AUDITING THEORY

INSTRUCTIONS: CHOOSE THE BEST ANSWER FOR EACH OF THE FOLLOWING.

STRICTLY NO ERASURES ALLOWED.

1. Which of the following statements is not correct?

A. It is possible to vary the sample size from one unit to 100% of the items in the
population.
B. The decision of how many items to test should not be influenced by the increased costs
of performing the additional tests.
C. The decision of how many items to test must be made by the auditor for each audit
procedure.
D. The sample size for any given procedure is likely to vary from audit to audit.

2. When a professional accountant learns of a material error or omission in a tax return of a

prior year, he/she has the responsibility to do the following, except
A. Consider discontinuing association with the client if the client does not correct the error.
B. Advise the employer to correct the error and recommend that disclosure be made to the
revenue authorities.
C. Promptly advise the client or employer of the error or omission and recommend that
disclosure be made to the revenue authorities.
D. Promptly inform the revenue authorities even without the permission of the client.

3. Using your knowledge of the relationships among acceptable audit risk, inherent risk, control
risk, planned detection risk, tolerable misstatement, and planned evidence, determine the
effect on planned evidence (increase or decrease) of changing each of the following factors,
while the other factors remain unchanged.

A B C D
1. An increase in acceptable audit risk. Increase Decrease Increase Decrease
2. An increase in inherent risk. Decrease Decrease Increase Increase
3. A decrease in control risk. Increase Increase Decrease Decrease
4. An increase in planned detection risk. Increase Decrease Increase Decrease
5. An increase in tolerable misstatement Increase Increase Decrease Decrease

4. A requirement that working papers be reviewed by the supervisor, and any deficiencies be
discussed with the preparer is an example of a quality control procedure in the area of
A. Acceptance and continuance of client relationships and specific engagements.
B. Human resources.
C. Relevant ethical requirements.
D. Engagement performance.

5. As a result of sampling procedures applied as tests of controls, an auditor incorrectly

assesses control risk higher than appropriate. The most likely explanation for this situation
is that
A. The deviation rate in the auditor's sample is less than the tolerable rate, but the deviation
rate in the population exceeds the tolerable rate.
B. The deviation rates of both the auditor's sample and the population exceed the tolerable
rate.

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 C. The deviation rates of both the auditor's sample and the population are less than the
tolerable rate.
D. The deviation rate in the auditor's sample exceeds the tolerable rate, but the deviation
rate in the population is less than the tolerable rate.

6. The following statements relate to the auditor’s responsibilities regarding related parties
and transactions with such parties. Which is incorrect?
A. Management is required to implement adequate internal control to ensure that
transactions with related parties are appropriately identified in the information system
and disclosed in the financial statements.
B. The auditor should have a sufficient understanding of the entity and its environment to
identify events, transactions, and practices that may result in a risk of material
misstatement regarding related parties and transactions with such parties.
C. A financial statement audit cannot be expected to detect all related party transactions.
D. The auditor is responsible for the identification and disclosure of related parties and
transactions with such parties.

Questions 7 – 11 are based on the following independent situations for which you will
recommend an appropriate audit opinion from the following alternatives:

A - Unmodified
B - Qualified
C - Adverse
D - Disclaimer

7. During the course of his audit of the financial statements of a corporation for the purpose
of expressing an opinion on the statements, a CPA is refused permission to inspect the
minutes book. The corporation secretary instead offers to give the CPA a certified copy of
resolutions and actions relating to accounting matters.

8. During 2020, the research staff of Saliksik Research Corporation devoted its entire efforts
toward developing a new pollution-control device. All costs that could be attributed directly
to the project were accounted for as deferred charges and classified on the balance sheet
at December 31, 2020, as a noncurrent asset. In the course of his audit of the corporation’s
2020 financial statements, Andok, CPA, found persuasive evidence that the research
conducted to date would probably result in a marketable product. The deferred research
charges are significantly material in relation to both income and total assets.

