b. Auditing Theory

Auditing Theory Disclaimer This material is not designed to replace the materials provided by the CPA Review Centers. No item in this test will appear in the actual CPA exams. This test will help you gauge your understanding the auditng concepts. It is best to print the test and answer the questions for an hour to simulate the actual board exam. More practice test in www.icpa.ph Michael & Jones, CPAs, has just accepted an engagement to audit Ginger and Cinnamon, a small manufacturer of spice products. Jennifer Castro has been selected as the in-charge auditor for the engagement, and Mark Cruz will be her assistant. In planning the audit field work, Jenkins makes the following assignments of audit tasks: Jennifer Castro Internal audit Test internal control over cash receipts Audit accounts receivable balances Final audit Test internal control over sales Obtain signed copy of engagement

Mark Cruz Audit property, plant, and equipment balances Test internal control over cash disbursements Audit cash balances Audit inventory balances

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1. What is the order of steps in completing the audit? a. audit planning, final audit, audit report b. audit planning, interim audit, final audit, audit report c. audit planning, interim audit, audit report d. audit planning, audit report, final audit

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2. If you are Jennifer Castro, what is the major strength of this audit planning? a. The audit tasks are delegated and clear. b. The signed copy of the engagement will be obtained by Jennifer Castro c. Audit procedures related cash, accounts receivable and inventory balances will be performed. d. The auditors tested internal control over cash receipts and disbursements before auditing cash balances.

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3. If you are Jennifer Castro, what is a correct audit procedure that you can do? a. Instruct that internal control over sales be performed on the interim audit instead on the final audit. b. I will ensure that we obtain the signed copy of the engagement letter before the audit closing meeting. c. I will divide the testing of internal control over cash receipts and disbursements to 2 auditors to ensure that 2 eyes will be looking into the process. To follow the money flow is crucial. d. I will forego with the internal control over sales transactions to save time because the audit of cash and accounts receivables balances will mitigate any audit risk.

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4. Which of the following statement best describes systematic auditing? a. Systematic auditing means that the auditor studies and tests the system of internal control before testing the substance of transactions and balances. b. Systematic auditing means that the auditor studies and tests the system of internal control before testing the substance of transactions and balances. Strong internal control increases the level of confidence and increases the extent of transaction and balance testing. c. Systematic auditing means that the auditor studies and tests the system of internal control before testing the substance of transactions and balances. Strong internal control increases the level of confidence and decreases the extent of transaction and balance testing. d. Strong internal control increases the level of confidence and decreases the extent of transaction and balance testing. Ernie Dela Cruz, CPA, has been approached by a prospective new audit client, Double Dragon Enterprises, Inc. Double Dragon had previously been audited by another CPA. Before accepting the engagement, Dela Cruz discussed several matters with Double Dragon’s controller and (with Double Dragon’s permission) the other CPA. As a result of these discussions, the following information was obtained. Incorporated in 1992, Double Dragon’s primary business is buying, developing, selling, and leasing commercial real estate. Apartment complexes, shopping malls, and industrial parks make up the major portion of the company’s business. Starting out in Albuquerque, New Mexico and the surrounding area, Double Dragon gradually expanded its operations to include most of southwestern United States, including the Phoenix--Scottsdale--Mesa area of Arizona. After two years of losses, the company reported its first earnings in 1994. From 1995 to 2000, revenues and earnings increased dramatically. Earnings for 2001 and 2002, however declined from earlier levels. For the current year, 2003, unaudited net income has rebounded to the 2000 level. Dela Cruz has learned from discussions with Double Dragon’s controller that, as of 12/31/03, the end of the current year, the company was in the process of completing a major mall project. The company currently owns several apartment complexes and leases its completed shopping malls to numerous retail establishments. After having been developed, industrial properties are sold either to municipalities or to companies locating in the complexes. In discussing past audits with the CPA formerly engaged by Double Dragon, Dela Cruz learned that several disagreements had arisen over the years, many of which had not been resolved to the satisfaction of the former auditors. The disagreements related to accounting matters as well as to the substance of certain transactions with lessees.

