CHAPTER 4: THE FINANCIAL STATEMENT AUDIT: CLIENT ACCEPTANCE AND PLANNING

1. In assessing whether to accept a client for an audit engagement, an auditor should consider the

I. Client’s business risk.

II. Auditor’s business risk

a. I only

b. II only

c. Both I and II

d. Neither I nor II

2. Which of the following factors most likely would cause an auditor to decline a new audit engagement?

A. Concluding that the entity’s management probably lacks integrity.

B. An inability to perform preliminary analytical procedures before assessing control risk

C. An inadequate understanding of the entity's internal control

D. The close proximity to the end of the entity's reporting period.

3. Before accepting an engagement to audit a new client, an auditor is required to

A. Obtain a copy of the client’s financial statements.

B. Prepare a memorandum setting forth the staffing requirements and documenting, the
preliminary audit plan.

C. Make inquiries of the predecessor auditor after obtaining the consent of the prospective client.

D. Discuss the management representation letter with the client’s audit committee.

4. Which of the following conditions most likely would pose the greatest risk in accepting a new audit
engagement?

A. There will be a client-imposed scope limitation.

 B. The client's financial reporting system has been in place for 10 years.

C. The firm will have to hire an expert in one audit area.

D. Staff will need to be rescheduled to cover this new client.

5. Which of the following circumstances would permit an independent auditor to accept an engagement
after the end of the reporting period?

A. Expectation of the operating effectiveness of controls.

B. Issuance of a disclaimer of opinion as a result of inability to conduct certain tests required by

PSAs due to the timing of the acceptance of the engagement.

C. Remedy the limitations resulting from accepting the engagement after the end of the reporting
period, such as those relating to the existence of physical inventory.

D. Receipt of an assertion from the predecessor auditor that the entity will be able to continue as a
going concern.

6. In an audit based on Philippine Standards on Auditing (PSAS), a successor auditor would normally
become satisfied with opening balances by

A. Performing analytic review procedures.

B. Reviewing the predecessor’s working papers.

C. Auditing the previous year’s working papers.

D. Interviewing client personnel.

7. A predecessor withdrew from the engagement after discovering that a client’s financial statements are
materially misstated that it would not revise. If asked by the successor auditor about me termination of
the engagement, the predecessor should

A. Suggest that the successor auditor should obtain the client’s consent to discuss the reasons.

B. Indicate that there was a misunderstanding.

 C. State that the audit revealed material misstatement that the client would not revise.

D. Suggest that the successor auditor ask the client.

8. Which of the following is not correct regarding the communications between successor/incoming and
predecessor/ previous auditors?

A. The burden of initiating the communication rests with the predecessor auditor.

B. The burden of initiating the communication rests with the successor auditor.

C. The predecessor auditor may choose to provide a limited response to a successor auditor.

D. The predecessor auditor must receive his/her former client’s permission prior to disclosing client
information to the auditor.

9. The auditor may accept or continue an audit engagement only when the basis upon which it is to be
performed has been agreed, through

I. Establishing whether the preconditions for an audit are present.

II. Confirming that there is a common understanding between the auditor and management
and, where appropriate, those charged with governance of the terms of the audit
engagement.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

10. The auditor shall agree the terms of the audit engagement with management or those charged with
governance, as appropriate. The agreed terms shall be recorded in a/an

A. Engagement letter

B. Letter of audit inquiry

 C. Management representation letter

D. Confirmation letter

11. The following matters are generally included in an auditor's engagement letter, except

A. The factors to be considered in determining the overall materiality.

B. The fact that because of the test nature and other inherent limitations of an audit, together with
the inherent limitations of internal control, there is an unavoidable risk that even some material
misstatements may remain undiscovered.

C. The scope of the audit.

D. Management’s responsibility for the financial statements.

12. The following are usually included in an auditor’s engagement letter, except

A. List of audit procedures to be used in inventory observation.

B. The financial statements are the responsibility of the company’s management.

C. A reference to PFRS.

D. A reference to PSAs.

13. An auditor’s engagement letter most likely will include

A. A request for permission to contact the client’s lawyer for assistance in identifying litigation,
claims, and assessments.

