CPA REVIEW SCHOOL OF THE PHILIPPINES AT-9011

Manila

AUDITING THEORY CPA Review

COMPLETING THE AUDIT

The procedures to “wrap-up” an audit engagement are:

1. Review for related party transactions,

2. Review for subsequent events,
3. Make inquiries of a client’s legal counsel,
4. Obtain a management representation letter,
5. Search for unrecorded liabilities,
6. Perform final review stage analytical procedures,
7. Review adequacy of disclosures using a disclosure checklist that lists all specific disclosures
required by PFRS and the SEC, if appropriate,
8. Review of working papers, and
9. Form an opinion.

RELATED PARTY TRANSACTIONS

Identifying transactions with related parties

The following procedures may identify material transactions with known related parties or indicate
the existence of previously unknown related parties:

1. Provide personnel performing all segments of the audit with the names of known related
parties.
2. Review the minutes of meetings of the board of directors and committees.
3. Review filings with the SEC and other regulatory agencies.
4. Review conflict-of-interest statements obtained from the client’s management.
5. Review business transacted with major customers, suppliers, borrowers, and lenders for
indications of undisclosed relationships.
6. Consider whether unrecognized transactions are occurring, such as receiving or providing
accounting, management, or other services at no charge.
7. Review accounting records for large, unusual, or nonrecurring transactions or balances,
especially those near the end of the period.
8. Review invoices from law firms.
9. Review confirmations of loans receivable and payable for guarantees.

Examining identified related party transactions

After identifying related party transactions, the auditor should become satisfied about their
purpose, nature, extent, and effect. The following should be considered:

1. Obtain an understanding of the business purpose of the transaction.

2. Examine invoices, executed copies of agreements, contracts, and other documents.
3. Determine whether the transaction has been approved by the board of directors or other
officials.
4. Test for reasonableness the compilation of amounts to be disclosed or considered for
disclosure.
5. Arrange for the audits of intercompany balances to be performed as of concurrent dates, even
if the fiscal years differ, and for the examination of specified, important, and representative
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related party transactions by the auditor for each of the parties, with appropriate exchange
of relevant information.

6. Inspect or confirm and obtain satisfaction concerning the transferability and value of
collateral.

EVENTS AFTER THE BALANCE SHEET DATE (Subsequent Events)

(Based on PSA 560 – Subsequent Events)

1. Events after the balance sheet date are those events, both favorable and unfavorable, that
occur between the balance sheet date and the date when the financial statements are
authorized for issue.

2. The following procedures are typically performed at or near the completion of fieldwork to
detect subsequent events:
a. Read the latest available interim financial statements and compare them with the financial
statements being reported on.
b. Read the available minutes of meetings of stockholders, directors, and appropriate
committees.
c. Assemble pertinent findings resulting from inquiries of legal counsel and other auditing
procedures for litigation, claims, and assessments.
d. Obtain a letter of representation from management.

3. When the auditor becomes aware of events which materially affect the financial statements,
the auditor should consider whether such events are properly accounted for and adequately
disclosed in the financial statements.

INQUIRIES OF CLIENT’S LEGAL COUNSEL

1. The auditor is required to communicate directly with a client’s attorney about liabilities arising
from litigation, claims, and assessments.

2. A list of legal issues should be prepared by the client’s management, rather than the client’s
attorney. This information is sent by the auditor to the attorney, requesting information
about:
a. pending or threatened litigation, claims, and assessments, and
b. unasserted claims and assessments

3. The client should request the attorney to furnish the following information for all pending or
threatened litigation, claims, and assessments, and to comment on differences between the
attorney’s and management’s views:
a. A description of the nature of the matter, progress to date, and action the client intends
to take.
b. An evaluation of the likelihood of an unfavorable outcome and an estimate, if one can be
made, of the amount or range of potential loss.
c. A statement that management’s list of pending or threatened claims is complete, or
identification of any omissions.

4. The attorney’s refusal to reply to the audit inquiry is a SCOPE LIMITATION that may affect
the audit report.

5. In the case of unasserted claims which the client has not disclosed, the lawyer is not required
to note them in his or her reply to the auditor. However, the lawyer is generally required to
inform the client of the omission and to consider withdrawing if the client fails to inform the
auditor.

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MANAGEMENT REPRESENTATION LETTER

(Based on PSA 580 – Written Representations)

1. The representation letter –

a. confirms the oral representations given by management to the auditor and reduces the
possibility of misunderstanding between the client and the auditor.
b. reminds management of its primary responsibility for the financial statements.
c. should be addressed to the auditor.
d. should be dated as of the audit report date.
e. should be signed by the chief executive officer and the chief financial officer.
f. is not a substitute for the application of other necessary auditing procedures.

