Audit and Assurance: Testbank

Testbank
to accompany
Audit and assurance

1st edition
by
Leung et al.
© John Wiley & Sons Australia, Ltd 2019

Chapter 5: Overview of the audit financial reports
Chapter 5: Overview of the audit of financial reports
Multiple-choice questions
1. The Corporations Act does not require the audit of which of the following type of entity,
except in specified circumstances?
*a. A small proprietary company.

b. A public company.
c. A government company.
d. A large proprietary company.
The correct option is a.

Learning objective 5.1 ~ discuss the legal and professional issues in appointing independent
auditors.
2. Who is responsible for the appointment of the auditor to a company?
a. The Australian Securities and Investment Commission.

b. The audit committee of the company.
*c. The members of the company.
d. The managing director of the company.
The correct option is c.

auditors.
3. As a general rule, the auditor is appointed by the shareholders at the annual general
meeting. Which of the following is not true concerning the appointment of an auditor?
a. In practice the shareholders generally accept the recommendations of the directors

concerning the appointment.
*b. The appointment stands for 12 months until the next annual general meeting.
c. The company is liable to pay reasonable fees and expenses of the auditor.
d. An auditor ceases to hold office after a company goes into liquidation.
The correct option is b.

auditors.
© John Wiley & Sons Australia, Ltd 2019 5.2

Testbank to accompany Audit and assurance 1e
4. An auditor must be registered:
*a. by the ASIC.

b. by the Financial Reporting Council.
c. through CPA Australia, CAANZ or the Institute of Public Accountants.
d. by the AUASB.

auditors.
5. The Corporations Act requires that auditors are competent. To be suitably qualified the
person must:
a. be a fit and proper person to be registered as an auditor.

b. be a member of CAANZ, CPA Australia, the Institute of Public Accountants or other
prescribed body.
c. hold a degree, diploma or certificate from a university or other prescribed body.
*d. all of the above.
The correct option is d.

auditors.
6. Which of the following is a benefit of the ASIC register of company auditors?
a. The register contains a code of ethics that auditors must follow.

*b. The register provides assurance of the qualification, level of competence and
experience of the auditor.
c. The register facilitates disciplinary procedures against auditors.
d. All of the above are benefits.

auditors.
7. The removal and resignation of auditors must be:
a. by resolution of the company.

b. with special notice to the ASIC for its consent.
*c. both the above.
d. none of the above.

auditors.

5. 3
8. An engagement letter contains express or implied terms of the contractual arrangement

with the client. Which of the following is not one of those terms?
a. To exercise a reasonable degree of skill and care.

*b. To report the duties of the auditor.
c. To be independent of the company.
d. To give an opinion on the truth and fairness of the financial statements of the
company.

Learning objective 5.2 ~ state the statutory and other duties of the independent auditor.
9. When auditors issue an audit report that expresses an audit opinion what duty are they
fulfilling?
a. The duty to use reasonable care and skill.

b. The duty to be independent.
*c. Statutory duty to report to members and to ASIC.
d. A procedural duty.

10. S. 308 of the Corporations Act requires certain implied conditions to be reported on in an
audit report if there is any deficiency, or failure to comply. Which of the following is one
of those implied conditions?
*a. Whether the auditor has obtained all information, explanation and assistance
required.
b. Whether an audit has been carried out.
c. Whether the auditor is independent of the company.
d. Whether the financial statements are properly drawn up so as to give a true and fair
view of the company's financial affairs.

11. The body that prepares the auditing standards that apply in Australia is:
a. the ASIC.
b. the AASB.
c. the IFAC.
*d. the AUASB.

Learning objective 5.3 ~ indicate the current auditing standards and their major concepts.

12. The primary reasons for the existence of Auditing Standards is:
*a. they provide assurance of the minimum standards that should have been employed
by the auditor in arriving at the opinion.
b. they are necessary to maintain a cost-effective service.
c. they will safeguard the auditor when they are sued.
d. all of the above.

