Auditing Theory 3rd Examination (Answer Key)
Auditing Theory 3rd Examination (Answer Key)
a. The auditor should use professional judgment to assess audit risk and to design audit
procedures to ensure it is eliminated.
b. The auditor is an insurer, and his or her report constitutes a guarantee.
c. The subsequent discovery that a material misstatement exists in the financial statements is
evidence of inadequate planning, performance, or judgment on the part of the auditor.
d. The auditor should obtain an understanding of the accounting and internal control systems
sufficient to plan the audit and develop an effective audit approach.
a. The auditor to obtain an understanding of the entity and its environment, including its internal
control.
b. Discussion among the engagement team about the susceptibility of the entity’s financial
statements to material misstatement.
c. The auditor to identify and assess the risks of material misstatement at the financial
statement and assertion levels.
d. All of the above.
a. The purpose of this PSA is to establish standards and to provide guidance on obtaining an
understanding of the entity and its environment, including its internal control, and on assessing
the risks of material misstatement in a financial statement audit.
b. This PSA requires the auditor to make risk assessments at the financial statement and
assertion levels based on an appropriate understanding of the entity and its environment,
including its internal control.
c. The requirements and guidance of this PSA are to be applied in conjunction with the
requirements and guidance provided in other PSAs.
d. This PSA discusses the auditor’s responsibility to determine overall responses and to design
and perform further audit procedures whose nature, timing, and extent are responsive to the risk
assessments.
4. Which statement is incorrect regarding obtaining an understanding of the entity and its
environment?
a. Obtain an understanding of the entity and its environment, including its internal control, to
assess the risks of material misstatement at the financial statement and assertion levels.
b. Test the operating effectiveness of controls in preventing, or detecting and correcting,
material misstatements at the assertion level.
c. Detect material misstatements at the assertion level.
d. All of the above.
6. The auditor should perform the following risk assessment procedures to obtain an
understanding of the entity and its environment, including its internal control, except:
7. Inquiries directed towards those charged with governance may most likely
a. Relate to their activities concerning the design and effectiveness of the entity’s internal
control and whether management has satisfactorily responded to any findings from these
activities.
b. Help the auditor understand the environment in which the financial statements are prepared.
c. Relate to changes in the entity’s marketing strategies, sales trends, or contractual
arrangements with its customers.
d. Help the auditor in evaluating the appropriateness of the selection and application of certain
accounting policies.
9. Which statement is incorrect regarding the discussion among the engagement team about
the susceptibility of the entity’s financial statements to material misstatements?
a. The members of the engagement team should discuss the susceptibility of the entity’s
financial statements to material misstatements.
b. The objective of this discussion is for members of the engagement team to gain a better
understanding of the potential for material misstatements of the financial statements resulting
from fraud or error in the specific areas assigned to them, and to understand how the results of
the audit procedures that they perform may affect other aspects of the audit.
c. The discussion provides an opportunity for more experienced engagement team members,
including the engagement partner, to share their insights based on their knowledge of the entity,
and for the team members to exchange information about the business risks.
d. All the team members should have a comprehensive knowledge of all aspects of the audit.
10. The auditor’s understanding of the entity and its environment consists of an understanding
of the following aspects:
I. Industry, regulatory, and other external factors, including the applicable financial reporting
framework.
II. Nature of the entity, including the entity’s selection and application of accounting policies.
III. Objectives and strategies and the related business risks that may result in a material
misstatement of the financial statements.
IV. Measurement and review of the entity’s financial performance.
V. Internal control.
a. The entity’s operations, its ownership and governance, the types of investments that it is
making and plans to make, the way that the entity is structured and how it is financed.
b. The overall plans for the entity.
c. The operational approaches by which management intends to achieve its objectives.
d. The result of significant conditions, events, circumstances, actions or inactions that could
adversely affect the entity’s ability to achieve its objectives and execute its strategies, or the
setting of inappropriate objectives and strategies.
a. The risk of material misstatement of the financial statements is broader than business risk,
though it includes the latter.
b. The auditor should identify or assess all business risks.
c. All business risks give rise to risks of material misstatement.
d. A business risk may have an immediate consequence for the risk of misstatement for classes
of transactions, account balances, and disclosures at the assertion level or the financial
statements as a whole.
13. A potential business risk created by industry developments may most likely include
14. The following are examples of conditions and events that may indicate the existence of risks
of material misstatement, except
15. Which of the following conditions and events may most likely indicate the existence of risks
of material misstatement?