B. A reminder that management is responsible for illegal acts committed by employees.

C. The auditor’s preliminary assessment of the risk factors relating to misstatements arising from
fraudulent financial reporting.

D. Management's acknowledgment of its responsibility for such internal control as it determines is

necessary to enable the preparation of financial statements that are free from material
misstatement.
 A

14. Before the completion of the audit engagement, an auditor is requested to change the engagement
to one that provides a lower level of assurance. If the auditor concludes that there is a reasonable
justification for the change in engagement, the report to be issued would

A. Be that appropriate for the revised terms of engagement.

B. Include reference to the original engagement.

C. Include reference to any procedures that may have been performed in the original engagement.

D. Not include reference to any procedures that may have been performed, particularly when the
new engagement is to undertake agreed-upon procedures.

15. If the auditor is unable to agree to a change of the engagement and is not permitted to continue the
original engagement, the auditor should

A. Insist on continuing the original engagement.

B. Express a qualified opinion.

C. Express an adverse opinion.

D. Withdraw from the engagement.

16. Planning an audit involves

I. Establishing the overall audit strategy for the engagement.

II. Developing an audit plan.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

C
17. Which of the following activities should be performed by the auditor at the beginning of the current
audit engagement?

I. Perform procedures regarding the continuance of the client relationship and the specific-
audit engagement.

II. Evaluate compliance with relevant ethical requirements, including independence.

III. Establish an understanding of the terms of the engagement.

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

18. Initial audit planning involves the following matters, except

A. Identify the client’s reason for the engagement.

B. Schedule engagement staff and auditor's experts.

C. Develop an overall audit strategy.

D. Request that bank balances be continued.

19. Which of the following is the least likely procedure to be performed in planning a financial statement
audit?

A. Selecting a sample of sales invoices for comparison with shipping documents.

B. Coordinating the assistance of entity personnel in data preparation.

C. Reading the current year's interim financial statements.

D. Discussing matters that may affect the audit with firm personnel responsible for non-audit
services to the entity.

A
20. The establishment of an overall audit strategy involves

I. Determining the characteristics of the engagement that define its scope.

II. Ascertaining the reporting objectives of the engagement to plan the timing of the audit and
the nature of the communications required.

III. Considering the important factors that will determine the focus of the engagement team's
efforts.

A. l and II only

B. II and III only

C. l and III only

D. I, II, and III

21. Which of the following should be included in the audit plan?

I. The nature, timing and extent of planned risk assessment procedures.

II. The nature, timing and extent of planned further audit procedures at the assertion level.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

22. In the planning stage of an audit engagement, the auditor is required to perform audit procedures to
obtain an understanding of the entity and its environment, including its internal control. These
procedures are called

A. Risk assessment procedures

B. Substantive tests

C. Tests of controls
 D. Dual-purpose tests

23. In planning the audit engagement, the auditor should consider each of the following, except

A. The type of opinion that is likely to be expressed.

B. The entity's accounting policies and procedures.

C. Matters relating to the entity's business and the industry in which it operates.

D. Materiality level and audit risk.

24. In designing written audit programs, an auditor should establish specific audit objectives that relate
primarily to the

a. Selected audit techniques.

b. Cost-benefit of gathering audit evidence.

c. Timing of audit procedures.

d. Financial statement assertions.

25. An audit program should be designed for each individual audit and should incorporate steps and
procedures to

A. Detect and eliminate fraud of any type.

B. Gather sufficient amount of management information available.

C. Provide assurances that the objectives of the audit are satisfied.

D. Insure that only material items are audited.

26. Which of the following is an aspect of scheduling and controlling the audit engagement?

A. Including in the engagement letter an estimate of the minimum and maximum audit fee.
 B. Writing a conclusion in individual working papers indicating how the results of the audit will
affect the auditor’s report.

