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Auditing - Multiple choice questions CHAPTER 1: Introduction and overview of audit and assurance Overview: The focus is on assurance engagements, in particular the nature and purpose of a financial report audit. Emphasis will be placed on understanding the role of different parties in an assurance engagement such as a financial report audit and on why there is always a demand for audit services. The audit expectation gap is an important concept. It is essentially the difference between users expectations of an auditor and what an auditor can realistically actually achieve when carrying out an audit. In this module emphasis is placed on identifying the components of the expectation gap with a view to understanding how we can attempt to reduce this gap in practice. 1.1 The parties relevant to an assurance engagement are: (a) users, responsible party, subject matter. (b) assurance practitioner, responsible party. (c) responsible party, users, subject matter, criteria. (d) assurance practitioner, users, responsible party Answer: D 1.2 When performing an audit required under section 301 of the Corporations Act the auditor has a responsibility to: (a) form an opinion on the subject criteria. (b) form an opinion on the independence of the directors. (c) form an opinion on the truth and fairness of the financial report. (d) all of the above. Answer: C 1.3 Performance audits are useful because they: (a) include a comprehensive audit. (b) allow the auditor to demonstrate how well they are performing. (c) are concerned with the economy, efficiency, and effectiveness of an organisation’s activities. (d) involve gathering evidence to ascertain whether the entity under review has followed the rules, policies, procedures, laws or regulations with which they must conform. Answer: C 1.4 The function of internal audit is determined by: (a) the IIA. (b) the government. (c) the external auditor. (d) those charged with governance and management. Answer: D 1.5 Negative assurance means: (a) the auditor has conducted an audit and provides an opinion that the financial reports are true and fair. (b) the auditor has conducted sufficient work to conclude that the appropriate outcome is an adverse audit report. (c) the auditor has done adequate work and nothing came to their attention which would lead them to believe that the information being assured is not true and fair. 1

(d) the auditor disclaims responsibility for the audit opinion because they are unable to do sufficient work to conclude that the information being assured is true and fair. Answer: C 1.6 An auditor disclaims responsibility when: (a) the users cannot rely on the financial report. (b) the audit opinion is unqualified and unmodified. (c) the auditor is unable to obtain sufficient evidence about a potentially material and pervasive matter. (d) the audit opinion is unqualified and the auditor includes a paragraph in the audit report to emphasise something important Answer: C 1.7 Those charged with governance have a responsibility to ensure that information in financial report is: (a) true and fair. (b) relevant and reliable. (c) comparable and understandable. (d) all of the above. Answer: D 1.8 Agency theory explains that audits are demanded because conflicts can arise between: (a) auditors and owners. (b) owners and principals. (c) agents and managers. (d) managers and owners Answer: D 1.9 The insurance hypothesis means: (a) an audit acts as insurance. (b) owners must take insurance. (c) managers must take insurance. (d) none of the above Answer: A 1.10 The audit expectation gap occurs when: (a) the public is well educated about auditing. (b) user beliefs do not align with what an auditor has actually done. (c) auditors perform their duties appropriately and satisfy users’ demands. (d) peer reviews of audits ensure that auditing standards have been applied correctly and the standards are at the level that satisfy users’ demands. Answer: B Q. In addition to the preparation of financial statements, it is also the responsibility of those charged with governance to: A. all of the above. (Selecting and applying appropriate accounting policies and making reasonable accounting estimates. Establish and maintain internal controls that are effective in preventing and