16. Which statement is incorrect regarding significant risks that require special audit
consideration?
a. The auditor should determine which of the risks identified are, in the auditor’s judgment, risks
that require special audit consideration.
b. The auditor excludes the effect of identified controls related to the risk to determine whether
the nature of the risk, the likely magnitude of the potential misstatement including the possibility
that the risk may give rise to multiple misstatements, and the likelihood of the risk occurring are
such that they require special audit consideration.
c. Routine, non-complex transactions that are subject to systematic processing are more likely
to give rise to significant risks because they have higher inherent risks.
d. Significant risks are often derived from business risks that may result in a material
misstatement.
17. Examples of situations where the auditor may find it impossible to design effective
substantive procedures that by themselves provide sufficient appropriate audit evidence that
certain assertions are not materially misstated include the following:
I. An entity that conducts its business using IT to initiate orders for the purchase and delivery of
goods based on predetermined rules of what to order and in what quantities and to pay the
related accounts payable based on system-generated decisions initiated upon the confirmed
receipt of goods and terms of payment. No other documentation of orders placed or goods
received is produced or maintained, other than through the IT system.
II. An entity that provides services to customers via electronic media (for example, an Internet
service provider or a telecommunications company) and uses IT to create a log of the services
provided to its customers, initiate and process its billings for the services and automatically
record such amounts in electronic accounting records that are part of the system used to
produce the entity’s financial statements.
19. The auditor should determine overall responses to address the risks of material
misstatement at the financial statement level. Such responses least likely include
a. Emphasizing to the audit team the need to maintain professional skepticism in gathering and
evaluating audit evidence.
b. Assigning more experienced staff or those with special skills or using experts.
c. Incorporating additional elements of unpredictability in the selection of further audit
procedures to be performed.
d. Performing substantive procedures at an interim date instead of at period end.
20. The assessment of the risks of material misstatement at the financial statement level is
affected by the auditor’s understanding of the control environment. Weaknesses in the control
environment ordinarily will lead the auditor to
a. Have more confidence in internal control and the reliability of audit evidence generated
internally within the entity.
b. Conduct some audit procedures at an interim date rather than at period end.
c. Modify the nature of audit procedures to obtain more persuasive audit evidence.
d. Decrease the number of locations to be included in the audit scope.
21. The auditor should design and perform further audit procedures whose nature, timing, and
extent are responsive to the assessed risks of material misstatement at the assertion level.
Which of the following is the most important consideration in responding to the assessed risks?
a. The nature of the audit procedures. c. The timing of the audit procedures.
b. The extent of the audit procedures. d. All of these are equally important.
22. The auditor’s assessment of the identified risks at the assertion level provides a basis for
considering the appropriate audit approach for designing and performing further audit
procedures. Which of the following is incorrect?
a. The auditor may determine that only by performing tests of controls may the auditor achieve
an effective response to the assessed risk of material misstatement for a particular assertion.
b. The auditor may determine that performing only substantive procedures is appropriate for
specific assertions and, therefore, the auditor excludes the effect of controls from the relevant
risk assessment.
c. The auditor needs to be satisfied that performing only substantive procedures for the relevant
assertion would be effective in reducing the risk of material misstatement to an acceptably low
level.
d. The auditor designs and performs substantive procedures for each material class of
transactions, account balance, and disclosure only when the auditor uses the substantive
approach.
23. Which statement is incorrect regarding the nature of further audit procedures?
a. The nature of further audit procedures refers to their purpose and their type.
b. Certain audit procedures may be more appropriate for some assertions than others.
c. The higher the auditor’s assessment of risk, the less reliable and relevant is the audit
evidence sought by the auditor from substantive procedures.
d. The auditor is required to obtain audit evidence about the accuracy and completeness of
information produced by the entity’s information system when that information is used in
performing audit procedures.
24. Which statement is incorrect regarding the timing of further audit procedures?
a. Timing refers to when audit procedures are performed or the period or date to which the audit
evidence applies.
b. The auditor may perform tests of controls or substantive procedures at an interim date or at
period end.
c. If the auditor performs tests of controls or substantive procedures prior to period end, the
auditor considers the additional evidence required for the remaining period.
d. All audit procedures can be performed prior to period end.
