
a. accept the engagement and carry it out consistent with the standards on
b. obtain a knowledge of matters that relate to the nature of the entity's auditing.
business. b. accept the engagement but exercise due professional care.
c. refer a substantial portion of the audit to another CPA who will act as c. accept the engagement and acquire the necessary competence
the principal auditor. or consult with established authorities.
d. first inform management that an unqualified opinion cannot be issued. d. decline the engagement for lack of experience or competence in an entirely
new line of specialization.

[Link] letters are widely used in practice for professional engagements of all
types. The primary purpose of the engagement letter is to

111-6 11I-7
 Cmir 207 The Financial Statements Audit

a. remind management that the primary responsibility for the c. the degree of cooperation the predecessor received
financial statements rests with management. concerning the inquiry of the client's lawyer.
b. satisfy the requirements of the CPA's liability insurance policy. d. the predecessor's assessments of inherent risk and judgments about
C. provide a starting point for the auditor's preparation of the materiality.

[Link] audit program.

provide a written record of the agreement with the client as to [Link] predecessor auditor is required to respond to the request of the successor
services to be provided. auditor for information, but the response can be limited to stating that no
information will be provided when
[Link] making arrangements for an audit, there should be a clear a. predecessor auditor has poor relations with successor auditor.
understanding between the auditor and the client as to the following except b. client is dissatisfied with predecessor's work.
c. there are legal problems between client and predecessor.
a. the type of audit to be performed. d. predecessor believes that client lacks integrity.
b. terms of settlement for audit services.
c. assurance of auditor's independence.
29. Aquino, CPA, requested permission to communicate with the predecessor
d. official to whom audit report shall be addressed.
auditors of a prospective client. The prospective client's refusal to permit this will
26. When a CPA is approached to perform an audit for the first time, the CPA bear directly on Aquino's decision concerning the
should make inquiries of the predecessor auditor. This procedure is a. adequacy of the preplanned audit program.
necessary because the predecessor may be able to provide the successor b. ability to establish consistency in application of accounting
with information that will assist the successor in determining principles between years.
a. whether the predecessor's work should be utilized. C. apparent scope limitation.
b. whether the company follows the policy of rotating its d. integrity of management.
auditors.
C. whether in the predecessor's opinion,internal control of the [Link] of the following most accurately summarizes what is meant by the term
company has been satisfactory. "material misstatement?"
d. whether the engagement should be accepted. a. Fraud and direct-effect illegal acts.
b. Fraud involving senior management and material fraud.
[Link] accepting an audit engagement, a successor auditor should C. Material error, material fraud, and certain illegal acts.
make specific inquiries of the predecessor auditor regarding
d. Material error and material illegal acts.
a. disagreements of the predecessor had with the client
concerning auditing procedures and accounting principles.
[Link] of the following statements is correct relating to the auditor's
b. the predecessor's evaluation of matters of continuing
consideration of fraud?
accounting significance.
a. The auditor's interest in fraud consideration relates to
fraudulent acts that cause a material misstatement of financial
statements.

111-8 11I-9
Unit Ill
The Financial Statements Audit

b. A primary factor that distinguishes fraud from error is that fraud

is always intentional, while errors are generally,but not always, [Link] of the following factors would most likely heighten an
auditor's concern about the risk of fraudulent financial reporting?
intentional. a. Large amounts of liquid assets that are easily convertible into
C. Fraud always involves a pressure or incentive to commit cash.
fraud, and a misappropriation of assets. b. Low growth and profitability as compared to other entities in
d. While an auditor should be aware of the possibility of the same industry.
fraud,management, and not the auditor, is responsible for c. Financial management's participation in the initial selection of
detecting fraud. accounting principles.
d. An overly complex organizational structure involving unusual
32. Which of the following factors or conditions is an auditor least likely lines of authority.
to plan an audit to discover?
a. Financial pressures affecting employees. [Link] auditor who discovers that a client's employees have paid small
b. High turnover of senior management. bribes to public officiaIs most likely would withdraw from the
c. Inadequate monitoring of significant controls. engagement if the
d. Inability to general positive cash flows from operations. a. Client receives financial assistance from a government agency.
b. Evidential matter that is necessary to prove that the illegal
[Link]'s attitude toward aggressive financial reporting and its acts were committed does not exist.
emphasis on meeting projected profit goals most likely would significantly c. Employees' actions affect the auditor's ability to rely on
influence an entity's control environment when management's representations.
a. External policies established by parties outside the entity d. Notes to the financial statements fail to disclose the
affect its accounting practices. employees' actions.
[Link] is dominated by one individual who is also a
shareholder. [Link] of the following illegal acts should an audit be designed to
c. Internal auditors have direct access to the board of directors obtain reasonable assurance of detecting?
and the entity's management. a. Securities purchased by relatives of management based on
d. The audit committee is active in overseeing the entity's knowledge of inside information.
financial reporting policies. b. Accrual and billing of an improper amount of revenue under
government contracts.
34. Which of the following is least likely to be required on an audit? C. Violations of antitrust laws.
a. Test appropriateness of journal entries and adjustment. d. Price fixing.
b. Review accounting estimates for biases.
[Link] of the following relatively small misstatements most likely
c. Evaluate the business rationale for significant unusual could have a material effect on an entity's financial statements?
transactions. a. An illegal payment to a foreign official that was not recorded.
d. Make a legal determination of whether fraud has occurred. b. A piece of obsolete office equipment that was not retired.

III-10 III-11
Unit Ill The Financial Statements Audit

C. A petty cash fund disbursement that was not

properly authorized. c. Assets costing less than P250 are expensed even when the
d. An uncollectible account receivable that was not written off. expected life exceeds one year.
d. Accelerated depreciation methods are used for amortizing the
[Link] most likely explanation why the auditor's examination costs of factory equipment.
cannot reasonably be expected to bring all illegal acts by the client
to the auditor's attention is that 42. To obtain an understanding of a continuing client's business
a. lllegal acts are perpetrated by management override in planning an audit, an auditor most likely would
of internal control. a. Perform tests of details of transactions and balances.
b. illegal acts by clients often relate to operating aspects b. Review prior year woring papers and the permanent file for
rather than accounting aspects. the client.
c. The client's internal control may be so strong that the c. Read specialized industry journals.
auditor performs only minimal substantive testing. d. Reevaluate the client's internal control environment.
d. illegal acts may be perpetrated by the only person in
43. Which of the following matters is generally included in an auditor's
the client's organization with access to both assets and
engagement letter?
the accounting records.
a. Management's responsibility for the entity's compliance with
laws and regulations.
[Link] of the following factors would most likely cause a CPA
b. The factors to be considered in setting preliminary judgments
to decide not to accept a new audit engagement?
about materiality.
a. The CPA's lack of understanding of the prospective
client's internal auditor's computer-assisted audit c. Management's vicarious liability for illegal acts committed by
techniques. its employees.
b. Management's disregard of its responsibility to maintain d. The auditor's responsibility to search for significant internal
an adequate internal control environment. control deficiencies.
c. The CPA's inability to determine whether related-
party transactions were consummated on terms 44. A listing of all the things which the auditor will use to gather
equivalent to arm's-length transactions. sufficient, competent evidence is the
d. Management's refusal to permit the CPA to a. audit procedure.
b. audit plan.
perform substantive tests before the year-end.
c. audit program.
[Link] of the following is most likely to require special d. audit risk model.
planning considerations related to asset valuation?
45. Tests of controls are directed towards the control's
a. Inventory is comprised of diamond rings.
a. efficiency.
b. The client has recently purchased an expensive copy machine.
b. effectiveness.
c. efficiency and effectiveness.
d. cost benefit ratio.