9. On January 2, 2021, the Reebok Auto Supply Company received a notice from its primary
supplier that effective immediately, all wholesale prices would be increased 10 percent. On
the basis of the notice, Reebok Auto Supply revalued its December 31, 2020, inventory to
reflect the higher costs. The inventory constituted a material proportion of total assets;
however, the effect of the revaluation was material to current assets but not to total assets
or net income. The increase in valuation is adequately disclosed in the notes to the financial
statements.

10. You were engaged to audit the Steelman Company’s financial statements after the close of
the company’s fiscal year. Because you were not engaged until after the balance sheet
date, you were not able to physically observe inventory, which is highly material. On the
completion of your audit, you are satisfied that Steelman’s financial statements are
presented fairly, including inventory about which you were able to satisfy yourself by the
use of alternative audit procedures.

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11. A CPA has completed his audit of the financial statements of a bus company for the year
ended December 31, 2020. Prior to 2020, the company had been depreciating its buses
over a 10-year period. During 2020, the company determined that a more realistic
estimated life for its buses was 12 years and computed the 2020 depreciation on the basis
of the revised estimate. The CPA has satisfied himself that the 12-year life is reasonable.
The company has adequately disclosed the change in estimated useful lives of its buses and
the effect of the change on 2020 income in a note to the financial statements.

12. If requested to perform a review engagement for an entity in which an accountant has an
immaterial direct financial interest, the accountant is
A. Not independent and, therefore, may issue a review report, but may not issue an
auditor’s report.
B. Not independent and, therefore, may not be associated with the entity’s financial
statements.
C. Not independent and, therefore, may not issue a review report.
D. Independent because the financial interest is immaterial and, therefore, may issue a
review report.

13. The communication between an external auditor and a client is confidential. Ordinarily,
A. The client is not required to answer an external auditor’s questions in certain
circumstances.
B. An external auditor is not permitted to testify in a court of law without the permission
of the client.
C. An external auditor is not required to divulge client information even if demanded by a
subpoena.
D. An external auditor should not disclose information obtained in the course of the
engagement without the client’s permission.

14. Which of the following statements best describes a positive request for confirmation of an
accounts receivable balance?
A. The customer will be asked to indicate to the auditor the current balance in the account.
B. The customer will be asked to respond to the confirmation request only if the balance
indicated in the request is incorrect.
C. The customer will be asked to inform the auditor whether the balance indicated in the
request is correct and to respond regardless of whether such stated balance is correct.
D. The customer will be asked to indicate to the auditor the balance in his/her account only
if it is positive (i.e., greater than zero).

15. Which of the following is the most objective type of evidence?

A. A letter written by the client’s attorney discussing the likely outcome of outstanding
lawsuits.
B. The physical count of securities and cash.
C. Inquiries of the credit manager about the collectibility of noncurrent accounts receivable.
D. Observation of cobwebs on some inventory bins.

16. The following are the benefits claimed for the practice of determining materiality in the
initial planning stage of starting an audit, except
A. Avoiding the problem of doing too little work (underauditing).
B. Avoiding the problem of doing more work than necessary (overauditing).
C. Being able to decide early what kind of audit opinion to express.
D. Being able to fine tune the audit work for effectiveness and efficiency.

17. When the audited financial statements of the prior year are presented together with those
of the current year, the continuing auditor’s report should cover
A. Only the current year, but the prior year’s report should be referred to.
B. Only the current year, but the prior year’s report should be presented.
C. Only the current year.
D. Both years.

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18. Internal auditing is considered to be part of an organization's
A. Accounting system.
B. Control activities.
C. Monitoring.
D. External controls.

19. Which of the following statements regarding analytical procedures is not correct?
A. Analytical procedures are required on all audits.
B. Analytical procedures can be used as substantive tests.
C. For certain accounts with small balances, analytical procedures alone may be sufficient
evidence.
D Analytical tests emphasize a comparison of client internal controls to PFRS.