2. If management refuses to provide a representation that the auditor considers necessary, this
constitutes a scope limitation and the auditor should express a qualified opinion or a disclaimer
of opinion.

3. Written representations requested from management may be limited to matters that are
considered either individually or collectively material to the financial statements.

Example of a management representation letter

(Entity Letterhead)
(To Auditor) (Date)

This representation letter is provided in connection with your audit of the financial statements of ABC
Company for the year ended December 31, 20X1 for the purpose of expressing an opinion as to whether
the financial statements present fairly, in all material respects, the financial position of ABC Company
as of December 31, 20X1 and of the results of its operations and its cash flows for the year then ended
in accordance with (indicate relevant financial reporting framework).

We acknowledge our responsibility for the fair presentation of the financial statements in accordance
with (indicate relevant financial reporting framework).

We confirm to the best of our knowledge and belief, the following representations:

Include here representations relevant to the entity. Such representations may include:

• There have been no irregularities involving management or employees who have a significant
role in the accounting and internal control systems or that could have a material effect on
the financial statements.
• We have made available to you all books of account and supporting documentation and all
minutes of meetings of shareholders and the board of directors (namely those held on March
15, 20X1 and September 30, 20X1, respectively).
• We confirm the completeness of the information provided regarding the identification of
related parties.
• The financial statements are free of material misstatements, including omissions.
• The Company has complied with all aspects of contractual agreements that could have a
material effect on the financial statements in the event of noncompliance. There has been
no noncompliance with requirements of regulatory authorities that could have a material
effect on the financial statements in the event of noncompliance.
• The following have been properly recorded and when appropriate, adequately disclosed in
the financial statements:
a) The identity of, and balances and transactions with, related parties.
b) Losses arising from sale and purchase commitments.
c) Agreements and options to buy back assets previously sold.
d) Assets pledged as collateral.
• We have no plans or intentions that may materially alter the carrying value or classification
of assets and liabilities reflected in the financial statements.
• We have no plans to abandon lines of product or other plans or intentions that will result in
any excess or obsolete inventory, and no inventory is stated at an amount in excess of net
realizable value.

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• The Company has satisfactory title to all assets and there are no liens or encumbrances on
the Company’s assets, except for those that are disclosed in Note X to the financial
statements.
• We have recorded or disclosed, as appropriate, all liabilities, both actual and contingent, and
have disclosed in Note X to the financial statements all guarantees that we have given to
third parties.
• Other than . . . described in Note X to the financial statements, there have been no events
subsequent to period end which require adjustment of or disclosure in the financial
statements or Notes thereto.
• The . . . claim by XYZ Company has been settled for the total sum of XXX which has been
properly accrued in the financial statements. No other claims in connection with litigation
have been or are expected to be received.
• There are no formal or informal compensating balance arrangements with any of our cash
and investment accounts. Except as disclosed in Note X to the financial statements, we have
no other line of credit arrangements.
• We have properly recorded or disclosed in the financial statements the capital stock
repurchase options and agreements, and capital stock reserved for options, warrants,
conversions and other requirements.
______________________________
(Senior Executive Officer)
______________________________
(Senior Financial Officer)

EVALUATION OF GOING CONCERN STATUS

(Based on PSA 570 – Going Concern)

1. The auditor should evaluate management’s assessment of the entity’s ability to continue as a
going concern.

2. In evaluating management’s assessment, the auditor considers:

• the process management followed to make its assessment;
• the assumptions on which the assessment is based; and
• management’s plans for future action.

3. When events or conditions have been identified which may cast significant doubt on the
entity’s ability to continue as a going concern, the auditor should:
• review management’s plans for future actions based on its going concern assessment;
• gather sufficient appropriate audit evidence to confirm or dispel whether or not a
material uncertainty exists through carrying out procedures considered necessary,
including considering the effect of any plans of management and other mitigating
factors; and
• seek written representations from management regarding its plans for future action.

4. Examples of events or conditions, which individually or collectively, may cast significant doubt
about the going concern assumption are:

FINANCIAL
• Net liability or net current liability position.
• Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment;
or excessive reliance on short-term borrowings to finance long-term assets.
• Indications of withdrawal of financial support by debtors and other creditors.
• Negative operating cash flows indicated by historical or prospective financial statements.
• Adverse key financial ratios.
• Substantial operating losses or significant deterioration in the value of assets used to generate cash
flows.
• Arrears or discontinuance of dividends.
• Inability to pay creditors on due dates.
• Inability to comply with terms of loan agreements.
• Change from credit to cash-on-delivery transactions with suppliers.
• Inability to obtain financing for essential new product development or other essential investments.

