Excel Professional Services, Inc.

Management Firm of Professional Review and Training Center (PRTC)

(LUZON) Manila 87339344 * Calamba City, Laguna * Dasmariñas City, Cavite * Lipa City,

Batangas (0917) 8852769 * (VISAYAS) Bacolod City (034) 4346214 * Cebu City (032)

2537900 loc. 218 (MINDANAO) Cagayan De Oro (0917) 7081465 * Davao City (082) 2250049

AUDITING THEORY
AT.300 5 – Preliminary R.C.P. SOLIMAN/ K.J. UY
Engagement Activities MAY 2021

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

DISCUSSION QUESTIONS
c. Materially misstated financial statements.
Overview d. All of these factors increase engagement risk.

1. Which of the following would an auditor least likely
perform as part of the auditor’s preliminary
engagement activities or pre-planning
preengagement phase?
a. Perform procedures regarding the continuance of
the client relationship and specific engagement.
b. Evaluate compliance with ethical requirements,
including independence.
c. Establish an understanding of the terms of the
engagement.
d. Obtain understanding of the legal and regulatory
framework applicable to the entity.
5. A CPA who has never audited a commercial bank
a. May not accept such an engagement.
or b. May accept the engagement only if the accounting
firm specializes in the audit of commercial banks.
c. May accept the engagement after attaining a
suitable level of understanding of the transactions
and accounting practices unique to commercial
banking.
d. May accept the engagement because training as a
CPA transcends unique industry characteristics.
Communication with Predecessor Auditor

6. Prior to the acceptance of an audit engagement with a

Client Acceptance and Continuance client who has terminated the services of the
predecessor auditor, the CPA should
2. In making a decision to accept or continue with a a. Contact the predecessor auditor without advising
client, the auditor should consider: the prospective client and request a complete
a. b. c. d. report of the circumstances leading to the
termination with the understanding that all
Its competence Yes Yes Yes Yes
information disclosed will be kept confidential.
Its Independence Yes No Yes No b. Accept the engagement without contacting the
Its ability to serve the client predecessor auditor since the CPA will include
properly Yes Yes Yes No procedures to verify the reason given by the client
The integrity of client’s for termination.
management Yes Yes No Yes c. Not communicate with the predecessor auditor
Agreement of the terms of because this would in effect be asking the auditor
engagement with the to provide the confidential relationship between
the auditor and client.
management Yes No Yes No
d. Advise the client of the intention to contact the
predecessor auditor and request permission for the
3. The auditor will utilize many resources to assess
contact.
management integrity in the client acceptance
process. Which of the following will an auditor most
likely refrain from using in this search? a. Predecessor 7. Which of the following will an auditor most likely
auditor. discuss with the former auditors of a potential client
b. Other professionals in the business community. prior to acceptance?
c. Public databases. a. Integrity of management.
d. All of the above will typically be used by an auditor b. Reasons for changing audit firms.
in the search. c. Disagreements with management regarding
accounting principles.
4. Engagement risk has been defined as the risk of d. All of the above must be discussed.
potential losses that are incurred by the auditor in
being associated with a particular client. Which of the 8. If permission from client to discuss its affairs with the
following factors are not associated with increased proposed auditor is denied by the client, the
engagement risk for the auditor? predecessor auditor should:
a. Management with questionable integrity. a. Keep silent of the denial.
b. A failed company.

