Father Saturnino Urios University

Accountancy Program
AUDIT THEORY REVIEW
Midterm Examination

Name: Instructor: Mr. Ace S. Tiape, CPA

Encircle the letter of your choice. NO erasures allowed.

1. Analytical procedures performed in the overall review stage of an audit suggest that
several accounts have unexpected relationships. The results of these procedures most
likely indicate that
a. Irregularities exist among the relevant account balances
b. Internal control procedures are not operating effectively
c. Additional tests of details are required
d. The communication with the audit committee should be revised
2. The auditor faces a risk that the audit will not detect material misstatements that occur in
the accounting process. In regard to minimizing this risk, the auditor relies primarily on
a. Substantive tests c. Sales Discounts allowed
b. Tests of controls d. Statistical analysis
3. For several years a client's physical inventory count has been lower than the books have
shown at the time of the count, and downward adjustments of the inventory account
have been required. Contributing to the inventory problem could be weaknesses in
internal control that led to the failure to record some
a. Purchases returned to vendors c. Sales discounts allowed
b. Sales returns received d. Cash purchases
4. In obtaining an understanding of internal control relevant to the audit, the auditor may
trace several transactions through the system, including how the transactions interface
with any service organizations whose services are part of the entity's information
system. The primary objective of this procedure is to
a. Evaluate the design of internal control and determine whether it has been
implemented
b. Determine the effectiveness of internal control
c. Detect fraud
d. Replace substantive tests
5. 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
6. A technique for regularly and systematically appraising a unit of function and its
effectiveness against corporate and industry standards with the objective of assuring
management that its aims are being carried out and'or identifying conditions capable of
being improved
a. Substantive tests c. operations auditing
b. Compliance auditing d. Financial auditing
7. The use of the computer changes the processing, storage, and communication of
financial information. An IT system environment may affect the following, except
a. the accounting and internal control systems of the entity
b. The overall objective and scope of an audit
c. The auditor's design and performance of tests of controls and substantive procedures
to satisfy the audit objectives
d. The specific procedures to obtain knowledge of the entity's accounting and internal
control systems
8. In verifying a November 30 ssales cutoff date, an auditor would be most concerned with
comparing records of
a. November cash receipts with December bank deposits
b. November purchases with December shipments
 c. November accounts receivable with November sales
d. November sales with November shipping documents
9. As part of its purchasing system, an entity's receiving department receives copies of
purchase orders for use in identifying and recording goods received. The purchase
orders list the name of the vendor and the quantities of the materials ordered. A possible
error that this system could allow is
a. Payment for unauthorized purchases c. Overpayment of partial deliveries
b. Payment to unauthorized vendors d. Delay in recording purchases
10. The likelihood of assessing control risk too high is the risk that the sample selected to
test controls
a.. Does not support the auditor's planned assessed level of control risk when the true
operating effectiveness of the control justifies such an assessment
b. Contains misstatements that could be material to the financial statements when
aggregated with misstatements in other account balances or transactions classes
c. Contains proportionately fewer deviations from prescribed controls than exist in the
balance or class as a whole
d. Does not support the tolerable misstatement for some or all of management's
assertions
11. Which of the following procedures can be performed only in the subsequent period?
a. Examination of data to determine that a proper cutoff has been made
b. Tests of details of balances
c. Tests of details of transactions
d. reading of minutes of the board of director's meetings
12. Which of the following fundamental ethical principle prohibits association of
professional accountants with reports, returns, communications or other information that
is believed to contain a materially false or misleading misstatement?
a. Integrity c. Professional competence and due care
b. Objectivity d. Confidentiality
13. Which of the following does not describe a condition that creates a demand for auditing?
a. Conflict between the information preparer and the user can result in a biased opinion
b. Information can have substantial economic consequences for a decision maker
c. Expertise is often required for information preparation and verification
d. Users can directly assess the quality of information
14. An entity's internal control system contains manual elements and often contains manual
elements and often contains automated elements. Manual elements in internal control
may be less reliable than automated elements because
a. Manual control elements can be more easily bypassed, ignored, or overriden and they
are also more prone to simple errors and mistakes
b. Manual control elements facilitate the additional analysis of information
c. Concsistency of application of manual control elements can always be assumed
d. Manual control elements include reliance on systems or programs that are
inaccurately processing data, processing inaccurate data, or both
15. Which of the following analytical procedures should be applied to the income
statement?
