T8 – Multiple choice questions

1 With regard to which of the following financial statement assertions may an auditor encounter particular difficulties in obtaining sufficient evidence where internal controls are weak?

A OwnershipB ExistenceC ValuationD Completeness

D Confirmation of completeness of recording in the company’s accounting records is a particular problem for an auditor, where the internal controls are weak. This is because lack of adequate controls leads to systems objectives not being met and there is often a lack of an audit trail to evidence the inception of transactions through to completion.

2 The auditors of Three Co recently completed their interim audit for the year ending 31 July 2009. They confined their work only to tests of control on accounting records to 31 March 2009 and concluded that controls were totally unreliable.

What will be the nature of the work carried out when conducting the final audit of the company’s financial statements for the year ending 31 July 2009?A Tests of control on the system and substantive procedures on transactions for the period from 1 April 2009 to31 July 2009, plus a review of the financial statements.B Tests of control on the system for the period from 1 April 2009 to 31 July 2009, substantive procedures on thestatement of financial position as at 31 July 2009, plus a review of the financial statements.C Substantive procedures on transactions for the whole accounting period and on the statement of financial positionas at 31 July 2009, plus a review of the financial statements.D Substantive procedures on the statement of financial position as at 31 July 2009, plus a review of the financialstatements.

C As the auditors of Three Co have concluded that the internal controls of the company are unreliable they cannot rely on them and will have to adopt a substantive procedures approach when conducting the final audit of the company’s financial statements. This will involve extensive testing of transactions for the whole accounting period in addition to the verification of the items in the statement of financial position and a review of the financial statements. Options (A) (B) and (D) do not allow the necessary substantive testing to be carried out

3 Which of the following would normally be retained on the current file maintained for a limited liability company audit client?

A Narrative notes describing the company’s accounting systems.B A copy of the company’s constitution.C A management representation letter.D A description of the company’s business and its operations.

C A management representation letter contains confirmations from management on matters relevant only to the audit of the financial statements subject to audit. It should therefore be retained on the current file.

4 Which of the following describes the auditor’s role when attending a client’s inventory count?A To count all of the inventory.B To observe the conduct of the inventory count.C To identify damaged and obsolete inventory.D To supervise the inventory counting teams.

B The auditor is not an employee of the client company and should therefore take no active part in the inventory count. Having observed the inventory count the auditor can judge the extent to which (s)he will rely on the inventory count records as a basis for verifying the inventory as reported in the company’s financial statements.

5 The auditor of Four Co, a manufacturing company, has noted an increase in total sales value but a decrease in thecompany’s gross profit percentage for 2009 as compared to the previous year.Which of the following is consistent with, and adequately explains, the decrease?

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A Sales commission payable to the company’s sales force increased in relation to sales values as compared to 2008.B Sales volumes have decreased as compared to 2008.C During 2009, due to a scarcity of supply the company had to pay higher prices when purchasing components.D During 2009 a major component supplier withdrew the settlement discounts previously granted.

C Sales commissions should not be accounted for in the trading account and thus should not affect reported gross profit. Sales volumes combined with other factors could also be accompanied by an increased gross profit percentage. Any settlement discounts received should not be accounted for in the trading account and thus should not affect reported gross profit. An increase in the cost of sales as explained in option (C) would be consistent with the noted decrease in gross profit.

6 Which of the following should be included in an auditors’ report, when there has been a limitation on the auditors’ work in connection with a matter they consider material but not pervasive to the financial statements of a company?

A An ‘except for’ opinion.B A ‘disclaimer’ of opinion.C An adverse opinion.D None of the above.

A The limitation on the scope of the auditors’ work has created material uncertainty with regard to one particular aspect of the company’s financial statements. However, whilst the matter is considered to be material (if it was immaterial then it would be ignored by the auditors), it is not considered to be pervasive to the financial statements. Consequently the auditors should express an ‘except for’ opinion in the financial statements. If the auditors did consider the matter under review to be pervasive to the financial statements then they should express a ‘disclaimer’ of opinion.

7 Which of the following would provide the most persuasive evidence of a company’s ownership of a freehold office building?

A Inspection of the purchase documentation.B Inspection of recent expense invoices for extensive repairs to the building, paid for by the company.C Inspection of the title deeds to the building.D Inspection of a directors’ board minute confirming ownership of the building.

C Whilst options (A), (B) and (D) may provide corroborative evidence as to the ownership of the freehold office building, the evidence they provide is insufficient and not as reliable as that provided by inspecting the title deeds to the building. The deeds provide independent reliable confirmation of ownership.