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EXCEL PROFESSIONAL SERVICES, INC.
b. Disclose the fact that the permission to disclose is
denied by the client.
c. Disclose adequately to proposed auditor all
noncompliance made by the client.
d. Seek legal advice before responding to the
proposed auditor
9. The predecessor auditor is required to respond to the
request of the successor auditor for information, but
the response can be limited to stating that no
information will be provided when:
a. the predecessor auditor has poor relations with the
successor auditor.
b. the client is dissatisfied with the predecessor’s
work.
c. there are actual or potential legal problems
between the client and the predecessor.
d. the predecessor believes that the client lacks
integrity.
10. The firm should obtain acceptance and continuance
information as it considers necessary in the following
circumstances:
a. When accepting an engagement with a new client.
b. When deciding whether to continue an existing
engagement.
c. When accepting a new engagement with an
existing client.
d. All of these.
11. A firm has obtained information that would have
caused it to decline an engagement had the
information been available earlier. Actions available to
the auditor include the following, except:
a. Reporting the information and its implications to
the person(s) who appointed the CPA.
b. Withdraw from the engagement.
c. Withdraw from both the engagement and the
client relationship.
d. Continue the engagement since the Code of Ethics
requires started engagements to be completed
regardless of subsequent developments and
information.
Basis of Engagement
12. The use by management of an acceptable financial
reporting framework in the preparation of the financial
statements and the agreement of management and,
where appropriate, those charged with governance to
the premise on which an audit is conducted. a. Terms
of audit engagement
b. Preconditions for the audit
c. Scope of the audit
d. Financial statements audit
Acceptable Financial Reporting Framework
13. In an audit of FSs, the financial reporting framework
used is generally the GAAP. In the Philippines, which
of the following is/are the acceptable framework?
a. Philippine Financial Reporting Standards (PFRSs)
b. PFRS for Small and Medium-sized entities (SMEs)
c. Other acceptable basis of reporting
d. Any of the above depending on the type of client
Management’s Responsibilities
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14. The following are the management’s responsibilities
that constitute the premise on which the audit is
conducted, except:
a. Preparation and presentation of the financial
statements.
b. Design, implementation and monitoring of internal
control relevant to financial statements.
c. To provide the auditor with access to all
information relevant to audit and additional
information the auditor may request.
d. To provide the auditor unrestricted access to
persons within and outside of the entity.
Limitation on Scope Prior to Audit Engagement
Acceptance
15. If management or TCWG impose a limitation on the
scope of the auditor’s work in the terms of a proposed
audit engagement such that the auditor believes the
limitation will result in the auditor disclaiming an
opinion on the financial statements, the auditor shall
a. not accept such a limited engagement as an audit
engagement, unless required by law or regulation
to do so.
b. not accept such a limited engagement as an audit
engagement, in all cases.
c. accept such a limited engagement as an audit
engagement as the auditor serves the public
interest.
d. accept such a limited engagement as an audit
engagement as long as documented in audit
engagement letter.
Agreement on Audit Engagement Terms
16. Engagement letters are widely used in practice for
professional engagements for all types. Which of the
following best describes the purpose of the
engagement letter?
a. The engagement letter relieves the auditor of
some responsibility for the exercise of due care.
b. By clearly defining the nature of the engagement,
the engagement letter helps to avoid and resolve
misunderstandings between CPA and client
regarding the precise nature of the work to be
performed and the type of report to be issued.
c. The engagement letter conveys to management
the detailed steps to be applied in the audit
process.
d. The engagement letter should be signed by both
the client and the CPA and should be used only for
independent audits.
17. When should an auditor obtain an engagement letter?
a. Whenever a prospective client offers to hire the
audit firm
b. During the interim audit period, after the auditor
has evaluated the client’s internal control and
estimated the amount of time required for the
audit
c. When a new client is accepted by the auditor
d. At the conclusion of the field work, just prior to
signing the audit report
18. It is in the interest of both client and auditor that the
auditor sends an audit engagement letter, preferably
before
a. The performance of substantive testing.
b. The commencement of the engagement.
c. The completion of audit.
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EXCEL PROFESSIONAL SERVICES, INC.
d. Before the issuance of audit report.
19. The auditor shall agree the terms of the audit
engagement with management or those charged with
governance, as appropriate. Which of the following
normally signs the engagement letter for an audit of a
public company?
a. Corporate treasurer.
b. Chief financial officer.
c. Chairman of the board of directors.
d. Audit committee.
20. The form and content of audit engagement letters may
vary for each client, but they would generally include
reference to the following, except
a. The objective of the audit of financial statements.
b. Auditor’s responsibility for the
financial statements.
c. The form of any reports or other communication of
results of the engagement.
d. Unrestricted access to whatever records,
documentation and other information requested in
connection with the audit.
21. Which of the following is not included in an
engagement letter?
a. Restriction on cash balances, lines of credit by
similar arrangements
b. Accessibility to all financial records
c. Client imposed limitation in the scope
d. Limitation in the scope of examination as imposed
by circumstances
22. In determining audit fees, an auditor may take into
account each of the following except
a. Volume and intricacy of work involved.
b. Degree of responsibility assumed.
c. Number and cost of manhours needed.
d. Size and amount of capital of client.
23. Retainer’s fee basis is when
a. Billing is done on the basis of actual time spent at
the agreed rates/hour.
b. The client is charged on a per diem basis with a
cap or ceiling amount.
c. The client is billed a fixed fee periodically for the
services rendered during a designated period of
time.
d. The client is billed at a single amount for the entire
engagement.
24. A type of billing audit client which combines lump sum
and per diem methods is known as
a. Retainer’s fee basis c. Either (a) and (b)
b. Maximum fee basis d. None of the above
Audits of Components
25. Which of the following factors do not influence the
decision of the auditor to send a separate engagement
letter to the parent entity and its component
(subsidiary, branch or division) assuming the same
auditor handles both entities? a. legal requirements
b. degree of ownership by parent
c. ethical requirements
d. whether a separate audit report is to be issued on
the component
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Recurring Audits
26. Assuming a recurring audit, in which of the following
situations would the auditor be unlikely to send a new
engagement letter to the client?
a. A recent change in partner and/or staff involved in
the audit engagement.
b. A change or revision in the terms of engagement.
c. A recent change of client nature or size or
management.
d. A misunderstanding as to the objective and scope
of audit.
Acceptance of a Change in the Terms
27. When a change in the type of engagement from higher
to lower level of assurance is reasonably justified, the
report based on the revised engagement
a. Should not contain a separate paragraph that
refers to the original engagement.
b. Should not refer to any procedures that may have
been performed in the original engagement.
c. Omits reference to the original engagement.
d. All of the above
28. Which of the following would ordinarily be considered
a reasonable basis for requesting a change in the
engagement
a. a change in circumstances.
b. a misunderstanding as to the nature of the audit.
c. a restriction on the scope of the engagement,
whether imposed by management or caused by
circumstances.
d. Both a and b
29. If a change in the type of engagement from higher to
lower level of assurance is not justified, the auditor
should
a. Continue with the revised engagement, but make
explicit reference about the original engagement.
b. Continue with the revised engagement, and not
make explicit reference about the original
engagement.
c. Refuse to agree to management’s request on the
change of engagement and continue with the
original engagement.
d. Withdraw from the engagement.
30. Which of the following actions may be appropriate if
the auditor is unable to agree to a change of the
engagement and is not permitted to continue the
original engagement?
I. Auditor should withdraw from the engagement
II.Consider whether there is any obligation to report
to the board of directors or shareholders the
circumstances necessitating withdrawal
a. I c. II
b. I, II d. Neither I nor II
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EXCEL PROFESSIONAL SERVICES, INC.