a. Select sales and expense items and trace amounts to related supporting documents
b. Ascertain that the net income amount in the statement of cash flows agrees with the
net income amount in the income statement
c. Obtain from the proper client representatives the beginning and ending inventory
amounts that were used to determine the cost of sales
d. Compare the actual revenues and expenses with the corresponding figures of the
previous years and investigate significant differences
16. 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 modified auditor's report
d. Auditor, as a result of the expert's work, adds an emphasis-of-matter paragraph in
 his/her unmodified auditor's report
17. The frequency of the comparison of recorded accountability with assets ( for the purpose
of safeguarding assets) should be determined by
a. the amount of assets independent of the cost of comparison
b. The nature and amount of the asset and the cost of making the comparison
c. The cost of the comparison and whether the susceptibility to loss results from errors
or fraud
d. The auditor in consultation with client management
18. While this type of engagement involves the application of audit skills and techniques
and the gathering of evidence, it does not ordinarily involve an assessment of accounting
and internal control systems, tests of records, and of responses to inquiries by obtaining
corroborating evidence through inspection, observation, confirmation, and computation
a. Compilation c. Agreed upon procedures
b. Review d. Consultancy
19. Which of the following has the power to conduct an oversight into the quality of audits
of financial statements through the review of the quality control measure instituted by
auditors?
a. Bureau of Internal Revenue
b. Securities and Exchange Commission
c. Board Of Accountancy
d. Insurance Commission
20. Mr. Soya has been retained as auditor of Timex Company. The function of his opinion
on the financial statements of Timex is to
a. Improve financial decisions of company management
b. Lend credibility to management's representations
c. Detect fraud and abuse in management operations
d. Serve the requirement of the BIR, SEC or BSP
21. The statements below describe the interrelationship of audit risk components. Which is
false?
a. There is an inverse relationship between detection risk and the combined level of
inherent and control risks
b. When inherent and control risks are high, the acceptable level of detection risk needs
to be low to reduce audit risk to an acceptably low level
c. When inherent and control risks are low, an auditor can accept a higher detection risk
and still reduce audit risk to an acceptably low level
d. The assessed level of inherent and control risks can be sufficiently low to eliminate
the need for the auditor to perform any substantive procedures
22. The CPA reviews Smantha's payroll procedures. An example of an internal control
weakness is to assign to a department supervisor the responsibility for
a. Distributing payroll checks to subordinate employees
b. Reviewing and approving time reports for subordinates
c. Interviewing applicants for subordinate positions prior to hiring by the personnel
department
d. Initiating requests for salary adjustments for subordinate employees
23. The internal auditor recognizes that certain limitations are inherent in any internal
control system. Which one of the following scenarios is the result of an inherent
limitation of internal control?
a. The controller both makes and records cash deposits
b. A security guard allows one of the warehouse employees to remove company assets
from the premises without authorization
c. The firm sells to customers on account, without credit approval
d. An employee, who is unable to read, is assigned custody of the firm's computer tape
library and run manuals that are used during the third shift
24. Theoretically, it is possible to provide an infinite range of assurance from a very low
level of assurance to an absolute level of assurance. In practice, professional accountants
cannot provide absolute assurance because of the following,except
a. Professional accountants employ testing process
b. The internal control has inherent limitations
c. The use of judgment in gathering evidence and drawing conclusions based on that
 evidence
d. The lack of expertise of professional accountants in doing a systematic engagement
process
25. Which of the following statements relating to the appropriateness of evidential matter is
always true?