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5. In deciding whether to accept this engagement, which of the following will be considered the least? a. Seriousness of disagreements with the prior auditor and their potential impact on the financial statements b. Duration of the audit procedures. c. Whether the disagreements demonstrate lack of management integrity d. Competence of Dela Cruz to satisfactorily perform the audit

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6. If you are Ernie Dela Cruz, what is the item that I will be most concerned about? a. agressive growth strategy of Double Dragon b. revenues are increasing dramatically despite the first losses in its first 2 years. c. unfinished and ongoing construction projects of Double Dragon d. increase in unaudited earnings suggests possible overstatement of revenues or understatement of expenses

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7. Audit reports frequently contain an explanatory paragraph following the scope paragraph or the opinion paragraph. What condition under which one might expect to find an explanatory paragraph following the opinion paragraph of the audit report. a. Default by the Company in paying its bank loans b. Some material receivables are not confirmed by the Company’s debtors c. Departure from a designated principle and the auditor agrees with the departure d. The corporate counsel failed to submit their Certification despite the persistent follow up of the auditors. A recently passed accounting graduate processed the following business transaction. An unsecured loan for P3.2 million was granted to Diane Gregorio, the chief executive officer of Tea House, Inc., at the beginning of 2014. On December 31, 2014, the company drew a check for P3.2 million on Bank A for deposit in Bank B. The transaction was recorded by a debit to “cash in Bank B” and a credit to “loans receivable-officers.” The check was not listed as outstanding on Bank A. It did appear as a credit on the December 31 bank statement received from Bank B. On January 2, 2015, the company made a journal entry debiting “loans receivable-officers” and crediting “cash in Bank A” for P3.2 million. The loan accounted for 35% of the entity’s total assets.

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8. Is there a fraud? a. There is no fraud and possible misstatement in this situation. b. This set of journal entries is an example of fraudulent misrepresentation in the form of kiting. c. There is no fraud but a mistatement because the accountant is a fresh graduate. d. There might be fraud in this case but the data is incomplete.

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9. You are a new hire of SGV & Co. Your senior associate left for an overseas trip and you were left on your own. Your partner in charge wants you to randomly select a sample of customers' accounts receivable for confirmation purposes. The population consists of 4,000 accounts with a book value of P6,000,000. The preliminary estimate of standard deviation (computer calculated from book value) is P25. The auditor considers P40,000 to be a material misstatement of accounts receivable. The auditor has assessed inherent risk at 60% and control risk at 70%, and has set alpha risk and overall audit risk at 10%. Assuming the following Z values, calculate the sample size: Alpha/2 or Beta 1% 2% 2.5% 5% 10% 20% 24% a. b. c. d.

Z Value 2.33 2.06 1.96 1.65 1.29 .85 .71

25 29 35 40

____ 10. An examination of the sample items produces a sample mean of P1,200 and a standard deviation of the sample items equal to P22. What is the estimated population value? a. 3,000,000 b. 4,800,000 c. 5,000,000 d. 5,200,000 ____ 11. What is the achieved precision? a. 24,539 b. 25,000 c. 27,654 d. 30,000 ____ 12. What is the minimum audit adjustment based on these findings? a. Downward adjustment of P1,284,539 b. Downward adjustment of P1,184,539 c. Upward adjustment of P1,284,539 d. Upward adjustment of P1,184,539 ____ 13. In an audit closing meeting, the newly appointed Country Manager of ABN AMRO asked you how their system can be protected against subversive threats. Which of the following will you not mention? a. firewalls b. one-time passwords c. field interrogation d. data encryption

____ 14. JM is the manager of the audit engagement of Coca Cola Bottlers. He noticed that Coca Cola is using the latest electronic data interchange to manager their vendor’s databases. In his test of controls, he would ensure that the customers of Coca Cola will routinely a. access the vendor's accounts receivable file with read/write authority b. access the vendor's price list file with read/write authority c. access the vendor's inventory file with read-only authority d. access the vendor's open purchase order file with read-only authority ____ 15. Hector just resigned from Isla Lipana as a Senior Associate. He was hired as the Accounting Manager of Ayala Land Inc. His CFO asked his advice how they can ensure that their accounting system are protected from computer viruses. Which of the following policies are relevant except a. the policy on the purchase of software only from reputable vendors b. the policy that all software upgrades are checked for viruses before they are implemented c. the policy that current versions of antivirus software should be available to all users d. he policy that permits users to take files home to work on them ____ 16. Jane Guerero is a newly promoted Senior Associate in Deloitte. Her new staff asked her advice which one of the following is not an audit objectives in the Electronic Data Interchange (EDI) environment? a. all EDI transactions are authorized b. unauthorized trading partners cannot gain access to database records c. a complete audit trail of EDI transactions is maintained d. backup procedures are in place and functioning properly ____ 17. Which of the following is not a requirement in management’s report on the effectiveness of internal controls over financial reporting? a. A statement of management’s responsibility for establishing and maintaining adequate internal control user satisfaction. b. A statement that the organizations internal auditors has issued an attestation report on management’s assessment of the companies internal controls. c. A statement identifying the framework used by management to conduct their assessment of internal controls. d. An explicit written conclusion as to the effectiveness of internal control over financial reporting. ____ 18. As a new staff, Michi Ang was assigned to monitor the disclosures of her new client, a publicly listed company. Before going to her lunch, she would access the website by the Philippine Stock Exchange and look for disclosures related to her company. On one occassion, she suddenly noticed that all disclosures filed are digitally signed y the Compliance Information Officer. She wanted to raise this observation to her boss. If her boss ask her to define what a digital signature is, what could be her best answer a. the encrypted mathematical value of the message sender’s name b. derived from the digest of a document that has been encrypted with the sender’s private key c. the computed digest of the sender’s digital certificate d. allows digital messages to be sent over analog telephone lines ____ 19. Auditors of ERP systems a. need not worry about segregation of duties. b. may feel that the data warehouse is too clean and free from errors c. find independent verification easy d. need not worry about system access since the ERP determines it