C. Performing audit work only after the entity’s books have been closed for the period under audit.

D. Including in the audit program a column for budgeted and actual time.

27. In connection with the planning phase of an audit engagement, which of the following statements is
always correct?

A. Final staffing decisions must be made prior to completion of the planning stage.

B. Observation of inventory count should be performed at year-end.

C. Portion of the audit of a continuing audit client can be performed at interim dates.

D. An engagement should not be accepted after the client's financial year-end.

28. The auditor shall undertake which of the following activities prior to starting an initial audit?

I. Performing procedures required by PSA 220 (Quality Control for an Audit of Financial
Statements) regarding the acceptance of the client relationship and the specific audit
engagement.

II. Communicating with the predecessor auditor, where there has been a change of auditors, in
compliance with relevant ethical requirements.

A. I only

B. II only

C. Either I or II

D. Both I and II

29. Before accepting an audit engagement, a proposed (successor/incoming) auditor should make
inquiries of the previous (predecessor) auditor regarding the previous auditor’s

A. Evaluation of all matters of continuing accounting significance.

 B. Understanding as to the reasons for the change of auditors.

C. Awareness of the consistency in the application of PAS/PFRS between periods.

D. Opinion on any subsequent events occurring since the previous auditor's report was issued.

30. The auditor is required to determine three different levels of materiality: (1) materiality for the
financial statements as a whole, (2) performance materiality, and (3)

A. Overall materiality

B. Planning materiality

C. General materiality

D. Specific materiality

31. What materiality level would be considered by the auditor to determine whether the proposed
adjustments are significant or not?

A. Overall materiality

B. Scoping materiality

C. Specific materiality

D. Performance materiality

32. What materiality level is used by the auditor in determining which line items in the financial
statements are to be tested?

A. Overall materiality

B. Performance materiality

C. Specific materiality

D. Individual materiality

B
33. _______ is the amount set by the auditor for particular classes of transactions, account balances or
disclosures for which misstatements, well though lower than overall materiality could reasonably be
expected to influence the economic decisions of users of the financial statements.

A. Performance materiality

B. Planning materiality

C. Specific materiality

D. General materiality

34. Which of the required materiality levels is calculated by multiplying a certain percentage by the
appropriate benchmark which is either an element or component of an entity's financial statements?

A. Overall materiality

B. Planning materiality

C. Scoping materiality

D. Specific materiality

35. Which of the following factors are normally considered by the auditor in determining the appropriate
benchmark for the purpose of calculating overall materiality?

I. Components of the entity’s financial statements

II. Laws and regulations

III. Nature of the entity

A. I and II only

B. I and III only

C. II and III only

D. I, II, and III

D
36. Which of the following would an auditor most likely use in determining a preliminary judgment
about materiality?

A. The contents of the management representation letter.

B. The anticipated sample size of the planned substantive tests.

C. The entity's annualized interim financial stamens.

D. The results of internal control questionnaire.

37. An auditor shall consider materiality when

I. Determining the nature, timing, and extent of audit procedures

II. Evaluating the effect of misstatements. .

A. I only

B. II only

C. Both I and II

D. Neither I nor II

38. It is an appraisal activity established within an entity. Its functions include, among other things,
examining, evaluating, and monitoring the adequacy and effectiveness of the accounting and internal
control systems.

A. External auditing

B. Internal auditing

C. Governmental auditing

D. Internal control

39. Which is not a similarity between external and internal auditors?

 A. Both consider materiality and risk in their work.

B. Both use similar methodologies in performing their work.

C. Both must be competent.

D. Both must be independent of the company.

40. Internal auditing can affect the scope of the external auditor’s audit of financial statements by

A. Decreasing the external auditor's need to perform detailed tests.

B. Eliminating the need to observe the physical inventory taking.

C. Allowing the external auditor to limit his/her audit to the performance of substantive test
procedures.

D. Limiting direct testing by the external auditor to management assertions not directly tested by
internal auditing

41. In determining whether the work of the internal auditors is likely to be adequate for purposes of the
audit, the external auditor shall evaluate the internal auditor’s

A. Efficiency and experience

B. Independence and review skills

C. Training and supervisory skills

D. Competence and objectivity

42. In assessing the technical competence of an internal auditor, an external auditor most likely would
obtain information about the

