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AUDITING THEORY – SOLUTION MANUAL

1. It is an audit sampling selection method in which the auditor selects the sample without following a structured
technique and is not appropriate when using statistical sampling.

A. Random selection
B. Systematic selection
C. Monetary unit sampling
D. Haphazard selection

Answer: D. Haphazard selection

Appendix 4 of PSA 530, Audit Sampling, applies:
(d) Haphazard selection, in which the auditor selects the sample without following a structured technique.
Although no structured technique is used, the auditor would nonetheless avoid any conscious bias or
predictability (for example, avoiding difficult to locate items, or always choosing or avoiding the first or last
entries on a page) and thus attempt to ensure that all items in the population have a chance of selection.
Haphazard selection is not appropriate when using statistical sampling.
2. This pertains to events or conditions that indicate an incentive or pressure to commit fraud or provide an
opportunity to commit fraud?

A. Fraud
B. Fraud risk
C. Fraud risk factor
D. Fraud triangle

Answer: C. Fraud risk factor

As defined in paragraph 11 of PSA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements, fraud risk factor pertains to events or conditions that indicate an incentive or pressure to commit
fraud or provide an opportunity to commit fraud.

3. Which of the following statement is FALSE:

A. The auditor shall express a qualified opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate,
are material, but not pervasive, to the financial statements.
B. The auditor shall express an adverse opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate
is material to the financial statements.
C. The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes that
the possible effects on the financial statements of undetected misstatements, if any, could
be both material and pervasive.
D. The auditor shall modify the opinion in the auditor’s report when the auditor concludes
that, based on the audit evidence obtained, the financial statements as a whole are not free
from material misstatement.

Answer: B
The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit
evidence, concludes that misstatements, individually or in the aggregate has material and pervasive effect to
the financial statement.
4. Which of the following is not an accurate statement about communication of internal control related matters to
management on a nonissuer (nonpublic) company?
A. The auditor must communicate both material weaknesses and significant deficiencies.
B. The auditor must communicate in writing.
C. Previously communicated weaknesses that have not been corrected need not be recommunicated.
D. A communication indicating that no significant deficiencies were identified should not be issued.
Answer: C
Previously communicated weaknesses that have not been corrected still need to be communicated.
5. A company’s petty cash fund is replenished on the first of each month, after the petty cash custodian presents
receipts for disbursements to the general cashier. Which of the following is not an appropriate procedure for
controlling the petty cash fund?

A. The petty cash custodian retains and files original receipts by category of expenditure
after their presentation to the general cashier, so that variations in different types of
expenditures can be monitored.
B. Surprise counts of the fund are made by the petty cash custodian’s supervisor to
determine that the fund is being accounted for satisfactorily.
C. The petty cash custodian obtains signed receipts from each individual to whom petty
cash is paid.
D. Upon receiving petty cash receipts as evidence of disbursements, the general cashier
issues a company check to the petty cash custodian, rather than cash, to replenish the
fund.

Answer: A

a. Correct. It would be inappropriate to retain the petty cash receipts. They should be canceled or
mutilated after they have been submitted for reimbursement, so that they cannot be used to secure
a second reimbursement.
b. Incorrect. Surprise counts of the fund are an appropriate control procedure.
c. Incorrect. Requiring signed receipts is an appropriate control procedure.
d. Incorrect. Reimbursement by company check is an appropriate control procedure.

6. The scope statement of an audit report should

A. Describe the audit objectives and tell the reader why the audit was conducted.)
B. Identify the audited activities and describe the nature and extent of auditing
performed.
C. Define the standards, measures, or expectations used in evaluating audit findings.
D. Communicate the internal auditor’s evaluation of the effect of the findings on the
activities reviewed.

Answer: B
Audited activities, time period audited, related activities not audited, and the nature and extent of
auditing performed may all be appropriately included in the scope statement.

Choice (a) is incorrect. Audit objectives and the reason for conducting the audit are described in the purpose
statement. Choice (c) is incorrect. The standards, measures, or expectations used in evaluating audit findings
are attributes of findings that emerge during the review of the activities identified in the scope statement.
Choice (d) is incorrect. The internal auditor’s evaluation of the effect of the findings on the activities reviewed
is properly presented in the conclusion or results section of the audit report.

7. Working papers should be disposed of when they are of no further use. Retention policies

A. Should specify a minimum retention period of three years.)
B. Should be prepared by the audit committee.
C. Should be approved by the legal counsel.
D. Should be approved by the external auditor

Answer: C

Legal counsel should approve retention policies. Choice (a) is incorrect because minimum retention is for
the period of further use, not simply three years. Choice (b) is incorrect because the audit committee should
not prepare retention policies. Choice (d) is incorrect because the external auditor need not approve retention
policies.

8. Which of the following is defined by PSA 450 “Evaluation of Misstatements Identified During the Audit” as the
difference between the amount, classification, presentation, or disclosure of a reported financial statement item
and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with
the applicable financial reporting framework.

A. Summary of audit differences
B. Error
C. Misstatement
D. None of the above

Answer: C
PSA 450 defines a misstatement as a difference between the amount, classification, presentation, or disclosure
of a reported financial statement item and the amount, classification, presentation, or disclosure that is required
for the item to be in accordance with the applicable financial reporting framework.