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detecting material misstatements. Identify the financial reporting framework to be used in the preparation and presentation of their financial report.) Q. The largest accounting firms in Australia are known collectively as the: A. 'Big-4' Q. The expectation gap is caused by: A. unrealistic user expectations Q. When auditors are engaged in work where no assurance is provided this means: A. An assurance is not provided as the client determines the nature, timing and extent of the evidence that is gathered and will determine their own outcome. Q. Auditor rotation in CLERP9 states that an auditor cannot perform a significant role in the audit of a client in more than: A. five out of seven years. Q. The expectation gap can be reduced by: A. all of the above. (Assurance provides reporting accurately the level of assurance being provided. Enhanced reporting to explain what processes have been followed in arriving at an audit or a review opinion. Auditors performing their duties properly.) Q. Suppliers as a user of the financial statements would least consider which of the following aspects of the financial statements: A. return on investment of the entity. Q. Agency theory can be described as the theory of: A. the relationship between the owner and the management of the business when the owner is not the manager of the business. Q. Which of the following is incorrect? The Australian Securities and Investments Commission (ASIC) A. requires all auditors' financial statements to be independently audited annually. Q. Which of the following is correct? The Accounting Professional Ethical Standards Board (APESB): A. standards are required to be complied with by members of each of CAANZ, CPA and IPA. Q. Which of the following would be an example of a reasonable assurance engagement? A. the audit of annual financial statements. Q. In a review engagement, which of the following is least likely to occur during the engagement? A. substantive audit procedures. Q. An assurance engagement can be defined as: A. an engagement to enhance the reliability of the subject matter. Q. Professional scepticism does not involve:

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A. the professional requirement that all management representations be substantiated with supporting documentation.

CHAPTER 3: Risk Assessment I Overview: The focus is on risk assessment and the planning phase of an audit. Emphasis will be placed on how to gain an understanding of a client and we will also explore strategies and processes for evaluating risk, in particular, fraud risk, going concern risk and risk associated with IT systems. 3.1 When gaining an understanding of the client, the auditor will identify the geographic location of the client because: (a) more spread out clients are harder to control. (b) the auditor will plan to use staff from affiliated offices to visit overseas locations. (c) the auditor will need to visit the various locations to assess processes and procedures at each site. (d) all of the above. Answer: D 3.2 When gaining an understanding of the client’s sources of financing the auditor: (a) will assess if the client is meeting interest payments when they are due. (b) is not interested in debt covenants because all debt contracts are the same. (c) will ignore the relative reliance on debt versus equity funding because that is a management decision, not an audit issue. (d) none of the above Answer: A 3.3 When gaining an understanding of the client at the industry level the auditor will: (a) use information about the client’s industry. (b) not consider government taxes on the industry because they are out of the client’s control. (c) ignore bad news reports about the client firm because the client’s reputation in the press is not important. (d) not consider the level of demand for the goods and services provided by other companies in the client’s industry. Answer: A 3.4 The ASX Corporate Governance Council’s Corporate governance principles and recommendations are designed to help companies: (a) improve performance. (b) improve their corporate structure. © enhance their accountability to shareholders and other interested third parties. (d) all of the above Answer: D 3.5 An attitude of professional scepticism means: (a) any indicator of fraud is properly investigated. (b) the auditor can rely on management assertions. (c) the auditor can rely on past experience to determine current risk of fraud. (d) all of the above. Answer: A 4

3.6 An example of an incentive or pressure that increases the risk of fraud is: (a) the client operates in a stable industry. (b) the client has a history of making losses. (c) management remuneration mostly comprises base salary. (d) all of the above Answer: B 3.7 The auditor must consider whether it is appropriate to assume that the client will remain as a going concern: (a) if there are mitigating circumstances. (b) only if the client is listed on a stock exchange. (c) because going concern means the client is facing bankruptcy. (d) because this question affects the appropriate basis for valuing assets. Answer: D 3.8 The risk assessment phase of an audit does not include: (a) audit execution and reporting. (b) gaining an understanding of the client. (c) development of an audit strategy and a risk and materiality assessment. (d) identification of factors that may affect the risk of a material misstatement in the financial report. Answer: A 3.9 When gaining an understanding of the client the auditor will consider: (a) related party identification. (b) controls over the technology used to process and store data electronically. (c) the appropriateness of the client’s system of internal controls to mitigate identified business risks. (d) all of the above. Answer: D 3.10 Client closing procedures: (a) affect expense accounts only. (b) are routine transactions that do not affect audit risk. (c) are the responsibility of those charged with governance who must ensure that transactions are recorded in the correct accounting period. (d) all of the above. Answer: C Q. Planning an audit of a financial report requires that an auditor plan their audit to reduce audit risk to an acceptable low level. Audit risk can be defined as: A. The risk that the auditor expresses and inappropriate opinion at the conclusion of the audit. Q. The risk response phase of an audit involves: A. The performance of detailed tests of controls and substantive testing of transactions and accounts.

