Excel Professional Services, Inc.

Management Firm of Professional Review and Training Center (PRTC)

(LUZON) Manila 87339344 * Calamba City, Laguna * Dasmariñas City, Cavite * Lipa City,
Batangas (0917) 8852769 * (VISAYAS) Bacolod City (034) 4346214 * Cebu City (032)
2537900 loc. 218 (MINDANAO) Cagayan De Oro (0917) 7081465 * Davao City (082) 2250049

AUDITING THEORY
AT.3005 – Preliminary R.C.P. SOLIMAN/ K.J. UY
Engagement Activities MAY 2021

References:
a. PSA 210 (Redrafted), Agreeing the terms of Audit Engagements
b. PSA 220 (Redrafted), Quality Control for an Audit of Financial Statements

DISCUSSION QUESTIONS
Overview d. May accept the engagement because training as a
CPA transcends unique industry characteristics.
1. Which of the following would an auditor least likely
perform as part of the auditor’s preliminary Communication with Predecessor Auditor
engagement activities or pre-planning or pre-
engagement phase? 6. Prior to the acceptance of an audit engagement with a
a. Perform procedures regarding the continuance of client who has terminated the services of the
the client relationship and specific engagement. predecessor auditor, the CPA should
b. Evaluate compliance with ethical requirements, a. Contact the predecessor auditor without advising
including independence. the prospective client and request a complete
c. Establish an understanding of the terms of the report of the circumstances leading to the
engagement. termination with the understanding that all
d. Obtain understanding of the legal and regulatory information disclosed will be kept confidential.
framework applicable to the entity. b. Accept the engagement without contacting the
predecessor auditor since the CPA will include
procedures to verify the reason given by the client
Client Acceptance and Continuance for termination.
c. Not communicate with the predecessor auditor
2. In making a decision to accept or continue with a because this would in effect be asking the auditor
client, the auditor should consider: to provide the confidential relationship between
a. b. c. d. the auditor and client.
Its competence Yes Yes Yes Yes d. Advise the client of the intention to contact the
Its Independence Yes No Yes No predecessor auditor and request permission for
Its ability to serve the the contact.
client properly Yes Yes Yes No 7. Which of the following will an auditor most likely
The integrity of client’s discuss with the former auditors of a potential client
management Yes Yes No Yes prior to acceptance?
Agreement of the terms of a. Integrity of management.
engagement with the b. Reasons for changing audit firms.
management Yes No Yes No c. Disagreements with management regarding
accounting principles.
3. The auditor will utilize many resources to assess d. All of the above must be discussed.
management integrity in the client acceptance
process. Which of the following will an auditor most 8. If permission from client to discuss its affairs with the
likely refrain from using in this search? proposed auditor is denied by the client, the
a. Predecessor auditor. predecessor auditor should:
b. Other professionals in the business community. a. Keep silent of the denial.
c. Public databases. b. Disclose the fact that the permission to disclose is
d. All of the above will typically be used by an auditor denied by the client.
in the search. c. Disclose adequately to proposed auditor all
noncompliance made by the client.
4. Engagement risk has been defined as the risk of d. Seek legal advice before responding to the
potential losses that are incurred by the auditor in proposed auditor
being associated with a particular client. Which of the
following factors are not associated with increased 9. The predecessor auditor is required to respond to the
engagement risk for the auditor? request of the successor auditor for information, but
a. Management with questionable integrity. the response can be limited to stating that no
b. A failed company. information will be provided when:
c. Materially misstated financial statements. a. the predecessor auditor has poor relations with the
d. All of these factors increase engagement risk. successor auditor.
b. the client is dissatisfied with the predecessor’s
5. A CPA who has never audited a commercial bank work.
a. May not accept such an engagement. c. there are actual or potential legal problems
b. May accept the engagement only if the accounting between the client and the predecessor.
firm specializes in the audit of commercial banks. d. the predecessor believes that the client lacks
c. May accept the engagement after attaining a integrity.
suitable level of understanding of the transactions
and accounting practices unique to commercial
banking.

