Applied Auditing

Preliminary Examination
Prepared by: REGIE R. BAOY
MULTIPLE CHOICE. ENCIRLCE THE LETTER THAT CORRESPONDS TO YOUR ANSWER. ERASURES ARE STRICTLY PROHIBITED.
PENCILS ARE NOT ALLOWED.
PRE-ENGAGEMENT
1. Prior to the acceptance of an audit engagement with a client who has terminated the services of the predecessor auditor, the
CPA should
a. Contact the predecessor auditor without advising the prospective client and request a complete report of the circumstance
leading to the termination with the understanding that all information disclosed will be kept confidential.
b. Accept the engagement without contacting the predecessor auditor since the CPA can include audit procedures to verify
the reason given by the client for the termination.
c. Not communicate with the predecessor auditor because this would in effect be asking the auditor to violate the
confidential relationship between auditor and client.
d. Advise the client of the intention to contact the predecessor auditor and request permission for the contact.
2.

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding
the predecessors
a. Opinion of any subsequent events occurring since the predecessors audit report was issued.
b. Understanding as to the reasons for the change of auditors.
c. Awareness of the consistency in the application of GAAP between periods.
d. Evaluation of all matters of continuing accounting significance.

3.

A successor auditor most likely would make specific inquiries of the predecessor auditor regarding
a. Specialized accounting principles of the clients industry.
b. The competency of the clients internal audit staff.
c. The uncertainty inherent in applying sampling procedures.
d. Disagreements with management as to auditing procedures.

4.

Which of the following should an auditor obtain from the predecessor auditor prior to accepting an audit engagement?
a. Analysis of balance sheet accounts
b. Analysis of income statement accounts
c. All matters of continuing accounting significance
d. Facts that might bear on the integrity of management

5.

When an independent auditor is approached to perform an audit for the first time, he or she should make inquiries of the
predecessor auditor. Inquiries are necessary because the predecessor may be able to provide the successor with information
that will assist the successor in determining whether
a. The predecessors work should be used.
b. The company rotates auditors.
c. In the predecessors opinion, control risk is low.
d. The engagement should be accepted.

6.

If permission from client to discuss its affairs with the proposed auditor is denied by the client, the predecessor auditor
should:
a. Keep silent of the denial.
b. Disclose the fact that the permission to disclose is denied by the client.
c. Disclose adequately to proposed auditor all noncompliance made by the client.
d. Seek legal advice before responding to the proposed auditor

7.

The objective and scope of the audit and the extent of the auditors responsibilities to the client are best documented in
a. Independent auditors report
c. Clients representation letter
b. Audit engagement letter
d. Audit program

8.
I.

Which of the following is appropriately included in an audit engagement letter?

Because of the test nature and other inherent limitations of an audit, together with the inherent limitations of any
accounting and internal control system, there is an unavoidable risk that even some material misstatements may remain
undiscovered.
II.
The audit will be made with the objective of expressing an opinion on the financial statements.
III.
An audit also includes assessing the accounting procedures used and significant estimates made by management.
a. I and II
c. II and III
b. I and III
d. I, II and III
9. Which of the following is least likely included in an audit engagement letter?
a. The objective of financial reporting.
b. Management responsibility for the financial statements.
c. The form of any reports or other communication of the results of the engagement.
d. Arrangement concerning the involvement of other auditors or experts in some aspects of the audit.
10. An audit engagement letter least likely includes

a.
b.
c.
d.

A reference to the inherent limitation of an audit that some material misstatements may remain undiscovered.
Identification of specific audit procedures that the auditor needs to undertake.
Description of any letters or reports that the auditor expects to submit to the client.
Arrangements concerning the involvement of internal auditors and other clients staff.
AUDIT PLANNING

1.

The development of a general strategy and a detailed approach for the expected nature, timing, and extent of audit refers
to :
a. Supervision
b. Audit procedures
c. Directing
d. Planning

2.

The auditor should consider the nature, extent, and timing of the work to be performed and should prepare a written audit
program for every audit. Which audit standard is most closely related to this requirement?
a. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor.
b. In all matters relating to the assignment, an independent mental attitude is to be maintained by the auditor(s).
c. Due professional care is to be exercised in the planning and performance of the audit and preparation of the report.
d. The work is to be adequately planned and assistants, if any, are to be properly supervised.

3.

Which of the following would a successor auditor normally perform after acceptance of an audit client?
Inquiry of predecessor auditor regarding the client.
Review the SEC filings of the client.
Inquiry of bankers regarding the client.
Review of predecessor auditor working papers.

a.
b.
c.
d.

4.

5.

a.
b.
c.
d.

d.

