AUDITING THEORY

AUDITING THEORY

October 1989

1. In performing an audit, a CPA does not warrant that he :

a. Possesses the degree of skill commonly possessed by others in the profession.

b. Will perform the audit with reasonable diligence and without fault or error.

c. Will adopt an attitude of professional skepticism.

d. Will adhere to identifiable professional obligations.

2. Which of the following generally accepted auditing standards involves the formulation of an ''audit strategy''?

a. The third general standard.

b. The first standard of field work.

c. The third standard of field work.

d. The fourth standard of reporting.

3. Which of the following is proper when a change of auditors has taken place or is in process?

a. The predecessor auditor should advise the client of his intention to contact the successor auditor and request permission for the contact.

b. The integrity of management should not be the subject of communication between the predecessor and successor auditors.

c. The successor auditor should not seek permission to make reference to the work of the predecessor auditor as a basis, in part, of his own opinion.

d. Communication between the predecessor and successor auditors should take place only after the successor auditor has accepted the engagement.

4. 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 in the terms of the engagement.

c. A recent change of client management.

d. A significant change in the nature or size of the client's business.

5. To be independent, the auditor must be intellectually honest; to be recognized as independent he must :

a. Guard against the presumption of loss of independence.

b. Be independent in fact.

c. Maintain the impartiality necessary for the dependability of his findings.

d. Act with integrity and objectivity.

6. An effective system of internal control :

a. Cannot be circumvented by management.

b. Can reduce the cost of an external audit.

c. Can prevent collusion among employees.

d. Eliminates risk and potential loss to the organization.

7. Which of the following is a violation of the code of professional ethics for certified public accountants?

a. A CPA permits his/her name to be used in a client's advertising as having verified financial data and/or statistical facts with respect to the client's product.

b. Based on information obtained in an audit, a CPA reports an illegal act of his client to government authorities.

c. Three years after a partner has retired, the remaining partners continue to practice under a firm name that includes the name of the retired partner. The retired partner has severed all connections with the CPA firm.

d. A CPA running for public office uses the professional designation ''CPA'' after his name on posters employed in connection with his election campaign.

8. Liwie, a CPA in public practice, makes an offer of employment to Manny, an employee of the CPA firm DJ & Associates. DJ did not know about the offer. Such a practice is not a violation of the code of professional ethics if :

a. Manny's acceptance of the offer is subject to the approval of DJ.

b. Manny is not a CPA.

c. Liwie's offer was made in response to an unsolicited application letter from Manny.

d. The offer is made on behalf of Liwie's audit client.

9. X is the partner in charge of the independent audit of Jona Co. Which of the following separate circumstances would be least likely to impair X's independence?

a. X who is also an attorney, provides legal service to Jona Co.

b. Jona Co. leases office space in a building owned by X.

c. A partner in X's CPA firm has an immaterial stock investment in Jona Co.

d. Both X and Jona Co. have minor investments in Avon Co., a publicity held corporation.

10. In planning an examination, the auditor would consider all of the following matters, except :

a. Anticipated reliance on internal controls.

b. Preliminary judgment about materiality levels for audit purposes.

c. Financial statement items likely to require adjustment.

d. The kind of opinion (unqualified, qualified, disclaimer, or adverse), likely to be given.

11. Audit programs may be either predetermined or progressive. All of the following are advantages of a predetermined audit program, except :

a. It places responsibility for each audit procedure.

b. It encourages independent, constructive thinking.

c. It results in proper audit routine and saves time.

d. It assures adherence to auditing standards and the application of generally accepted accounting principles.

12. In reviewing and evaluating internal controls over marketable securities, the auditor would be specially concerned about :

a. Recording of stock investments by the controller.

b. Approval of stock investment purchases by the Board of Directors.

c. Access to stock certificates by the corporate treasurer.

d. Access to stock certificates by the corporate controller.