a. Evidential matter gathered by an auditor from outside an enterprise is reliable
b. Accounting data developed under satisfactory conditions of internal control are more
relevant than data developed under satisfactory conditions of internal control conditions
c. Oral representations made by management are not valid evidence
d. Evidence gathered by an auditor must be both valid and relevant to be considered
appropriate
26. The auditor should obtain an understanding of the entity's objectives and strategies, and
those business risks that may result in risks of material misstatement. Which of the
following statements concerning the entity's business risk is incorrect?
a. Business risk is broader than the risk of material misstatement of the financial
statements, though it includes the latter
b. An understanding of the business risks facing the entity increases the likelihood of
identifying risks of material misstatement
c. The auditor has a responsibility to identify or assess all business risks
d. Business risk may arise from the development of new products or services that may
fail
27. The negative form of accounts receivable confirmation request is useful except when
a. Internal control surrounding accounts receivable is considered to be effective
b. A large number of small balances are involved
c. The auditor has reason to believe the persons receiving the requests are likely to give
them consideration
d. Individual account balances are relatively large
28. The engagement partner should be satisfied that appropriate procedures regarding the
acceptance and continuance of client relationships and specific audit engagements have
been followed, and that conclusions reached in this regard are appropriate and have been
documented. Acceptance and continuance of client relationships and specific audit
engagements include considering:
I. The integrity of the principal owners, key management, and those charged with
governance of the entity
II. Whether the engagement team is competent to perform the audit engagement and has
the necessary time and resources
III. Whether the firm and the engagement team can comply with ethical requirements
a. I only c. II and III only
b. I and II only d. I, II, and III
29. Which of the following most likely would not be considered an inherent limitation of the
potential effectiveness of an entity's internal control?
a. Incompatible duties c. Mistakes in judgment
b. Management override d. Collusion among employees
30. In connection with the audit of financial statements by an independent auditor, the client
suggests that members of the internal audit staff to be utilized to minimize audit costs.
Which of the following tasks could most appropriately be delegated to the internal audit
staff?
a. Selection of accounts receivable for confirmation, based on the internal auditor's
judgment as to how many accounts and which accounts will provide sufficient coverage
b. Preparation of schedules for negative accounts receivable responses
c. Evaluation of the internal control for accounts receivable and sales
d. Determination of the adequacy of the allowance for doubtful accounts
31. A common difficulty in auditing a computerized accounting system is
a. Because of the lack of an audit trail, computer systems have weaker controls and
more substantive testing is required
b. because of the uniform nature of transaction processing, computer systems have
strong controls and less substantive testing is required
c. Data can be erased from the computer with no visible evidence
d. The large dissemination of entry points into the computer system leads to weak
 overall reliance in information generated by a computer
32. Which of the following relates to rights and obligations assertions?
a. The entity holds or controls the rights to assets, and liabilities are obligations of the
entity
b. All assets, liabilities and equity interests that should have been recorded have been
recorded
c. Transactions and events that have been recorded have occurred and pertain to the
entity
d. Assets, liabilities, and equity interests are included in the financial statements at
appropriate amounts
33. The auditor's risk assessment procedures
a. By themselves, do not provide sufficient appropriate audit evidence on which to base
the audit opinion
b. Should not consider information obtained from the auditor's previous experience with
the entity
c. Are designed to detect material misstatements at the assertion level for classes of