____ 20. Which steps in the Financial Accounting Process are in the correct sequence? a. record the transaction, post to the ledger, prepare the adjusted trial balance, enter adjusting entries, prepare financial statements b. record the transaction, prepare the unadjusted trial balance, record adjusting journal entries, record closing entries, prepare financial statements c. record the transaction, post to the ledger, record adjusting entries, prepare the unadjusted trial balance, prepare financial statements d. record the transaction, post to the ledger, prepare the adjusted trial balance, prepare financial statements, record closing entries ____ 21. With a limited work force and a desire to maintain strong internal control, which combination of duties performed by a single individual presents the least risk exposure? a. maintaining the inventory ledger and recording the inventory journal voucher in the general ledger b. recording the inventory journal voucher in the general ledger and maintaining custody of inventory c. maintaining the cash disbursements journal and recording direct labor costs applied to specific jobs d. preparing the accounts payable journal voucher and recording it in the general ledger ____ 22. Transaction authorization occurs in a traditional manufacturing environment in all of the following ways except a. production planning and control initiates production with a work order b. movement of the work through the production process follows the move ticket c. the sales department modifies work orders to match changes in demand d. the materials requisition authorizes the storekeeper to release materials to the work centers ____ 23. Ken Perez, a CPA wanted to know what advantage will it have if require the paymaster to deliver all unclaimed paychecks to the internal audit department? a. to detect a “phantom employee” for whom a check was produced b. to prevent an absent employee’s check from being lost c. to avoid paying absent employees for payday d. to prevent the paymaster from cashing unclaimed checks ____ 24. Which of the following statements is not correct? a. the voucher system is used to improve control over cash disbursements b. the sum of the paid vouchers represents the voucher payable liability of the firm c. the voucher system permits the firm to consolidate payments of several invoices on one voucher d. many firms replace accounts payable with a voucher payable system

____ 25. If tests of controls reveal that controls are sufficiently effective to justify reducing control risk, the auditor is justified in reducing substantive audit tests. To maximize audit efficiency, the auditor should allocate less tolerable misstatement to accounts that can be verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit. a. b. c. d.

True, True False, False True, False False, True

____ 26. Auditors have difficulty applying the concept of materiality in practice because they often do not know who the users of the financial statements are or what decisions will be made. The results of tests of controls and tests of details of balances affect the design of substantive tests of transactions. a. b. c. d.

True, True False, False True, False False, True

____ 27. Balance-related audit objectives are usually applied to the ending balance in income statement accounts; transaction-related audit objectives are usually applied to transactions reflected in balance sheet accounts. Auditing standards require that tests of controls be performed on every audit engagement. a. b. c. d.

True, True False, False True, False False, True

____ 28. The cutoff objective, “transactions near the balance sheet date are recorded in the proper period,” is a balance-related audit objective. The transaction-related audit objective of timing is related to the assertion of cutoff. a. b. c. d.

True, True False, False True, False False, True

____ 29. Procedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing control risk in a well defined transaction cycle that has not contained material misstatements in prior audits. When an auditor believes there is a moderate or high risk of management fraud, the auditor will normally do less audit work at interim dates instead of at year-end. a. b. c. d.

True, True False, False True, False False, True

____ 30. Analytical procedures provide fewer types of evidence than any other type of audit test. The auditor’s responsibility for uncovering direct-effect illegal acts is the same as for fraud. a. b. c. d.

True, True False, False True, False False, True