9. Which of the following factors affect the form, content and extent of audit documentation:
I. The nature and extent of exceptions identified
II. Checklist
III. The identified risks of material misstatement
IV. Correspondence with Chief Finance Officer
V. The audit methodology and tools used
VI. The significance of the audit evidence obtained

A. I, II, III, IV, V, VI
B. I, III, IV, V, VI
C. I, III, V, VI
D. I, II, III, IV

Answer: C

PSA 230 “Audit Documentation” – paragraph A2 states that the form, content and extent of audit documentation
depend on factors such as:
• The size and complexity of the entity.
• The nature of the audit procedures to be performed.
• The identified risks of material misstatement.
• The significance of the audit evidence obtained.
• The nature and extent of exceptions identified.
• The need to document a conclusion or the basis for a conclusion not readily determinable from the
documentation of the work performed or audit evidence obtained.
• The audit methodology and tools used.

PSA 230.A3 provides:
Audit documentation may be recorded on paper or on electronic or other media. Examples of audit
documentation include:
• Audit programs.
• Analyses.
• Issues memoranda.
• Summaries of significant matters.
• Letters of confirmation and representation.
• Checklists.
• Correspondence (including e-mail) concerning significant matters.

The auditor may include abstracts or copies of the entity's records (for example, significant and specific
contracts and agreements) as part of audit documentation. Audit documentation, however, is not a substitute
for the entity's accounting records.

10. Analytical procedures include the consideration of comparisons of the entity’s financial information with which
of the following?

A. Anticipated results of the entity
B. Similar industry information
C. Comparable information for prior periods
D. All of the above

Answer: D. All of the above.

Paragraph A1 of PSA 520, Analytical Procedures, states that analytical procedures include the consideration of
comparisons of the entity’s financial information with, for example:
 Comparable information for prior periods.
 Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor, such as an
estimation of depreciation.
 Similar industry information, such as a comparison of the entity’s ratio of sales to accounts receivable
with industry averages or with other entities of comparable size in the same industry.

11. When the documents contain both the audited financial statements and other information that are materially
inconsistent with each other and the said information was obtained prior to the date of the auditor’s report,
which of the following must an auditor do?

A. When revision of the audited financial statements is necessary and management
refuses to make the revision, the auditor must issue an unmodified opinion.
B. When revision of the other information is necessary and management refuses to make
the revision, the auditor must withdraw from the engagement immediately.
C. When revision of the other information is necessary and management refuses to make
the revision, the auditor shall communicate this matter to those charged with
governance.
D. When revision of the other information is necessary and management refuses to make
the revision, the auditor may ignore it.

Answer: C. When revision of the other information is necessary and management refuses to make the
revision, the auditor shall communicate this matter to those charged with governance.

PSA 720, The Auditor's Responsibilities Relating to Other Information in Documents Containing Audited
Financial Statements, provides:

Par. 8 - If, on reading the other information, the auditor identifies a material inconsistency, the auditor shall
determine whether the audited financial statements or the other information needs to be revised.

Material Inconsistencies Identified in Other Information Obtained Prior to the Date of the Auditor’s Report

Par. 9 - When revision of the audited financial statements is necessary and management refuses to make the
revision, the auditor shall modify the opinion in accordance with PSA 705, Modifications to the Opinion in the
Independent Auditor's Report.

Par. 10 - When revision of the other information is necessary and management refuses to make the revision,
the auditor shall communicate this matter to those charged with governance.
12. When using the work of an auditor’s expert, an auditor must:

A. Evaluate whether the auditor has the necessary competence, capabilities and
objectivity for the auditor’s expert’s purposes.
B. The auditor shall obtain a sufficient understanding of the field of expertise of the
auditor’s expert.
C. The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s
expert’s purposes.
D. Both A and C

Answer: B. The auditor shall obtain a sufficient understanding of the field of expertise of the auditor’s
expert.

The following provisions of PSA 620, Using the Work of an Auditor's Expert, apply:

Par. 9 - The auditor shall evaluate whether the auditor’s expert has the necessary competence, capabilities and
objectivity for the auditor’s purposes.

Par. 10 - The auditor shall obtain a sufficient understanding of the field of expertise of the auditor’s expert.

Par. 12 - The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes.

13. Which of the following are the three principal methods in sample selection specifically identified in
PSA 530, Audit Sampling?

A. Statistical sampling, attribute sampling and haphazard sampling
B. Random selection, systematic selection and haphazard selection
C. Sequential sampling, discovery sampling and statistical sampling
D. Sequential sampling, discovery sampling and random selection

Answer: B. Random selection, systematic selection and haphazard selection

Paragraph A13 of PSA 530 applies:

The principal methods of selecting samples are the use of random selection, systematic selection and
haphazard selection.

14. Which of the following is true?

A. In documenting the nature, timing and extent of audit procedures performed, the
auditor shall record who performed the audit work and the date such work was
completed.
B. If, in exceptional circumstances, the auditor judges it necessary to depart from a
relevant requirement in a PSA, the auditor is only required to document how the
alternative audit procedures performed achieve the aim of that requirement.
C. The auditor shall assemble the audit documentation in an audit file and complete the
administrative process of assembling the final audit file on a timely basis after the date
of the stockholders’ meeting.
D. None of the above.

Answer: A

PSA 230, Audit Documentation, provides the following:

Par. 9 - In documenting the nature, timing and extent of audit procedures performed, the auditor shall record
who performed the audit work and the date such work was completed.

Par. 12 - If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement
in a PSA, the auditor shall document how the alternative audit procedures performed achieve the aim of that
requirement, and the reasons for the departure.

Par. 14 - The auditor shall assemble the audit documentation in an audit file and complete the administrative
process of assembling the final audit file on a timely basis after the date of the auditor's report.

15. Which of the following fraudulent entries is most likely to be made to conceal the theft of an asset?

a. Debit expenses, and credit the asset.
b. Debit the asset, and credit another asset account.
c. Debit revenue, and credit the asset.
d. Debit another asset account, and credit the asset.