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10. The firm should obtain acceptance and continuance c. accept such a limited engagement as an audit
information as it considers necessary in the following engagement as the auditor serves the public
circumstances: interest.
a. When accepting an engagement with a new client. d. accept such a limited engagement as an audit
b. When deciding whether to continue an existing engagement as long as documented in audit
engagement. engagement letter.
c. When accepting a new engagement with an
existing client. Agreement on Audit Engagement Terms
d. All of these.
16. Engagement letters are widely used in practice for
11. A firm has obtained information that would have professional engagements for all types. Which of the
caused it to decline an engagement had the following best describes the purpose of the
information been available earlier. Actions available to engagement letter?
the auditor include the following, except: a. The engagement letter relieves the auditor of
a. Reporting the information and its implications to some responsibility for the exercise of due care.
the person(s) who appointed the CPA. b. By clearly defining the nature of the engagement,
b. Withdraw from the engagement. the engagement letter helps to avoid and resolve
c. Withdraw from both the engagement and the misunderstandings between CPA and client
client relationship. regarding the precise nature of the work to be
d. Continue the engagement since the Code of Ethics performed and the type of report to be issued.
requires started engagements to be completed c. The engagement letter conveys to management
regardless of subsequent developments and the detailed steps to be applied in the audit
information. process.
d. The engagement letter should be signed by both
Basis of Engagement the client and the CPA and should be used only for
independent audits.
12. The use by management of an acceptable financial
reporting framework in the preparation of the financial 17. When should an auditor obtain an engagement letter?
statements and the agreement of management and, a. Whenever a prospective client offers to hire the
where appropriate, those charged with governance to audit firm
the premise on which an audit is conducted. b. During the interim audit period, after the auditor
a. Terms of audit engagement has evaluated the client’s internal control and
b. Preconditions for the audit estimated the amount of time required for the
c. Scope of the audit audit
d. Financial statements audit c. When a new client is accepted by the auditor
d. At the conclusion of the field work, just prior to
Acceptable Financial Reporting Framework signing the audit report

13. In an audit of FSs, the financial reporting framework 18. It is in the interest of both client and auditor that the
used is generally the GAAP. In the Philippines, which auditor sends an audit engagement letter, preferably
of the following is/are the acceptable framework? before
a. Philippine Financial Reporting Standards (PFRSs) a. The performance of substantive testing.
b. PFRS for Small and Medium-sized entities (SMEs) b. The commencement of the engagement.
c. Other acceptable basis of reporting c. The completion of audit.
d. Any of the above depending on the type of client d. Before the issuance of audit report.

Management’s Responsibilities 19. The auditor shall agree the terms of the audit
engagement with management or those charged with
14. The following are the management’s responsibilities governance, as appropriate. Which of the following
that constitute the premise on which the audit is normally signs the engagement letter for an audit of a
conducted, except: public company?
a. Preparation and presentation of the financial a. Corporate treasurer.
statements. b. Chief financial officer.
b. Design, implementation and monitoring of internal c. Chairman of the board of directors.
control relevant to financial statements. d. Audit committee.
c. To provide the auditor with access to all
information relevant to audit and additional 20. The form and content of audit engagement letters may
information the auditor may request. vary for each client, but they would generally include
d. To provide the auditor unrestricted access to reference to the following, except
persons within and outside of the entity. a. The objective of the audit of financial statements.
b. Auditor’s responsibility for the financial
Limitation on Scope Prior to Audit Engagement statements.
Acceptance c. The form of any reports or other communication of
results of the engagement.
15. If management or TCWG impose a limitation on the d. Unrestricted access to whatever records,
scope of the auditor’s work in the terms of a proposed documentation and other information requested in
audit engagement such that the auditor believes the connection with the audit.
limitation will result in the auditor disclaiming an
opinion on the financial statements, the auditor shall 21. Which of the following is not included in an
a. not accept such a limited engagement as an audit engagement letter?
engagement, unless required by law or regulation a. Restriction on cash balances, lines of credit by
to do so. similar arrangements
b. not accept such a limited engagement as an audit b. Accessibility to all financial records
engagement, in all cases. c. Client imposed limitation in the scope

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d. Limitation in the scope of examination as imposed