Learning objective 5.3 ~ indicate the current auditing standards and their major concepts.
13. Audit committees are perceived to strengthen the independence of auditors. Which of the
following is normally an objective of an audit committee?
a. Ensuring that the entity operates in the best interests of the shareholders.
*b. Assisting the board of directors to discharge its responsibility to exercise due care,
diligence and skill.
c. Giving advice on the selection of the board of directors.
d. All are objectives of an audit committee.

Learning objective 5.4 ~ describe the auditor’s relationship with the shareholders, audit
committee and other important groups.
14. It is regarded as best practice in regard to the composition of audit committees to:
a. have an executive director as chairperson.

b. have the internal auditor as a member.
c. have the external auditor as a member.
*d. none of the above are regarded as best practice in regard to the composition of audit
committees.

15. The group which has the legal responsibility for removal of the auditor is:
a. management.
*b. the shareholders.
c. the audit committee.
d. the board of directors.

5. 5
16. The Australian Securities Exchange (ASX):
a. requires all listed companies to have an audit committee.

*b. requires the Top 300 companies to have an audit committee.
c. recommends but does not require listed companies to have an audit committee.
d. requires all listed companies with a capitalisation of more than $200 million to have
an audit committee.

17. The work of an internal auditor can be used to complement, but not substitute for, the
work of the independent auditor. Which of the following factors is not one of the
considerations listed by ASA 610 that is relevant in determining the effect of an internal
auditor's work on the audit?
*a. Past communications of the internal auditors with management.

b. The organisational status.
c. The scope of the work.
d. Technical training and proficiency of the internal auditor.

18. The words that best describes the relationship which should exist between the external
auditor and the management of the client company are:
*a. mutual trust and respect.

b. advocacy of management’s position.
c. skeptical vigilance.
d. adversarial relationship.

19. Which of the following is not a benefit arising from having the financial reports audited?
a. Auditors suggest how controls can be improved.

b. Auditors suggest how greater operating efficiencies may be achieved.
c. Audits have a favourable effect on employee efficiency and honesty.
*d. Audits provide access to less favourable borrowing terms.


Learning objective 5.5 ~ describe the benefits and limitations of audits of financial reports.
20. Which of the following is not an inherent limitation of an audit?
a. Audit testing of selective samples.

b. Forming professional judgements in highly specialised areas.
c. Time lapse between the balance date and the presentation of the audit report.
*d. All are inherent limitations.

Learning objective 5.5 ~ describe the benefits and limitations of audits of financial reports.
21. In a financial statement audit, the auditor maintains professional relationships with:
a. the board of directors and ASIC.

*b. the audit committee and the internal auditors.
c. management and the professional accounting bodies.
d. shareholders and creditors.

22. Place these phases of an audit in chronological order:
A. Assess the risk of material misstatement

B. Respond to assessed risks
C. Perform risk assessment procedures
D. Evaluate audit evidence
a. A, B, C, D.
*b. C, A, B, D.
c. A, C, D, B.
d. D, C, B, A.

Learning objective 5.6 ~ describe the overall audit process.
23. During phase I of the audit, the auditor performs risk assessment procedures. Which of
the following is not one of the tasks undertaken during this phase of the audit?
a. Understand internal control.

*b. Assess the risk of material misstatements.
c. Develop preliminary audit strategies.
d. Make decisions about materiality.

5. 7

24. Which of the following is part of phase III of the audit process, which is responding to
assessed risks?
*a. Determine the nature, timing and extent of audit tests.

b. Conduct tests of controls.
c. Assess the risk of material misstatement.
d. Identify significant inherent risks.