Answer: A
a. Correct. Most fraud perpetrators would attempt to conceal their theft by charging it against an
expense account.
b. Incorrect. Debiting the stolen asset account would be going in the wrong direction to conceal an asset
theft.
c. Incorrect. An entry decreasing revenue would be unusual and would stand out.
d. Incorrect. This entry would not permanently conceal the fraud. It would simply shift the irreconcilable
balance to another asset account.

16. In establishing the existence and ownership of a long-term investment in the form of publicly traded stock, an
auditor should inspect the securities or

A. Correspond with the investee company to verify the number of shares owned
B. Inspect the audited financial statements of the investee company
C. Confirm the number of shares owned that are held by an independent custodian
D. Determine that the investment is carried at market value

Answer: C. Confirm the number of shares owned that are held by an independent custodian

17. SSS & Co., an auditing firm is commissioned to perform an initial audit of the financial statement of XYZ
Company. In performing the audit, SSS & Co obtains appropriate audit evidence regarding the opening
balances. Which of the following shall SSS & Co. perform?

I Read the most recent financial statements of XYZ Company
II Review working paper of the predecessor auditor
III Immediately express a qualified opinion

A. I only
B. I and II only
C. I, II and III
D. None of I, II and III

Answer: B. I and II only

The following provisions of PSA 510, Initial Audit Engagement – Opening Balances provides:

Paragraph 5 - The auditor shall read the most recent financial statements, if any, and the predecessor auditor’s
report thereon, if any, for information relevant to opening balances, including disclosures.

Paragraph 6 - The auditor shall obtain sufficient appropriate audit evidence about whether the opening
balances contain misstatements that materially affect the current period's financial statements by: …. (c)
Performing one or more of the following: (i) Where the prior year financial statements were audited,
reviewing the predecessor auditor's working papers to obtain evidence regarding the opening balances;….

Paragraph 10 - If the auditor is unable to obtain sufficient appropriate audit evidence regarding the
opening balances, the auditor shall express a qualified opinion or disclaim an opinion on the financial
statements, as appropriate, in accordance with PSA 705, Modifications to the Opinion in the Independent
Auditor's Report.

18. Which of the following circumstances may lead to the auditor to consider inclusion of Emphasis of Matter
paragraph in the auditor’s report?

A. Early application (where permitted) of a new accounting standard that has a pervasive
effect on the financial statements in advance of its effective date.
B. Outcome of exceptional litigation or regulatory action affecting the entity is certain.
C. A major catastrophe that has had a minimal effect on the entity’s financial position.
D. None of the above.

Answer: A. Early application (where permitted) of a new accounting standard that has a pervasive
effect on the financial statements in advance of its effective date.

Paragraph A1 of PSA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent
Auditor’s Report, provides the following examples of circumstances where the auditor may consider it
necessary to include an Emphasis of Matter paragraph:

 An uncertainty relating to the future outcome of exceptional litigation or regulatory action.
 Early application (where permitted) of a new accounting standard (for example, a new Philippine Financial
Reporting Standard) that has a pervasive effect on the financial statements in advance of its effective date.
 A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

19. In designing and performing tests of controls, the auditor shall perform other audit procedures in
combination with inquiry to obtain audit evidence about the operating effectiveness of the controls, including
which of the following?
A. By whom or by what means controls were applied
B. The errors encountered during the application of control for the past three years
C. Composition of the company’s IT department
D. A and B only

Answer: A. By whom or by what means controls were applied.

Paragraph 10 of PSA 330, The Auditors’ Responses to Assessed Risks provides:
“In designing and performing tests of controls, the auditor shall:
(a) Perform other audit procedures in combination with inquiry to obtain audit evidence about the operating
effectiveness of the controls, including:
(i) How the controls were applied at relevant times during the period under audit;
(ii) The consistency with which they were applied; and
(iii) By whom or by what means they were applied

20. Which of the following is false?

Statement I - A change in circumstances that affects the entity’s requirements or a misunderstanding
concerning the nature of the service originally requested is not considered a reasonable basis for requesting
a change in the audit engagement.

Statement II – When there is a request from the entity for the auditor to change the terms of the audit
engagement, the auditor shall consider the justification given for the request, particularly the implications of
a restriction on the scope of the audit engagement.

A. Statement I
B. Statements I and II
C. Statement II
D. None of the above

Answer: A. Statement I

The following provisions of PSA 210, Agreeing the Terms of Audit Engagements provide:

Par. 14 - The auditor shall not agree to a change in the terms of the audit engagement where there is no
reasonable justification for doing so.

Par. A29 - A request from the entity for the auditor to change the terms of the audit engagement may result
from a change in circumstances affecting the need for the service, a misunderstanding as to the nature of an
audit as originally requested or a restriction on the scope of the audit engagement, whether imposed by
management or caused by other circumstances. The auditor, as required by paragraph 14, considers the
justification given for the request, particularly the implications of a restriction on the scope of the audit
engagement.

Par. A30 - A change in circumstances that affects the entity’s requirements or a misunderstanding concerning
the nature of the service originally requested may be considered a reasonable basis for requesting a change
in the audit engagement.