111-12 III-13
Unit Ill The Financial Statements Audit

111-12 III-13
Unit III The Financial Statements Audit

46. Which one of these is not a type of evidence that would be usedfor c. cash flow statement [Link] obtaining an
understanding of the control structure and testing the controls? d. three statements above.

a. Inquiries. [Link] procedures are defined in the Statements on Auditing b. Inspection.

[Link] as
Observation. a. compliance tests.
d. Reperformance. b. substantive tests.
c. tests of controls.
47.A procedure designed to test for peso errors or irregularities directly d. helpful procedures not possessing the validity of other tests affecting the correctness of
financial statement balances is a available to the auditor.
a. substantive test.
b. compliance test. 52. More types of evidence are obtained by using this test than by using c. test of controls.
any other type of test.
d. definition of peso-unit sampling. a. Tests of controls.
b. Tests of transactions.
c. Tests of balances.
[Link] to determine whether the accounting transactions have been d. Analytical procedures.
properly authorized, correctly recorded and summarized in the
journals, and correctly posted to subsidiary ledgers and the general 53. This type of evidence can be gathered with every type of audit test.
ledger are of controls.
a. tests a. Inquiries of client personnel.
b. substantive tests of transactions. b. Inspection of documents and records.
c. substantive tests of balances. c. Observation of application of policies and procedures.
d. analytical procedures. d. Reperformance of procedures.

49. Tests of controls, for efficiency, are frequently done at the same time [Link] of the following audit tests is usually the most costly to as
perform?
a. analytical procedures. a. Analytical procedures.
b. compliance tests. b. Tests of controls.
c. substantive tests of transactions. c. Tests of balances.
d. substantive tests of balances. d. Substantive tests of transactions.

[Link] primary emphasis in most tests of details of balances is on the [Link] of the following audit tests is usually the least costly to a. balance sheet
accounts. perform?
b. income statement accounts. a. AnalyticaI procedures.
b. Tests of controls.

III-14 III-15
Unit Ill The Financial Statements Audit

c. Tests of balances.
d. Substantive tests of transactions. C. an estimate of the peso amount of the probable loss.
d. an expert opinion as to whether a loss is possible, probably,or
56. At what stage in the audit are the analytical procedures performed? remote.
a. In the planning stage.
b. In conjunction with tests of transactions and tests of details of 60.A written client representation letter most likely would be an auditor's
balances. best source of corroborative information of a client's plans to
c. Near the end.
a. terminate an employee pension plan.
d. During all three stages.
b. make a public offering of its common stock.
c. settle an outstanding lawsuit for an amount less than the
57. When planning tests of details of balances, the auditor forecasts the
accrued loss contingency.
results of tests of controls, substantive tests of transactions, and analytical
d. discontinue a line of business.
procedures. The prediction for these three areas is usually that there will be
a. no exceptions.
[Link] auditor concludes that the omission of a substantive procedure
b. few or no exceptions.
considered necessary at the time of the examination may impair the
C. an average number of exceptions.
auditor's present ability to support the previously expressed [Link]
d. many exceptions. auditor need not apply the omitted procedure if
a. the risk of adverse publicity litigation is low.
[Link] of the following statements is not true?
b. the resuts of other procedures that were applied tend to
a. Tests of transactions are often performed several months
compensate for the procedure omitted.
prior to the balance sheet date.
c. the auditor's opinion was qualified because of a departure from
b. It is common to use analytical procedures at any time during the
financial reporting standards.
audit.
d. the results of the subsequent period's tests of controls make the
c. When controls are not considered effective,or when control
omitted procedure less important.
deviations are discovered, substantive tests wvill be eliminated and
replaced with tests of details of balances. [Link] of the following documentation is required for an audit in
d. Tests of details of balances are normally done last. accordance with the standards on auditing?
a. An internal control questionnaire.
[Link] should request that an audit client send a letter of inquiry to those b. A client engagement letter.
attorneys who have been consulted concerning litigation,claims, or c. A planning memorandum or checklist.
assessments. The primary reason for this request is to provide d. A client representation letter.

a. information concerning the progress of cases to date.

b. corroborative evidential mnatter.

III-16 111-17
Unit Iil The Financial Statements Audit

[Link] purpose of tests of compliance is to provide

[Link] of compliance are concerned primarily with each of the
reasonable assurance that the
following questions except
a. accounting treatment of transactions and balances is a. How were the procedures performed?
valid and proper.
b. Why were the procedures performed?
b. accounting control procedures are functioning as intended.
c. Were the necessary procedures performed?
C. entity has complied with disclosure requirements of d. By whom were the procedures performed?
financial reporting standards.
d. entity has complied with requirements of quality control. 68. With respect to the auditor's planning of a year-end
[Link] reliance placed on substantive tests in relation to the examination,which of the following statements is always true?
reliance placed on internal control varies in a relationship that is a. An engagement should not be accepted after the fiscal year
ordinarily ends.
a. parallel. b. An inventory count must be observed at the balance sheet
b. inverse. date.
C. direct. c. The client's audit committee should not be told of the specific
[Link]. audit procedures which will be performed.
[Link] of the following ultimately determines the specific d. It is an acceptable practice to carry out substantial parts of
audit procedures necessary to provide an independent the examination at interim dates.
auditor with a reasonable basis for the expression of an
opinion? 69. The actual operation of an internal control system may be most
a. The audit program. objectively evaluated by
b. The auditor's judgment. a. completing a questionnaire and flowchart related to the
c. Philippine Standards on Auditing. accounting system in the year under audit.
d. The auditor's working papers. b. review of the previous year's audit work papers to update the
report of internal control evaluation.
[Link] performing a study and evaluation of the client's c. selection of items processed by the system and determination
system of internal control an auditor has concluded that the of the presence or absence of errors and compliance deviations.
system is well designed and is functioning as anticipated. Under d. substantive tests of accounts balances based on the auditor's
these circumstances the audit would most likely assessment of internal control strength.
a. cease to perform further substantive tests.
b. not increase the extent of predetermined substantive tests. 70. At interim dates an auditor evaluates a client's internal accounting
C. increase the extent of anticipated analytical control procedures and finds them to be effective. The auditor then
review procedures. performs a substantial part of the audit engagement on a continuous
d. perform all compliance tests to the extent outlined in basis throughout the year. At a minimum, the auditor's year-end audit
the preplanned audit program. procedures must include