8 ‘Audit risk’ is the risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated.Which of the following categories of risk can be controlled by the auditor?

Category of risk:(1) Inherent risk(2) Control risk(3) Detection risk(4) Sampling riskA 1 and 2 onlyB 1, 3 and 4C 2, 3 and 4D 3 and 4 only

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D Control risk and inherent risk are components of fi nancial statement risk, which is governed by the circumstances of the audit client and therefore is outside the control of the auditor. Sampling risk is a component of detection risk, which is controlled by the auditor.

9 Which audit working paper should provide satisfactory evidence that audit resources have been directed towards high risk areas of an audit?

A Systems narrative notes.B Systems flowcharts.C Audit attention points brought forward from the previous period.D The overall audit strategy documentation.

D The correct answer is option D. The overall audit strategy documentation should identify the areas of the fi nancial statements deemed to be of high risk and outline the strategy for the audit of those areas. Systems narrative notes and system flowcharts serve a similar purpose in that they provide an overview of systems for review and evaluation purposes, whilst audit attention points brought forward simply highlight areas and points to be reviewed as a consequence of relevant findings in the previous year’s audit.

10 Which of the following should be facilitated by the standardisation of substantive procedure working papers?

(1) Meeting of specified audit objectives.(2) Communicating with the staff of the audit client.(3) Delegation of audit work.(4) Review of audit work.A 1 and 4 onlyB 1, 3 and 4C 2 and 3 onlyD 1, 2, 3 and 4

B With the exception of the area identified in (2) – communications with the staff of the audit client, the standardisation of the working papers should facilitate in all of the areas identified. The extent and quality of the communication with the staff of the audit client, will depend on the personal attributes of audit staff and their individual ability to communicate effectively.

11 Which of the following strategies should give an auditor the STRONGEST assurance as to the existence of trade receivables year-end balances in a company with weak internal controls over the sales and trade receivables function?

A Carrying out a positive circularisation of receivable balances in respect of the year-end balances.B Carrying out a negative circularisation of receivables balances in respect of year-end balances.C Confirming receivables balances by agreeing to sales invoices, authorised delivery notes and valid order.D Confirming receivables balances by verifying subsequent payments after the year end.

A Whilst a circularisation of trade receivable balances is intended to provide assurance with regard to several audit objectives, the principal objective is to provide assurance with regard to existence. As the results from a positive circularisation are generally recognised to be more reliable than those from a negative circularisation, the correct answer is option A. The verification of subsequent payments is primarily a test for valuation and testing for balances by agreeing to sales documentation does not take account of payments that may have been received.

12 Which of the following financial indicators ratios on its own, provides the WEAKEST evidence of possible working capital problems in a limited liability company?

A Trade receivables collection period.B Quick (acid test) ratio.C Gross profit margin.D Trade payables payment period.

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C The correct answer is option C. The gross profi t margin is an income statement ratio and therefore does not give any indication of the working capital position of a company. In isolation both the trade receivables collection period and the trade payables payment period can provide an indication of a company’s working capital position – albeit a weak indication.

13 The auditor’s responsibility paragraph in an auditor’s report should describe an audit as including which of the following:

(1) Reporting on whether the financial statements give a true and fair view.(2) Reading other information contained in the annual report and considering whether it is consistent with the auditedfinancial statements.(3) Evaluating the overall presentation of the financial statements.(4) Evaluating the reasonableness of accounting estimates made by management.

A 1, 2 and 3B 1 and 3 onlyC 2, 3 and 4D 3 and 4 only

D The correct answer is option D. The descriptors given at (1) and (2) should not be included.

14 Which of the following statements is TRUE with regard to an emphasis of matter paragraph included in a modified auditor’s report?

A The paragraph should be included before the Opinion paragraph.B The paragraph may refer to a matter other than those presented or disclosed in the financial statements that, inthe auditor’s opinion is relevant to users’ understanding of the audit.C The paragraph should ordinarily refer to the fact that the auditor’s opinion is modified in respect of the subjectmatter.D The inclusion of the paragraph should not affect the auditor’s opinion on the financial statements.

D An emphasis of matter paragraph should be included after the Opinion paragraph, must not be used to report matters other than those affecting information presented or disclosed in the financial statements and should indicate that the auditor’s opinion is not modified in respect of the matter emphasised. The correct answer is option D – the inclusion of the paragraph should not affect the auditor’s opinion on the financial statements subject to audit.

15. D

16. B

17.A

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