21. Which of the following may indicate an indication of non-compliance with laws and regulations?
A. Purchasing goods and services at market price
B. Usual transactions with companies registered in tax havens
C. Payments for goods or services made other than to the country from which the
goods or services originated
D. Payments with proper exchange control documentation

Answer: C. Payments for goods or services made other than to the country from which the goods or
services originated

A13 of PSA 250, Consideration of Laws and Regulations in an Audit of Financial Statements states that if the
auditor becomes aware of the existence of, or information about, the following matters, it may be an
indication of non-compliance with laws and regulations:
 Investigations by regulatory organizations and government departments or payment of fines or
penalties.
 Payments for unspecified services or loans to consultants, related parties, employees or government
employees.
 Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the
entity or in its industry or to the services actually received.
 Purchasing at prices significantly above or below market price.
 Unusual payments in cash, purchases in the form of cashiers’ checks payable to bearer or transfers to
numbered bank accounts.
 Unusual transactions with companies registered in tax havens.
 Payments for goods or services made other than to the country from which the goods or services
originated.
 Payments without proper exchange control documentation.
 Existence of an information system which fails, whether by design or by accident, to provide an
adequate audit trail or sufficient evidence.
 Unauthorized transactions or improperly recorded transactions.
 Adverse media comment.

22. The auditor shall design and perform audit procedures in order to identify litigation and claims involving the
entity which may give rise to a risk of material misstatement. This may include any of the following except?
A. Inquiry of management.
B. Reviewing minutes of meetings of employees cooperative.
C. Reviewing legal expense accounts.
D. Inquiry of legal counsel.

Answer: B - Reviewing minutes of meetings of employees cooperative.

Paragraph 9 of PSA 501, Audit Evidence-Specific Considerations for Selected Items provides that the auditor shall
design and perform audit procedures in order to identify litigation and claims involving the entity which may
give rise to a risk of material misstatement, including:
 Inquiry of management and, where applicable, others within the entity, including in-house legal counsel;
 Reviewing minutes of meetings of those charged with governance and correspondence between the entity
and its external legal counsel; and
 Reviewing legal expense accounts.

23. An adequate system of internal controls is most likely to detect an irregularity perpetrated by a:

A. Group of employees in collusion
B. Group of managers in collusion
C. Single employee
D. Single manager

Answer: C. Single employee

A. Incorrect. A group has a better chance of successfully perpetrating an irregularity than does an individual
employee.
B. Incorrect. Management can often override controls, singularly or in groups.
C. Correct. A good system of internal controls is likely to expose an irregularity if it is perpetrated by
one employee, without the aid of others.
D. Incorrect. Management can often override controls, singularly or in groups.

24. Unpredictability in the selection of audit procedures can be achieved by any of the following except?

I. Performing substantive procedures on selected account balances and assertions not
otherwise tested due to their materiality or risk.
II. Adjusting the timing of audit procedures from that otherwise expected.
III. Using different sampling methods.
IV. Performing audit procedures at different locations or at locations on an unannounced
basis.

A. I only.
B. I and II only
C. I and IV
D. None of the above.

Answer: D – None of the above.

A36 of PSA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements,
incorporating an element of unpredictability in the selection of the nature, timing and extent of audit
procedures to be performed is important as individuals within the entity who are familiar with the audit
procedures normally performed on engagements may be more able to conceal fraudulent financial reporting.
This can be achieved by, for example:
 Performing substantive procedures on selected account balances and assertions not otherwise tested due
to their materiality or risk.
 Adjusting the timing of audit procedures from that otherwise expected.
 Using different sampling methods.
 Performing audit procedures at different locations or at locations on an unannounced basis.

25. The user auditor’s decision as to which procedure to undertake, in order to obtain the information necessary to
provide a basis for the identification and assessment of the risks of material misstatement in relation to the
user entity’s use of the service organization, may be influenced by any of the following except?

A. The size of both the user entity and the service organization.
B. The complexity of the transactions at the service organization and the complexity of the
services provided by the user entity.
C. The location of the service organization
D. The nature of the relationship between the user entity and the service organization.

Answer: B - The complexity of the transactions at the service organization and the complexity of the
services provided by the user entity.

A15 of PSA 402, Audit Considerations Relating to an Entity Using a Service Organization provides the user
auditor’s decision as to which procedure to undertake, in order to obtain the information necessary to provide
a basis for the identification and assessment of the risks of material misstatement in relation to the user
entity’s use of the service organization, may be influenced by such matters as:
 The size of both the user entity and the service organization;
 The complexity of the transactions at the user entity and the complexity of the services provided by the
service organization;
 The location of the service organization (for example, the user auditor may decide to use another auditor to
perform procedures at the service organization on the user auditor’s behalf if the service organization is in
a remote location);
 Whether the procedure(s) is expected to effectively provide the user auditor with sufficient appropriate
audit evidence; and
 The nature of the relationship between the user entity and the service organization.



26. Which of the following specific considerations in obtaining audit evidences for audit of inventory is false?

A. If inventory is immaterial to the financial statements, the auditor shall obtain sufficient appropriate
audit evidence regarding the existence and condition of inventory.
B. If the auditor is unable to attend physical inventory counting due to unforeseen circumstances, the
auditor shall make or observe some physical counts on an alternative date and perform audit
procedures on intervening transactions.
C. If physical inventory counting is conducted at a date other than the date of the financial statements, the
auditor shall perform audit procedures to obtain audit evidence about whether changes in inventory
between the count date and the date of the financial statements are properly recorded.
D. The auditor may request confirmation from the third party as to the quantities and condition of
inventory held on behalf of the entity when inventory under the custody and control of a third party is
material.

Answer: A
The following provision of PSA 501 (Redrafted) “Audit Evidence – Additional Considerations on Specific Items”
applies:

Par. 4 - When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate
audit evidence regarding the existence and condition of inventory by: (a) Attendance at physical inventory
counting, unless impracticable, to and (b) Performing audit procedures over the entity’s final inventory records
to determine whether they accurately reflect actual inventory count results.

