The CPA’s Professional Responsibilities and Overview of the Financial Statement Audit Process

Question 1

Misstatements in the financial statements can arise from either:

Answer 1

fraud or error.

Question 2

The auditor is concerned with fraud that causes a ________________in the financial statements

Answer 2

material misstatement

Question 3

Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, the auditor does not _______________________.

Answer 3

legal determinations of whether fraud has actually occurred.

Question 4

Fraud, whether fraudulent financial reporting or misappropriation of assets, involves:

Answer 4

1. Incentive or pressure
2. A perceived opportunity
3. Rationalization

Question 5

To commit fraud may exist when an individual believes internal control can be overridden, for example, because the individual is in a position of trust or has knowledge of specific weaknesses in internal control

Answer 5

A perceived opportunity

Question 6

Some individuals possess an attitude, character or set of ethical values that allow them knowingly and intentionally to commit a dishonest act.

Answer 6

Rationalization

Question 7

This involves intentional misstatements including omissions of amounts or disclosures in financial statements to deceive financial statement users. It can be caused by the efforts of management to manage earnings in order to deceive financial statement users by influencing their perceptions as to the entity’s performance and profitability.

Answer 7

Fraudulent Financial Reporting

Question 8

This involves the theft of an entity’s assets and is often perpetrated by employees in relatively small and immaterial amounts.

Answer 8

Misappropriation of Assets

Question 9

The risk of not detecting a material misstatement resulting from fraud is ___________ than the risk of not detecting one resulting from error

Answer 9

higher

Question 10

___________ may cause the auditor to believe that audit evidence is persuasive when it is, in fact, false

Answer 10

Collusion

Question 11

The auditor’s ability to detect a fraud depends on factors such as the:

Answer 11

 skillfulness of the perpetrator,
 the frequency and extent of manipulation,
 the degree of collusion involved,
 the relative size of individual amounts manipulated, and
 the seniority of those individuals involved

Question 12

The risk of the auditor not detecting a material misstatement resulting from
management fraud is ________ than for employee fraud.

Answer 12

greater

Question 13

Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations. Such acts include transactions entered into by, or in the name of, the entity, or on its behalf, by those charged with governance, management or employees

Answer 13

Noncompliance

Question 14

Common examples of noncompliance include:

Answer 14

 Tax evasion
 Violation of environmental protection laws
 Inside trading of securities

Question 15

Who is responsible for ensuring that the entity’s operations are conducted in accordance with laws and regulations?

Answer 15

Management, with the oversight of those charged with governance

Question 16

In cases of fraud and error, the auditor is responsible for obtaining reasonable assurance that the financial statements ______________________________

Answer 16

taken as a whole, are free from material misstatement, whether caused by fraud or error.

Question 17

Whether an act constitutes non-compliance is ultimately a matter ______________________.

Answer 17

for legal determination by a court of law.

Question 18

If the auditor becomes aware of information concerning an instance of noncompliance or suspected non-compliance with laws and regulations, the auditor shall obtain:

Answer 18

(a) An understanding of the nature of the act and the circumstances in which it has occurred; and
(b) Further information to evaluate the possible effect on the financial statements.

Question 19

Unless all of those charged with governance are involved in management of the entity, and
therefore are aware of matters involving identified or suspected noncompliance already communicated by the auditor, the auditor shall communicate with

Answer 19

those charged with governance matters involving non-compliance with laws and regulations that come to the auditor’s attention during the course of the audit, other than when the matters are clearly inconsequential.

Question 20

If, in the auditor’s judgment, the non-compliance referred above is believed to be intentional and material, _______________________________.

Answer 20

the auditor shall communicate the matter to those charged with governance as soon as practicable.

Question 21

If the auditor suspects that management or those charged with governance are involved in
non-compliance,________________.

Answer 21

the auditor shall communicate the matter to the next higher level of
authority at the entity, if it exists, such as an audit committee or supervisory board

Question 22

Where no higher authority exists, or if the auditor believes that the communication may not be acted
upon or is unsure as to the person to whom to report, _________________.

Answer 22

the auditor shall consider the need to
obtain legal advice.

Question 23

In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditor’s report is insufficient in the circumstances for purposes of reporting to the intended users of the financial statements, _______________________.

Answer 23

the PSAs require that the auditor disclaim an opinion or withdraw from the engagement, where withdrawal is legally permitted.