Which of the following is required documentation in an audit in accordance with generally accepted auditing standards?
A flowchart or narrative of the information system describing the recording and classification of transactions for financial
reporting.
An audit program setting forth in detail the procedures necessary to accomplish the engagements objectives.
A planning memorandum establishing the timing of the audit procedures and coordinating the assistance of entity
personnel.
An internal control questionnaire identifying policies and procedures that assure specific objectives will be achieved.

a.
b.
c.
d.

Which of the following procedures would an auditor most likely perform in planning a financial statement audit?
Inquiring of the clients legal counsel concerning pending litigation.
Comparing the financial statements to anticipated results.
Examining computer generated exception reports to verify the effectiveness of internal controls.
Searching for unauthorized transactions that may aid in detecting unrecorded liabilities.

a.
b.
c.
d.

Analytical procedures used in planning an audit should focus on

Reducing the scope of tests of controls and substantive tests.
Providing assurance that potential material misstatements will be identified.
Enhancing the auditors understanding of the clients business.
Assessing the adequacy of the available evidential matter.

a.
b.
c.

6.

7.

To obtain an understanding of a continuing clients business in planning an audit, an auditor most likely would
Perform tests of details of transactions and balances.
Review prior-year working papers and the permanent file for the client.
Read specialized industry journals.
Reevaluate clients internal control environment.

8.

Analytical procedures, which means the analysis of significant ratios and trends including the resulting investigation of
fluctuations and relationships that are inconsistent with other relevant information or which deviate from predicted amounts, are
not required to be applied
a. At the planning stage of the audit
c. As substantive procedures
b. Overall review stage of the audit
d. None of the above

9.

Which of the following is an effective audit planning and control procedures that helps prevent misunderstandings and
inefficient use of audit personnel?
a. Make copies, for inclusion in the working papers, of those client supporting documents examined by the auditor.
b. Provide the client with copies of the audit programs to be used during the audit.
c. Arrange a preliminary conference with the client to discuss audit objectives, fees, timing, and other information.
d. Arrange to have the auditor prepare and post any necessary adjusting or reclassification entries prior to final closing.

10.
a.
b.
c.
d.

Which of the following is an aspect of scheduling and controlling the audit engagement?
Including in the audit program a column for estimated and actual time.
Performing audit work only after the clients books of account have been closed for the period under examination.
Writing a conclusion in individual working papers indicating how the results of the audit will affect the auditors report.
Including in the engagement letter an estimate of the minimum and maximum audit fee.

11.

a.
b.
c.
d.

12. The
a.
b.
c.
d.
13.

14.

Which of the following statements is not correct about materiality?

The concept of materiality recognizes that some matters are important for fair presentation of financial statements in
conformity with GAAP, while other matters are not important.
An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could
be material to any one of the financial statements.
Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and
qualitative judgments.
An auditors consideration of materiality is influenced by the auditors perception of the needs of a reasonable person who
will rely on the financial statements.
audit program should contain the following, except:
Audit objective
Time budget for the various audit areas
Set of planned audit procedures
The combined assessed level of inherent and control risk

Which of the following will most likely help the auditor to identify and understand the events, transactions and
practices of his audit client?
a.
Obtaining a sufficient knowledge of the business of his client.
b.
Understanding of accounting and internal control.
c.
Testing control policies and procedures.
d.
a.
b.
c.
d.

Obtaining a representation letter from the client management.

Which of the following is correct statement?
The auditor should use professional judgment to assess audit risk and to design audit procedures to ensure it is eliminated.
The auditor is an insurer, and his or her report constitutes a guarantee.
The subsequent discovery that a material misstatement exists in the financial statements is evidence of inadequate
planning, performance, or judgment on the part of the auditor.
The auditor should obtain an understanding of the accounting and internal control systems sufficient to plan the audit and
develop an effective audit approach.

15. Audit risk means

a. The susceptibility of an account balance or class of transactions to misstatement that could be material, individually or when
aggregated with misstatements in other balances or classes, assuming that there were no related internal controls.
b. The risk that a misstatement, that could occur in an account balance or class of transactions and that could be material,
individually or when aggregated with misstatements in other balances or classes, will not be prevented or detected and
corrected on a timely basis by the accounting and internal control systems.
c. The risk that an auditors substantive procedures will not detect a misstatement that exists in an account balance or class of
transactions that could be material, individually or when aggregated with misstatements in other balances or classes.
d. The risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated.
16. Inherent risk and control risk differ from detection risk in that they
a. Arise from the misapplication of auditing procedures.
b. May be assessed in either quantitative or nonquantitative terms.
c. Exist independently of the financial statement audit.
d. Can be changed at the auditors discretion.
17. Inherent risk and control risk differ from detection risk in that inherent risk and control risk are
a. Elements of audit risk while detection risk is not.
b. Changed at the auditors discretion while detection risk is not.
c. Considered at the individual account-balance level while detection risk is not.
d. Functions of the client and its environment while detection risk is not.
18. Which of the following is an incorrect statement?
1. Detection risk is a function of the effectiveness of an auditing procedure and its application.
2. Detection risk arises partly from uncertainties that exists when the auditor does not examine 100 percent of the population.
3. Detection risk arises partly because of other uncertainties that exist even if the auditor were to examine 100 percent of the
population.
4. Detection risk exists independently of the audit of the financial statements.
19. The relationship between acceptable level of detection risk and the combined level of inherent and control risk is
a. Direct
b. Inverse
c. Parallel
d. Independent
20. An auditor decides to increase the assessed level of control risk from that originally planned on the basis of audit evidence
gathered and evaluated. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the
auditor would
a. Decrease substantive testing.
c. Increase inherent risk.
b. Increase materiality levels.
d. Decrease detection risk.
CONSIDERATION OF INTERNAL CONTROL