25. Which statement is incorrect regarding the extent of further audit procedures?
a. As the planned level of assurance increases, the auditor seeks more reliable audit evidence.
b. Those controls subject to testing by performing inquiry combined with inspection or
reperformance ordinarily provide more assurance than those controls for which the audit
evidence consists solely of inquiry and observation.
c. The absence of misstatements detected by a substantive procedure provides audit evidence
that controls related to the assertion being tested are effective.
d. A material misstatement detected by the auditor’s procedures that was not identified by the
entity ordinarily is indicative of the existence of a material weakness in internal control.
a. The auditor designs tests of controls to obtain sufficient appropriate audit evidence that the
controls operated effectively throughout the period of reliance.
b. The more the auditor relies on the operating effectiveness of controls in the assessment of
risk, the lesser is the extent of the auditor’s tests of controls.
c. If the rate of expected deviation is expected to be too high, the auditor may determine that
tests of controls for a particular assertion may not be effective.
d. Because of the inherent consistency of IT processing, the auditor may not need to increase
the extent of testing of an automated control.
31. The auditor’s substantive procedures should include the following audit procedures related
to the financial statement closing process:
32. Which statement is incorrect regarding the nature, timing and extent of substantive
procedures?
33. Which statement is incorrect regarding evaluation of the sufficiency and appropriateness of
audit evidence obtained?
a. Based on the audit procedures performed and the audit evidence obtained, the auditor should
evaluate whether the assessments of the risks of material misstatement at the assertion level
remain appropriate.
b. As the auditor performs planned audit procedures, the audit evidence obtained may cause
the auditor to modify the nature, timing, or extent of other planned audit procedures.
c. In developing an opinion, the auditor considers only the audit evidence which corroborate the
assertions in the financial statements.
d. If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor should
express a qualified opinion or a disclaimer of opinion.
35. Analytical procedures, which means the analysis of significant ratios and trends including
the resulting investigation of fluctuations and relationships that are inconsistent with other
relevant information or which deviate from predicted amounts, are not required to be applied
a. The concept of materiality recognizes that some matters are important for fair presentation of
financial statements in conformity with GAAP, while other matters are not important.
b. An auditor considers materiality for planning purposes in terms of the largest aggregate level
of misstatements that could be material to any one of the financial statements.
c. Materiality judgments are made in light of surrounding circumstances and necessarily involve
both quantitative and qualitative judgments.
d. An auditor’s consideration of materiality is influenced by the auditor’s perception of the needs
of a reasonable person who will rely on the financial statements.
38. The risk that the assertion contains material misstatements that, when aggregated with
misstatements in other assertions, could make the entire financial statements materially
misstated is:
39. Incremental risk is the increased risk that errors may not be detected at the balance sheet
date because:
40. Which of the following best describe the interrelated components of internal control?
43. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of
the risk that
44. A proper understanding of the client’s internal control is an integral part of the audit planning
process. The results of the understanding
45. A measure of how willing the auditor is to accept that the financial statements may be
materially misstated after the audit is completed and an unmodified opinion has been issued is
the
a. Inherent risk.
b. Acceptable audit risk.
c. Control risk.
d. Detection risk.
a. Yes Yes
b. No No
c. Yes No
d. No Yes
47. Which of the following is not one of the three primary objectives of effective internal control?
49. Which of the following statements concerning the relevance of various types of controls to a
financial statement audit is correct?
50.An auditor should consider two key issues when obtaining an understanding of a client’s
internal controls. These issues are
51. Authorizations can be either general or specific. Which of the following is not an example
of a general authorization?
52. An auditor should obtain sufficient knowledge of an entity’s information system, including
the related business processes relevant to financial reporting, to understand the
53. Which of the following controls most likely would provide reasonable assurance that all
credit sales transactions of an entity are recorded?
54. Which of the following control activities in an entity’s revenue/receipt cycle would provide
reasonable assurance that all billed sales are correctly posted to the accounts receivable
ledger?
a. Indicating on the voucher the affected asset and expense accounts to be debited.
b. Approving vouchers for payment by having an authorized employee sign the vouchers.
c. Accounting for unused prenumbered purchase orders and receiving reports.
d. Matching the vendor’s invoice with the related purchase requisition, purchase order,
and receiving report.
56. Which of the following is of least concern to an auditor in assessing the risks of material
misstatement?
57. Your client, a merchandising concern, has annual sales of P30,000,000 and a 40% gross
profit rate. Tests reveal that 2% of the peso amount of purchases do not get into inventory
because of breakage and inventory pilferage by employees. The company estimates that these
losses could be reduced to 0.5% of purchases by designing and implementing certain controls
costing approximately P350,000. Should the controls be designed and implemented?