Q. Which of the following is an example of a misappropriation of assets fraud? 5

A. Unauthorised discounts or refunds to customers. Q. The ASX Corporate Governance Council's Principle 2 'Structure the board to add value' includes which of the following recommendations? A. a and b. (The chair should be an independent director. The board have a nomination committee.) Q. When assessing fraud risk, an auditor will adopt an attitude of: A. Professional scepticism. Q. The going concern assumption is made when it is believed that: A. A company will remain in business for the foreseeable future. Q. Auditors can assess the adequacy of their client's closing procedures by: A. a and b. (Checking the accuracy of accruals calculations around the year, looking at earnings trends to assess whether reported income is in line with similar periods in prior years.) Q. An auditor is usually most concerned with which of the ASX Corporate Governance Council's principles? A. Safeguard integrity in financial reporting. Q. The 'if not, why not' approach of the ASX Corporate Governance Council to its recommendations requires companies to: A. Disclose whether they have complied with the principles and recommendations. Q. Corporate governance means: A. The rules, systems and processes within companies used to guide and control them. Q. If auditors believe there is a risk that expenses incurred before year-end will be excluded from the current year's expenses, they will: A. Trace transactions recorded close to year-end to source documentation. Q. Which of the following is an example of information used by auditors in gaining an understanding of a client at the entity level? A. Whether the client is an importer or exporter of goods. Q. The purchase of a new 'off the shelf' program reduces the risks as: A. The software has been tested before being made available for sale. Q. Opportunities to perpetrate (commit) a fraud include all the following except: A. rapid growth. Q. Red flags that auditors can use to alert them to the possibility that a fraud may have occurred include: A. A high turnover of key employees. Q. If auditors identify risk factors that indicate that the going concern assumption is in doubt, they will: A. Undertake procedures to gather evidence regarding each risk factor. 6

Q. Attitudes and rationalisation to justify a fraud include: A. An excessive focus on profit maximisation. Q. Preliminary risk identification can be affected by: A. Both a and b. (Corporate governance. Fraud risk) Q. In assessing the client's relationship with its employees, the auditor will consider: A. All of the above. (The level of unionisation among the workforce, how well a client pays its employees, the attitude of staff to their employer.) Q. When gaining an understanding of their client, at which level do auditors not usually consider the relevant issues? A. Audit committee level. Q. Unauthorised access to a company's data can occur when: A. There are poor password protection procedures. Q. Which of the following is not an example of a mitigating factor that reduces the risk that the going concern assumption may be in doubt? A. Significant rapid increase in competition

CHAPTER 4: Risk Assessment II Overview: The focus is on risk assessment and the planning phase of an audit. Emphasis will be placed on how to evaluate audit risk and we will explore strategies for use of analytical procedures at the planning stage of the audit. The concept of materiality is explored in some depth and we will also gain an understanding of the importance in determining an appropriate audit strategy. 4.1 Adopting an audit strategy that relies heavily on substantive testing: (a) is appropriate when internal controls are very strong. (b) requires the auditor to conduct extensive control testing. (c) means that the auditor will conduct some interim testing and minimal year-end account balance testing. (d) means that the auditor will gain the minimum necessary knowledge of the client’s system of internal controls. Answer: D 4.2 Adopting an audit strategy that does not rely heavily on substantive testing: (a) is appropriate when internal controls are minimal. (b) requires the auditor to conduct extensive control testing. (c) means that the auditor will conduct extensive year-end account balance testing. (d) means that the auditor will gain the minimum necessary knowledge of the client’s system of internal controls. Answer: B 4.3 Which of the following is a true statement about profitability ratios? (a) All companies have a high inventories turnover ratio. 7