Question 24

The purpose of an audit is ___________________________.

Answer 24

to enhance the degree of confidence of intended users in the financial statements.

Question 25

The objective of the auditor is to design and perform audit procedures in such a way as to ___________________________.

Answer 25

enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion.

Question 26

_______________ is the measure of the quantity of audit evidence

Answer 26

Sufficiency

Question 27

_________________________ is the measure of the quality of audit evidence; that is, its ________________________ in providing support for, or detecting material misstatements in, the classes of transactions, account balances, and disclosures and related assertions.

Answer 27

Appropriateness; relevance and its reliability

Question 28

Audit evidence I more reliable when it is obtained from _____________________________

Answer 28

independent sources outside the entity

Question 29

Audit evidence that is generated internally is more reliable _____________________________________________.

Answer 29

when the related controls imposed by the entity are effective

Question 30

Audit evidence obtained directly by the auditor (for example, observation of the application of a control) is more reliable than ___________________________________________________________.

Answer 30

audit evidence obtained indirectly or by inference (for example, the inquiry about the application of control)

Question 31

If audit evidence obtained from one source is inconsistent with that obtained from another, the auditor shall_____________________________________________________________.

Answer 31

determine what modifications or additions to audit procedures are necessary to resolve the matter, and shall consider the effect of the matter, if any, on other aspects of the audit.

Question 32

This is the magnitude of misstatement or omission and the ability to influence the economic decision of a reasonable FS user.

Answer 32

Materiality

Question 33

When is a misstatement or omission material?

Answer 33

It is material if it could influence the economic decision of FS users. If it is probable that the judgment of a reasonable person would have been changed or influenced by the omission or misstatement of information, then that information is material.

Question 34

Meaning of the term "present fairly, in all material respects" is that the auditor ___________________________________________________________.

Answer 34

considers only those matters that are significant to the FS users and the phrase refers to the auditors expression of opinion.

Question 35

_______________ is the amount (threshold or cut-off point) at which judgment of informed decision makers based on the financial statement may be altered (changed or influenced).

Answer 35

Materiality

Question 36

An item or information is material if ___________________________________________________________.

Answer 36

its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.

Question 37

In determining appropriate level of materiality, the auditor uses ___________________________________________________________.

Answer 37

professional judgment using his perception of the needs of reasonable users of the financial statements.

Question 38

Uses of materiality in planning the audit:

Answer 38

A. To determine the nature, timing and extent of risk assessment procedures B. To identify and assess risk of material misstatement, and C. To determine the nature, timing and extent of further audit procedures

Question 39

The three stages in considering materiality throughout the audit

Answer 39

1. Planning stage 2. Testing stage 3. Completion stage

Question 40

The planning stage of considering materiality throughout the audit is done to:

Answer 40

a. To identify and assess risks of material misstatements b. To determine the nature, timing and extent of further audit procedure.

Question 41

The testing stage of considering materiality throughout the audit is done to:

Answer 41

revise/update the set materiality levels during audit planning if necessary

Question 42

The completion stage of considering materiality throughout the audit is done to:

Answer 42

a. To evaluate the effect of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report

Question 43

Documentation on materiality: Documentation should include the amounts and the factors considered in their determination:

Answer 43

A. Materiality level for the financial statements as a whole B. Materiality level or levels for a particular classes of transactions, account balances or disclosures, if applicable C. Performance materiality D. Any revision of materiality levels (a to c) as the audit progresses

Question 44

Materiality should address __________________________________________________________.

Answer 44

qualitative and quantitative considerations

Question 45

Inverse relationship between materiality and audit procedures/evidence:

Answer 45

● More evidence will be required for a low peso amount of materiality than for a high peso amount. ● The lower the tolerable misstatement, the more extensive the required audit procedures

Question 46

Levels of Materiality

Answer 46

A. Materiality at financial statement as a whole B. Materiality at assertion level C. Performance materiality

Question 47

Also known as materiality threshold or planning materiality or overall materiality

Answer 47

Materiality at financial statement as a whole

Question 48

This is the materiality level for individual or particular class of transactions, account balance, or disclosure where appropriate.

Answer 48

Materiality at assertion level

Question 49

This is also known as tolerable misstatement — refers to allocated materiality to affected accounts (usually statement of financial position accounts because they are fewer).