by circumstances Acceptance of a Change in the Terms

22. In determining audit fees, an auditor may take into 27. When a change in the type of engagement from higher
account each of the following except to lower level of assurance is reasonably justified, the
a. Volume and intricacy of work involved. report based on the revised engagement
b. Degree of responsibility assumed. a. Should not contain a separate paragraph that
c. Number and cost of manhours needed. refers to the original engagement.
d. Size and amount of capital of client. b. Should not refer to any procedures that may have
been performed in the original engagement.
23. Retainer’s fee basis is when c. Omits reference to the original engagement.
a. Billing is done on the basis of actual time spent at d. All of the above
the agreed rates/hour.
b. The client is charged on a per diem basis with a 28. Which of the following would ordinarily be considered
cap or ceiling amount. a reasonable basis for requesting a change in the
c. The client is billed a fixed fee periodically for the engagement
services rendered during a designated period of a. a change in circumstances.
time. b. a misunderstanding as to the nature of the audit.
d. The client is billed at a single amount for the entire c. a restriction on the scope of the engagement,
engagement. whether imposed by management or caused by
circumstances.
24. A type of billing audit client which combines lump sum d. Both a and b
and per diem methods is known as
a. Retainer’s fee basis c. Either (a) and (b) 29. If a change in the type of engagement from higher to
b. Maximum fee basis d. None of the above lower level of assurance is not justified, the auditor
should
Audits of Components a. Continue with the revised engagement, but make
explicit reference about the original engagement.
25. Which of the following factors do not influence the b. Continue with the revised engagement, and not
decision of the auditor to send a separate engagement make explicit reference about the original
letter to the parent entity and its component engagement.
(subsidiary, branch or division) assuming the same c. Refuse to agree to management’s request on the
auditor handles both entities? change of engagement and continue with the
a. legal requirements original engagement.
b. degree of ownership by parent d. Withdraw from the engagement.
c. ethical requirements
d. whether a separate audit report is to be issued on 30. Which of the following actions may be appropriate if
the component the auditor is unable to agree to a change of the
engagement and is not permitted to continue the
Recurring Audits original engagement?
I.Auditor should withdraw from the engagement
26. Assuming a recurring audit, in which of the following II.Consider whether there is any obligation to report
situations would the auditor be unlikely to send a new to the board of directors or shareholders the
engagement letter to the client? circumstances necessitating withdrawal
a. A recent change in partner and/or staff involved in a. I c. II
the audit engagement. b. I, II d. Neither I nor II
b. A change or revision in the terms of engagement.
c. A recent change of client nature or size or
- now do the DIY drill –
management.
d. A misunderstanding as to the objective and scope
of audit.

DO-IT-YOURSELF (DIY) DRILL

1. Which of the following is most likely to occur at the 3. Which of the following factors most likely would cause
beginning of an initial audit engagement? an auditor not to accept a new audit engagement?
a. Prepare draft of the FSs and auditor’s report. a. An inadequate understanding of the entity’s
b. Study and evaluate the system of internal internal control structure.
administrative control. b. The close proximity to the end of the entity’s fiscal
c. Determine the client’s reason for an audit. year.
d. Consult with and review the work of the c. Concluding that the entity’s management probably
predecessor auditor prior to discussing the lacks integrity.
engagement with the client management. d. An inability to perform preliminary analytical
procedures before assessing control risk.
2. The following are considered by a CPA firm in deciding
4. Kool Connections, Inc. requests that Wreath and
whether to accept a new client, except:
Greenworth Auditors make a proposal to provide audit
a. The prospective client’s financial capacity.
services for the company. Which of the following is a
b. The prospective client’s relations with its previous
correct assumption surrounding the result of the
CPA firm.
proposal?
c. The prospective clients standing in the business
a. Greenworth is required to accept Kool Connections
community.
if selected as its auditors.
d. The prospective client’s probability of an
unqualified opinion.