Short answer questions
25. Identify and explain two of the benefits of having audited financial statements.
Correct answer:
Any two of the following:
Access to capital markets: without audits, companies are restricted in the access to capital
markets. The ASX in Australia requires that listed companies have their financial statements
audited.
A lower cost of capital: audited financial statements are considered less risky by creditors
who may then be willing to accept a lower rate of return (interest rate) on their investment.
A deterrent to inefficiency and fraud: knowledge of audits can result in fewer errors by staff
as they are more careful. They can also reduce the occurrence of employees misappropriating
assets as employee fraud is more likely to be identified than if there was no audit.
Control and operational improvements: based on observations made during an audit of the
financial statements, the independent auditor can suggest how controls could be improved
and how greater operating efficiencies within the entity’s organisation may be achieved.
Reference: Learning objective 5.5 ~ describe the benefits and limitations of audits of
financial reports.
26. Identify and explain two of the limitations of audited financial statements.
Correct answer:
A time lapse: the auditor’s report may be made several months after the balance date.
Although auditors are required to undertake a review of subsequent events, this still does not
result in an ‘up-to-date’ report on the current financial position.
Audit testing on selective samples: audit testing on selective samples has limitations due to
sampling risk, which is the risk that a sample drawn from a population may not be
representative of that population.
Assessment of materiality: the assessment of materiality requires a high degree of
professional judgement. There are no universally agreed-upon guidelines for quantitative or
qualitative measures of materiality with the result that it is up to the auditor whether
something is deemed material.
Highly specialised areas: auditors may be required to form a professional judgement in areas
that are highly specialised or that are not dealt with adequately by the accounting standards.
Report format limitations: the standard format of the auditor’s report, as prescribed by ASA
700, may not reflect fully the complexities involved in the audit process and the decision of
the audit opinion. The information contained within the report is therefore subject to
interpretation.
Reference: Learning objective 5.5 ~ describe the benefits and limitations of audits of
financial reports.

5. 9
27. List the requirements necessary for an individual to become a registered auditor.
Correct answer:
To be suitably qualified, the person must:
 Be a member of Chartered Accountants Australia New Zealand (CAANZ), CPA
Australia, the Institute of Public Accountants or other prescribed body.
 Hold a degree, diploma or certificate from a university or other prescribed body in
Australia, and have passed a course of study in accountancy of not less than 3 years
duration and a course of study in commercial law of not less than 2 years duration.
 Have such practical experience in auditing as prescribed (work experience in company
auditing under the direction of a registered company auditor and at least one year’s
experience in the supervision of audits of companies).
 Be capable of performing the duties of an auditor and be a fit and proper person to be
registered as an auditor.
Reference: Learning objective 5.1 ~ discuss the legal and professional issues in appointing
independent auditors.
28. ABC Ltd recently established an audit committee in compliance with the Australian Stock
Exchange listing requirements. The committee is made up of Ian Wright, John Small and
Todd Smith. Ian is an executive of the company and has worked his way up from a factory
worker through to management. Ian is the chairperson of the audit committee. John is not a
member of management and is therefore a non-executive director but he does serve on a
number of boards. John’s background is in accounting and before he became a director he
was the CFO of a large corporation for many years. Todd is the chairperson of the board of
directors and is an executive of the company. Todd’s background is in manufacturing and he
has been with the current company for 5 years. The committee has just completed having its
formal charter drawn up which details its rights and responsibilities.
Identify the strengths and weaknesses of ABC Ltd’s audit committee.
Correct answer:
Strengths:
 Chairperson of the audit committee is not the same as chairperson of the board
 One member (John) with financial expertise
 Formal charter specifying the rights and responsibilities.
Weaknesses:
 Only one non-executive member (should be a majority).
Reference: Learning objective 5.4 ~ describe the auditor’s relationship with the shareholders,
audit committee and other important groups.

29. For each of the following groups explain the relationship with the auditors and how they
may interact.
 The shareholders
 The board of directors and the audit committee
 Internal auditors
 Management.
Correct answer
The shareholders: The shareholders of the company are the main beneficiaries of the audit
function. Shareholders rely on the audited financial statements for assurance that
management has properly discharged its stewardship responsibility. Therefore, the
shareholders rely on the auditors. The shareholders also determine the appointment, removal
and resignation of auditors (usually based on the recommendations of the board though). The
auditors have very little interaction with the shareholders unless company staff are
shareholders. They do interact during the annual general meeting if required.
The board of directors and the audit committee: Depending on how many members of the
board are independent, the auditor may interact the same as they do with management. If
there are more non-executive members, then the board may serve as an intermediary between
management and the auditors. The audit committee serves as an intermediary between
management and the auditor, and the board and the auditor. The audit committee can also
facilitate auditor independence. The auditors interact with the audit committee through
meetings.
Internal auditors: Auditors usually have a close working relationship with the internal
auditors. The auditors must assess the work of internal auditors for the purpose of planning
the audit, and the auditor may use the internal audit function in conducting the audit after
testing. Internal auditors and auditors interact frequently throughout the audit.
Management: Management is responsible for the preparation and presentation of the financial
statements whilst the auditors are responsible for expressing an opinion on those statements.
In forming that opinion, the auditor will work closely with management and may have to rely
on certain assertions that they make.
Reference: Learning objective 5.4 ~ describe the auditor’s relationship with the shareholders,
audit committee and other important groups.