13. he president of JJ Company did not disclose to its board of directors that he is a principal stockholder of AA Company. The president compelled JJ Company's purchasing agent to purchase supplies from AA Company at prices in excess of typical prices for such supplies. Which question, if answered ''No'' would have been most likely to disclose the internal control weakness that permitted this incident to occur or to remain undetected?

a. Are formal written purchase orders requested for all significant purchases?

b. Does the accounting department match vendors' invoices with purchase orders?

c. Are vendors selected on the basis of competitive bids?

d. Are purchase requisitions used to originate purchasing activity?

14. Of the following statements about an internal control system, which one is not valid?

a. No one person should be responsible for the custodial responsibility and the recording responsibility for an asset.

b. To prevent duplicate payment, vendors' invoices should be cancelled by means of a "Paid" stamp or perforation prior to approval.

c. Because of the cost/benefit relationship, a client may apply control procedures on a test basis.

d. An employee has incompatible duties if the person is in a position to perpetuate and conceal errors or irregularities in the normal course of performing his or her duties.

15. Assertions are representations by management that are embodied in financial statements. Which of the following is not a management assertion?

a. Obligations classified as long-term liabilities in the balance sheet will not mature within one year.

b. Properly is recorded at historical cost and such cost is systematically allocated to appropriate accounting period.

c. Finished goods inventory in the balance sheet are available for sale.

d. Net income reflects the earning power of the enterprise.

16. What management assertion is violated if the client's balance sheet includes equipment that was leased under an operating lease?

a. Existence or occurrence.

b. Completeness.

c. Rights and obligations.

d. Presentation and disclosure.

17. The reliability of audit evidence is influenced by all of the following factors, except :

a. Independence of the source.

b. System of internal control.

c. Objectivity of the evidence.

d. Relevance of the evidence.

18. Which of the following is the least competent audit evidence?

a. Minutes of the Board of Directors meeting to determine value of properly received in a related-party transaction.

b. Cost allocation schedule prepared by client's controller to verify pricing of finished goods inventory.

c. Duplicate sales invoices to support entries in sales journal.

d. Legal letter requested by auditor from client's legal counsel to determine status of pending lawsuit.

19. Working papers serve mainly to provide the principal support for the auditor's report and :

a. As a line of defense when audit findings are questioned.

b. Provide information for the preparation of tax returns and other requirements of various government agencies.

c. Aid the auditor in the conduct and supervision of the examination.

d. As a guide in future engagements for the same auditee?

20. Which of the following is not an audit technique?

a. Calculation or recomputation.

b. Valuation or allocation.

c. Comparison.

d. Analysis.

21. The term ''audit risk'' refers to the risk :

a. Of legal exposure and related costs should the auditor be charged with negligence in conducting an audit.

b. That the auditor may unknowingly fail to appropriately modify his opinion on financial statements that are materially misstated.

c. That errors or irregularities may cause financial statements not be fairly presented.

d. That the auditor may fail to anticipate all circumstances which will influence his judgment in evaluating the audit findings upon completion of the audit.

22. The auditor is least likely to presume that a high risk of error or irregularity exist if :

a. There are frequent changes of auditors.

b. The entity is heavily dependent on a few products.

c. The accounting department is overstaffed.

d. There are unusual transactions near the year end.

23. The auditor should be aware of conditions that may motivate related-party transactions. Which of the following is not one of these conditions?

a. Lack of sufficient working capital to continue the business.

b. Inadequate capacity.

c. An overly optimistic earnings forecast.

d. Significant litigation, especially litigation between stockholders and management.

24. You are examining a firm's December 31 financial statements. Which of the following procedures is most likely to reveal unrecorded liabilities?

a. Comparison of December purchases with December cash disbursements.

b. Comparison of January cash disbursements with December 31 accounts payable.

c. Comparison of January purchases with December cash disbursements.

d. Comparison of December cash disbursement with December 31 accounts payable.