1.
a.
b.
c.
d.

Which of the following is correct regarding internal control system?

Internal control system refers to all the policies and procedures adopted by the auditor to assist in achieving managements
objective.
A strong environment, by itself, ensure the effectiveness of the internal control system.
In the audit of financial statements, the auditor is only concerned with those policies and procedures within the accounting
and internal control systems that are relevant to the financial statements.
The internal control system is confined to those matters which relate directly to the functions of the accounting system.

2.

Which of the following statements concerning control risk is correct?

a. When control risk is at the maximum level, an auditor is required to document the basis for that assessment.
b. Control risk may be assessed sufficiently low to eliminate substantive testing for significant transaction classes.
c. When assessing control risk, an auditor should not consider evidence obtained in prior audits about the operation of
controls.
d. Assessing control risk and obtaining an understanding of an entitys internal control may be performed concurrently.

3.

An auditor wishes to perform tests of controls on a clients cash disbursements procedures. If the controls
leave no audit trail of documentary evidence, the auditor most likely will test the procedures by
a. Confirmation and observation.
c. Analytical procedures and confirmation.
b. Observation and inquiry.
d. Inquiry and analytical procedures

4.

The auditor is examining copies of sales invoices only for the initials of the person responsible for checking the
extensions. This is an example of a
a. Test of controls
c. Dual purpose test
b. Substantive test
d. Test of balances

5.

Which of the following is the correct order for performing the auditing procedures A through C below
A = Tests of Controls
B = Preparation of a flowchart depicting the clients internal control structure
C = Substantive tests
a. ABC
b. BAC
c. ACB
d. BCA
TEST OF CONTROL PROCEDURES

Revenue and Receipt Cycle

1.

After the auditor has prepared a flowchart of internal control for sales, and cash receipts transactions and evaluated the design
of the system, the auditor would perform tests of controls on all control procedures
a. Documented in the flowchart.
b. Considered to be deficiencies that might allow errors to enter the accounting system.
c. Considered to be strengths that the auditor plans to rely on in assessing control risk.
d. That would aid in preventing irregularities.

2.

Which of the following is not a universal rule for achieving control over cash?
a. Separate the cash-handling and record-keeping functions.
b. Deposit each days cash receipts by the end of the day.
c. Have bank reconciliations performed by employees who do not handle cash.
d. Decentralize the receiving of cash as much as possible.

3.

The
a.
b.
c.
d.

least crucial element of control over cash is

Separation of cash record keeping from custody of cash.
Preparation of the monthly bank reconciliation.
Separation of cash receipts from cash disbursements.
Batch processing of checks.

4.

The
a.
b.
c.
d.

use of fidelity bonds protects a company from embezzlement losses and also
Minimizes the possibility of employing persons with dubious records in positions of trust.
Protects employees who make unintentional errors form possible monetary damages resulting from such errors.
Allows the company to substitute the fidelity bonds for various parts of internal control.
Reduces the companys need to obtain expensive business interruption insurance.

5.

An auditor is reviewing internal control for accounts receivable:

I. The billing function should not be assigned to the person who is responsible for maintaining accounts receivable records.
II. Responsibility for approval of the write-off of accounts receivable that are uncollectible should not be assigned to the
cashier.
a.
Only I is true
c. Both I and II are true
b.
Only II is true
d. Neither I nor II is true

6.

Which of the following is an effective internal control over accounts receivable?

a. Only persons who handle cash receipts should be responsible for the preparation of documents that reduce accounts
receivable balances.
b. Responsibility for approval of the write-off of uncollectible accounts receivable should be assigned to the cashier.
c. Balances in the subsidiary accounts receivable ledger should be reconciled to the general ledger control account once a year,
preferably at year-end.
d. The billing function should be assigned to persons other than those responsible for maintaining accounts receivable
subsidiary records.