5. 11
30. Identify and explain two duties of an auditor.
Correct answer:
The duty to use reasonable care and skill: an auditor is obligated to use ‘reasonable care and
skill’ when conducting an audit. However, interpretation of reasonable care and skill is a
matter of professional judgement, whereby the auditor considers his or her priorities of duties
and rights under specific circumstances.
The duty to be independent: An auditor must be independent from the client in fact and in
appearance. An auditor must not conduct an audit if they are unable to satisfy independence
requirements.
Statutory duties – the audit opinion: The auditor must express an opinion on whether the
financial statements are in accordance with the Corporations Act, comply with accounting
standards and give a true and fair view.
Statutory duties – the duty to report: An auditor must report to the members on the
company’s financial statements for an accounting period and on the accounting records
relating to those statements.
The duty to report to ASIC: The auditor conducting a financial statement audit must notify
ASIC as soon as possible if there are reasonable grounds to suspect a contravention of the
Corporations Act unless the auditor believes the contravention will be adequately dealt with
by commenting on it in the auditor’s report or bringing it to the attention of the directors.
Professional duties: The auditor has professional responsibilities to ensure that the accounting
standards have been consistently applied in the preparation and presentation of the financial
report, that auditing standards have been adhered to, and that any ethical or legal
requirements are met.
Reference: Learning objective 5.2 ~ state the statutory and other duties of the independent
auditor.

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Testbank

Audit and assurance

© John Wiley & Sons Australia, Ltd 2019

Chapter 5: Overview of the audit of financial reports

*a. A small proprietary company.

The correct option is a.

2. Who is responsible for the appointment of the auditor to a company?

a. The Australian Securities and Investment Commission.

The correct option is c.

a. In practice the shareholders generally accept the recommendations of the directors

The correct option is b.

© John Wiley & Sons Australia, Ltd 2019 5.2

4. An auditor must be registered:

*a. by the ASIC.

The correct option is a.

a. be a fit and proper person to be registered as an auditor.

The correct option is d.

6. Which of the following is a benefit of the ASIC register of company auditors?

a. The register contains a code of ethics that auditors must follow.

The correct option is b.

7. The removal and resignation of auditors must be:

a. by resolution of the company.

The correct option is c.

© John Wiley & Sons Australia, Ltd 2019

8. An engagement letter contains express or implied terms of the contractual arrangement

a. To exercise a reasonable degree of skill and care.

The correct option is b.

a. The duty to use reasonable care and skill.

The correct option is c.

The correct option is a.

The correct option is d.

© John Wiley & Sons Australia, Ltd 2019 5.4

The correct option is a.

The correct option is b.

a. have an executive director as chairperson.

The correct option is d.

The correct option is b.

© John Wiley & Sons Australia, Ltd 2019

16. The Australian Securities Exchange (ASX):

a. requires all listed companies to have an audit committee.

The correct option is b.

*a. Past communications of the internal auditors with management.

The correct option is a.

*a. mutual trust and respect.

The correct option is a.

a. Auditors suggest how controls can be improved.

© John Wiley & Sons Australia, Ltd 2019 5.6

The correct option is d.

a. Audit testing of selective samples.

The correct option is d.

a. the board of directors and ASIC.

The correct option is b.

22. Place these phases of an audit in chronological order:

A. Assess the risk of material misstatement

The correct option is b.

a. Understand internal control.

© John Wiley & Sons Australia, Ltd 2019

The correct option is b.

*a. Determine the nature, timing and extent of audit tests.

The correct option is a.

© John Wiley & Sons Australia, Ltd 2019 5.8

Short answer questions

© John Wiley & Sons Australia, Ltd 2019