5TH YEAR BSA

ACCOUNTING 16A
MIDTERM EXAMINATION

ANSWER SHEET- TEST 1

1. Auditors' reports are important to users of financial statements because they inform users of

the auditor's opinion as to whether or not the financial statements are fairly stated or whether
no conclusion can be made with regard to the fairness of their presentation.

2. The requirement for an effective audit, in addition to obtain sufficient understanding of the
client businesses and industry are obtaining knowledge about the entity’s:
 Objectives and strategies and the related business risks that may result in a material
misstatement of the FS,
 Measurement and review of the entity’s performance, and
 Internal control

3. The scope paragraph describes the nature of the audit, that it was conducted in accordance with
generally accepted auditing standards and provides reasonable assurance that the financial
statements are free of material misstatement. In the opinion paragraph, the auditors are
expressing nothing more than an informed opinion. They do not guarantee or certify that the
statements are accurate.

4. An engagement letter serves as the written contract between the auditor and the client. It is in
the interest of both the auditor sends engagement letter in order to:
 Avoid misunderstandings with respect to the engagement
 Document and confirm the auditor’s acceptance of the appointment

5. An audit program provides a basic plan for the audit team regarding the entity’s business, its
size, how to conduct the audit, allocation of work among team members and the estimation of
time within which it should complete the work. It contains details regarding the relevancy of
evidence, materiality level, risk tolerance, measure of the sufficiency of the evidence. Thus,
programs enhance the accountability of the audit team and its members for the work
performed by them.

6. Engagement team members should participate in the pre-audit conference. The discussion shall
be the entity’s:
 Industry, regulatory and other external factors including financial reporting framework,
 Nature of the entity, including entity’s selection and application of accounting policies,
 Objectives and strategies and the related business risks that may result in a material
misstatement of the Financial Statement,
 Measurement and review of the entity’s performance, and
 Internal control

ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

7. An interim audit is done usually three months before the year end due to time constraints. The
auditors would attempt to perform some test of controls (Compliance tests), analytical
procedures, and some limited substantive tests. These will enable then to better design audit
procedures so that the audit is done efficiently and effectively. At the final audit the auditor
would have known with some assurances the high risks areas identified during the interim audit.
This will significantly reduce audit risk to an acceptably low level.

8. During the course of an audit, information and data is gathered that can help spot a weakness in
operational controls in your financial department, potential workplace dangers, or certain IT
risks that can affect the security of your company. When the auditors’ preliminary assessment of
control risk is below the maximum level, they may decide to perform tests of controls to
establish the effectiveness of controls in preventing or detecting material misstatements in a
financial statement assertion. When auditors assess control risk at the maximum level, they are
not required to perform any tests of controls. Tests of controls are performed to determine
whether a control is working.

9. The Board of Accountancy promulgated ten generally accepted auditing standards (GAAS) that
establishes required level of quality for performing financial statement audits. These standards
should be looked at as a minimum standard of performance that auditors should follow.

10. Attestation is the process, performed by accountants or auditors, of providing independent

opinion on published financial and other business information of a business, public agency, or
other organization. Attestation is the reporting of the results analyzed and confirmed in the
auditing process. A CPA involved in an attest engagement will issue a written report and take
responsibility as to the fairness of the information presented. There are levels of responsibility
including three standard types: an examination is referred to as an audit, a review which is less
in scope, and an agreed-upon-procedures report.

11. It is one of the auditor’s responsibilities to identify and assess the risks of material misstatement
of the financial statements, whether due to fraud or error; to design and perform audit
procedures responsive to those risks; and to obtain audit evidence that is sufficient and
appropriate to provide a basis for the auditor’s opinion. The risk of not detecting a material
misstatement resulting from fraud is higher than for one resulting from error, as fraud may
involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal
control.

Audit risk may be considered as the product of the various risks which may be encountered in
the performance of the audit. In order to keep the overall audit risk of engagements below
acceptable limit, the auditor must assess the level of risk pertaining to each component of audit
risk.

One significant change with the Auditor Reporting standards is the revised Philippine Standard
on Auditing (PSA) PSA 701, Communicating Key Audit Matters in the Independent Auditor’s
Report. The PSA applies both to audits of financial statements of listed entities and in

ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

circumstances when the auditor otherwise decides to communicate key audit matters in the
auditor’s report. This PSA also applies when the auditor is required by law or regulation to
communicate key audit matters in the auditor’s report. It may therefore be relevant to different
sized entities and all practitioners, including small- and medium-sized practices.

The standard is intended to address both the auditor’s judgment as to what to communicate in
the auditor’s report and the form and content of such communication. The purpose of
communicating key audit matters is to enhance the communicative value of the auditor’s report
by providing greater transparency about the audit that was performed. Key Audit Matters (KAM)
are defined as “Those matters that, in the auditor’s professional judgment, were of most
significance in the audit of the financial statements of the current period. Key audit matters are
selected from matters communicated with those charged with governance.”

