sy SS Chapter 5 — Planning an Audit of Financial Statements CHAPTER 5: SELF-TEST EXERCISES DISCUSSION QUESTIONS 1, What is planning in the context of a financlal statement audit? 2. What are the benefits of a properly planned audit? 3. What are the factors affecting the nature and extent of planning activities? 4. What are the main outputs of audit planning? 5. What is the objective of risk assessment procedures? 6. Howisthe materiality of an audit determined? 7. What are the components of audit risk? 8. How does the auditor perform the inherent risk assessment process? 9. What are the required responses for identified significant risks? 10. How does the assessed level of detection risk affect the nature, timing, and extent of procedures of the auditor? 11. What is the relationship between materiality and level of audit risk? 12. What are the considerations in establishing the overall audit strategy? 413. Howis an audit plan developed? 14. What are the factors that affect the nature, timing, and extent of the direction and supervision of the audit? 15. What are circumstances that may create the need for an auditor's expert? 16. What are the necessary procedures when using the work of internal auditors? 17. What is the required audit documentation when the work of internal auditors is used? 18. Do the purpose and objective of an audit change if it is an initial audit? 19. What are the additional considerations for initial audit engagements? 20. What are the additional considerations for audits of smaller entities? 5~1 TRUE OR FALSE 1. Autit effectiveness is the primary objective of the auditor in engagement planning which results in the utilization of the least amount of resources. 2, Aucit planning helps the auditor properly organize and manage the audit engagement. 3. For recurring audits, members of the previous year’s engagement team are advised to participate in the planning of the current year’s audit 4. Audit planning helps in achieving effective and efficient audits which must be completed before the performance of further audit procedures. 5. The audit plan sets the scope, timing, and direction of the audit which leads to the establishment of the overall audit strategy. ————— SESS Aim... Bele Page 209 Scanned with CamScannerChapter 5 — Planning ah Aug ur 7 6. Risk assessment procedures enable the auditor to understand the enti, and its environment and identify and assess risks of material misstatement “T7.. Risk assessment procedures help in specifically identifying the applicab ‘further audit procedures to respond to identified risks, T. & Inquiry consists of seeking both financial and non-financial informatio from knowledgeable persons within the entity 9, Observation consists of looking at a process or audit procedure, T 10. Physical verification of the entity's premises and plant facilities i, considered an inspection procedure © 41, Analytical procedures are seldom used for planning an audit engagement. ‘ because they are substantive procedures. 12, Preliminary arrangements with clients should be set forth in the management letter. ¥ 13. An audit plan includes a detailed listing of the audit procedures to be, performed in the verification of items in the financial statements. 14, Risks of material misstatement are assessed at the assertion level in order to determine the nature, timing, and, extent of further audit procedures necessary to obtain sufficient appropriate audit evidence. {_15: Inerent risk and contol risk shouldbe assessed separately. / 5-2 TRUEOR FALSE 1. Analytical procedures enable the auditor to conclude ifthe fluctuations and relationships in the entity's financial information make sense. 2. Preliminary analytical review is only required for new or unusual business transactions entered by the entity during the period under audit. 3. Industry benchmarks or averages may be used to develop expectations regarding financial statements. T_ 4 only planning and concluding analytical review are required to be performed in an audit. 5. Test of details obtains corroborative evidence for a particular assertion as compared to substantive analytical procedures which doesn’t. ‘ 6. Materiality is an absolute concept as prescribed by the engagement standards. a Page 210 Air... Believe... Claim.. Scanned with CamScannerA ye 1 as Chapter 5 - Planning an Audit of Financial Statements 7. Misstatements, including omissions, are considered to be material if individually they could reasonably be expected to Influence the economic decisions of users. 8, The determination of materiality is a mathematical exercise with a prescribed formula that differs depending on the Industry of the entity, 9, The auditor should revise the overall materiality should he become aware of information during the audit that would lead to a different amount. 10. The identification and assessment of risks of material misstatements are both done at the financial statement and assertion levels. 11, Detection risk is determined and controlled by the auditor. 12. The results of preliminary engagement activities are also considered when establishing the overall audit strategy. 