25. A ''proof of cash'' is used by an auditor to :

a. Prove the correctness of the cash balance in the client's year end balance sheet.

b. Prove that the client's bank did not make an error during the period under examination.

c. Comply with generally accepted standards.

d. Determine if there were any unauthorized disbursements or unrecorded deposits during the reconciliation period.

26. Which of the following is the best procedure for identifying shortages of specific items in an inventory of raw materials?

a. Review internal controls for the physical protection of inventories.

b. Compare the results of a physical inventory of raw materials with perpetual inventory records.

c. Compare inventory turnover rates with prevailing rates from previous years.

d. Estimate inventory quantities by using the gross profit method.

27. In the audit of inventories, the auditor traced test counts recorded during the physical inventory observation to the inventory listing and counted for all inventory tags and count sheets used in recording the physical inventory counts. These procedures are preliminary intended to verify which of the following management assertions?

a. Existence or occurrence.

b. Completeness.

c. Rights and obligations.

d. Correlation.

28. A CPA analyses the accrued interest payable account for the year, recomputes the amounts of payments and beginning and ending balances and reconciles to the interest-expense account. Which error or questionable practice below has the best chance of being detected by this specific audit procedure?

a. A note payable had not been recorded. Interest of P300 on the note was properly paid and charged to the interest-expense account.

b. There was a violation of a term in the client's loan agreement prohibiting dividends on common stock unless net income available for interest and dividends is at least three times interest requirements.

c. Interest paid on an open account was charged to the purchases account.

d. Interest revenues of P120 on a note receivable was credited against miscellaneous expenses.

29. An essential phase of the audit of the cash balance at the end of the year is the auditor's review of a cutoff bank statement. This specific procedure is not useful in determining if :

a. Lapping has occurred.

b. Kiting has occurred.

c. The cash receipts journal was held open.

d. Disbursements per the bank statement can be reconciled with total checks written.

30. The auditor would not expect the client to debit retained earnings for which of the following transactions?

a. A 4-for-1 stock split.

b. A 1-for-10 stock dividend.

c. ''Loss'' resulting from disposition of treasury shares.

d. Correction of error affecting prior years' earnings.

31. Word-of-Joy, Inc. publishes a monthly magazine that had 9,000 subscribers on January 1, 1989. The number of subscribers increased uniformly throughout the year and on December 31, 1989, there were 10,800 subscribers. The annual subscription price was P25 on January 1,1989. This was increased by P3 for new members on May 1,1989. An auditor would expect that the receipts from subscriptions for the year ended December 31,1989 would be approximately :

a. P237, 600.

b. P295, 400.

c. P291, 600.

d. P295, 650.

32. Which of the following phrases is found in the standard audit report prescribed in Statement No. 5 of the Auditing Standards and Practices Council?

a. In connection therewith, we examined or tested the accounting records.

b. . . . . . have reviewed the system of internal control . . .

c. . . . . . . to the extent we deemed appropriate in the circumstances . . . . .

d. . . . . . . . . . . . . . . . the financial statements referred to above . .

33. Under which of the following circumstances would an auditor not be required to depart from the wording of the standard audit report form?

a. The client does not want to prepare a statement of changes in financial position.

b. The client did not allow the CPA to review the minutes of stockholders' meetings.

c. The client did not allow the confirmation of receivables; the CPA applied alternative auditing procedures and was satisfied as to the receivables.

d. The client does not want to disclose damage to enterprise property caused by fire which took place after the balance sheet date.

34. An auditor's report should not be designated as a ''special report'' if it is issued in connection with the financial statements or reports prepared :

a. To show the effects of contemplated transactions on the entity's financial position and operating results.

b. For limited purposes, such as a report that relates only to certain aspects of financial statements.

c. In accordance with requirements of a governmental regulatory agency such as the Insurance Commission.

d. For a not-for-profit organization which follows accounting practices differing in some respects from those followed by enterprises organized for profit.