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b. Greenworth should interview the prior audit firm are necessary because the predecessor may be able to
prior to releasing the proposal to Kool provide the successor with information that will assist
Connections. the successor in determining whether
c. Greenworth may decide not to accept Kool a. The predecessor’s work should be used.
Connections based upon the perceived risk of b. The company rotates auditors.
being associated with Kool. c. In the predecessor’s opinion, control risk is low.
d. Greenworth will contact the BOA or the PICPA and d. The engagement should be accepted.
ask for a review of the proposal prior to
acceptance. 11. Upon discovering material misstatements in a client’s
financial statements that the client would not revise,
5. Which of the following is typically not a significant risk
the auditor withdrew from the engagement. If asked
factor that an auditor will consider in the client
by the incoming auditor about the termination the
acceptance of Stitch Magee Co.?
engagement, the predecessor auditor should
a. Brad Stitch, the president and 50% owner of Stitch
a. State that he found material misstatements that
Magee was investigated for securities violations
the client would not revise.
four years earlier.
b. Suggest that the incoming auditor ask the client.
b. Stitch Magee Co. is a public company in the high
c. Suggest that the incoming auditor obtain the
technology industry.
client’s permission to discuss the reasons.
c. Stitch Magee Co. is a manufacturing company that
d. Indicate that the misunderstanding occurred.
procures much of its raw materials from the
Detroit, Michigan area.
12. Engagement letters are required for?
d. Stitch Magee Co. sells 25% of its inventory to
a. All engagements
Nani, Inc. which is owned primarily by Nani Magee,
b. Audit engagements only
the father of Stitch Magee's treasurer, vice
c. Assurance engagements only
president of finance and 50% owner.
d. All engagements except the preparation of
income tax returns
6. An auditor who accepts an audit engagement and does
not possess the industry expertise of the business
13. The primary purpose of the engagement letters is to
entity, should
a. Remind management that the primary
a. Engage financial experts familiar with the nature
responsibility for the financial statements rests
of the business entity.
with management
b. Obtain a knowledge of matters that relate to the
b. Provide a written record of the agreement with the
nature of the entity's business.
client as to the services to be provided
c. Refer a substantial portion of the audit to another
c. Satisfy the requirements of the CPA’s liability for
CPA who will act as the principal auditor.
insurance policy
d. First inform management that an unqualified
d. Provide a starting point for the auditor’s
opinion cannot be issued.
preparation of the preliminary audit program
7. Which of the following is(are) proper when a change
14. The following matters are generally included in an
of auditors has taken place or is in process?
auditor’s engagement letter, except
a. The successor auditor should advise the client of
a. Management’s responsibility for the FSs
his intention to contact the predecessor auditor
b. The scope of the audit
and request permission for the contact
c. The fact that because of the test nature and other
b. The integrity of management should not be
inherent limitations of the audit, together with the
subject of communication between the
inherent limitations of internal control, there is an
predecessor and successor auditors
unavoidable risk that even some material
c. Communication between the predecessor and
misstatements may remain undiscovered.
successor auditors should take place only after the
d. The factors to be considered in setting preliminary
successor auditor has accepted the engagement
judgments about materiality
d. All of the above
15. Which of the following matters is generally included in
8. Before accepting an audit engagement, a successor
auditor's engagement letter?
auditor should make specific inquiries of the
a. Management's responsibility for the entity's com-
predecessor auditor regarding
pliance with laws and regulations.
a. disagreements the predecessor had with the client
b. The factors to be considered in setting preliminary
concerning auditing procedures and accounting
judgments about materiality.
principles
c. Management's liability for illegal acts committed
b. the predecessor’s evaluation of matters of
by its employees.
continuing accounting significance
d. The auditor's responsibility to search for significant
c. the degree of cooperation the predecessor
internal control deficiencies.
received concerning the inquiry of client’s lawyer
d. the predecessor auditor’s assessment of inherent 16. An audit engagement letter least likely includes
risk and judgments about materiality a. A reference to the inherent limitation of an audit
that some material misstatements may remain
9. An incoming auditor should request the new client to
undiscovered.
authorize the predecessor auditor to allow a review of
b. Identification of specific audit procedures that the
the predecessor’s
auditor needs to undertake.
Engagement letter Working paper c. Description of any letters or reports that the
a. Yes Yes auditor expects to submit to the client.
b. Yes No d. d. Arrangements concerning the involvement of
c. No Yes internal auditors and other client’s staff.
d. No No
17. In determining estimates of fees, an auditor may take
10. When an independent auditor is approached to into account each of the following, except the
perform an audit for the first time, he or she should a. Value of the service to the client.
make inquiries of the predecessor auditor. Inquiries

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EXCEL PROFESSIONAL SERVICES, INC.

b. Degree of responsibility assumed by undertaking

the engagement.
c. Skills required to perform the service.
d. Attainment of specific findings.

18. When a professional accountant is the auditor of a

parent entity and also the auditor of its subsidiary,
branch or division (component), which of the following
factors need not be considered in deciding whether to
send the separate engagement letter to the
component?
a. Who appoints the auditor of the component.
b. Whether a separate audit report is to be issued on
the component.
c. Legal requirements
d. Number of reports to be prepared during the peak
audit season.

19. On recurring audits, the auditor may decide not to

send a new engagement letter each year. However,
he might decide to send a new letter when:
a. There is a change in the auditors who will assist
in the conduct of the audit.
b. There is a legal requirement
c. There is a change in the client's accounting policy
for inventories.
d. There is a change in the estimated life of the
client's property and equipment.
20. The auditor should not agree for a change of
engagement when there is no reasonable justification
for doing so.
If the auditor is unable to agree to a change of the
engagement and is not permitted to continue the
original engagement, this will have an effect on the
auditor’s report.
a. True, False c. True, True
b. False, False d. False, True

- end of AT.3005 -

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