13. When the work of an expert is involved in the audit, the auditor's responsibility for the audit opinion is shared with the expert. 14. To comply with ethical requirements, the current year auditor shall communicate with the previous auditor for initial engagements. 415. Establishing an overall audit strategy and plan for audits of small entities need to be complex but not time-consuming. ‘5-3 MULTIPLE CHOICE QUIZZERS 1. Which of the following statements is/are correct? Statement 1: The client should plan the audit work so that the audit will be performed in an effective manner. Statement 2: The auditor should conduct the audit with an attitude of professional skepticism. Statement 3: The auditor should develop and document an overall audit plan describing the scope and conduct of the audit. A. Only one statement is correct C. All statements are correct, © Only two statements are correct D. All statements are incorrect 2. The auditors plan should |. Precede action ll, Be flexible Il Be cost-beneficial A. landil Cl and Ill B. Mand ill @ Nand iil Aim... Believe, Clie Page 211 Scanned with CamScannerChapter 5 — Planning an Audit of Financial Statements 3, Adequate planning benefits the audit of financial statements in several (i including the following, except Helping the auditor to devote appropriate attention to less important areas of the audit B. Helping the auditor identify and resolve potential problems on a timely basis Helping the auditor properly organize and manage the audit ‘engagement so that it is performed in an effective and efficient manner D. Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to respond to anticipated risks, and the proper assignment of work to them 4. Which of the following statements is incorrect? A. The auditor should plan the audit so that the engagement will be performed in an effective manner. B. Planning an audit involves establishing the overall audit strategy for the engagement and developing the audit plan, in order to reduce audit risk to an acceptably low level. C. Planning involves the engagement partner and other key members of the engagement team to benefit from their experience and insight and to enhance the effectiveness and efficiency of the planning process. Planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins shortly after (or in connection with) the completion of the previous audit and continues until the finalization of the audit program. 5. Which of the following statements is/are correct? Statement 1: According to PSA 300, the auditor may discuss elements of planning with those charged with governance and the entity's management. Statement 2: The audit plan sets the scope, timing, and direction of the audit and guides the development of the more detailed overall audit strategy. Statement 3: The overall audit strategy is more detailed than the audit plan and includes the nature, timing and extent of audit procedures to be performed engagement team members to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level. Only 1 statement is correct C. All statements are correct Only 2 statements are correct _D. All statements are incorrect Scanned with CamScannerChapter 5 — Planning an Audit of Financial Statements 6, An initial (first-time) audit requires more audit time to complete than a recurring audit. One of the reasons for this is that A. New auditors are usually assigned to an initial audit. B, Predecessor auditors need to be consulted. \The client's business, industry, and internal control are unfamiliar to the auditor and need to be carefully studied, D. A larger proportion of customer accounts receivable need to be confirmed on an initial audit. 7, Anauditor should design the audit plan so that A. Allmaterial transactions will be selected for substantive testing. B._ Substantive tests prior to the balance sheet date will be minimized. Othe audit procedures selected will achieve specific audit objectives. D. Each account balance will be tested under either tests of controls or tests of transactions. g,_ Indeveloping an overall audit strategy, an auditor should consider: A. Whether the allowance for sampling risk exceeds the achieved upper precision limit. B. Findings from substantive tests performed at interim dates. C. Whether the inquiry of the client's attorney identifies any litigation, claims, or assessments not disclosed in the financial statements. Preliminary evaluations of materiality, audit risk, and internal control. 9. An understanding of a client’s business and industry and knowledge bout operations are essential for performing an adequate audit. For a new client, most of this information is obtained: ‘A. from the predecessor auditor. B. from the Securities and Exchange Commission. from the permanent file. at the client’s premises. 410. Which of the following is most likely to occur at the beginning of an initial audit engagement? A. Prepare a rough draft of the financial statements and of the auditor's report. 