A. Quality of working paper documentation, reports, and recommendations.

B. Organizational level to which the internal auditor reports.

C. Influence of management on the internal auditor’s duties.

 D. Entity’s commitment to integrity and ethical values.

43. The coordination of activities between internal and external auditors

A. Eliminates duplication of audit efforts.

B. Includes the exchange of audit reports and management letters.

C. Prevents external auditors from having access to the programs used by internal auditors.

D. Prohibits the internal auditor from using the same audit techniques as external auditors and vice
versa.

44. The coordination of activities between internal and external auditors

A. Eliminates duplication of audit efforts.

B. Includes the exchange of audit reports and management letters.

C. Prevents external auditors from having access to the programs used by internal auditors.

D. Prohibits the internal auditor from using the same audit techniques as external auditors and vice
versa.

45. Which of the following are included in the activities of the internal audit function?

I. Monitoring of internal control.

II. Examination of financial and operating information.

III. Review of operating activities.

A. I and II only

B. I and III only

C. II and III only

D. I, II and III

D
46. ________ is an individual or organization possessing expertise in a field other than accounting or
auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient
appropriate audit evidence.

A. Auditor's expert

B. Management's expert.

C. Expert

D. Specialist

47. _________ is an individual or organization possessing expertise in a field other than accounting or
auditing, whose work in that field is used by the entity to assist the entity preparing the financial
statements.

A. Auditor's expert

B. Management’s expert

C. Expert

D. Specialist

48. When planning to use the work of an expert the auditor should evaluate the expert's

I. Professional competence

II. Objectivity

A. I only

B. II only

C. Both I and II

D. Neither I nor II

49. Which of the following statements is correct concerning the auditor’s use of the work of an expert?
 A. The auditor is required to perform substantive test procedures to verify the expert’s assumptions
and findings.

B. The auditor should obtain an understanding of the methods and assumptions used by the
expert.

C. The entity should not have an understanding of the nature of the work to be performed by the
expert.

D. The expert should not have an understanding of the auditor’s corroborative use of the expert’s
findings.

50. Which of the following is not an expert upon whose work an auditor may rely?

A. An actuary.

B. An individual with expertise in complex modeling for the purpose of valuing financial
instruments.

C. An expert in taxation law

D. An individual with expertise in applying methods of accounting for deferred Income tax.

51. If the results of the expert’s work do not provide sufficient appropriate audit evidence or are not
consistent with other audit evidence, the auditor should

A. Report the matter to the appropriate regulatory agency of the government.

B. Resolve the matter.

C. Withdraw from the engagement.

D. Express an unmodified opinion with reference to the work of the expert.

52. When issuing an unmodified auditor's report, the auditor

A. May refer to the work of an expert.

B. Should refer to the work of an expert to indicate a division of responsibility.

 C. Should include in the auditor's report the identity of the expert and the extent of the expert's
involvement.

D. Should not refer to the expert's work.

53. In using the work of an expert, an auditor referred to the expert's findings in the auditor’s report.
This is an appropriate reporting practice if the

A. Auditor, as a result of the expert’s work, decides to indicate a division of responsibility with the
expert.

B. Expert is aware that his/her work will be used to evaluate the assertions in the financial
statements.

C. Auditor, as a result of the expert's work, issues a report that contains a modified opinion.

D. Auditor, as a result of the expert’s work, adds an emphasis-of-matter paragraph in his/her

unmodified auditor's report.

54. As used in PSA 600, Special Considerations - Audits of Group Financial Statements (Including the
Work of Component Auditors), _________ is an entity or business activity for which group or component
management prepares financial information that should be included in the group financial statements.

A. Component

B. Group

C. Significant component

D. Group management

55. As used in PSA 600, financial statements that include the financial information of more than one
component are called

A. Component financial statements

B. Group financial statements

C. Consolidated financial statements

 D. Common financial statements

56. The __________ is the partner or other person in the firm who is responsible for the group audit
engagement and its performance, and for the auditor’s report on the group financial statements that is
issued on behalf of the firm.