I1l-18 IlI-19
Unit lll The Financial Statements Audit

a. determination that the client's internal accounting

[Link] programs are modified to suit the circumstances on particular
control procedures are still effective at year end.
engagemnents. A complete audit program for an engagement
b. confirmation of those year-end accounts that were generally should be developed
examined at interim dates.
a. prior to beginning the actual audit work.
c. tests of compliance with internal control in the same
b. after the auditor has completed an evaluation of the existing
manner as those tests made at the interim dates.
d. comparison of the responses to the auditor's internal internal accounting records and procedures.
control questionnaire with a detailed flowchart at year end. C. after reviewing the client's accounting records and
procedures.
71. In the context of an audit of financial statements,substantive d. when the audit engagement letter is prepared.
tests are audit procedures that
a. may be eliminated under certain conditions. [Link] of the following audit tests would be regarded as a test of
b. are designed to discover significant subsequent events. "compliance"?
C. may be either tests of transactions, direct tests of a. Tests of the specific items making up the balance in a given
financial balances, or analytical tests. general ledger account.
d. will increase proportionately with the auditor's reliance b. Tests of the inventory pricing to vendor's invoices.
on internal control. C. Tests of the signatures on canceled checks to board of
director's authorizations.
[Link] of the following might, in itself, form a valid basis for an d. Tests of the additions to property, plant, and equipment by
auditor to decide to omit a test except the physical inspection.
a. relative risk involved.
b. relationship between the cost of obtaining evidence and 76. An auditor evaluates the existing system of internal control in order
its usefulness. to
c. difficulty and expense involved in testing a particular item. a. determine the extent of substantive tests which must be
d. degree of reliance on the relevant internal controls. performed.
b. determine the extent of compliance tests which must be
[Link] of the following is ordinarily designed to detect performed.
possible material peso errors on the financial statements? C. ascertain whether irregularities are probable.
a. Compliance testing. d. ascertain whether any employees have incompatible
b. Analytical review. functions.
c. Computer controls.
d. Post audit working paper review. [Link] finishing the review phase of the study and evaluation of
internal control in an audit engagement, the auditor should perform
compliance tests on
a. those controls that the auditor plans to rely on.
b. those controls in which material weaknesses were identified.

111-20 111-21
Unit Ill
The Financial Statements Audit
C. those controls that have a material effect upon the
[Link] intended to ensure that transactions are recorded in the
financial statement balances.
right accounts are designed to achieve the objective of
d. a random sample of the controls that were reviewed.
a. validity.
78. Reasons to evaluate internal control would not include b. accuracy.
a. basis for planning the audit. c. classification.
b. determining the nature, timing, and extent of d. accounting
audit procedures.
C. basis for type of opinion to be rendered. [Link] financial statement assertion of existence and occurrence would
d. formulating constructive suggestions for improvements. not be related to internal control objective
a. validity.
[Link] audit team's responsibility would not include b. completeness.
a. designing an effective control structure. c. authorization.
b. documentation of understanding of internal control structure. d. proper period.
C. communicating reportable conditions on internal
[Link] "obtaining-an-understanding" work phase of internal control
control structure. evaluation would not give auditors an overall acquaintance with the
d. an evaluation of existing internal control structure. [Link] environment.
b. flow of transactions.
[Link] functional responsibilities that should be performed by c. effectiveness of control procedures.
different people would not include d. control risk assessment.
a. authorization to execute transactions.
b. recording of transactions. [Link] basic standard flowchart symbols would not include
c. custody of assets involved in the transactions. a. display.
d. reporting of recorded amounts. b. input/output.
c. process.
81.A set of characteristics that defines good control [Link].
working relationships in a company is referred to as
a. control objectives.
86. Control strengths and weaknesses should be documented
b. control environment. in workpapers, sometimes called
c. control risk assessment. a. questionnaires, narratives, flowcharts.
d. functional responsibilities.
b. bridge working papers.
C. communications of reportable conditions.
d. internal control letters.

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 Unit Ill The Financial Statements Audit

87. The internal control in small business is highly dependent on the [Link] planning an audit engagement, which of the following is a factor
a. segregation of functional responsibilities. that affects the independent auditor's judgment as to the quantity,type
b. complexity of the internal control structure. and content of working papers?
C. owner-manager's competence and integrity. a. The estimated occurrence rate of attributes.
d. bonding of employees. b. The preliminary evaluation based upon initial substantive
testings.
88. PSA 300 (Revised), Planning an Audit of Financial Statements,which c. The contents of the client's representation letter.
states that the work is to be adequately planned, and assistants, if d. The anticipated nature of the auditor's report.
any,are to be properly supervised, recognizes that
a. early appointment of the auditors is advantageous to the [Link] programs are modified to suit the circumstances of a particular
auditors and the client. engagement. A final audit program for an engagement generally should be
b. acceptance of an audit engagement after the close of the developed
client's fiscal year is generally not permissible. a. prior to beginning the actual audit work.
c. acceptance of an audit engagement after the close of the b. after the auditors have completed their consideration of the
client's fiscal year requires a disclaimer of opinion. existing internal control.
d. performance of substantial parts of the examination is c. after reviewing the client's accounting records and
necessary at interim dates. procedures.
d. when the audit engagement letter is prepared.
89. Which of the following is an effective audit planning and control
procedure that helps prevent misunderstandings and inefficient use of [Link] audit committee's responsibilities normally would not include
audit personnel? a. discussing the meaning and significance of audited financial
statements.
a. Arrange to make copies, for inclusion in the working papers,of
b. discussing problems and experience with independent
those client supporting documents examined by the auditors.
auditors in completing the audit of annual financial
b. Arrange to provide the client with copies of the audit statements.
programs to be used during the audit. c. nominating the independent auditors.
c. Arrange a preliminary conference with the client to discuss d. discussing the audit programs of the independent auditors.
audit objectives, fees, timing, and other information.
d. Arrange to have the auditors prepare and post any necessary [Link], during an audit examination, the successor auditor becomes aware
adjusting or reclassification entries prior to final closing. of information that may indicate that financial statements reported on by
the predecessor auditor may require revision, the successor auditor should
[Link] auditors typically perform all of the following tasks, except a. ask the client to arrange a meeting among the three parties to
discuss the information and attempt to resolve the matter.
a. supervise staff assistants. b. notify the client and the predecessor auditor of the matter
b. draft the audit report.
and ask them to attempt to revise the statements.
c. sign the audit report.
d. review the working papers prepared by staff assistants.

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Unit Ill The Financial Statements Audit

c. notify the predecessor auditor who may be required to

revise the previously issued financial statements and auditor's 98. It is an accepted practice for external auditors to request letter of
report. representation from their clients. A principal purpose of a letter of
representation from the client is to
d. ask the predecessor auditor to arrange a meeting with
a. discharge the auditor from legal liability of his examination.
the client to discuss and resolve the matter.
b. confirm in writing management's approval of limitations on
95. Wald, CPA, is preparing unaudited financial statements for Zalkin the scope of audit.
C. serve as an introduction to company's personnel and
Company. During the engagement,Wald becomes aware that the
authorization to examine the records.
statements are misleading. Wald should
d. remind management for its primary responsibility for financial
a. disclaim an opinion.
statements.
b. insist that the statements be corrected.
C. issue an adverse opinion. 99. The auditor's opinion on the financial statements of his clients should
d. insist that the statements be audited. be dated as of the date of
96. When management refuses to disclose illegal activities which are a. submittal of the report to the client.
identified by the independent auditor, the independent auditor may b. receipt of client's letter of representation.
be charged with violating the Code of Professional Ethics for c. completion of all important audit procedures.
a. withdrawing from the engagement. d. closing of the client's books.
b. issuing a disclaimer of opinion. e. close of the period under audit.
c. failure to uncover the illegal activities during prior audits.
d. reportingthese activities to the audit committee. [Link] primary difference between an audit of the balance sheet and
an audit of the income statement lies in the fact that the audit of
97. CPAs may send a formal "management letter" to clients in order income statement deals with the verification of
that such a letter may provide a. transactions.
a. a summary of the CPA's observations arising out of his b. authorizations.
study of the client's internal control system. C. costs.
b. a written record of discussions between the auditor and d. cut-off.
the client concerning the former's observations and
suggestions for improvements in financial management. [Link] of the following [Link] considered among the benefits of
C. a permanent record of the review of the internal control audit planning?
work accomplished by the auditor during the course of his a. Audit planning helps coordinate the work to be done by
engagement. auditors of components and other parties such as
d. evidence as to the adequacy or inadequacy of the experts,specialists,etc.
operating Internal control system. b. Audit planning helps ensure that the audit is properly
organized, managed and performed in an effective and
efficient manner.