Par. 5 - If physical inventory counting is conducted at a date other than the date of the financial statements, the
auditor shall, in addition to the procedures required by paragraph 4, perform audit procedures to obtain audit
evidence about whether changes in inventory between the count date and the date of the financial statements
are properly recorded.

Par. 6 - If the auditor is unable to attend physical inventory counting due to unforeseen circumstances, the
auditor shall make or observe some physical counts on an alternative date, and perform audit procedures on
intervening transactions.

Par. 8 - When inventory under the custody and control of a third party is material to the financial statements,
the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that
inventory by performing one or both of the following: (a) Request confirmation from the third party as to the
quantities and condition of inventory held on behalf of the entity, (b) Perform inspection or other audit
procedures appropriate in the circumstances.

27. Risk factors that relate to misstatements arising from misappropriation of assets are classified according to the
three conditions generally present when fraud exists: incentives/pressures, opportunities, and
attitudes/rationalization. Which of the following is not among the examples of risk factor classified as
“opportunities”?

A. Inventory items that are small in size, of high value, or in high demand
B. Fixed assets which are small in size, marketable, or lacking observable identification of ownership
C. Promotions, compensation, or other rewards inconsistent with expectations
D. Large amounts of cash on hand or processed
Answer: C
Choices A, B and D are among the risk factors that relate to misstatements arising from misappropriation of
assets classified under “opportunities”. Choice C is an example of risk factors classified under
“pressure/incentives”.

28. The auditor shall design and perform tests of controls to obtain sufficient appropriate audit evidence as to the
operating effectiveness of relevant controls when:

A. The auditor’s assessment of risks of material misstatement at the assertion level includes an
expectation that the controls are operating effectively.
B. Substantive procedures alone can provide sufficient appropriate audit evidence at the assertion level.
C. Both A and B.
D. Neither A or B.

Answer: A
Par. 8 of PSA 330 (Redrafted) “The Auditor’s Responses to Assessed Risks”, states:
The auditor shall design and perform tests of controls to obtain sufficient appropriate audit evidence as to
the operating effectiveness of relevant controls when:

(a) The auditor’s assessment of risks of material misstatement at the assertion level includes an
expectation that the controls are operating effectively (i.e., the auditor intends to rely on the operating
effectiveness of controls in determining the nature, timing and extent of substantive procedures); or

(b) Substantive procedures alone cannot provide sufficient appropriate audit evidence at the assertion
level.

29. Which of the following shall be stated in the Other Matter paragraph in the auditor’s report, if the financial
statements of the prior period were audited by a predecessor auditor and the auditor is permitted by law or
regulation to refer to the predecessor auditor’s report on the corresponding figures and decides to do so?
I. That the financial statements of the prior period were audited by the predecessor auditor.
II. The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the
reasons therefore.
III. The date of predecessor auditor’s report.

A. I and II only
B. I and III only
C. I, II and III
D. None of the above

Answer: C
Par. 13 of PSA 710 “Comparative Information—Corresponding Figures and Comparative Financial
Statements” states;

If the financial statements of the prior period were audited by a predecessor auditor and the auditor is
permitted by law or regulation to refer to the predecessor auditor’s report on the corresponding figures
and decides to do so, the auditor shall state in an Other Matter paragraph in the auditor’s report:

(a) That the financial statements of the prior period were audited by the predecessor auditor;
(b) The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the
reasons therefore; and
(c) The date of that report.

30. Which of the following is an appropriate consideration in auditor’s selection of sample size?

A. The auditor may select a voided or cancelled document in a sample. If the document has been properly
voided, treat the item as deviation.
B. If the auditor encounters missing documents and he is unable to determine whether control has been
properly performed, replace the document with another sample item.
C. The auditor may select a voided or cancelled document in a sample. If the document has been properly
voided, replace the document with another sample item
D. If the auditor encounters missing documents and he is unable to determine whether control has been
properly performed, treat the item as deviation and replace the document with another sample item.

Answer: C
(PSA 530, Audit Sampling)

The auditor may select a voided or cancelled document in a sample. If the document has been properly
voided, the document must be replaced with another sample item. If the auditor encounters missing
documents and he is unable to determine whether control has been properly performed, the auditor must
treat the item as deviation.

31. Fraudulent financial reporting involves intentional misstatements or omissions of amount or disclosures in
the financial statements to deceive financial statement users. Which of the following acts appropriately
involves fraudulent financial statements?

I. Manipulations, falsification or alteration of records or documents
II. Lapping of accounts receivable
III. Recording of transactions without substance
IV. Stealing entity’s assets such as cash, marketable securities and inventory
V. Intentional application of accounting policies

A. I and II
B. I, II , III and IV
C. I, III and V
D. All of the above

Answer: C
(PSA 240, Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements)

Fraudulent financial reporting involves intentional misstatements or omissions of amount or disclosures in
the financial statements to deceive financial statement users. This may involve:
I. Manipulations, falsification or alteration of records or documents.
II. Misrepresentation in or intentional omission of the effects of transactions from records or documents.
III. Recording of transactions without substance and
IV. Intentional application of accounting policies


32. Which of the following is not true with reference to the Code of Professional Ethics for CPAs?

A. Acting as advocate of an audit client in resolution of a dispute or litigation that involves amounts
material to the financial statements of the audit client impairs CPA’s independence.
B. A firm or network firm should not provide accounting and bookkeeping services for an audit client that
is not a listed entity.
C. Fees are not to be regarded as contingent if these are fixed by a court.
D. A professional accountant in public practice may enter into an arrangement for the purchase of the
whole or part of an accounting practice requiring payments to individuals formerly engaged in the
practice.