transactions, account balances and disclosures
d. Are designed to test the effectiveness of the entity's control
34. Which of the following statements about tests of controls is most accurate?
a. Auditing procedures cannot concurrently provide both evidence of the effectiveness of
internal control procedures and evidence required for substantive tests
b. Tests of controls include observations of the proper segregation of duties that
ordinarily may be limited to the normal audit period
c. Tests of controls should be based upon proper application of an appropriate statistical
sampling plan
d. Tests of controls oedinarily should be performed as of the balance sheet date or during
the period subsequent to that date
35. In gathering evidence in the performance of substantive tests, the auditor
a. Should use the test month approach
b. Reies on persuasive rather than convincing evidence in the majority of cases
c. Would consider the client's documentary evidence more competent than evidence
gathered form observation and physical inspection
d. Would express an adverse opinion if s(he) has substantial doubt as to any assertion of
material significance
36. A secondary result of the auditor's consideration of internal control is that the
consideration may
a. Provide a basis for determining the nature, timing and extent of audit tests
b. Assure that management's procedures to detect fraud are properly functioning
c. Bring to the auditor's attention possible significant deficiences in the design or
operation of internal control
d. Develop evidence to support the assessed level of control risk
37. When considering internal control an auditor must be aware of the concept of reasonable
assurance, which recognizes that
a. Employment of competent personnel provides assurance that the objectives of internal
control will be achieved
b. Establishment and maintenance of internal control is an important responsibility of
the management and not of the auditor
c. Cost of internal control procedures should not exceed the benefits expected to be
derived from the control
d. Segregation of incompatible functions is necessary to ascertain that the control
procedures are effective
38. Which of the following audit procedures provides the best evidence about the
collectibility of notes receivable?
a. Confirmation of notes receivable balances with the debtors
b. Examination of notes for appropriate debtors' signatures
c. Reconciliation of the details of notes receivable and the provision for uncollectible
accounts
d. Examination of cash receipts records to determine promptness of interest and
principal payments
39. Which of the following situations will normally result to a decrease in the extent of audit
procedures?
a. Increase in the risk of material misstatement
b. Increase in the degree of assurance the auditor plans to obtain
c. Increase in materiality level
d. Increase in control risk assessment
40. In connection with the planning phase of an audit engagement, which of the following
statements is always correct?
a. Final staffing must be made prior to completiion of the planning stage
b. Observation of inventory count should be performed at year-end
c. A 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
41. The auditor looks for an indication on duplicate sales invoices to see if the invoices have
been verified. This is an example of
a. A test of details of balances
b. A test of control
c. A substantive test of transactions
d. Both test of control and a substantive test of transactions
42. Which of the following questions would not be appropriate for an internal control
questionnaire concerning inventory?
a. Are goods stored in locked storage areas?
b. Are disbursement vouchers approved before payment?
c. Is access to the storeroom limited to the authorized personnel?
d. Are there independent, periodic comparisons of inventory record with goods on hand?
43. Monitoring is an important component of internal control. Which of the following terms
would not be an example of monitoring?
a. Management regularly compares divisional performance with budgets for the division
b. IT management regularly generates exception reports for unusual transactions or
volumes of transactions and follows up with investigation as to causes
c. IT management regularly reconciles batch control totals for items processed with
batch controls for items submitted
d. Management has asked internal auditing to perform regular audits of the controls over
cash processing
44. In pursuing its quality control objectives with respect to acceptance of a client, a CPA
firm is not likely to
a. Make inquiries of the propoed client's legal counsel
b. Review financial statements of the proposed client
c. Make inquiries of previous auditors
d. Review the personnel practices of the proposed client
45. Which statement is incorrect concerning audit evidence?
a. The greater the risk, the more audit evidence is likely to be required
b. The higher the quality, the more may be required
c. Merely obtaining more audit evidence may not compensate for its poor quality
d. Obtaining audit evidence relating to a particular assertion is not a substitute to
obtaining audit evidence regarding another assertion
46. When assessing an internal auditor's objectivity, an independent auditor should
a. Review the internal auditor's working papers
b. Evaluate the adequacy of the internal auditor's audit programs
c. Inquire about the internal auditor's educational background and professional
certification
d. Consider the organizational level to which the internal auditor reports
47. Which of the following should be included in the audit plan?
I. The nature, timing and extent of planned risk assessment procedures, as determined
under PSA 315 (Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment)
II. The nature, timing and extent of planned further audit procedures at the assertion
level, as determined under PSA 330 ( The Auditor's Responses to Assessed Risks)
a. I only c. Both I and II
b. II only d. Neither I nor II
48. The most reliable forms of documentary evidence are those documents that are
a. Prenumbered
b. Internally generated
c. Issued subsequently
d. Authorized by a responsible official
49. Which of the following is the best explanation of the difference, if any, between audit
objectives and audit procedures?