35. Which of the changes listed below would cause the independent auditor's report to be worded as follows :

. . . . . . applied on a basis consistent with that of the preceding year after giving retroactive effect to the change with which we concur x x x x as described in Note X to the financial statements . . . . .

a. Change from accrual to cash basis of accounting.

b. Change from accelerated to straight-line depreciation method.

c. Change in the method of accounting contracts.

d. Change in classification of an item current to concurrent.

36. The phrase ''present fairly . . . . in conformity with generally accepted accounting principles'' appears in the standard audit report. Unless modified, this phrase implies that all of the following conditions have been met, except :

a. The accounting principles selected and applied have all been promulgated by the Accounting Standards Council.

b. The financial statements are informative on matters that may affect their use, understanding, and interpretation.

c. The information presented in financial statements is classified and summarized in a reasonable manner.

d. Comparability of financial statements between periods have not been materially affected by changes in accounting principles.

37. A Corporation whose securities are not traded in securities exchanges or over-the-counter markets is not required under GAAP to disclosed :

a. Unused letters of credit.

b. Guarantees of the indebtedness of stockholders.

c. Commitments to restrict dividends.

d. Earnings per share.

38. The computer is sometimes blamed for making errors. In reality, computers make very few mechanical errors. The most likely source of errors in a fully operational computer-based system is due to :

a. Systems analysis.

b. Programming.

c. Input.

d. Processing.

39. Which of the following tasks could not be performed when using a generalized audit software package?

a. Selecting inventory items for observations.

b. Physical count of inventories.

c. Comparison of inventory test counts with perpetual records.

d. Summarizing inventory turnover statistics for obsolescence analysis.

40. The statistical sample drawn from a population of invoices indicates a mean value of P150 and sampling precision of + P30 of at a 95% confidence level. What is the correct interpretation of this sample data?

a. In repeated sampling, the point estimate of the true population mean will be P150 about 95% of the time.

b. In repeated sampling, the true population mean will fall in the precision range of P120 to P180 about 95% of the time.

c. There is a 95% probability that the true population mean falls in the range of P135 to P165.

d. There is a 95% probability that the true population mean is P150.

41. The auditor expects a very small error rate, but is looking for evidence of a very critical characteristic that might indicate more widespread errors. Which of the following sampling methods should he use?

a. Attribute sampling.

b. Variable sampling.

c. Stop-or go sampling.

d. Discovery sampling.

42. A government auditor evaluates a disbursement to determine if it is necessary, excessive or extravagant in accordance with existing rules and regulations. What kind of audit is he conducting?

Compliance AuditEconomy Audit

a.

Yes

No

b.

No

Yes

c.

Yes

Yes

d.

No

No

43. The following statements relate to audit certificates issued by auditors of government agencies. Which statement is not true?

a. The certificate is addressed to the head of the agency, not to the Commission on Audit.

b. The authority on which the audit is based is described in the scope paragraph.

c. The opinion paragraph contains an assertion that the auditor was guided by applicable laws, rules, and regulations in the expression of his opinion.

d. The opinion paragraph contains an assertion that the auditor was guided by generally accepted state accounting principles in the expression in his opinion.

44. The preliminary reason for establishing an internal auditing function in an organization is to :

a. Assist members of the organization in the effective discharge of their responsibilities.

b. Ensure adherence to the policies, plans, and procedures prescribed by management.

c. Ensure the accuracy, reliability, and timeliness of financial and operating data used as a basis for management decision-making.

d. Safeguard assets of the organization and ensure that they are employed economically and efficiently.

45. The following statements relate to the Revised Accountancy Law (PD 492). Which statement is true?

a. The Professional Regulation Commission has the authority to remove any member of the Board of Accountancy for negligence, incompetence, or any other just cause.

b. Insanity is not a ground for proceeding against a CPA.

c. A person shall be considered to be in the professional practice of accounting if, as an officer in a private enterprise, he makes decisions requiring professional accounting knowledge even if his position does not require that the holder should be a CPA.

d. After two years, subject to certain conditions, the Board of Accountancy may order the reinstatement of a CPA whose certificate of registration has been revoked.