20. When an auditor believes that an understanding with the client has not been established,
he or she should ordinarily
A. Perform the audit with increased professional skepticism.
B. Assess control risk at the maximum level and perform a primarily substantive audit.
C. Modify the scope of the audit to reflect an increased risk of material misstatement due
to fraud.
D. Decline to accept or perform the audit.

21. Which of the following is most likely to be a response to the auditor’s assessment that the
risk of material misstatement due to fraud for the existence of inventory is high?
A. Perform analytical procedures rather than taking test counts.
B. Request that inventories be counted prior to year-end.
C. Request that inventory counts at the various locations be counted on different dates so
as to allow the same auditor to be present at every count.
D. Observe test counts of inventory at certain locations on an unannounced basis.

22. Audit documentation should possess certain characteristics. Which of the following is one
of the characteristics?

Audit documentation should be indexed Audit documentation should be organized

and cross-referenced to benefit the client’s staff
A. Yes Yes
B. No No
C. Yes No
D. No Yes

23. Which of the following is a step in an auditor’s decision to assess control risk at below
maximum?
A. Apply analytical procedures to both financial data and nonfinancial information to detect
conditions that may indicate weak control.
B. Perform tests of details of transactions and account balances to identify potential errors
and irregularities.
C. Identify specific control procedures that are likely to detect or prevent material
misstatements.
D. Document that the additional audit effort to perform tests of controls exceeds the
potential reduction in substantive testing.

24. Prior to or in conjunction with obtaining information to identify risks of fraud, which of the
following is required?
A. Professional skepticism concerning indirect effect illegal acts.
B. Indirect verification of significant financial statement assertions.
C. A discussion with the client’s legal counsel as to contingent liabilities likely to affect the
financial statements.
D. A brainstorming session among team members about where financial statements may
be susceptible to fraud.

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25. In which circumstance will the auditor not consider the need to modify the report?
A. The client’s legal counsel is requested to advise whether a material act is legal or illegal
but refuses to do so.
B. The auditor concludes that the effect of an illegal act creates substantial doubt about
the entity’s ability to continue as a going concern.
C. The auditor concludes that the effect of an illegal act, taken alone or with similar acts,
is material in amount and has not been properly accounted for or disclosed in the
financial statements.
D. All of the circumstances require modification of the auditor’s report.

26. When discussing control risk and the audit risk model, which one of the following statements
is false?
A. The relationship between control risk and evidence is direct.
B. If the auditor concludes that an internal control system is completely ineffective to
prevent or detect errors, he/she would assign a 0% to control risk.
C. The relationship between control risk and detection risk is inverse.
D. Control risk is a measure of the auditor’s assessment of the likelihood that errors will
not be prevented or detected by the client’s internal control system.

27. When approached to perform an audit for the first time, the CPA should make inquiries of
the predecessor auditor. This is a necessary procedure because the predecessor may be
able to provide the successor with information that will assist the successor in determining
A. Whether the predecessor’s work should be used.
B. Whether the company follows the policy of rotating its auditors.
C. Whether in the predecessor’s opinion internal control of the company has been
satisfactory.
D. Whether the engagement should be accepted.

28. The date of the end of the latest period covered by the financial statements, which is
normally the date of the most recent balance sheet in the financial statements subject to
audit is the
A. Date the financial statements are issued.
B. Date of the auditor’s report.
C. Date of the financial statements.
D. Date of approval of the financial statements.

29. Hazel Corp. maintains a large internal audit staff that reports directly to the chief financial
officer. Audit reports prepared by the internal auditors indicate that the system is functioning
as it should and that the accounting records are reliable. An independent auditor will
probably
A. Eliminate tests of controls.
B. Increase the depth of the study and evaluation of administrative controls.
C. Avoid duplicating the work performed by the internal audit staff.
D. Place limited reliance on the work performed by the internal audit staff.

30. Reyes, CPA, is planning the audit of Kiko’s company. Kiko verbally asserts to Reyes that all
expenses for the year have been recorded in the accounts. Kiko’s representation in this
regard
A. Is sufficient evidence for Reyes to conclude that the completeness assertion is supported
for the expenses.
B. Can enable Reyes to minimize his work on the assessment of control risk for the
completeness of expenses.
C. Should be disregarded because it is not in writing.
D. Is not considered a sufficient basis for Reyes to conclude that all expenses have been
recorded.

