20 Chapter 1

REVIEW QUESTIONS

I. Explain why auditors' reports are important to users or financial statements. •

2. What purpose is served by the Philippine Standards on Auditing?
3. Discuss the role of risk in the audit process and how its existence is
communicated to the user in the audit report.
4. Prior to naming Cruz and Company as its .auditors, Del Pelay,o of Verbatim, Inc., met with
Gtacie Cruz and inquired about the auditors who would work on Verbatim's audit. Pelayo wants
Cruz to assign only persons who graduated from his alma mater.
Required: How should Gracie Cruz respond?
5. Describe the conditions under which an auditor is associated with financial statements.
6. What factors should an auditor consider in determining whether financial statements are
presented fairly in conformity with applicable financial reporting standards?
7. Why must the auditor reftain from explaining why she or he is independent?
8. Define the following terms:
a. audit risk c. control risk
b. inherent risk d. detection risk
9. a. What is the audit risk model?
b. How can an auditor use the audit risk model?
10. Describe the relationship between detection risk and evidence accumulation.
11. Below are an auditor's planned audit risk and assessment of inherent risk and control risk
for five situations.
Assess Assess
ed ed
Inherent Control
Planne Risk Risk
Situatio d Audit
n Risk ____

1 1% 20% 20%

2 1 100 50

3 4 20 20

4 5 100 . 50
_

_ 5 100 100

5
A MA-Based Approach to Conducting a Quality Audit 21
Required:
a. Determine the detection risk that can he allowed for each situation.
b. Rank the five situations, based on the amount of audit evidence that will he needed. You
may assume that all other factors that may affect audit evidence accumulation are the same.
12. Last year you were assigned to minor parts of the audit of the sales and collections cycle for
Patrick Corporation. This year you have been assigned significant responsibility in the audit of
the sales and collections cycle. You recall that last year, the credit manager, Josic Tan, treated
you as if you were one of the clerks. In fact, you had to call her "Ms. Tan" when you went to ask
her several questions. This year, she has become very friendly. Josie, as she now wants you to
call her, has just invited you to join her for dinner at a very exclusive private club in town. You
were called away before you could give Josie a reply, but she did indicate to you that last year
she took your predecessor to such a dinner.
Required: How do you respond to Josic?
13. The fairness of financial statements and the adequacy of internal controls are judged only by
reference to pre-established criteria. What serves as the criteria to judge the fairness of financial
statements and the adequacy of internal controls? Explain why "reference to criteria" is
important to the audit function and the results communicated by the audit function.
14. How does complexity affect (I) the demand for auditing services and (2) the performance of
auditing services?
15. Who is the most important user of an auditor's report on a company's financial
staternents•company management, the company's shareholders, or the company's creditors?
Briefly explain your rationale and indicate how auditors should resolve potential conflicts in the
needs of the three parties.
16. How does an audit enhance the quAlity of financial statements and . management's reports
on internal control? Does an audit ensure a fair presentation of a company's financial
statements or that internal control systems are free of material deficiencies? Explain.
17. In what ways does the practice of internal auditing differ from the practice of public
accounting? To whom is the internal auditing function responsible?

22 ekti,‘, /
1S. Main Cr?.i A Co, CPAs, is planning its molt piocedines for its le.,1„
the valuation of inventories of hoe,. Mannikin, ing Co. The
on the engagement have assessed inherent risk and control risk tor
valuation of inventories nt 100 percent and 50 percent, respectively.
Required:
a. Calculate the appropriate level of detection risk for the audit of this assertion, given that the
auditors wish to restrict audit risk for the assertion to 3 percent.
b. Calculate the appropriate level of detection risk for the audit of this assertion, given that the
auditors wish to restrict audit risk for the assertion to 5 percent.
19. State whether each of the following statements is correct or incorrect concerning audit risk
and its components — inherent risk, control risk, and detection risk.
a. The risk of material misstatement is composed of the three components of audit risk.
b. Inherent risk is the possibility of material misstatement before considering the client's
internal control.
c. Less control risk means in increase in tile risk of material misstatement.
d. Detection risk does not exist when no audit is performed.
e. Rather than restrict detection risk through the performance of more substantive procedures,
auditors assess it.
I. Absent any other changes, an increase in the risk of material misstatement results in an
increase in audit risk.
g. Audit risk refers to the possibility that the auditors may unknowingly fail to appropriately
modify their opinion on financial statements that are materially or immaterially misstated.
11. Both inherent risk and control risk exist independently of the audit of financial statements.
20. in applying a top-down, risk-based approach to an audit, should the auditor start with the
ending account balances or does the auditor start with the significant processes that lead to
material account balances? is one approach preferred over the other? Explain.