- now do the DIY drill – 7. Which of the following is(are) proper when a change of
b. Greenworth should interview the prior audit firm prior auditors has taken place or is in process?
to releasing the proposal to Kool Connections. a. The successor auditor should advise the client of
his intention to contact the predecessor auditor
DO-IT-YOURSELF (DIY) DRILL

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

c. Greenworth may decide not to accept Kool and request permission for the contact
Connections based upon the perceived risk of b. The integrity of management should not be
being associated with Kool. subject of communication between the
d. Greenworth will contact the BOA or the PICPA and predecessor and successor auditors
ask for a review of the proposal prior to c. Communication between the predecessor and
acceptance. successor auditors should take place only after
the successor auditor has accepted the
5. Which of the following is typically not a significant risk engagement
factor that an auditor will consider in the client d. All of the above
acceptance of Stitch Magee Co.?
a. Brad Stitch, the president and 50% owner of 8. Before accepting an audit engagement, a successor
Stitch Magee was investigated for securities auditor should make specific inquiries of the
violations four years earlier. predecessor auditor regarding
b. Stitch Magee Co. is a public company in the high a. disagreements the predecessor had with the client
technology industry. concerning auditing procedures and accounting
c. Stitch Magee Co. is a manufacturing company principles
that procures much of its raw materials from the b. the predecessor’s evaluation of matters of
Detroit, Michigan area. continuing accounting significance
d. Stitch Magee Co. sells 25% of its inventory to c. the degree of cooperation the predecessor
Nani, Inc. which is owned primarily by Nani received concerning the inquiry of client’s lawyer
Magee, the father of Stitch Magee's treasurer, d. the predecessor auditor’s assessment of inherent
Engagement letter Working paper risk and judgments about materiality
a. Yes Yes
b. Yes No 9. An incoming auditor should request the new client to
authorize the predecessor auditor to allow a review of
c. No Yes
the predecessor’s
d. No No
vice president of finance and 50% owner.
10. When an independent auditor is approached to
6. An auditor who accepts an audit engagement and does perform an audit for the first time, he or she should
not possess the industry expertise of the business make inquiries of the predecessor auditor. Inquiries
entity, should are necessary because the predecessor may be able to
a. Engage financial experts familiar with the nature provide the successor with information that will assist
of the business entity. the successor in determining whether
b. Obtain a knowledge of matters that relate to the a. The predecessor’s work should be used.
nature of the entity's business. b. The company rotates auditors.
c. Refer a substantial portion of the audit to another c. In the predecessor’s opinion, control risk is low.
CPA who will act as the principal auditor. d. The engagement should be accepted.
d. First inform management that an unqualified
opinion cannot be issued. 11. Upon discovering material misstatements in a client’s
financial statements that the client would not revise,