8. Study and evaluate the system of internal administrative control. @ Determine the client’s reason for an audit. D. Consult with and review the work of the predecessor auditor prior to discussing the engagement with the client management. Scanned with CamScannerChapter 5 - Planning an Audit of Financial Statements 11, While assessing the risks of material misstatement auditors identify risks, relate risk to what could go wrong, consider the magnitude of risks and A. Assess the risk of misstatements due to illegal acts, Consider the complexity of the transactions involved. Consider the likelihood that the risks could result in material misstatements, D. Determine materiality levels. 12. The extent of audit planning will vary according to the |. Size of the entity ll, Complexity of the audit Il Auditor’s experience with the entity and knowledge of the business A. land It C.land Ill B. land I pon tH 13. Which of the following is not one of the three main reasons why the itor should properly plan engagements? (Q) To enable proper on-the-job training of employees. B. Toenable the auditor to obtain sufficient appropriate evidence. C. Toavold misunderstandings with the client, D. Tohelp keep audit costs reasonable. 14. With respect to the auditor's planning of a year-end audit, which of the following statements is always true? A. Anengagement should not be accepted after the fiscal year-end. B. Aninventory count must be observed at the balance sheet date. C. The client's audit committee should not be told of any specific audit procedures which will be performed. () It is an acceptable practice to carry out parts of the examination at interim dates. 415. Early appointment of the independent auditor will enable: A. amore thorough examination to be performed. 8. a proper study and evaluation of internal control to be performed. C._ sufficient competent evidential matter to be obtained. Ce a more efficient examination to be planned. 5-4 MULTIPLE CHOICE QUIZZERS 1. Ifitis probable that the judgment of a reasonable person would have been changed or influenced by the omission or misstatement of information, n that information is: Material, C. Significant, Insignificant, D. Relevant. Page 214 Aim Roliove Claim. Scanned with CamScannerChapter 5 - Planning an Audit of Financial Statements 2. The preliminary judgment about materiality is the amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users. A. Minimum C. Mean average ® Maximum D, Median average 3, Auditors are responsible for determining whether financial statements are materially misstated, so upon discovering a material misstatement they ‘must bring it to the attention of: ‘A. noone in particular, C. the audit firm’s managing partner, 8. regulators. Ode client's management. 4, The definition of materiality emphasizes what class of financial statement users? A. Regulators. (esos persons. 8, Informed investors. . Potential investors. 5, When auditors allocate the preliminary judgment about materiality to account balances, the materiality allocated to any given account balance is referred to as: ‘A, the materiality range. C. tolerable materiality, B: the error range. L Dyolerable misstatement. 6. Which of the following statements concerning materiality is incorrect? A. Aggregate materiality thresholds are a function of the auditor's preliminary judgments concerning audit risk. In general, the more misstatements the auditor expects, the higher should be the aggregate materiality threshold. C. The smallest aggregate level of errors or fraud that could be considered material to any one of the financial statements is referred to as a "materiality threshold." D. Materiality thresholds may change between the planning and review stages of the audit. These changes may be due to quantitative and/or qualitative factors. 7. Itisa threshold calculated as a certain percentage of overall materiality in order to capture any uncorrected misstatements, the total amount of Which may exceed overall materiality, A. Overall materiality C, Performance materiality B. Scoping materiality . Tolerable misstatement 8. Amounts involving fraud are usually considered important than unintentional errors of equal peso amounts. A. Less B. Noless fim Roliawa 1 Page 215 Scanned with CamScannerChapter 5 - Planning an Audit of Financial Statements 9, Statement 1: The benchmark to be used in determining materiality couly either be an element or component of the financial statements Statement 2: In practice, the benchmark commonly used for profit. oriented companies is profit from continuing operations before tax (PBT). Statement 3: Specific materiality is the amount set by the auditor for particular elements or components, well though higher than overal) materiality could influence decision-making. A. Onlyone statement is correct C. All statements are correct Only two statements are correct D. All statements are incorrect 10. The preliminary judgment about materiality and the amount of audit evidence accumulated are related. A. Directly . Not B. Indirectly \nversely 11. After the preliminary judgment about materiality has been established, auditors may: A. notadjustit. B. adjust it downward only. adjust it upward only. (B.) adjust it either downward or upward. 12. In an audit area that has a lower inherent risk, it would be prudent to: A. increase the amount of audit evidence gathered. B. assign more experienced staff to that area. C.) increase the tolerable misstatement for the area. ). expand planning procedures. 