a. Audit procedures establish broad general goals; audit objectives specify the detailed
work to be perfomed
b. Audit objectives are tailor-made for each assignment'; audit procedures are generic in
application
c. Audit objectives define specific desireed accomplishments; audit procedures provide
the means of achieving audit objectives
d. Audit procedures and audit objectives are essentially the same
50. In an audit of financial statements, an auditor's primary consideration regarding a
control is whether it
a. Reflects management philosophy and operating style
b. affects management's financial statement assertions
c. Provides adequte safeguards over access to assets
d. Enhances management's decision-making processes
51. The objective of quality control mandates that a public accounting frim should establish
policices and procedures for professional development that provide reasonable
assurance that all entry- level personnel
a. Prepare working papers that are standardized in form and content
b. Have the knowledge required to enable them to fulfill responsibilities assigned
c. Will advance within the organization
d. Develop specialties in specific areas of public accounting
52. The objective of performing analytical procedures in planning an audit is to identify the
existence of
a. Unusual transactions and events
b. Noncompliance with laws that went undetected because of internal control
weaknesses
c. Related party transactions
d. Recorded transactions that were not properly authorized
53. The following matters are generally included in an auditor's engagement letter, except
a. The factors to be considered in setting preliminary judgements about 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
54. All of the following are examples of substantive tests to verify the valuation of net
accounts receivable except the
a. Recomputation of the allowance for bad debts
b. Inspection of accouonts for current versus noncurrent status in the statement of
financial position
c. Inspection of the accounts receivable aging schedule
d. Comparison of the aloowance for bad debts with past periods
55. As a reusult of analytical procedures, the independent auditor determines that the gross
profit percentage has declined from 30% in the preceding year to 20% in the current
year. The auditor should
a. Document management's intentions with respect to plans for reversing this trends
b. Evaluate management's performance in causing this decline
c. Require note disclosure
d. Consider the possibility of a misstatement in the financial statements
56. Which of the following describe the interrelated components of internal control?
a. Organizational structure, management responsibility, and planning
b. Control environment, risk assessment, control activities, information and
communications systems, and monitoring
 c. Risk assessment, back up facilities, responsibility accounting, and regulatory
requirements
d. Legal environment of the enityty, management philosophy, and organizational
structure
57. The following statements relate to the auditor's consideration of the work of internal
auditing. Which is incorrect?
a. The role of internal auditing is determined by management, and its objectives differ
from those of the external auditor who is appointed to report independently on the
financial statements
b. The external auditor should obtain a sufficient understanding of internal audit
activities to assist in planning the audit and developing an effective audit approach
c. During the course of planning the audit, the external auditor should perform a
preliminary assessment of the internal audit function when it appears that internal
auditing is relevant to the external audit of the financial statements in specific audit
areas
d. Internal auditing activities do not include review of the economy, effeciency and
effectiveness of the entity's operations
58. An auditor's expert
a. Is an indicvidual or organization possessing expertise in a field other than accounting
or auditing, whose work in that field is used by the entity in preparing its financial
statements
b. A member of the engagement team with expertise in a specialized area of accounting
or auditing
c. An individual or organization possessing expertise in accounting or auditing whose
work is used by the auditor in obtaining sufficient appropriate audit evidence
d. May be either an auditor's internal expert or an auditor's external expert
59. When an auditor believes that an understanding with the client has not been established,
he or she should ordinarily
a. Perform the audit with increased professional skepticism
b. Becline to accept or perform the audit
c. Assess control risk at the maximum level and perform a primarily substantive audit
d. Modify the scope of the audit to reflect an increased risk of material misstatement due
to fraud
60. The principle of professional competence and due care imposes which of the following
obligations on professional accountants?
a. To maintain professional knowledge and skill at the level required to ensure that
clients or employers receive competent professional service
b. To refrain from disclosing confidential information obtained as a result of
professional and business relationships without proper and specific authority unless
there is a legal or professional right or duty to disclose
c. To comply with relevant laws and regulations and avoid any situation that may may
bring discredit to the profession
d. Not to compromise professional or business judgment because of bias, conflict of
interest or undue influence of others