58. After gaining an understanding of internal control and assessing the risks of material
misstatement, an auditor decided to perform tests of controls. The auditor most likely decided
that
59. An auditor may decide to assess control risk at the maximum level for certain assertions
because the auditor believes
60. Which of the following statements is correct concerning an auditor’s assessment of control
risk?
a. Assessing control risk may be performed concurrently during an audit with obtaining
an understanding of the entity’s internal control.
b. Evidence about the operation of controls in prior audits may not be considered during
the current year’s assessment of control risk.
c. The basis for an auditor’s conclusions about the assessed level of control risk need not
be documented unless control risk is assessed at the maximum level.
d. The lower the assessed level of control risk, the less assurance the evidence must provide
that the controls are operating effectively.
61. According to PSA 330 (The Auditor’s Procedures in Response to Assessed Risks), an
auditor who plans to rely on controls that have not changed since they were last tested should
test the operating effectiveness of such controls at least once every
a. Second audit
b. Third audit
c. Fourth audit
d. Fifth audit
62. In performing tests of the operating effectiveness of an entity’s controls, an auditor selects
from a variety of techniques, including
63. An auditor intends to perform tests of control on a client’s cash disbursements procedures.
If the control procedures leave no audit trail of documentary evidence, the auditor most likely will
test the procedures by
64. Which of the following tests of controls most likely would help assure an auditor that goods
shipped are properly billed?
65. When there are numerous property and equipment transactions during the year, an auditor
who plans to assess control risk at a low level usually performs
a. Tests of controls and extensive tests of property and equipment balances at the end of the
year.
b. Analytical procedures for current year property and equipment transactions.
c. Tests of controls and limited tests of current year property and equipment transactions.
d. Analytical procedures for property and equipment balances at the end of the year.
66. Auditors are responsible for determining whether financial statements are materially
misstated, so upon discovering a material misstatement they must bring it to the attention of:
a. regulators.
b. the audit firm's managing partner.
c. the client shareholders.
d. the client's management.
67. Audit standards require the auditor to consider materiality early in the audit. Which
statement(s) regarding preliminary materiality are true?
68. Auditing standards ________ that the basis used to determine the preliminary judgment
about materiality be documented in the audit files.
a. permit
b. do not allow
c. require
d. strongly encourage
70. A measure of how willing the auditor is to accept that the financial statements may be
materially misstated after the audit is completed and an unqualified opinion has been issued is
the:
a. inherent risk.
b. acceptable audit risk.
c. statistical risk.
d. financial risk.
II. Enumeration
79- 83. Matters that the auditor may consider in determining the extent of tests of controls
79. The frequency of the performance of the control by the entity during the period
80. The length of time during the audit period that the auditor is relying on the operating
effectiveness of the control
81. The expected rate of deviation from a control
82. The relevance and reliability of the audit evidence to be obtained regarding the operating
effectiveness of the control at the assertion level
83. The extent to which audit evidence is obtained from tests of other controls related to the
assertion
84-85. Levels that the auditor shall identify and assess the risks of material misstatements
84. Financial Statement Level
85. Assertion Level for all classes of transactions, account balances and disclosures
86-91. Factors that the auditor shall consider in exercising the judgment as to which risks are
significant risks
86. Whether the risk is a risk of fraud
87. Whether the risk is related to recent significant economic, accounting or other development
sand, therefore, requires specific attention
88. The complexity of the transactions
89. Whether the risk involves significant transactions with related parties
90. The degree of subjectivity in the measurement of financial information related to the risk,
especially those measurements involving a wide range of measurement uncertainty
91. Whether the risk involves significant transactions that are outside the normal course of
business for the entity, or that, otherwise appear to be unusual
94-97. Factors that need to be documented as required by PSA 320 (Materiality in Planning and
Performing an Audit) in the application of the concept of materiality
94. Materiality for the financial statements as a whole
95. Materiality level or levels for particular classes of transactions, account balances or
disclosures
96. Performance materiality
97. Any revision as the audit progressed
98-100. Ways that the auditor may respond to an ineffective control environment
98. Conducting more audit procedures as of the period end rather that at an interim date
99. Obtaining more extensive audit evidence from substantive procedures
100. Increasing the number of locations to be included in the audit scope