31. A CPA started to audit the financial statements of an entity. After completing certain audit
procedures, the client requested the CPA to change the engagement to a review because

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 of a scope limitation. The CPA concludes that there is reasonable justification for the
change. Under these circumstances, the CPA’s review report should include a
A. Statement that a review is substantially less in scope than an audit.
B. Reference to the scope limitation that caused the changed engagement.
C. Description of the auditing procedures that were completed before the engagement was
changed.
D. Reference to the CPA’s justification for agreeing to change the engagement.

32. Ariel, CPA, was engaged by a group of royalty recipients to apply agreed-upon procedures
to financial data supplied by Modesta Co. regarding Modesta's written assertion about its
compliance with contractual requirements to pay royalties. Ariel's report on these agreed-
upon procedures should contain a (an)
A. Disclaimer of opinion about the fair presentation of Modesta's financial statements.
B. List of the procedures performed and Ariel's findings.
C. Opinion about the effectiveness of Modesta's internal control activities concerning
royalty payments.
D. Acknowledgment that the sufficiency of the procedures is solely Ariel's responsibility.

33. Which of the following statements ordinarily is not included among the written client
representations made by the chief executive officer and the chief financial officer?
A. "Sufficient evidential matter has been made available to the auditor to permit the
issuance of an unmodified opinion."
B. "There are no unasserted claims or assessments that our lawyer has advised us are
probable of assertion and must be disclosed."
C. "We have no plans or intentions that may materially affect the carrying value or
classification of assets and liabilities."
D. "No events have occurred subsequent to the balance sheet date that would require
adjustment to, or disclosure in, the financial statements."

34. An external auditor will use internal auditors to assist in the audit of accounts receivable.
Of the following procedures, the one that would be most appropriate for the internal
auditors to perform is the
A. Assessment of control risk for accounts receivable.
B. Determination of the number of positive confirmation requests to be mailed to
substantiate the existence of accounts receivable.
C. Preparation of an aged trial balance of accounts receivable.
D. Establishment of the amount of accounts receivable that is considered material.

35. Which one of the following statements concerning sampling risk and nonsampling risk is
correct?
A. Neither sampling risk nor nonsampling risk can be reduced by the auditor.
B. Sampling risk, but not nonsampling risk, can be reduced by the auditor.
C. Nonsampling risk, but not sampling risk, can be reduced by the auditor.
D. Both sampling risk and nonsampling risk can be reduced by the auditor.

36. Auditors may identify conditions during fieldwork that change or support a judgment about
the initial assessment of fraud risks. Which of the following is not a condition which should
alert an auditor that the initial assessment should be changed?
A. The auditor’s lack of independence
B. Discrepancies in the accounting records
C. Unusual relationships between the auditor and management
D. Missing or conflicting evidence

37. When an on-line, real-time computer system is in use, the computer control procedures can
be strengthened by
A. Making a validity check of identification number before a user can obtain access to the
computer files.
B. Preparing batch totals to provide assurance that file updates are made for the entire
output.

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 C. Providing for the separation of duties between data input and error listing operations.
D. Attaching plastic file protection rings to reels of magnetic tape before new data can be
entered on the file.

38. An auditor believes there is substantial doubt about an entity’s ability to continue as a going
concern for a reasonable period of time. In evaluating the entity’s plans for dealing with
the adverse effects of future conditions and events, the auditor most likely would consider,
as a mitigating factor, the entity’s plans to
A. Purchase production facilities that are currently being leased from a third party.
B. Postpone expenditures to upgrade its information technology system.
C. Pay cash dividends that are in arrears to the preference shareholders.
D. Increase the useful lives of property, plant, and equipment for depreciation purposes.