OPERATING
• Loss of key management personnel without replacement.
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• Loss of a major market, franchise, license, or principal supplier.

• Labor difficulties or shortages of important supplies.

OTHER
• Non-compliance with capital or other statutory requirements.
• Pending legal or regulatory proceedings against the entity that may, if successful, result in claims
that are unlikely to be satisfied.
• Changes in legislation or government policy expected to adversely affect the entity.

WRITING A MANAGEMENT LETTER

1. The auditor writes a management letter for two reasons:

a. to encourage a better relationship between the auditor and management
b. to suggest additional tax and management services that the auditor can provide

2. A management letter is OPTIONAL and is intended to help the client operate its business more
effectively.

3. There is no standard format or approach for writing management letters. The management
letter should be developed to meet the style of the auditor and the needs of the client.

MULTIPLE CHOICE QUESTIONS

1. The primary source of information to be reported about litigation, claims, and assessments is
the
A. Independent auditor C. Court records
B. Client’s management D. Client’s lawyer

2. The primary reason an auditor requests that letters of inquiry be sent to a client’s attorneys
is to provide the auditor with
A. A description and evaluation of litigation, claims, and assessments that existed at the
balance sheet date.
B. The attorneys’ opinions of the client’s historical experiences in recent similar litigation.
C. Corroboration of the information furnished by management about litigation, claims, and
assessments.
D. The probable outcome of asserted claims and pending or threatened litigation.

3. The letter of audit inquiry should be

A. Prepared and sent by the auditor.
B. Prepared by management and sent by the auditor.
C. Prepared and sent by management.
D. Prepared by the auditor and sent by management.

4. The refusal of a client’s lawyer to provide a representation on the legality of a particular act
committed by the client is ordinarily
A. Proper grounds to withdraw from the engagement.
B. Insufficient reason to modify the auditor’s report because of the lawyer’s obligation of
confidentiality.
C. Considered to be a scope limitation.
D. Sufficient reason to issue a “subject to” opinion.

5. Management’s refusal to give the auditor permission to communicate with the entity’s legal
counsel is most likely to lead to
A. An adverse opinion.
B. A qualified opinion or an adverse opinion.
C. An unmodified opinion.
D. A qualified opinion or a disclaimer of opinion.

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6. In which of the following circumstances would an auditor most likely meet with the client’s
legal counsel to discuss the likely outcome of the litigation and claims?
I. The auditor determines that the matter is a significant risk.
II. There is a disagreement between management and the entity’s legal counsel.
III. The subject matter of the litigation is complex.
A. I and II only. C. I and III only.
B. II and III only. D. I, II, and III.

7. Which of the following statements extracted from a client’s lawyer’s letter concerning
litigation, claims, and assessments most likely would cause the auditor to request clarification?
A. “I believe that the action can be settled for less than the damages claimed.”
B. “I believe that the company will be able to defend this action successfully.”
C. “I believe that the plaintiff’s case against the company is without merit.”
D. “I believe that the possible liability to the company is nominal in amount.”

8. The auditor should consider the status of legal matters up to the

A. Balance sheet date.
B. Date of the auditor’s report.
C. Date of approval of the financial statements.
D. Date of issuance of the financial statements.

9. Analytical procedures used in the overall review stage of the audit generally include
A. Retesting controls that appeared to be ineffective during the assessment of control risk.
B. Considering unusual or unexpected account balances that were not previously identified.
C. Gathering evidence concerning account balances that have not changed from the prior
year.
D. Performing tests of transactions to corroborate management’s financial statement
assertions.

10. Analytical procedures performed in the overall review stage of an audit suggest that several
accounts have unexpected relationships. The results of these procedures most likely indicate
that
A. The communication with the audit committee should be revised.
B. Irregularities exist among the relevant account balances.
C. Additional substantive tests of details are required.
D. Internal control activities are not operating effectively.

11. The responsibility for the identification and disclosure of related parties and transactions with
such parties rests with the
A. Auditor.
B. Entity’s management.
C. Financial Reporting Standards Council (FRSC).
D. Securities and Exchange Commission (SEC).

12. The auditor should review information provided by those charged with governance and
management identifying
I. The names of all known related parties.
II. Related party transactions.
A. I only. C. Both I and II.
B. II only. D. Neither I nor II.

13. Which of the following events most likely indicates the existence of related parties?
A. Making a loan without scheduled terms for repayment of the funds.
B. Discussing merger terms with a company that is a major competitor.
C. Selling real estate at a price that differs significantly from its book value.
D. Borrowing a large sum of money at a variable rate of interest.