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Unit III The Financial Statements Audit

C. Audit planning aids in ensuring the examination of financial

c. Audit areas where there is a higher risk of material
statements can be performed without problems and
misstatement.
difficulties.
d. The entity's timetable of reporting such as at interim andfinal
d. Audit planning helps ensure that appropriate attention is stages.
devoted to important areas of the audit.
105. The auditor should plan the nature, timing and extent of direction
102. Which of the following procedures is not undertaken by the auditor and supervision of engagement team members and review of their work.
at the beginning of the current audit engagement? Which of the following factors need not be considered by the auditor in
a. Determines whether ethical requirements including preparing this plan?
independence are complied with. a. Size and complexity of the entity.
b. Establishes an understanding of the terms of engagement. b. The reporting currency to be used,including any need for
C. Determines whether relationship with client can be continued currency translation for the financial information audited.
or not. c. The capabilities and competence of personnel performing the
audit work.
d. Determines the types of opinion that should be expressed on
the financial statements. d. The risks of material misstatement.

106. For initial audits, additional matters the auditor may consider in the
[Link] of the following is not considered by the auditor when overall audit strategy and audit plan include the following except
establishing the scope of the audit engagement? a. Confirmation of material accounts receivable balance at the
a. The financial reporting framework on which the financial end of the year.
information to be audited has been prepared. b. Planned audit procedure to obtain sufficient appropriate
b. Industry-specific reporting requirements. audit evidence regarding opening balances.
c. Expected audit coverage including the number and locations c. Assignment of firm personnel with appropriate levels of
of components to be included. capabilities and competence to respond to anticipated
d. Expected nature and timing of communications among significant risks.
engagement team members including the nature and timing of d. Major issues including the application of accounting principles or
team meetings and timing of the review of work performed. any auditing and reporting standards discussed with management.

104. Which of the following should be considered by the auditor when [Link] determining the number of people who will be assigned to an
ascertaining the reporting objectives of the engagement, the timing of engagement, an auditor normally considers the following except
the audit and the nature of communications required? a. Audit's size and complexity.
a. Availability of client personnel and data. b. The availability of the work of internal auditors and the extent of
b. Effect of information technology on the audit procedures. the auditor's potential reliance on such work.
c. Availability and experience of personnel.
d. The necessity for special expertise.

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Unit IlI The Financial Statements Audit

108. In considering the work to be performed by other auditors,

the following should be taken into account except C. may not be increased because it would become statistically
a. The involvement of experts. invalid, but it may be reduced.
b. The number of locations. d. may not be modified.
C. The involvement of other auditors in the audit of
components such as subsidiaries, branches, and divisions. 112. Which of the following is not a consideration when the auditor is
d. The expected use of audit evidence obtained in prior audits. attempting to assess the inherent risk?
a. Nature of client's business.
109. PSA requires auditors to evaluate whether substantial doubt exists
b. Existence of related parties.
about an entity's ability to continue as a going concern. Which of the
C. Frequency and intensity of top management's review of the
following items will not signify that a material uncertainty exists?
accounting transactions and records.
d. Susceptibility to defalcation.
a. Substantial operating losses or significant deterioration in
[Link]
Change from
value of cash-on-delivery
assets to cash
used to generate credit transactions
flows. [Link] of the following is an example of the concept of inherent
with suppliers.
risk?
c. Withdrawal of financial support by creditors for essential
new product development. a. Humans make more errors than computers, therefore a
manual accounting system is riskier than a computerized
d. Adverse key financial ratios.
system.
b. Accounting systems with vouchers have many more controls
110. A time budget is an estimate of the total hours an audit is
built in, so the risk that there will be errors on the financial
expected to take. The following are among the factors to be
statements is reduced.
considered in developing this budget, except
c. Loans receivable for a finance company are less likely to be
a. Location of client facilities.
collectible than those of a bank.
b. Client's size as indicated by its gross assets, sales, number
d. Audits with larger sample sizes are less risky than those with
of employees.
smaller sample sizes.
c. The competence and experience of available staff.
d. Whether the audit is performed during the interim or at
114. Which of the following discoveries by the auditor would not raise
year-end.
the red flag of increased inherent risk?
a. Management bonuses are based on a percentage of net
[Link] the audit progresses and additional information about the client
income.
is obtained, the acceptable level of audit risk
b. A bond indenture requires a current ratio of at least three to
a. may be modified.
one.
b. may not be reduced because it would become
c. Client makes extensive use of notes receivable and notes
statistically invalid, but it may be increased. payable rather than buying and selling on open account.
d. Client is a parent company with a subsidiary.

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The Financial Statements Audit
115. Inherent risk is reduced where the likelihood of defalcations is
[Link] would be true for an account such as 119. An auditor may compensate for a weakness in the internal
a. inventory. control by increasing the
b. marketable securities. a. level of detection risk.
c. cash. b. extent of tests of controls (compliance tests).
d. accounts receivable. c. preliminary judgment about audit risk.
[Link] control risk and inherent risk are set by the auditor. d. extent of analytical procedures.
On a typical engagement the auditor would not set both of
these for [Link] conducting an audit, errors that arouse suspicion of fraud
should be given greater attention than other errors. This is an
a. the overall audit.
b. each cycle. example of applying the criterion of
c. each account. a. reliability of evidence.
d. each objective. b. materiality.
c. risk.
[Link] control risk and inherent risk vary from cycle to d. dual-purpose testing.
cycle,account to account, or objective to objective,
a. acceptable audit risk must remain a constant. 121. When an independent auditor's examinationof financial statements
b. detection risk and required audit evidence will also vary. discloses special circumstances that make the auditor suspect that
C. detection risk will vary but audit evidence will material errors and irregularities may exist, the auditor's initial course of
remain constant. action should be to
d. detection risk will remain constant but audit evidence a. recommend that the client pursue the suspected fraud to a
will vary. conclusion that is agreeable to the auditor.
b. extend normal audit procedures in an attempt to detect the
[Link] obtaining an understanding of an entity's internal full extent of the suspected fraud.
control structure and assessing control risk, an auditor may next c. reach an understanding with the proper client representative
a. perform tests of controls to verify management's as to whether the auditor or the client is to make the
assertions that are embodied in the financial statements. investigation necessary to determine if a fraud has in fact
b. consider whether evidential matter is available to occurred.
support a further reduction in the assessed level of control
risk. d. decide whether the fraud, if in fact it should exist, might be of
c. apply analytical procedures as substantive tests to such a magnitude as to affect the auditor's report on the financial
validate the assessed level of control risk. statements.
d. evaluate whether the internal control structure policies
and procedures detected material misstatements in the 122. The audit risk against which the auditor requires reasonable
protection is a combination of two separate risks. The first of these is
financial statements. that material errors will occur in the accounting process by which the
financial statements are developed, and the second is that