13. Which of the following is least likely to be appropriate as the basis for determining the preliminary judgment about materiality in the audit of financial statements? ‘A. Net income before taxes.C. Owners’ equity. B. Current assets. ()nentn. 14, Auditing standards ___ that the basis used to determine the preliminary Judgment about materiality be documented in the audit files. A. Permit (eet 8. donot allow . strongly encourage Scanned with CamScannerChapter 5 ~ Planning an Audit of Financial Statements 15. Which of the following statements is correct regarding the auditor's determination of materiality? A. The planning level of materiality should normally be the larger of the amount considered for the balance sheet versus the Income statement, The auditors’ planning level of materiality may be disaggregated into smaller "tolerable misstatements" for the various accounts. C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not for determining the planning level of materiality, 0. The amount used for the planning should equal that used for evaluation. 5-5 MULTIPLE CHOICE QUIZZERS 4. The auditors must consider materiality in planning an audit engagement. Materiality for planning purposes is: A. The auditors’ preliminary estimate of the largest amount of misstatement that would be material to any one of the client's financial statements. The auditors' preliminary estimate of the smallest amount of misstatement that would be material to any one of the client's financial statements. C. The auditors! preliminary estimate of the amount of misstatement that would be material to the client's balance sheet. D. Anamount that cannot be quantitatively stated since it depends on the nature of the item. 2. Which of the following situations would most likely require special audit planning by the auditors? ‘A. Some items of factory and office equipment do not bear identification numbers. B. Depreciation methods used on the client's tax return differ from those used on the books. C. Assets costing less than $500 are expensed even though the expected life exceeds one year. Inventory is comprised of precious stones, 3, Fhe auditor's analytical procedures will be facilitated if the client Uses a standard cost system that produces variance reports. Segregates obsolete inventory before the physical inventory count, C. Reduces inventory balances to the lower of cost or net realizable value. D. Corrects material weaknesses in internal control before the beginning of the audit. Scanned with CamScannerChapter 5 - Planning an Audit of Financial statements 4, Analytical procedures are performed in the planning stage because ‘A. These procedures replace test of balances and transactions that excees scoping materiality. B. The study of financial ratios is an acceptable alternative to investigate unusual fluctuations that lead to audit efficiency C. Statistical tests of financial information may lead to the discovery of aes errors in the financial statements D. )Plausible relationships among information are expected and continue \ inthe absence of opposing conditions 5, An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the planning phase of the audit by the use of: A. Specialized audit programs. C. Tests of transactions and balances, 8.) Analytical procedures. D. An assessment of internal control. Y 6. Which of the following statements is not correct with respect to analytical procedures? ‘A. Auditing standards emphasize the need for auditors to develop and use , expectations. 'b,) Analytical procedures must be performed throughout the audit. C. Analytical procedures may be performed at any time during the audit. D. Analytical procedures use comparisons and relationships to assess whether account balances appear reasonable. 7. Which of the following is correct with respect to the use of analytical procedures? ‘A. Analytical procedures may be used in evaluating balances in the testing phase as long as the auditor also uses them in assessing the going concern assumption. B, Analytical procedures must be used throughout the audit. C. Analytical procedures used in the testing phase of the audit are primarily used to direct an auditor's attention so that the auditor's ‘2, understanding ofthe business is improved. , Analytical procedures are performed by studying plausible relationships between financial and non-financial data 8. The most widely used profitability ratio is the: A. quick ratio. C. return on assets. B. profit margin. Barres per share, 9. Which of the following ratios is best used to assess a company’s ability to meet it long-term debt obligations? ,-. A. Quick ratio. Ghetto eauity. B,_Return on common equity Page 218 Ai Current ratio. Scanned with CamScannerchapter 5— Planning an Audit of Financial statements 10. Which of the following statements is not correct? ‘A. Analytical procedures used in the planning phase of the audit are primarily directed at understanding the client’s business and directing the auditor's attention to areas that may contain possible misstatements. Analytical procedures used in the completion phase are primarily aimed at assessing going concern and secondarily aimed at directing the auditor’s attention to areas that may contain possible misstatements, C. Analytical procedures must be used in the planning and completion phases of the audit, and are optional in the testing phase. D. Analytical procedures used in the completion phase are primarily aimed at directing the auditor's attention to areas that may contain possible misstatements and secondarily aimed at assessing going concern. 