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14. An auditor searching for related party transactions should obtain an understanding of each
subsidiary’s relationship to the total entity because
A. This may permit the audit of intercompany account balances to be performed as of
concurrent dates.
B. This may reveal whether particular transactions would have taken place if the parties had
not been related.
C. The business structure may be deliberately designed to obscure related party transactions.
D. Intercompany transactions may have been consummated on terms equivalent to arm’s-
length transactions.

15. After determining that a related party transaction has, in fact, occurred, an auditor should
A. Obtain an understanding of the business purpose of the transaction.
B. Substantiate that the transaction was consummated on terms equivalent to an arm’s-
length transaction.
C. Add a separate paragraph to the auditor’s report to explain the transaction.
D. Perform analytical procedures to verify whether similar transactions occurred, but were
not recorded.

16. PSA 570 (Going Concern) states that a fundamental principle in the preparation of financial
statements is the going concern assumption. Under this assumption, an entity is ordinarily
viewed as continuing in business for the foreseeable future with neither the intention nor the
necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to laws
and regulations. The responsibility to make an assessment of an entity’s ability to continue
as a going concern rests with the
A. Auditor C. SEC
B. Entity’s management D. Entity’s creditors

17. Which of the following statements best describes the auditor’s responsibility concerning the
appropriateness of the going concern assumption in the preparation of the financial
statements?
A. The auditor’s responsibility is to make a specific assessment of the entity’s ability to
continue as a going concern.
B. The auditor’s responsibility is to predict future events or conditions that may cause the
entity to cease to continue as a going concern.
C. The auditor’s responsibility is to consider the appropriateness of management’s use of the
going concern assumption and consider whether there are material uncertainties about
the entity’s ability to continue as a going concern that need to be disclosed in the financial
statements.
D. The auditor’s responsibility is to give a guarantee in the audit report that the entity has
the ability to continue as a going concern.

18. Which of the following conditions or events most likely would cause an auditor to have
substantial doubt about an entity’s ability to continue as a going concern?
A. Cash flows from operating activities are negative.
B. Stock dividends replace annual cash dividends.
C. Significant related party transactions are pervasive.
D. Research and development projects are postponed.

19. Which of the following conditions or events most likely would cause an auditor to have
substantial doubt about an entity’s ability to continue as a going concern?
A. Restrictions on the disposal of principal assets are present.
B. Usual trade credit from suppliers is denied.
C. Significant related party transactions are pervasive.
D. Arrearages in principal stock dividends are paid.

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20. Which of the following audit procedures would most likely assist an auditor in identifying
conditions and events that may indicate there could be substantial doubt about an entity’s
ability to continue as a going concern?
A. Confirmation of bank balances.
B. Confirmation of accounts receivable from major customers.
C. Reconciliation of interest expense with debt outstanding.
D. Review of compliance with terms of debt agreements.

21. Harold, CPA, believes there is substantial doubt about the ability of Jersamtan Co. to continue
as a going concern for a reasonable period of time. In evaluating Jersamtan’s plans for
dealing with the adverse effects of future conditions and events, Harold most likely would
consider, as a mitigating factor, Jersamtan’s plans to
A. Postpone expenditures for research and development projects.
B. Purchase production facilities currently being leased from a related party.
C. Strengthen internal controls over cash disbursements.
D. Discuss with lenders the terms of all debt and loan agreements.

22. When an auditor concludes that there is substantial doubt about a continuing audit client’s
ability to continue as a going concern for a reasonable period of time, the auditor’s
responsibility is to
A. Consider the adequacy of disclosure about the client’s possible inability to continue as a
going concern.
B. Issue a qualified or adverse opinion, depending upon materiality, due to the possible
effects on the financial statements.
C. Report to the client’s audit committee that management’s accounting estimates may need
to be adjusted.
D. Reissue the prior year’s auditor’s report and add an emphasis of matter paragraph that
specifically refers to “substantial doubt” and “going concern.”

23. As used in PSA 560 (Subsequent Events), the term “subsequent events” refers to
I. Events occurring between the date of the financial statements and the date of the auditor’s
report.
II. Facts discovered after the date of the auditor’s report.
A. I only. C. Both I and II.
B. II only. D. Neither I nor II.