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Unit III The Financial Statements Audit

a. a company's system of internal control is not adequate

to detect errors and irregularities. [Link] of the following is not generally considered a
b. those errors that occur will not be detected in the financial statement audit risk factor?
auditor's examination. a. Management operating and financing decisions
C. management may possess an attitude that lacks integrity. are dominated by top management.
d. evidential matter is not competent enough for the auditor b. A new client with no prior audit history.
to form an opinion based on reasonable assurance. c. Rate of change in the entity's industry is rapid.
d. Profitability of the entity relative to its industry
123. A CPA may reduce the audit work on a first-time audit by is inconsistent.
reviewing the working papers of the predecessor auditor. The [Link] risk that the auditors' procedures will lead them to
predecessor should permit the successor to review working papers conclude that a material misstatement does not exist in an account
relating to matters of continuing accounting significance such as those balance when in fact such a misstatement does exist is referred to
as:
that relate to
a. Account risk.
a. extent of reliance onthe work of specialists. b. Control risk.
b. fee arrangements and summaries of payments. c. Detection risk.
c. analysis of contingencies. d. Inherent risk.
d. staff hours required to complete the engagement.
[Link] of the following statements is correct regarding the
[Link] of the following procedures is not performed as a part auditor's determination of materiality?
of planning an audit engagement? a. The planning level of materiality will normally be the larger
a. Reviewing the working papers of the prior year. of the amount considered for the balance sheet vs. the income
b. Performing analytical procedures. statement.
C. Tests of controls. b. The auditor's planning level of materiality may be
d. Designing an audit program. disaggregated into smaller "tolerable misstatements" for the
various accounts.
[Link] risk of a material misstatement occurring in an
account,assuming an absence of internal control, is referred c. Auditors may use various rules of thumb to arrive at an
to as: evaluation level of materiality, but not for determining the
a. Account risk planning level of materiality.
b. Control risk d. The amount used for the planning will equal that used
c. Detection risk for evaluation.
d. Inherent risk.
[Link] auditors must consider materiality in planning an
audit [Link] for planning purposes is:
a. The auditor's preliminary estimate of the largest amount of
error that would be material to any one of the client's
financial statements.

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The Financial Statements Audit

III-36 11I-37
Unit Ill
The Financial Statements Audit
b. The auditor's preliminary estimate of the smallest amount of
error that would be material to any one of the client's financial 134. Tracing from source documents forward to ledgers is most likely to
statements. address which assertion related to posted entries:
c. The auditor's preliminary estimate of the amount of error that a. Completeness.
would be material to the client's balance sheet. b. Existence.
d. An amount that cannot be quantitatively stated since it c. Rights.
depends on the nature of the item. d. Valuation.

130. The systems approach to an audit is least likely to be appropriate [Link] that receivables are presented at net-realizable value is
for: most directly related to which management assertion?
a. Clients with weak internal control. a. Existence or occurrence.
b. Rights.
b. Clients that are large in size.
c. Valuation or allocation.
c. Clients in specialized industries.
d. Presentation and disclosure.
d. Clients that are publicly held.

136. Which of the following is not a general objective for the audit of
131. Which of the following is not an assertion that is made in the
asset accounts?
financial statements by management concerning each major account and
a. Establishing existence of assets.
class of transaction?
b. Establishing proper valuation of assets.
a. Completeness.
c. Establishing proper safeguarding of assets.
b. Rights and obligations. d. Establishing the completeness of assets.
c. Legality.
d. Presentation and disclosure. [Link] of the following is not used by auditors to establish the
completeness of recorded assets?
132. Which of the following income statements is least likely to be
verified in conjunction with the audit of a balance sheet account? a. Assessing control risk.
a. Depreciation expense. b. Tracing from source documents to entries in the accounting
b. Interest revenue. records.
c. Travel and entertainment. C. Performing analytical procedures.
d. Uncollectible accounts expense. d. Vouching transactions.

[Link] for unrecorded assets typically involve tracing from: 138. To test for unsupported entries in the journals, the direction of
a. Source documents to recorded journal entries. audit testing should be to the:
b. Source documents to observations. a. Ledger entries.
c. Recorded journal entries to documents. b. Jounal entries.
d. Recorded journal entries to observations. c. Original source documents.
d. Financial statements.

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Unit Il1 The Financial Statements Audit

[Link] auditors will not ordinarily initiate discussion with the audit
a. Adequacy of the preplanned audit program.
committee concerning the:
a. Extent to which the work of internal auditors will b. Ability to establish consistency in application of accounting
principles between years.
influence the scope of the examination.
b. Extent to which change in the company's organization will c. Apparent scope limitation.
influence the scope of the examination. d. Integrity of management.
C. Details of potential problems which the auditors believe
might cause a qualified opinion. [Link] auditor faces a risk that the examination will not detect
d. Details of the procedures which the auditors intend to apply.
material misstatements in the financial statements. In regard to
minimizing this risk, the auditor primarily relies on:
[Link] planning an examination, an auditor should: a. Substantive tests.
a. Consider whether the extent of substantive tests may be b. Tests of controls.
reduced based on the results of the internal control c. Internal control.
questionnaire. d. Statistical analysis.
[Link] abnormal fluctuation in gross profit that might suggest the need
b. Make preliminary judgments about materiality levels for audit for extended audit procedures for sales and inventories would most likely
purposes. be identified inthe planning phase of the audit by the use of:
C. Conclude whether changes in compliance with
prescribed control procedures justifies reliance on them. a. Tests of transactions and balances.
d. Prepare a preliminary draft of the b. An assessment of internal control.
c. Specialized audit programs.
management representation letter.
d. Analytical procedures.
141. With respect to the auditor's planning of a year-end
examination,which of the following statements is always true? [Link] the acceptable level of detection risk decreases, the assurance
a. An engagement should not be accepted after the fiscal year- directly provided from
end. a. substantive tests should increase.
b. An inventory count must be observed at the balance b. substantive tests should decrease.
sheet date. c. tests of controls should increase.
c. The client's audit committee should not be told of any specific d. tests of controls should decrease.
audit procedures which will be performed.
146. As the acceptable level of detection risk decreases, an auditor may
d. It is an acceptable practice to carry our parts of change the
the examination at interim dates.
a. timing of substantive tests by performing them at an interim
date rather than at year end.
[Link] requested permission to communicate with the predecessor
b. nature of substantive tests from a less effective to a more
auditor and review certain portions of the predecessor auditor's working
effective procedure.
papers. The prospective client's refusal to permit this will bear directly
on Santos' decision concerning the:

I11-38 11I-39
Unit III
The Financial Statements Audit
C. timing of tests of controls by performing them at
several dates rather than at one time. c. Selecting a sample of vendors' invoices for comparison to
receiving reports.
d. assessed level of inherent risk to a higher amount.
d. Reading the current year's interim financial statements.
[Link] of the following audit risk components may be assessed
[Link] of the first things that the auditor will do after accepting a
in non-quantitative terms?
new client is
Inherent risk Control risk Detection risk
a. tour client's facilities.
a. Yes Yes No
b. contact client's attorney to discover legal obligations.
b. Yes No Yes
c. study client's internal control structure.
C. No Yes Yes
d. communicate with predecessor auditor.
d. Yes Yes Yes
[Link] of the following is not a document or record that should be
[Link] risk and control risk differ from detection risk in examined early in the engagement?
that inherent risk and control risk are a. Corporate charter and bylaws.
a. elements of audit risk while detection risk is not. b. Management letter.
b. changed at the auditor's discretion while detection risk is not. C. Minutes of board of directors' and stockholders' meetings.
c. considered at the individual account-balance level d. Contracts.
while detection risk is not.
d. functions of the client and its environment while [Link] of the following would not be found in the corporate
detection risk is not. charter?
a. The date of incorporation.
[Link] of the following elements underlies the application of b. The kinds and amount of capital stock authorized.
the standards on auditing, particularly the standards of field work c. The rules and procedures adopted by the stockholders.
and reporting? d. The types of business activity that the corporation is allowed
a. Internal control. to conduct.
b. Corroborating evidence.
c. Quality control. 154. During the planning phase when the auditor is examining
the contracts of client, the primary attention should focus on
d. Materiality and relative risk.
a. large peso value items.
b. any aspect of the agreement affecting financial disclosure.
[Link] of the following procedures would an auditor least
c. tracing the information to verify correct journal entries.
likely perform in planning a financial statement audit?
d. the discovery of related party transactions.
a. Coordinating the assistance of entity personnel in
data preparation.
b. Discussing matters that may affect the audit with firm
personnel responsible for non-audit services to the entity.