Answer 49

Materiality at assertion level

Question 50

This an individual line item in the financial statements, such as cash and cash equivalents, loans and receivable, etc

Answer 50

Account balance

Question 51

types of transaction processed by the client’s accounting system, such as sales transactions and purchasing transactions

Answer 51

Class of transactions

Question 51

types of transaction processed by the client’s accounting system, such as sales transactions and purchasing transactions

Answer 51

Class of transactions

Question 52

Materiality at this level is lesser than the overall materiality level but could reasonably be expected to influence the economic decisions of financial statement users.

Answer 52

Materiality at assertion level

Question 53

This is materiality of amount or amounts set by the auditor:

Answer 53

Performance materiality

Question 54

Purpose of performance materiality:

Answer 54

It provides margin to reduce the possibility of undetected misstatements because: ○ It reduces to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in the financial statements exceeds the materiality level for the financial statements as a whole. ○ It reduces to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in the particular class of transactions, account balance or disclosure exceeds the materiality level for that particular class of transactions, account balance or disclosure.

Question 55

This is the risk that audit opinion is inappropriate

Answer 55

Audit Risk Model

Question 56

Steps in assessing Audit Risk:

Answer 56

1. Set the desired level of Audit Risk 2. Assess the level of Inherent Risk (such as low, medium, or high) – for example, low level if likelihood of misstatement is low 3. Assess the level of Control Risk (such as low, medium, or high) – for example, low control risk if internal control is effective, or high control risk if internal control is not effective 4. Determine the acceptable level of detection risk: The acceptable level of detection risk depends on the assessed level of inherent and control risk (inverse relationship) 5. Design audit substantive tests

Question 57

This is the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated; it is the risk that the auditor may unknowingly fail to modify appropriately the opinion on financial statements that are materially misstated.

Answer 57

Audit risk

Question 58

This is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls to mitigate such risks.

Answer 58

Inherent risk

Question 59

This is the risk that a material misstatement, either individually or when aggregated with other misstatements, that could occur will not be prevented or detected and corrected on a timely basis by the entity’s internal control.

Answer 59

Control risk

Question 60

Sources of assessment of inherent risk include ___________________.

Answer 60

knowledge of the entity and its environment and preliminary analytical procedures.

Question 61

Sources of assessment of control risk include _______________________.

Answer 61

knowledge of internal control and observation and inspection

Question 62

The auditor usually makes combined assessment of inherent and control risks. If the combined assessment of inherent risk and control risk is high, the auditor should:

Answer 62

● Place more emphasis on obtaining external evidence. ● Reduce reliance on internal evidence. ● Design more effective substantive procedures.

Question 63

This is the risk that the auditor will not detect such a material misstatement that exists/occurs in an assertion

Answer 63

Detection risk

Question 64

This risk is a function of the effectiveness of an auditing procedure and its application by the auditor

Answer 64

Detection risk

Question 65

This is significantly affected by the nature, timing, and extent of the auditor’s substantive procedures

Answer 65

Detection risk

Question 66

This can be increased or decreased by the auditor by performing substantive tests but can never be reduced to zero because of the inherent limitations in the procedures carried out, the human judgments required, and the nature of the evidence examined.

Answer 66

Detection risk

Question 67

This is essential to the proper conduct of an audit. This is because interpretation of relevant ethical requirements and the PSAs and the informed decisions required throughout the audit cannot be made without the application of relevant knowledge and experience to the facts and circumstances.

Answer 67

Professional judgment

Question 68

The distinguishing feature of the professional judgment expected of an auditor is that it is __________________________________________________________.

Answer 68

exercised by an auditor whose training, knowledge and experience have assisted in developing the necessary competencies to achieve reasonable judgments.

Question 69

The exercise of professional judgment in any particular case is ________________________________________.

Answer 69

based on the facts and circumstances that are known by the auditor

Question 70

Professional judgment is not to be used as _________________________________________________________________.

Answer 70

the justification for decisions that are not otherwise supported by the facts and circumstances of the engagement or sufficient appropriate audit evidence.

Question 71

Phases of the Audit Process

Answer 71

1. Accepting an Engagement 2. Audit Planning 3. Considering Internal Control 4. Performing Substantive tests 5. Completing the Audit 6. Issuing a report