24. Which of the following statements best describes the “date of the financial statements?”
A. The date on which those with the recognized authority assert that they have prepared the
entity’s complete set of financial statements, including the related notes, and that they
have taken responsibility for them.
B. The date that the auditor’s report and audited financial statements are made available to
third parties.
C. The date of the end of the latest period covered by the financial statements, which is
normally the date of the most recent balance sheet in the financial statements subject to
audit.
D. The date on which the auditor has obtained sufficient appropriate audit evidence on which
to base the opinion on the financial statements.

25. Which of the following procedures would an auditor most likely perform to obtain evidence
about the occurrence of subsequent events?
A. Inquiring as to whether any unusual adjustments were made after the date of the financial
statements.
B. Confirming a sample of material accounts receivable established after the date of the
financial statements.
C. Comparing the financial statements being reported on with those of the prior period.
D. Investigating personnel changes in the accounting department occurring after the date of
the financial statements.

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26. Which of the following statements best expresses the auditor’s responsibility with respect to
facts discovered after the date of the auditor’s report but before the date the financial
statements are issued?
A. The auditor should amend the financial statements.
B. If the facts discovered will materially affect the financial statements, the auditor should
issue a new report which contains either a qualified opinion or an adverse opinion.
C. The auditor should consider whether the financial statements need amendment, discuss
the matter with management, and consider taking actions appropriate in the
circumstances.
D. The auditor should withdraw from the engagement.

27. After issuing a report, an auditor has no obligation to make continuing inquiries or perform
other procedures concerning the audited financial statements, unless
A. Final determinations or resolutions are made of contingencies that had been disclosed in
the financial statements.
B. Information about an event that occurred after the date of the auditor’s report comes to
the auditor’s attention.
C. The control environment changes after issuance of the report.
D. Information, which existed at the report date and may affect the report, comes to the
auditor’s attention.

28. Which of the following events occurring after the issuance of an auditor’s report most likely
would cause the auditor to make further inquiries about the previously issued financial
statements?
A. A technological development that could affect the entity’s future ability to continue as a
going concern.
B. The entity’s sale of a subsidiary that accounts for 30% of the entity’s consolidated sales.
C. The discovery of information regarding a contingency that existed before the financial
statements were issued.
D. The final resolution of a lawsuit disclosed in the notes to the financial statements.

29. The auditor is required to obtain audit evidence that management

I. Acknowledges its responsibility for the fair presentation of the financial statements in
accordance with applicable financial reporting framework.
II. Has approved the financial statements.
A. I only. C. Both I and II.
B. II only. D. Neither I nor II.

30. When an audit is made in accordance with generally accepted auditing standards, the auditor
should always
A. Observe the taking of physical inventory on the balance sheet date.
B. Obtain certain written representations from management.
C. Employ analytical procedures as substantive tests to obtain evidence about specific
assertions related to account balances.
D. Document the understanding of the client’s internal control and the basis for all
conclusions about the assessed level of control risk for financial statement assertions.

31. When considering the use of management’s written representations as audit evidence about
the completeness assertion, an auditor should understand that such representations
A. Constitute sufficient appropriate audit evidence to support the assertion when considered
in combination with a sufficiently low assessed level of control risk.
B. Are not part of the audit evidence considered to support the assertion.
C. Replace a low assessed level of control risk as audit evidence to support the assertion.
D. Complement, but do not replace, substantive tests designed to support the assertion.

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32. A written representation from a client’s management that, among other matters,
acknowledges responsibility for the fair presentation of financial statements, should normally
be signed by the
A. Chief financial officer and the chair of the board of directors.
B. Chief executive officer and the chief financial officer.
C. Chief executive officer, the chair of the board of directors, and the client’s lawyer.
D. Chair of the audit committee of the board of directors.

33. The date of the management representation letter should coincide with the date of the
A. Balance sheet C. Auditor’s report
B. Latest related party transaction D. Latest interim financial information

34. Which of the following statements concerning management representations is incorrect?

A. Representations by management can be a substitute for other audit evidence that the
auditor could reasonably expect to be available.
B. If the auditor is unable to obtain sufficient appropriate audit evidence regarding a matter,
which has, or may have, a material effect on the financial statements and such audit
evidence is expected to be available, this will constitute a limitation in the scope of the
audit, even if a representation from management has been received on the matter.
C. If a representation by management is contradicted by other audit evidence, the auditor
should investigate the circumstances and, when necessary, reconsider the reliability of
other representations by management.
D. The auditor’s working papers would ordinarily include a summary of oral discussions with
management or written representations from management.

35. What type of opinion should be expressed if the client’s management refuses to provide a
representation that the auditor considers necessary?
A. Qualified opinion or a disclaimer of opinion. C. Adverse opinion or a disclaimer of opinion.
B. Qualified opinion or an adverse opinion. D. Unqualified opinion.

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