111-40 III-41
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The Financial Statements Audit

155. Which of the following is the most likely first step an auditor would 158. Which of the following is an effective audit planning and control
perform at the beginning of an initial audit engagement? procedure that helps prevent misunderstandings and inefficient use of
a. Prepare a rough draft of the financial statements and of the audit personnel?
a. Make copies, for inclusion in the working papers, of those
auditor's report. client supporting documents examined by the auditor.
b. Study and evaluate the system of internal administrative b. Arrange to provide the client with copies of the audit
control. programs to be used during the audit.
c. Tour the client's facilities and review the general records. c. Arrange a preliminary conferencewith the client to discuss
d. Consult with and review the work of the predecessor auditor audit objectives, fees, timing, and other information.
prior to discussing the engagement with the client management. d. Arrange to have the auditor prepare and post any necessary
adjusting or reclassification entries prior to final closing.
156.A CPA is conducting the first examination of a non-public company's
financial statements. The CPA hopes to reduce the audit work by [Link] auditor should carefully consider the competence of the
consulting with the predecessor auditor and reviewing the predecessor's auditee's employees because their competence deals directly and
working papers. This procedure is importantly upon the
a. acceptable if the client and the predecessor auditor agree to a. cost/benefit relationship of the system of internal control.
it. b. achievement of the objectives of the system of internal
b. acceptable if the CPA refers in the audit report to reliance control.
upon the predecessor auditor's work. c. comparison of recorded accountability with assets.
C. required if the CPA is to render an unqualified opinion. d. timing of the tests to be performed.
d. unacceptable because the CPA should bring an independent
viewpoint to a new engagement. [Link] considering materiality for planning purposes, an auditor believes
that misstatements aggregating P10,000 would have a material effect on an
[Link] auditors will not ordinarily initiate discussion with the audit entity's income statement, but that misstatements would have to
committee concerning the aggregate P20,000 to materially affect the balance [Link], it
would be appropriate to design auditing procedures that would be
a. extent to which the work of internal auditors will influence
expected to detect misstatements that aggregate
the scope of the examination.
a. P10,000.
b. extent to which change in the company's organization will
influence the scope of the examination. b. P15,000.
c. details of potential problems which the auditors believe might c. P20,000.
cause a qualified opinion. d. P30,000.
d. details of the procedures which the auditors intend to apply.

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Unit lll The Financial Statements Audit

161. Analytical procedures used in planning an audit should focus

[Link] analytical procedures available to the auditor are
on a. evaluating the adequacy of evidence gathered concerning
1) Compare current year's balances with the preceding year.
unusual balances. 2) Compare detail of a total balance with the preceding
b. testing individual account balances that depend [Link] of these two procedures are that
on accounting estimates.
C. enhancing the auditor's understanding of the client's a. the first failsto consider growth or decline in business activity
business. and the second ignores relationships of data to other data.
b. the first ignores relationships of data to other data and the
d. identifying material weaknesses in the internal control second fails to consider growth or decline in business activity.
structure. c. both fail to consider growth or decline in business activity and
ignore relationships of data.
162. Analytical procedures
d. it is difficult, time consuming, and therefore costly to perform
a. are required to be performed in the planning phase of the
these procedures.
audit.
b. are often done during the examination's testing phase. 166.A common comparison occurs when the auditor calculates the
C. are required to be done during the completion phase of the expected balance and compares it with the actual balance. The
audit. auditor's expected account balance may be determined by
d. may be performed at any of three times during a. using industry standards.
the engagement. b. using Dun and Bradstreet reports.
c. relating it to some other balance sheet or income statement
163. A benefit obtained from comparing client's data with account or accounts.
industry averages is that it provides d. inquiry of client.
a. an indication of the likelihood of financial failure.
b. an indication where errors exist in the statements. [Link] first step in applying analytical procedures is to
c. a benchmark to be used in evaluating client's budgets. a. set the objectives.
d. a comparison of "what is" with "what should be". b. apply the decision rules.
c. conduct the tests.
[Link] most companies in the industry use FIFO inventory valuation and
d. determine what would be relevant data to use.
straight-line depreciaion, and the audit client uses weighted-average and
double-declining balance comparisons of client and industry data
[Link] design of the specific analytical procedures depends upon
a. will be a meaningful highlight of the result of
a. the objectives the auditor sets.
these differences in accounting methods.
b. the data available.
b. will enable the auditor to spot errors but not irregularities.
c. the decision rules which apply.
c. will enable the auditor to spot irregularities but not errors.
d. the conclusion to be reached.
d. may not be meaningful.

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The Financial Statements Audit
169. When analytical procedures are being designed, the auditor
should evaluate whether relationships among data are both plausible
and predictable. Which one of the following statements is not true? [Link] most common statistical technique used with
a. As a general rule, relationships in a stable environment are analytical procedures is
a. disaggregated data.
more predictable than those in an unstable or dynamic
environment. b. regression analysis.
c. a decision rule table.
b. If the relationships among data are plausible but not
d. comparison of current-year with prior-year data, looking
adequately predictable, the procedure will not provide useful
for large peso or large percentage changes.
results.
c. Relationships are plausible when there is a clear cause
[Link] an unusual fluctuation is indicated by analytical procedures
and effect relationship among them.
and management is unable to provide a satisfactory explanation, the
d. Once plausibility has been verified, then predictability can
auditor must assume that there is a high probability that an error or
be presumed.
irregularity exists. In this case,the auditor must
a. issue either a qualified or an adverse opinion.
[Link] one of the following statements regarding use of appropriate
b. issue a disclaimer.
data is not true?
c. issue either a qualified opinion or a disclaimer.
a. For comparisons to be useful, the data used must be relevant
d. design other appropriate audit procedures to determine if
to the objectives involved.
such errors do exist.
b. It is of questionable value to compare current-year unaudited
data with data that is unreliable. 174. One feature which is common to all microcomputer-based
C. To determine trends that enable meaningful audit software is
analysis,comparisons should be made of at least four periods a. the ability to input client's general ledger into the auditor's
for each ratio and percentage used. computer system.
d. Analytical procedures performed on disaggregated data b. the ability to generate decision-rule tables.
ate not as effective as those applied to the financial c. the ability to download data from client's mainframe into the
statement data. auditor's microcomputer system.
d. the ability to record adjusting journal entries into client's
[Link] auditors believe that the mostimportant aspect of analytical system directly from the auditor's system.
procedures are
a. making the calculations based on design of the test. [Link] of the following ratios is not an indicator of client's short-
b. classifying the results according to the decision rule. term debt-paying ability?
c. performing follow-up procedures. a. Current ratio.
d. all three of the above. b. Debt to equity ratio.
c. Quick ratio.
d. Cash ratio.