(b) Auditors will be interested in trends in profitability ratios. (c) Profitability ratios should be the same for all divisions of the company. (d) Companies will try to have the same profitability ratio in each month of operation. Answer: B 4.4 Common uses of analytical procedures include: (a) risk identification during the risk assessment stage. (b) estimating account balances during the risk response stage. (c) overall assessment of the financial report at the final review stage of the audit. (d) all of the above Answer: D 4.5 An auditor is interested in the client’s inventories turnover ratio because it helps the auditor understand: (a) if the client is in the right industry. (b) if the industry is the same as another industry. (c) if the client’s debtors are paying their accounts on time. (d) if the client is as competitive and has as high a turnover as the industry average. Answer: D 4.6 Analytical procedures: (a) can only be performed on annual data. (b) are only useful if the client’s variation from budget is low. (c) are not affected if the client changes its accounting methods. (d) must take into account seasonal variation in the client’s business. Answer: D 4.7 An auditor will identify accounts and related assertions at risk of material misstatement: (a) after testing internal controls. (b) before writing the audit report. (c) in order to plan the audit to focus on those accounts. (d) to eliminate audit risk and make the audit report more timely. Answer: C 4.8 For an audit, the auditor can control: (a) inherent risk. (b) control risk. (c) financial risk. (d) detection risk. Answer: D 4.9 The relationship between risk and the materiality level set in the risk assessment phase: (a) is positive. (b) is inverse. (c) is irrelevant. (d) depends on the size of the client. Answer: B

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4.10 Testing controls means that: (a) no substantive testing is required. (b) the auditor can completely rely on a client’s system of internal controls. (c) the auditor can plan to reduce their reliance on detailed substantive testing of transactions and account balances. (d) all of the above. Answer: C Q. An audit strategy will include increased reliance on tests of controls when: A. Inherent risk and control risk are low. Q. As a rule of thumb which of the following items would be considered immaterial? A. None of the above. (An item greater than 10 per cent of profit before tax. An item greater than 1 per cent of total assets. An item greater than 2 per cent of equity.) Q. By assessing control risk as high, an auditor has determined that their client's system of internal controls: A. Is unlikely to be effective in mitigating inherent risks identified. Q. Analytical procedures are conducted at the risk assessment phase of the audit to: A. Both a and c. (Aid in the identification of risk. Enhance the understanding of a client.) Q. An audit strategy: A. Both b and c. (Involves determining the amount of time to be spent testing the client’s internal controls and conducting detailed substantive testing. Sets the scope, timing and direction of the audit.) Q. The audit strategy for a client with high inherent risk and high control risk will include: A. No or very limited tests of controls. Q. Which of the following statements regarding key performance indicators (KPIs) is correct? A. All of the above. (Some KPIs are common to many clients, including return on assets. They reflect the success factors of an organisation. They can be quantified.) Q. An item that is considered material due to its nature is referred to as being: A. Qualitatively material. Q. Explain audit risk and the three components of the audit risk model by linking the following terms with the correct definitions. A. Audit risk (The risk that an auditor expresses an inappropriate audit opinion when a financial report is materially misstated. This means that an auditor reports that in their opinion the financial report is true and fair when it contains a significant error or fraud. Inherent risk (The susceptibility (vulnerability/awareness) of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls. Control risk (The risk that a client's system of internal controls will not prevent or detect a material misstatement.) 9

Detection risk (The risk that the auditor's testing procedures will not be effective in detecting a material misstatement should there be one.) Q. By setting a lower planning materiality level an auditor: A. Increases the quality and quantity of evidence that needs to be gathered. Q. Which of the following statements is correct about audit risk? A. All of the above. (It is impossible to completely eliminate audit risk. Audit risk can be reduced at the (risk response phase) planning stage of an audit by identifying the key risks faced by the client. Audit risk is the risk that an auditor expresses an inappropriate opinion when a financ...