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EXCEL PROFESSIONAL SERVICES, INC.

the auditor withdrew from the engagement. If asked
by the incoming auditor about the termination the
engagement, the predecessor auditor should
a. State that he found material misstatements that
the client would not revise.
b. Suggest that the incoming auditor ask the client.
c. Suggest that the incoming auditor obtain the
client’s permission to discuss the reasons.
d. Indicate that the misunderstanding occurred.
12. Engagement letters are required for?
a. All engagements
b. Audit engagements only
c. Assurance engagements only
d. All engagements except the preparation of
income tax returns
13. The primary purpose of the engagement letters is to
a. Remind management that the primary
responsibility for the financial statements rests
with management
b. Provide a written record of the agreement with
the client as to the services to be provided
c. Satisfy the requirements of the CPA’s liability for
insurance policy
d. Provide a starting point for the auditor’s
preparation of the preliminary audit program
14. The following matters are generally included in an
auditor’s engagement letter, except
a. Management’s responsibility for the FSs
b. The scope of the audit
c. The fact that because of the test nature and other
inherent limitations of the audit, together with the
inherent limitations of internal control, there is an
unavoidable risk that even some material
misstatements may remain undiscovered.
d. The factors to be considered in setting preliminary
judgments about materiality
d. Attainment of specific findings.
18. When a professional accountant is the auditor of a
parent entity and also the auditor of its subsidiary,
branch or division (component), which of the following
factors need not be considered in deciding whether to
send the separate engagement letter to the
component?
a. Who appoints the auditor of the component.
b. Whether a separate audit report is to be issued on
the component.
c. Legal requirements
d. Number of reports to be prepared during the peak
audit season.
19. On recurring audits, the auditor may decide not to
send a new engagement letter each year. However,
he might decide to send a new letter when:
a. There is a change in the auditors who will assist in
the conduct of the audit.
b. There is a legal requirement
c. There is a change in the client's accounting policy
for inventories.
d. There is a change in the estimated life of the
client's property and equipment.
20. The auditor should not agree for a change of
engagement when there is no reasonable justification
for doing so.
If the auditor is unable to agree to a change of the
engagement and is not permitted to continue the
original engagement, this will have an effect on the
auditor’s report.
a. True, False c. True, True
b. False, False d. False, True
- end of AT.3005 -

15. Which of the following matters is generally included in

auditor's engagement letter?
a. Management's responsibility for the entity's
compliance with laws and regulations.
b. The factors to be considered in setting preliminary
judgments about materiality.
c. Management's liability for illegal acts committed
by its employees.
d. The auditor's responsibility to search for
significant internal control deficiencies.

16. An audit engagement letter least likely includes

a. A reference to the inherent limitation of an audit
that some material misstatements may remain
undiscovered.
b. Identification of specific audit procedures that the
auditor needs to undertake.
c. Description of any letters or reports that the
auditor expects to submit to the client.
d. d. Arrangements concerning the involvement of
internal auditors and other client’s staff.

17. In determining estimates of fees, an auditor may take

into account each of the following, except the a. Value
of the service to the client.
b. Degree of responsibility assumed by undertaking
the engagement.
c. Skills required to perform the service.

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