12. Grace should decline. It’s not applicable to assign auditors that is personally or familiar with the
company, due to familiarity threat that can compromise an auditor’s independence. The auditor
should be independent from the client company, so that the audit opinion will not be influenced
by any relationship between them. The auditors are expected to give an unbiased and honest
professional opinion on the financial statements to the shareholders.

13. The auditor shall form an opinion on whether the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting framework.
In order to form that opinion, the auditor shall conclude as to whether the auditor has obtained
reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error. That conclusion shall take into account:

(a) The auditor’s conclusion, in accordance with PSA 330, whether sufficient appropriate audit
evidence has been obtained;

(b) The auditor’s conclusion, in accordance with PSA 450, whether uncorrected misstatements
are material, individually or in aggregate; and

The auditor shall evaluate whether the financial statements are prepared, in all material
respects, in accordance with the requirements of the applicable financial reporting framework. This
evaluation shall include consideration of the qualitative aspects of the entity’s accounting practices,
including indicators of possible bias in management’s judgments.

In particular, the auditor shall evaluate whether, in view of the requirements of the applicable
financial reporting framework:

(a) The financial statements adequately disclose the significant accounting policies selected and
applied;
(b) The accounting policies selected and applied are consistent with the applicable financial
reporting framework and are appropriate;
(c) The accounting estimates made by management are reasonable;

ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

(d) The information presented in the financial statements is relevant, reliable, comparable, and
understandable;
(e) The financial statements provide adequate disclosures to enable the intended users to
understand the effect of material transactions and events on the information conveyed in the
financial statements; and
(f) The terminology used in the financial statements, including the title of each financial
statement, is appropriate.

14. The auditor shall evaluate whether the financial statements are prepared, in all material
respects, in accordance with the requirements of the applicable financial reporting framework.
This evaluation shall include consideration of the qualitative aspects of the entity’s accounting
practices, including indicators of possible bias in management’s judgments.
In particular, the auditor shall evaluate whether, in view of the requirements of the applicable
financial reporting framework:
(a) The financial statements adequately disclose the significant accounting policies
selected and applied;
(b) The accounting policies selected and applied are consistent with the applicable
financial reporting framework and are appropriate;
(c) The accounting estimates made by management are reasonable;
(d) The information presented in the financial statements is relevant, reliable,
comparable and understandable;
(e) The financial statements provide adequate disclosures to enable the intended users
to understand the effect of material transactions and events on the information conveyed in the
financial statements; and
(f) The terminology used in the financial statements, including the title of each financial
statement, is appropriate.

15. When auditing financial statements, an auditor assumes certain professional responsibilities,
Auditor’s opinion must be based on an examination conducted in accordance with professional
standards. Failure to comply with these standards exposes the auditor to risks such as loss of
public respect or even assessment of legal damages.

16. The auditor should be independent from the client company, so that the audit opinion will not
be influenced by any relationship between them. The auditors are expected to give an unbiased
and honest professional opinion on the financial statements to the shareholders.
Doubts are sometimes expressed regarding the independence of external auditors. It can be
argued that unless suitable corporate governance measures are in place, a firm of auditors may
reach audit opinions and judgments that are heavily influenced by the wish to maintain good
relations with a client company. If this happens, the auditors can no longer be said to be
independent and the shareholders cannot rely on their opinion.

ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

ANSWER SHEET- TEST 2

1. a) AUDIT RISK- refers to the risk that an auditor expresses an inappropriate opinion on the
financial statements. This occurs because the auditor believes that the Financial statement are
fairly stated when in fact the financial statements are materially misstated.

b) INHERENT RISK- refers to the risk of a material misstatement in the financial statements
arising due to error or omission as a result of factors other than the failure of controls (factors
that may cause a misstatement due to absence or lapse of controls are considered separately in
the assessment of control risk). Inherent risk is generally considered to be higher where a high
degree of judgment and estimation is involved or where transactions of the entity are highly
complex.

c) CONTROL RISK- refers to the risk of a material misstatement in the financial statements
arising due to absence or failure in the operation of relevant controls of the entity.

d) DETECTION RISK- refers to the risk that the auditors fail to detect a material misstatement in
the financial statements.

2. In audit planning, the auditor considers what would make the financial statements materially
misstated. The auditor’s assessment of materiality helps the auditor decide questions as to what
items to examine, the option to use sampling and analytic procedures. This enables the auditor
to select audit procedures that can be expected to reduce the audit risk to an acceptably low
level.