111-46 111-47
Unit IlI
The Financial Statements Audit
- 176. If a company does not have sufficient cash and cash-like
[Link] conditions are matters that come to an
items to meet its obligations
auditor's attention, which should be communicated to an
a. it is bankrupt. entity's audit committee because they represent
b. it is insolvent. ·a. material irregularities or illegal acts perpetrated by high-
C. the key to its debt-paying ability will be the length of time
level management.
it takes the company to convert less liquid current assets
b. significant deficiencies in the design or operation of
into cash. the internal control structure.
d. the key to its debt-paying ability is the line of credit c. flagrant violations of the entity's documented conflict-
which it has available from banks. of-interest policies.
[Link] help plan the nature, timing, and extent of substantive d. intentional attempts by client personnel to limit the scope
auditing procedures,preliminary analytical procedures should focus of the auditor's field work.
on
a. enhancing the auditor's understanding of the client's
business and event that have occurred since the last audit [Link] auditor searching for related party transactions should obtain
date. an understanding of each subsidiary's relationship to the total entity
b. developingplausible relationships that corroborate because
anticipated results with a measurable amount of
precision. a. this may permit the audit of intercompany account
C. applying ratio analysis to externally generated data such balances to be performed as of concurrent dates.
as published industry statistics or price indices. b. intercompany transactions may have been consummated
d. comparing recorded financial information to the results on terms equivalent to arm's-length transactions.
of other tests of transactions and balances. c. this may reveal whether particular transactions would
have taken place if the parties had not been related.
178. In connection with the examination of financial statements by an d. the business structure may be deliberately designed to
independent auditor, the client suggests the members of the internal obscure related party transactions.
audit staff be utilized to minimize audit costs. Which of the following
tasks could most appropriately be delegated to the internal audit 181.A basic premise underlying analytical procedures is that
staff? a. these procedures can not replace tests of balances and
a. Selection of accounts receivable for confirmation, based transactions.
upon the internal auditor's judgment as to how many b. statistical tests of financial information may lead to the
accounts and which accounts will provide sufficient coverage. discovery of material errors in the financial statements.
b. Preparation of schedules for negative accounts c. the study of financial ratios is an acceptable alternative to the
receivable responses. investigation of unusual fluctuations.
c. Evaluation of the internal control of accounts receivable d. relationships among data may reasonably be expected to exist
and sales. and continue in the absence of known conditions to the contrary.
d. Determination of the adequacy of the allowance for
doubtful accounts.

111-48 11I-49
Unit III
The Financial Statements Audit
for extended audit procedures for sales and inventories would most c. Research and development costs.
likely be identified in the planning phase of the audit by the use of d. Legal expense.
a. tests of transactions and balances.
b. a preliminaryreview of internal control. 186. An auditor should examine minutes of board of directors' meetings
c. specialized audit programs. a. through the date of his report.
d. analytical procedures. b. through the date of the financial statements.
c. on a test basis.
[Link] example of an analytical procedure is the comparison of d. only at the beginning of the audit.
a. financial information with similar information regarding
the industry which the entity operates. [Link] reason why the independent auditor makes an
analytical review of the client's operations is to identify
b. recorded amounts of major disbursements with probable
appropriate invoices. a. weaknesses of a material nature in the system of
c. results of a statistical sample with the expected internal control.
characteristics of the actual population. b. non-compliance with prescribed control procedures.
d. EDP generated data with similar data generated by a C. improper separation of accounting and other financial duties.
manual accounting system. d. unusual transactions.

[Link] applying principal substantive tests to the details of [Link] of the following ratios would be the least useful in
asset and liability accounts at an interim date, the auditor should
reviewing the overall profitability of a manufacturing company?
a. assess the difficulty in controlling incremental audit risk.
a. Net income to net worth.
b. investigate significant fluctuations that have occurred in b. Net income to total assets.
the asset and liability accounts since the previous balance- c. Net income to sales.
sheet date. d. Net income to working capital.
c. select only those accounts which can effectively be
sampled during year-end audit work. [Link] of the following best describes the most important stage
of an auditor's statistical analysis of significant ratios and trends?
d. consider the tests of controls that must be applied at the
balance-sheet date to extend the audit conclusions reached at a. Computation of significant ratios and trends.
the interim date. b. Interpretation of significant variations and
unusual relationships.
185. For which of the following account balances are substantive c. Reconciliation of statistical data to the client's
tests of details least likely to be performed unless analytical accounting records.
d. Comparison of statistical data to prior-year statistics and to
procedures indicate the need to extend detail testing? similar data published by governmental and private sources.
a. Payroll expense.
b. Marketable securities.

111-50 III-51
Unit lll
The Financial Statements Audit
[Link] auditor generally gives most emphasis to ratio and
trend analysis in the examination of the statement of c. Write a conclusion on individual working papers
indicating how the results thereon will affect the auditor's
a. retained earnings. report.
b. income. d. Include in the engagement letter an estimate of the
c. financial position. minimum and maximum audit fee.
d. cash flows.
[Link] of the following analytical review procedures, should
191. A not-for-profit organization published a monthly magazine that be applied to the income statement?
had 30,000 subscribers on January 2, 2011. The number of subscribers a. Select sales and expense items and trace amounts to
increased steadily throughout the year and at December 31,2011,there related supporting documents.
were 32,400 subscribers. The annual magazine subscription cost was b. Ascertain that the new income amount in the statement
P10 on January 1, 2011, and was increased to P12 for new members of changes in financial position agrees with the net income
on April 1, 2011. An auditor would expect that the receipts from amount in the income statement.
subscriptions for the year ended December 31,2011,would be C. Obtain from the proper client representatives, the
beginning and ending inventory amounts that were used to
approximately
determine costs of sales.
a. P358,800.
b. P343,200. d. Compare the actual revenues and expenses with the
corresponding figures of the previous year and investigate
c. P328,800.
significant differences.
d. P327,600.
195. Audit programs generally include procedures necessary to
192. Audit programs are modified to suit the circumstances on
test actual transactions and resulting balances. These procedures
particular engagements. A complete audit program for an
are primarily designed to
engagement generally should be developed
a. detect irregularities that result in misstated
a. prior to beginning the actual audit work.
financial statements.
b. after the auditor has completed an evaluation of the
b. test the adequacy of internal control.
existing internal accounting control.
c. gather corroborative evidence.
C. after reviewing the client's accounting records d. obtain information of informative disclosures.
and procedures.
d. when the audit engagement letter is prepared. [Link] auditor uses analyticaI review during the course of an audit.
The most important phase of this review is the
193. Which of the following is an aspect of scheduling and controlling
a. computation of key ratios such as inventory turnover
the audit engagement?
and gross profit percentages.
a. Include in the audit program a column for estimated
b. investigation of significant variations and
and actual time.
b. Perform audit work only after the client's books of unusual relationships.
account have been closed for the period under
examination.