39. A member of the Board of Accountancy (BOA) shall, at the time of his/her appointment,
must be a duly registered Certified Public Accountant (CPA) with at least __________ years
of work experience in any scope of practice of accountancy.
A. 12
B. 10
C. 8
D. 5

40. VGR Corporation has numerous customers. A customer file is kept on disk. Each customer
file contains name, address, credit limit, and account balance. The auditor wishes to test
this file to determine whether credit limits are being exceeded. The best procedure for the
auditor to follow would be to
A. Develop test data that would cause some account balances to exceed the credit limit
and determine if the system properly detects such situation.
B. Develop program to compare credit limits with account balances and print out the details
of any account with a balance exceeding its credit limit.
C. Request a printout of all account balances so they can be manually checked against the
credit limits.

41. The Philippine Standards on Assurance Engagements (PSAEs) are to be applied in

A. Assurance engagements dealing with subject matters other than historical financial
information.
B. Compilation engagements and agreements to apply agreed-upon procedures to
information.
C. The audit or review of historical financial information.
D. Assurance engagements dealing with historical financial information.

42. An audit client’s description that its financial statements are prepared in accordance with a
particular applicable financial reporting framework is appropriate only if
A. The financial statements are in substantial compliance with that framework.
B. The financial statements adequately disclose the significant accounting policies selected
and applied.
C. The terminology used in the financial statements, including the title of each financial
statement, is appropriate.
D. The financial statements comply with all the requirements of that framework that are
effective during the period covered by the financial statements.

43. Companies with non-complex IT environments often rely on microcomputers to perform

accounting system functions. Which of the following is not an audit consideration in such
an environment?
A. Limited reliance on automated controls.
B. Unauthorized access to master files.
C. Vulnerability to viruses and other risks.
D. Excess reliance on automated controls.

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44. When an auditor suspects material misstatement in the financial statements resulting from
management fraud, he/she may direct inquiries from the following personnel, except
A. Top executives who initiated, approved, and authorized recording of complex and
unusual transactions.
B. In-house legal counsel.
C. Chief ethics officer or equivalent person.
D. Operating personnel not directly involved in the financial reporting process.

45. In a practitioner’s review of interim financial information, the practitioner typically performs
each of the following, except
A. Reading the minutes of the meetings of shareholders, those charged with governance,
and other appropriate committees to identify matters that may affect the interim
financial information.
B. Obtaining corroborating external evidence.
C. Inquiring of members of management responsible for financial and accounting matters.
D. Applying financial ratios to the interim financial information.

46. The principle of professional competence and due care imposes which of the following
obligations on professional accountants?
A. To maintain professional knowledge and skill at the level required to ensure that clients
or employers receive competent professional service.
B. To refrain from disclosing confidential information obtained as a result of professional
and business relationships without proper and specific authority unless there is a legal
or professional right or duty to disclose.
C. To comply with relevant laws and regulations and avoid any situation that may bring
discredit to the profession.

47. Which of the following is not a valid basis for omitting an audit test?
A. The difficulty and expense involved in testing a particular item.
B. The relative risk involved.
C. The degree of reliance on the relevant internal controls.
D. The relationship between the cost of obtaining evidence and its usefulness.

48. Accepting an engagement to examine an entity’s financial projection most likely would be
appropriate if the projection were to be distributed to
A. All employees who work for the entity.
B. Potential stockholders who request a prospectus or a registration statement.
C. A bank with which the entity is negotiating for a loan.
D. All stockholders of record as of the report date.

49. Using laptop computers in conducting financial statement audits may affect the methods
used to review the work of staff assistants because
A. Supervisory personnel may not have an understanding of the capabilities and limitations
of computers.
B. Working paper documentation may not contain readily observable details of calculations.
C. The overall audit objectives may differ.
D. Documenting the supervisory review may require assistance of management services
personnel.

50. A proof of cash is not useful in discovering differences in the actual and reported cash
balances due to:
A. Deposits in transit.
B. Collections on the company’s behalf by the bank which are deposited directly to the
company’s account.
C. Cash receipts that were not recorded in the relevant journals.
D. Service charges.

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