Answer: B
(Code of Professional Ethics for CPAs)

According to Code of Professional Ethics for CPAs, a firm or network firm should not provide accounting
and bookkeeping services for an audit client that is a listed entity. The provision of such services may
impair CPAs independence, or at least give the appearance of impairing independence.

33. During an assessment of the risk associated with sales contracts and related commissions, which of the
following factors would most likely result in an expansion of the engagement scope?

A. An increase in product sales, along with an increase in commissions
B. An increase in sales returns, along with an increase in commissions
C. A decrease in sales commissions, along with a decrease in product sales
D. A decrease in sales returns, along with an increase in product sales

Answer: B
(Gleim’s Certified Internal Auditor Reviewer)

Trends described in A, C and D are compatible while trend in B are incompatible and may indicate inflated
sales figures.

34. Which of the following explanations suggests the least amount of relative risk stemming from a failure to
compare a purchase order to an approved price list?

A. A temporary employee processed the purchase order.
B. The comparison is not required by company policy.
C. The vendor is one used often by the company.
D. The director of the purchasing department approved the purchase order.

Answer: A
(Sawyer’s Certified Internal Auditor Reviewer)

“A” is correct. The relative risk of loss to the company would be lower if a temporary employee were
responsible for the error. This suggests an isolated incident, as the employee will not be able to repeat the
error once he or she has left the purchasing department. However, the error should still be reported to
management.
“B” is incorrect. If employees are not required to consult an approved price list, the company risks buying
at too great a price.
“C” is incorrect. Even if the company regularly buys from this vendor, there is no assurance that the price is
reasonable unless the purchase order is compared to the approved price list.
“D” is incorrect. The director should have required the purchase order to be compared to the approved
price list before approving it. Otherwise, the purchase price may exceed the approved price.

35. Which of the following situations is most likely to be the subject of a written interim report to the engagement
client?

A. Seventy percent of the planned audit work has been completed with no significant adverse
observations.
B. The auditors have decided to substitute survey procedures for some of the planned detailed review of
certain records.
C. The engagement program has been expanded because of indications of possible fraud.
D. Open burning at a subsidiary plant poses a prospective violation of pollution regulations.

Solution: D
A. Incorrect. There is no need for earlier consideration in this situation.
B. Incorrect. Changes in auditor methodology are not of particular importance to the engagement client.
C. Incorrect. Indications of possible fraud would not be communicated to the engagement client.
D. Correct. Such a situation would require immediate attention.

36. The manager of a production line has the authority to order and receive replacement parts for all machinery
that require periodic maintenance. The internal auditor received an anonymous tip that the manager ordered
substantially more parts than were necessary from a family member in the parts supply business. The
unneeded parts were never delivered. Instead, the manager processed receiving documents and charged the
parts to machinery maintenance accounts. The payments for the undelivered parts were sent to the supplier,
and the money was divided between the manager and the family member.
Which of the following tests would best assist the auditor in deciding whether to investigate this anonymous
tip further?
A. Comparison of the current quarter’s maintenance expense with prior-period activity.
B. Physical inventory testing of replacement parts for existence and valuation.
C. Analysis of repair parts charged to maintenance to review the reasonableness of the number of items
replaced.
D. Review of a test sample of parts invoices for proper authorization and receipt.

Solution: C
A. Incorrect. The current quarter’s expense would equal the prior period’s activity unless the manager
just started this fraud. The auditor has no information on how long this might have been occurring.
B. Incorrect. Physical testing would not locate nonexistent parts that have already been charged to
maintenance.
C. Correct. An analysis of repair parts charged to maintenance would quantify the excessive
number of items and detect that abuse may be occurring.
D. Incorrect. Lack of segregation of duties allowed the fraud to occur. The manager was authorized to
process both the purchase and receipt, so the test would only verify the fraudulent paperwork.

37. While testing a division’s compliance with company affirmative-action policies, an auditor found that:
i. Five percent of the employees are from minority groups.
ii. No one from a minority group has been hired in the past year.

The most appropriate conclusion for the auditor to reach is that:
A. Insufficient evidence exists of compliance with affirmative-action policies.
B. The division is violating the company’s policies.
C. The company’s policies cannot be audited and hence cannot be enforced.
D. With five percent of its employees from minority groups, the division is effectively complying.

Solution: A
A. Correct. Without knowledge of guidelines for compliance, a reasonable conclusion cannot be
reached.
B. Incorrect. The fact that no minority has been hired this year is irrelevant without knowing the total
hires for the period.
C. Incorrect. An affirmative-action policy is clearly auditable.
D. Incorrect. This conclusion cannot be reached without knowledge of the actual company policy.

38. An auditor is conducting a survey of perceptions and beliefs of employees concerning an organization’s
health-care plan. The best approach to selecting a sample would be to:

A. Focus on people who are likely to respond so that a larger sample can be obtained.
B. Focus on managers and supervisors because they can also reflect the opinions of the people in their
departments.
C. Use stratified sampling where the strata are defined by marital and family status, age, and salaried or
hourly status.
D. Use monetary-unit sampling according to employee salaries.

Solution: C
A. Incorrect. This convenience sample is likely to emphasize people with lots of available time at the
expense of key employees who are too busy with company work to respond.
B. Incorrect. Managers and supervisors often do not have the same needs and perceptions as their
subordinates and also may misperceive their views.
C. Correct. Because different employees probably have different situations, needs, and
experiences, stratified sampling would best ensure that a representative sample would result.
D. Incorrect. This approach would produce a disproportionate number of highly paid employees who may
not have the same needs as lower-paid employees.