A. Engagement partner

B. Component engagement partner

C. Principal auditor

D. Group engagement partner

57. The group engagement team shall obtain an understanding that is sufficient to

I. Confirm or revise its initial identification of components that are likely to be significant.

II. Assess the risks of material misstatement of the group financial statements, whether due to
fraud or error.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

58. If the group engagement team plans to request a component auditor to perform work on the
financial information of a component, the group engagement team shall obtain an understanding of

I. Whether the component auditor understands and will comply with the ethical requirements
that are relevant to the group audit and, in particular, is independent.

II. The component auditor’s professional competence.

A. I only

B. II only
 C. Both I and II

D. Neither I nor II

59. Which of the following statements concerning group audits is incorrect?

A. The group engagement team has the responsibility to establish an overall group audit strategy
and audit plan.

B. The group engagement team shall determine the materiality for the group financial statements
as a whole when establishing the overall group audit strategy.

C. The component engagement partner shall review the overall group audit strategy and group
audit plan.

D. The group engagement partner shall agree on the terms of the group audit engagement in
accordance with PSA 210.

60. An auditor who, at the request of the group engagement team, performs work on financial
information related to a component for the group audit is a

A. Group auditor

B. Component auditor

C. Component engagement team

D. Group engagement team

TRUE OR FALSE

1. Inherent risk is a measure of the auditor's assessment of the possibility that there are material
misstatements in an account before considering the effectiveness of the client's in internal control.

2. Acceptable audit risk is a measure of the auditor's willingness to accept that the financial statements
do not contain material misstatements after the audit is completed and a modified opinion has been
expressed.
 F

3. The purpose of an engagement letter is to document the terms of the engagement.

4. Early appointment of the independent auditor will enable a more thorough examination to be
performed.

5. Related party transactions may be indicated when another entity has had a distributor relationship
with the company for 10 years.

6. During audit planning, the auditor uses analytical procedures primarily to understand the client's
business and industry and to indicate possible misstatements.

7. Increased fraud risk could also result in higher inherent risk, lower control risk, and lower detection
risk.

8. A property planned and performed audit may fail to detect a material misstatement resulting from
fraud because an audit is planned and performed to provide reasonable assurance of detecting
material misstatements caused by errors but not by fraud.

9. An auditor's consideration of materiality is influenced by the auditor‘s perception of the needs of a

reasonable person who will rely on the financial statements.

10. Comparison of recorded amounts of major disbursements with appropriate invoices a typical
analytical procedure.

11. Analytical procedures are required for planning, substantive testing, and overall review of the
financial statements.

F
12. In assessing the competence of an internal auditor, an independent CPA most likely would obtain
information about the quality of the internal auditor's work.

13. The successor auditor has the responsibility to initiate contact with the predecessor auditor to ask
about the client before the engagement is accepted; the predecessor has no responsibility to initiate
this contact, even when aware of matters bearing on the integrity of management.

14. Materiality and audit risk are considered throughout the audit.

15. Analytical procedures are seldom used for planning an audit engagement because they are
substantive test procedures.

16. A predecessor auditor is required to attempt to initiate communication with the successor auditor
prior to the successor’s acceptance of the engagement.

17. Audits of financial statements are designed to obtain reasonable assurance of detecting material
misstatements due to errors and fraud.

18. All uncorrected misstatements that are below the amount of materiality established in the planning
stage of the audit will always be evaluated as immaterial.

19. If the prospective client refuses to allow the predecessor auditor to communicate with the successor
auditor, the successor auditor should have reservations about accepting the proposed audit
engagement.

20. A written understanding between the auditor and the client concerning the auditor's responsibility
for the discovery of illegal acts is usually set forth in letter of audit inquiry.

F
21. When a company has changed auditors, the predecessor auditor has no responsibility to initiate
contact with the successor auditor, even when the predecessor is aware of matters bearing on the
integrity of management.

22. An example of fraudulent financial reporting is when an employee diverts customer payments to his
personal use, concealing his actions by debiting an expense account, thus overstating expenses.

23. Generally, the external auditor may rely on the work of an internal auditor if the internal auditor is
competent and objective.

24. An independent auditor might consider the procedures performed by the internal auditors because
they are employees whose work must be reviewed during substantive testing.

25. An auditor obtains knowledge about a new client's business and its industry in order to maintain
professional skepticism concerning management's financial statement assertions.