3. Name three sources of business and industry information.

 Previous experience with the entity and its industry
 Discussion with people with the entity (for example, directors and senior operating
personnel)
 Discussion with internal audit personnel and review of internal audit reports

4. a) audit risk model is a tool used by auditors to understand relationship between various risks
arising from an audit engagement enabling them to manage the overall audit risk. This is
represented in equation form as follows:
Audit Risk   =   Inherent Risk   x   Control Risk   x   Detection Risk

b) Auditor’s goal is to reduce overall audit risk to an acceptable level. In order to do that, they
will first assess the levels of each component risk of the model. The risk values are not readily
quantifiable though and auditors use professional judgement to assess the risks. This means that
ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

the above equation is not typically used to calculate risks like other mathematical equations are
normally used. The auditors will nevertheless assess the risk values in some form, often by
descriptive means. The auditors then use the model to establish relationship between the risks
and take action to reduce overall audit risk to an acceptable level.

5. Detection risk is the risk that the auditors fail to detect a material misstatement in the financial
misstatements. Detection risk can be reduced by auditors by increasing the number of sampled
transactions for detailed testing thus increasing evidence accumulation.

6. Required:
a. Describe the broad purpose of analytical procedures.
 To assist the auditor in planning the nature, timing, and extent of other auditing
procedures
 As a substantive test to obtain evidential matter about particular assertions
related to account balances or classes of transactions
 As an overall review of the financial information in the final review stage of the
audit.

b. Identify the sources of information from which an auditor develops expectations.

 Financial information for comparable prior periods giving consideration to
known changes
 Anticipated results – for example budgets or forecasts
 Relationships among elements of financial information within the period
 Information regarding the industry in which the client operates – for example,
gross margin information
 Relationships of financial information with relevant non-financial information.

c. Describe the factors that influence an auditor's consideration of the reliability of data
for purposes of achieving audit objectives.
In deciding whether to reduce the amount of testing for specific assertions because of
work performed by internal auditors, the independent auditor should consider:
 The materiality of the amount
 The risk of misstatement
 The degree of subjectivity involved in evaluating the accumulated audit
evidence
7. a) 4. Materiality is a matter of professional judgment.
b) 4.effects of his direct financial interest in a client upon his independence.

8. a) 1. Materiality
b) 1. Auditor judgement
c) 4. The scope of the examination need not be expanded if errors that arouse suspicion of fraud
are of relatively insignificant amounts.
ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

9. a) 1. advise management to disclose the event in notes to the financial statements.

b) 1. If the sale and repurchase are disclosed, an unqualified opinion should be rendered.
c) 1. requires a consistency modification in the auditor's report and disclosure in the financial
statements.

10. Required:
a. Determine the detection risk that can be allowed for each situation.
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Situation Detection Risk
1 25 %
2 2%
3 100 %
4 10 %
5 5%

b. Rank the five situations, based on the amount of audit evidence that will be needed. You
may assume that all other factors that may affect audit evidence accumulation are the
same.
Rank Situation Detection Risk
2 1 25 %
5 2 2%
1 3 100 %
3 4 10 %
4 5 5%

11. Required:
A.
1. Define audit risk.
 AUDIT RISK- Refers to the possibility that the auditors fail to appropriately modify their
opinion on financial statements that are materially misstated.
2. Describe is components of inherent risk, control risk, and detection risk.
 Inherent Risk – It is the risk of a material misstatement in the financial statements
arising due to error or omission as a result of factors other than the failure of controls.
 Control Risk – It is the risk of a material misstatement in the financial statements arising
due to absence or failure in the operation of relevant controls of the entity.
 Detection Risk – it is the risk that the auditors fail to detect a material misstatement in
the financial statements.

ACCOUNTING 16A
MIDTERM EXAMINATION
5TH YEAR BSA

3. Explain how these components are interrelated.

 Where the auditor’s assessment of inherent and control risk is high, the detection risk is
set at a lower level to keep the audit at an acceptable level. Lower detection risk may be
achieved by increasing the sample size for audit testing. Conversely, where the auditor
believes that inherit and control risks of an engagement to be low, detection risk is
allowed to be set at a relatively higher level.
B.
1. Materiality – omissions or misstatements of items are material if they could, individually or
collectively, influence the economic decisions of users taken on the basis of the financial
statements.
2. Discuss the factors affecting its determination.
 The factors that affects the determination of materiality is that it should have an impact
on the decision making of users. It sizes and nature or combination of both could also be
a determining factors. Both the amount (quantity) and nature (quality) of misstatements
need to be considered. Examples of qualitative misstatements would be the inadequate
or improper description of an accounting policy when it is likely that a user of the
financial statements would be misled by the description.

12. The primary issue raised here is how friendly an auditor should be with client personnel. This
situation is especially interesting in light of the auditor’s view of the relationship prior to being
assigned significant responsibility. The issue is whether Josie is trying to become friendly in
order to try to manipulate the auditor’s decisions.

ACCOUNTING 16A
MIDTERM EXAMINATION