39. Which of the following observations by an auditor is most likely to indicate the existence of control
weaknesses over safeguarding of assets?

I. A service department's location is not well suited to allow adequate service to other units.
II. Employees hired for sensitive positions are not subjected to background checks.
III. Managers do not have access to reports that profile overall performance in relation to other
benchmarked organizations.
IV. Management has not taken corrective action to resolve past engagement observations related to
inventory controls.

A. I and II only.
B. I and IV only.
C. II and III only.
D. II and IV only.

Solution: D (II and IV only)
I. Incorrect. This is a symptom of weak controls for achieving organizational goals and objectives, but not
for safeguarding of assets.
II. Correct. This is a symptom of weak controls for safeguarding of assets.
III. Incorrect. This is a symptom of weak controls for achieving organizational goals and objectives, but not
for safeguarding of assets.
IV. Correct. Management's failure to take corrective action on past engagement observations, which
related to safeguarding of assets, is a weakness related to safeguarding of assets.

40. Which of the following acts is prohibited by the Code of
Professional Ethics for CPAs?

a. The use of a firm name which includes the name of a retired partner
b. An announcement in a newspaper of the opening of a public accounting office
c. Engaging in civic activities during business hours
d. Accepting an engagement or employment which one cannot reasonable expect to complete or discharge
with professional competence

Answer: D
(Code of Professional Ethics for CPAs)

41. A document that details what the auditor will do to gather sufficient, appropriate evidence is the ________________
Answer: Audit Program
42. What computer-assisted audit technique would an auditor use to identify a fictitious or terminated employee?

A. Parallel simulation of payroll calculations.
B. Exception testing for payroll deductions.
C. Recalculations of net pay.
D. Tagging and tracing of payroll tax-rate changes.

Solution: B. Exception testing for payroll deductions.

A. Incorrect. In a parallel simulation, data that were processed by the engagement client’s system are
reprocessed through the auditor’s program to determine if the output obtained matches the output
generated by the client’s system. This technique might identify problems with the client’s processing but
would not identify a fictitious or terminated employee.
B. Correct. This type of computer-assisted audit technique (CAAT) program can identify employees
who have no deductions. This is important because fictitious or terminated employees will
generally not have any deductions.
C. Incorrect. A CAAT program can recalculate amounts such as gross pay, net pay, taxes and other
deductions, and accumulated or used leave times. These recalculations can help determine if the payroll
program is operating correctly or if employee files have been altered, but would not identify a fictitious or
terminated employee.
D. Incorrect. In this type of CAAT program, certain actual transactions are “tagged,” and as they proceed
through the system, a data file is created that traces the processing through the system and permits an
auditor to subsequently review that processing. This would not, however, identify a fictitious or terminated
employee.

43. If the auditor identifies related parties or significant related party transactions that management has not
previously identified or disclosed to the auditor, the auditor shall:

A. Promptly communicate the relevant information to the other members of the other
engagement team
B. Where the applicable financial reporting framework establishes related party
requirements, request from local public authorities to identify all transactions with
the newly identified related parties for the auditor’s further evaluation
C. If the non-disclosure by management appears to be intentional, evaluate the
implications for the audit.
D. None of the above

Solution: C is correct

Paragraph 22 of PSA 550 (Revised and Redrafted), Related Parties, states if the auditor identifies related
parties or significant related party transactions that management has not previously identified or disclosed
to the auditor, the auditor shall:
(a) Promptly communicate the relevant information to the other members of the engagement team;
(b) Where the applicable financial reporting framework establishes related party requirements:
(i) Request management to identify all transactions with the newly identified related parties for the
auditor’s further evaluation; and
(ii) Inquire as to why the entity’s controls over related party relationships and transactions failed to
enable the identification or disclosure of the related party relationships or transactions;
(c) Perform appropriate substantive audit procedures relating to such newly identified related parties or
significant related party transactions;
(d) Reconsider the risk that other related parties or significant related party transactions may exist that
management has not previously identified or disclosed to the auditor, and perform additional audit
procedures as necessary; and
(e) If the non-disclosure by management appears intentional (and therefore indicative of a risk of material
misstatement due to fraud), evaluate the implications for the audit.

44. Which of the following erroneous conclusions may result from sampling risk affecting audit efficiency?

A. In the case of a test of controls, that controls are more effective than they actually are,
or in the case of a test of details, that a material misstatement does not exist when in
fact it does.
B. In the case of a test of controls, that controls are less effective than they actually are,
or in the case of a test of details, that a material misstatement exists when in fact it
does not.
C. Both A and B.
D. Neither A nor B.

Solution: B is correct

As stated in paragraph 5 of PSA 530 (Redrafted), Audit Sampling, sampling risk can lead to two types of
erroneous conclusions as follows:

 In the case of a test of controls, that controls are less effective than they actually are, or in the case
of a test of details, that a material misstatement exists when in fact it does not. This type of
erroneous conclusion affects audit efficiency as it would usually lead to additional work to establish
that initial conclusions were incorrect.
 In the case of a test of controls, that controls are more effective than they actually are, or in the case
of a test of details, that a material misstatement does not exist when in fact it does. The auditor is
primarily concerned with this type of erroneous conclusion because it affects audit effectiveness
and is more likely to lead to an inappropriate audit opinion.