I1I-52 111-53
Unit lll
The Financial Statements Audit
C. comparison of client-computed statistics with industry data
on a quarterly and full-year basis. [Link] of the following is not generally considered a financial
d. examinations of the client data that generated the statistics statement audit risk factor?
that are analyzed. a. Management operating and financing decisions are
dominated by top management.
[Link] of the following is not a typical analytical review procedure? b. A new client with no prior audit history.
c. Rate of change in the entity's industry is rapid.
a. Study of relationships of the financial information with
d. Profitability of the entity relative to its industry is
relevant non-financial information.
inconsistent.
b. Comparison of the financial information with similar
information regarding the industry in which the entity
[Link] predecessor auditor is required to respond to the request of the
operates.
successor auditor for information, but the response can be limited to
c. Comparison of recorded amounts of major disbursements
stating that no information will be provided when
with appropriate invoices.
a. predecessor auditor has poor relations with successor auditor.
d. Comparison of the fnancial information with budgeted
b. client is dissatisfied with predecessor's work.
amounts.
c. there are legal problems between client and predecessor.
d. predecessor believes that client lacks integrity.
198. Auditors sometimes use comparison of ratios as audit evidence. For
example,an unexplained decrease in the ratio of gross profit to sales may 202. The systems approach to an audit is least likely to be appropriate
suggest which of the following possibilities? for
a. Unrecorded purchases. a. clients with weak internal control.
b. Unrecorded sales. b. clients that are large in size.
c. Merchandise purchases being charged to selling and general c. clients in specialized industries.
expense. d. clients that are publicly held.
d. Fictitious sales.
[Link] of the following is an aspect of scheduling and controlling the
[Link] risk of a material misstatement occurring in an audit engagement?
account,assuming an absence of internal control is referred to as
a. Include in the audit program a column for estimated and
a. Account risk.
actual time.
b. Control risk.
b. Perform audit work only after the client's books of account
c. Detection risk.
have been closed for the period under examination.
d. Inherent risk.
c. Write a conclusion in individual working papers indicating
how the results of the audit willaffect the auditor's report.
d. Include in the engagement letter in estimate of the minimum
audit fee.

I1I-54 11I-55
Unit Ill
The Financial Statements Audit

I1I-56 111-57
Unit Ill
The Financial Statements Audit

204. An audit program provides proof that

a. sufficient competent evidential matter was obtained. [Link] auditor who believes that a material irregularity may exist should
b. the work was adequately planned. initially
c. there was compliance with generally accepted standards a. Withdraw form the engagement
of reporting. b. Discuss the matter with higher level of management
d. there was a proper study and evaluation of internal control.
c. Discuss the matter with those believed to be involved in the
perpetration of the material irregularity
[Link] programs are modified to suit the circumstances on
d. Consult legal counsel
particular engagements. A complete audit program for an engagement
generally should be developed
[Link] the independent auditor decide that the work performed by the
a. prior to beginning the actual audit work.
internal auditor may have a bearing on their own procedures,they
b. after the auditor has completed an evaluation of the
should consider the internal auditor's
existing internal accounting control.
a. Training and supervisory skills.
C. after reviewing the client's accounting records b. Efficiency and experience.
and procedures. c. Competence and objectivity.
d. when the audit engagement letter is prepared. d. Independence and review skills.

[Link] acceptance and retenton policies and procedures do

[Link] auditors are planning an audit engagement for a new clientin a
not include
business that is unfamiliar to the auditors. Which of the following would
a. evaluating firm's independence with potential client.
be the most useful source of information for the auditors during the
b. obtaining and reviewing information about company.
preliminary planning stage when they are trying to obtain a general
c. permission of the predecessor auditor. understanding of audit problems that might be encountered?
d. considering whether engagement requires special skills.
a. Client manuals of accounts and charts of accounts.
b. Industry Audit Guides.
[Link] probability that an auditor will give an inappropriate opinion
c. Prior-year working papers of the predecessor auditors.
on financial statements is
d. Latest annual and interim financial statements issued by
a. audit risk.
b. inherent risk. the client.
c. control risk.
[Link] of the following situations would most likely require special
d. detection risk.
audit planning by the auditor?
[Link] would appear not to exhibit due audit care if there was a a. Some items of factory and office equipment do not
a. high audit risk. bear identification numbers.
b. low detection risk. b. Depreciation methods used on the client's tax return differ
C. high inherent risk. from those used on the books.
d. low control risk.

I1I-56 111-57
Unit Ill
The Financial Statements Audit

I1I-56 111-57
Unit IIl
The Financial Statements Audit

c. Assets costing less than P500 are expensed even

though expected life exceeds one year. a. The degree to which external users rely on the statements.
d. Inventory is comprised of precious stones. b. The likelihood that client will have financial difficulties after
the audit report is issued.
213. The element of the audit planning process most likely to be c. The integrity of management.
agreed upon with the client before implementation of the audit d. Weaknesses in client's internal control structure.
strategy is the determination of the
a. timing of inventory observation procedures to be performed. [Link] audit risk against which the auditor requires reasonable
b. evidence to be gathered to provide a sufficient basis for protection is a combination of two separate risks. The first of these is that
the auditor's opinion. material errors will occur in the accounting process by which the financial
c. procedures to be undertaken to discover litigation, statements are developed, and the second is that
claims,and assessments. a. a company's system of internal control is not adequate to
detect errors and irregularities.
d. pending legal matters to be included in the inquiry of
b. those errors that occur will not be detected in the auditor's
the client's attorney.
examination.
C. management may possess an attitude that lacks integrity.
214. Investigation of new clients and reevaluation of existng ones is
d. evidential matter is not competent enough for the auditor to
an essential part of deciding form an opinion based on reasonable assurance.
a. inherent risk.
b. acceptable audit risk.
c. statistical risk.
d. financial risk.

[Link] extensive understanding of the client's business and industry

and knowledge about the company's operations are essential for doing
an adequate audit. For a new client, most of this information is
obtained
a. from the predecessor auditor.
b. from the Securities and Exchange Commission.
c. from the permanent file.
d. at the client's premises.

[Link] has indicated several factors which affect business risk

and therefore acceptable risk. Which of the following does not affect
business risk?

11I-58 Ill-59
 Unit III

ANSWER KEY

1. d 36. C 71. 211.

106. C 141. d 176. C C
C d
212. a
2. d 37. b 72. C 107. b 142. d 177. a b
3. d 38. a 73. b 213.
108. d 143. a 178. b d
214. d
4. C 39. b 74. C 109. a 144. d 179. b b
215.
5. d 40. b 75. b 110. b 145. a 180. C
6. a 41. a 76. a 216.
111. a 146. b 181. d
7. d 42. b 77. a 217.
112. C 147. d 182. d
8. b 43. a 78. C 113. C 148. d 183. a
9. a 44. C 79. 114. C 149. d 184. a
10. C 45. b 80. 115. a 150. C 185. a
11. a 46. d 81. b 116 a 151. a 186. a
.
12. d 47. 82. b b 187. d
C 117. 152.
13. b 48. 83. b 118. a 153. C 188. d
14. C 49. C 84. d 119. a 154. b 189. b
15. d 50. a 85. a 120. C 155. C 190. b
16. C 51. b 86. b 121. d 156. a 191. d
17. a 52. C 87. C 122. b 157. d 192. b
18. b 53. a 88. a 123. C 158. C 193. a
19. b 54. C 89. C 124. C 159. b 194. d
20. b 55. a 90. C 125. d 160. a 195. C
21. d 56. d 91. d 126. a 161. C 196. b
22. b 57. b 92. b 127. C 162. d 197. C
23. C 58. C 93. d 128. b 163. a 198. b
24. d 59. b 94. a 129. b 164. d 199. d
25. C 60. 95. b 130. a 165. a 200. a
26. d 61. b 96. b 131. C 166. C 201. C
27. a 62. d 97. a 132. C 167. a 202. a
28. C 63. 98. d 133. a 168. a 203. a
29. d 64. b 99. C 134. a 169. d 204. b
30. C 65. b 100. a 135. C 170. d 205. b
31. a 66. b 101. a 136. C 171. C 206. C
32. a 67. b 102. b 137. d 172. b 207. a
33. d 68. d 103. a 138. C 173. d 208. a
34. d 69. C 104. d 139. d 174. a 209. C
35. d 70. a 105. d 140. b 175. b 210. d

I1I-60