11. When are auditors likely to encounter judgment Problems in the use of analytical procedures? ‘A. Whenever the auditor places reliance on management's explanations for unusual fluctuations in account balances without first developing independent expectations. B. Whenever the auditor allows unaudited balances to unduly influence his/her expectations of current balances. C. Whenever the auditor fails to consider the pattern reflected by several unusual fluctuations when trying to explain what caused them. () The auditor is likely to encounter judgment problems in each of the above instances. 12, The major concern when using nonfinancial data in analytical procedures is source of the nonfinancial data. type of nonfinancial data. 0 accuracy of the nonfinancial data. G ._ presence of multiple sources of nonfinancial data. 13. In using the information on the statement of cash flows while obtaining an understanding of a profitable, growing company, which of the following would ordinarily be least surprising to an auditor? ‘A. Decreases in accounts payable. Decreases in accounts receivable. @ Negative cash flows from investing. Y, Negative operating cash flows. ——[—[—[—=_[_$_$_$_$_§_$_ _ ——————== a Paga 210 Scanned with CamScannerChapter 5 — Planning an Audit of Financial Statements 14, If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts? Purchase returns and allowances. Allowance for doubtful accounts. C. Common stock. D. Noncontrolling interest of a subsidiary purchased during the year. 15. Which of the following procedures is not performed as a part of planning an audit engagement? ‘A. Reviewing the working papers of the prior year. Performing analytical procedures. Confirmation of all major accounts. Designing an audit program. 5-6 MULTIPLE CHOICE QUIZZERS 1. An audit approach that allocates proportionately more audit resources to areas of high audit risk is referred to asa audit. A. Controls based approach Data driven approach 8B. Substantive approach (Ose approach 2. These are audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risks of material misstatement, whether due to ud or error, atthe financial statement and assertion levels. Const assessment procedures B. Further audit procedures C. Test of operating effectiveness of controls D. Preliminary analytical procedures 3. Which component of the audit risk model may be expressed in qualitative terms? |. Inherent Risk Il, Control Risk IIL Detection Risk A. andi C.land Ill 8. andl p): Nand til 4, The risk of a material misstatement occurring in an account, assuming an absence of internal control, is referred to as: ‘A. Account risk. C. Detection risk. 8. Control risk. Ppnterent tisk. Scanned with CamScannerChapter 5 ~ Planning an Audit of Financial Statements 5, The risk that the auditors' procedures will lead them to conclude that a material misstatement does not exist in an account balance when in fact such a misstatement does exist is referred to as: A. Account risk. CDetetion risk, B. Control risk. Inherent risk. 6, It is easier and more common to implement increased evidence mulation for inherent risk than for acceptable audit risk because: (ie risk can usually be isolated to specific accounts. inherent risk applies to the entire audit, C. acceptable audit risk and sample sizes are set statistically. D, acceptable audit risk does not impact on the amount of evidence which must be accumulated. 7. Which of the following is least likely to be considered a financial statement it risk factor? Management operating and financing decisions are dominated by top management. 8. Anew client with no prior audit history. C._ Rate of change in the entity's industry is rapid. D. Profitability of the entity relative to its industry is inconsistent. 8. When inherent risk is high, there will need to be: |. Alower assessment of audit risk Il. More evidence accumulated by the auditor lonly C. Both | andi! & only D. Neither | nor Il 9. Which of the following is not a potential effect of an auditor's decision that alower acceptable audit risk is appropriate? A. More evidence is accumulated. Less evidence is accumulated. Special care is required in assigning experienced staff. D. Review of audit documentation is performed by personnel not assigned to the engagement. 10. Which of the following is not an example of a likely adjustment in the auditors’ overall audit approach when significant risk is found to exist? A. Apply increased professional skepticism about material transactions. Increase the assessed level of detection risk. C. Assign personnel with particular skill to areas of high risk. D. Obtain increased evidence about the appropriateness of management's selection of accounting principles. Scanned with CamScanner