45. When an independent auditor decides that the work performed by internal auditors may have a bearing on the
nature, timing and extent of planned audit procedures, the independent auditor should evaluate the objectivity
of the internal auditors. Relative to objectivity, the independent auditor should

a. Consider the organizational level to which internal auditors report
b. Review the quality control program in effect for the internal audit staff
c. Examine the quality of the internal audit reports
d. Consider the qualifications of the internal audit staff

Answer: A
(PSA 610, Using the Work of Internal Auditors)

46. A professional accountant is required to comply with fundamental principles which include the following
except:
I. Honesty
II. Integrity
III. Objectivity
IV. Perseverance

A. I only
B. III only
C. I and IV
D. II and III

Answer: C. I and IV

Paragraph 100.4 of the Code of Ethics for Professional Accountants in the Philippines enumerates the
following fundamental principles that a professional accountant should comply with:
a. Integrity
b. Objectivity
c. Professional competence and due care
d. Confidentiality
e. Professional behavior

47. Which of the following specific considerations in obtaining audit evidences for audit of inventory is false?
A. If inventory is immaterial to the financial statements taken as a whole, the auditor
should attend the physical count observation.
B. If physical inventory counting is conducted at a date other than the date of the
financial statements, the auditor shall perform audit procedures to obtain audit
evidence about whether changes in inventory between the count date and the date of
the financial statements are properly recorded.
C. The auditor may request confirmation from the third party as to the quantities and
condition of inventory held on behalf of the entity when inventory under the custody
and control of a third party is material.
D. If the auditor is unable to attend physical inventory counting due to unforeseen
circumstances, the auditor shall make or observe some physical counts on an
alternative date.

Answer: A. If inventory is immaterial to the financial statements, the auditor should attend the
physical count observation.

PSA 501, Audit Evidence – Specific Considerations for Selected Items, provides:

Par. 4 - When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate
audit evidence regarding the existence and condition of inventory by: (a) Attendance at physical inventory
counting, unless impracticable….. and (b) Performing audit procedures over the entity’s final inventory
records to determine whether they accurately reflect actual inventory count results.

Par. 5 - If physical inventory counting is conducted at a date other than the date of the financial statements, the
auditor shall, in addition to the procedures required by paragraph 4, perform audit procedures to obtain audit
evidence about whether changes in inventory between the count date and the date of the financial statements
are properly recorded.

Par. 6 - If the auditor is unable to attend physical inventory counting due to unforeseen circumstances, the
auditor shall make or observe some physical counts on an alternative date, and perform audit procedures on
intervening transactions.

Par. 8 - If inventory under the custody and control of a third party is material to the financial statements, the
auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that
inventory by performing one or both of the following: (a) Request confirmation from the third party as to the
quantities and condition of inventory held on behalf of the entity, (b) Perform inspection or other audit
procedures appropriate in the circumstances.


48. The use of an analytical review to verify the correctness of various operating expenses would not be a
preferred approach if:
A. An auditor notes strong indicators of a specific fraud involving these accounts.
B. Operations are relatively stable and have not changed much over the past year.
C. An auditor would like to identify large, unusual, or non-recurring transactions during the year.
D. Operating expenses vary in relation to other operating expenses, but not in relation to revenue.

Solution: A
A. Correct. If the auditor already suspects fraud, a more directed audit approach would be
appropriate.
B. Incorrect. Relatively stable operating data is a good scenario for using analytical review.
C. Incorrect. Analytical review would be useful in identifying whether large, non-recurring, or unusual
transactions occurred.
D. Incorrect. Analytical review only needs to have accounts related to other accounts or other independent
data. It does not require that they be related to revenue.

49. An organization uses electronic data interchange and on-line systems rather than paper-based documents for
purchase orders, receiving reports, and invoices. Which of the following audit procedures would an auditor use
to determine if invoices are paid only for goods received and at approved prices?

A. Select a statistical sample of major vendors and trace the amounts paid to specific invoices.
B. Use generalized audit software to select a sample of payments and match purchase orders, invoices, and
receiving reports stored on the computer using a common reference.
C. Select a monetary-unit sample of accounts payable and confirm the amounts directly with the vendors.
D. Use generalized audit software to identify all receipts for a particular day and trace the receiving reports to
checks issued.

Solution: B
A. Incorrect. This procedure only provides data on whether payments agree with invoices. It does not provide
data on whether the invoiced amounts are correct.
B. Correct. This would help the auditor determine that all three pieces of data were most likely
matched before payment.
C. Incorrect. As with answer “a”, this only provides data on whether payments agree with invoices. It does not
provide data on whether the goods were actually received.
D. Incorrect. This provides data only on one day. While it matches items received with those paid, it does not
provide data on whether the billings were correct.

50. A sales department has been giving away expensive items in conjunction with new product sales to stimulate
demand. The promotion seems successful, but management believes the cost may be too high and has asked for
a review by the internal audit activity. Which of the following procedures would be the least useful to
determine the effectiveness of the promotion?
A. Comparing product sales during the promotion period with sales during a similar non-promotion period.
B. Comparing the unit cost of the products sold before and during the promotion period.
C. Performing an analysis of marginal revenue and marginal cost for the promotion period, compared to the
period before the promotion.
D. Performing a review of the sales department’s benchmarks used to determine the success of a promotion.

Solution: B
A. Incorrect. This comparison would help highlight the effectiveness of the promotion in increasing sales.
B. Correct. There is no indication that cost of the products sold has changed. The challenge is to
address the effectiveness of the promotion.
C. Incorrect. This is the key analysis as it would show the extent of additional revenue versus cost.
D. Incorrect. This would be helpful because the sales department may have useful information on new
customers and repeat purchases.