7.

To achieve control when there is no billing department, the billing function should be performed by the
a. Accounting department
c. Shipping department
b. Sales department
d. Credit and collection department

8.

The person who opens the mail commonly prepares a remittance advice when a customer fails to return one with a payment.
Consequently, mail should be opened by the
a. Credit manager.
c. Sales manager.
b. Receptionist.
d. Accounts receivable clerk.

9.

Which of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the
mail room?
a. The cashier makes the daily deposit at a local bank.
b. The cashier prepares the daily deposit.
c. The cashier endorses the checks.
d. The cashier posts the receipts to the accounts receivable subsidiary ledger.

10. Which of the following would best protect a company that wishes to prevent lapping?
a. Segregating duties so that accounting has no access to an incoming mail
b. Segregating duties so that no employee has access both to checks from customers and to currency from daily cash receipts
c. Having customers send payments directly to the companys bank
d. Requesting that customers checks be made payable to the company and be addressed to the treasurer
11. Defective merchandise returned by customers should be presented to
a. Inventory control personnel.
c. Purchasing personnel
b. Sales personnel.
d. Receiving personnel
12. In considering internal control within the revenue/receipt cycle, what is the purpose of a transaction walk through?
a. To assure that employees are performing assigned functions accurately.
b. To confirm the auditors understanding of the internal control structure.
c. To select documents for detailed tests of controls.
d. To verify the results of the auditors sampling plan.
13. The
a.
b.
c.
d.

purpose of tests of controls over shipping is to determine whether

Billed goods have been shipped.
Shipments are billed.
Shipping department personnel are competent.
Credit is approved before goods are shipped.

14. The
a.
b.
c.
d.

purpose of tests of controls over billing is to determine whether

Billed goods have been shipped.
Shipments are billed.
Billing department personnel are competent.
Credit is approved before goods are billed.

15. Which of the following control procedures could prevent or detect errors or frauds arising from shipments made to unauthorized
parties?
a. Document policies and procedures for scheduling shipments.
b. Establish procedures for reviewing and approving prices and sales terms before sale.
c. Prenumber bills of lading and assure that related billings are made on a periodic basis.
d. Prepare and periodically update lists of authorized customers.
Expenditure and Disbursement Cycle
1.

The
a.
b.
c.
d.

accounts payable department receives a purchase order form to accomplish all of the following except
Comparing invoice price to purchase order price.
Ensuring that the purchase had been properly authorized.
Comparing quantity ordered to quantity purchased.
Ensuring that the goods had been received by the party requesting the goods.

2.

Which of the following is a primary function of the purchasing department?

a.
b.
c.
d.

Ensuring the acquisition of goods of a specified quality.

Authorizing the acquisition of goods.
Verifying the propriety of goods of a specified quality.
Reducing expenditures for goods acquired.

3.

Matching the suppliers invoice, the purchase order, and the receiving report normally should be the responsibility of the
a. Receiving department
c. Accounting function
b. Purchasing department
d. Treasury function

4.

The
a.
b.
c.
d.

5.

Internal control is improved when the quantity of merchandise ordered is omitted from the copy of the purchase order sent to
the
a. Department that initiated the requisition
c. Purchasing agent
b. Receiving department
d. Accounts payable department

6.

When goods are received, the receiving clerk should match the goods with the
a. Purchase order and requisition.
b. Vendors invoice and the receiving report.
c. Vendors shipping document and the purchase order.
d. Receiving report and the vendors shipping documents.

7.

The
a.
b.
c.
d.

accounts payable department should compare the information on each vendors invoice with the
Receiving report and the purchase order.
Receiving report and the vendor.
Vendors packing slip and the purchase order.
Vendors packing slip and the voucher.

8.

The
a.
b.
c.
d.

mailing of disbursement checks and remittance advices should be controlled by the employee who
Signed the checks last
Approved the vouchers for payment
Matched the receiving reports, purchase orders, and vendor invoices
Verified the mathematical accuracy of the vouchers and remittance advices

9.

What is the reason for ensuring that every copy of a vendors invoice has a receiving report?
a. To ascertain that merchandise billed by the vendor was received by the company.
b. To ascertain that merchandise received by the company was billed by the vendor.
c. To ascertain that the invoice was correctly prepared.
d. To ascertain that a check was prepared for every invoice.

accounts payable department generally should

Cancel supporting documentation after a cash payment is mailed
Approve the price and quantity of each purchase requisition
Assure that the quantity ordered is omitted from the receiving departments copy of the purchase order
Agree the vendors invoice with the receiving report and purchase order

10. How can an auditor test to determine whether Receiving Department procedures are applied properly?
a. Test a sample of receiving documents.
b. Observe receiving procedures on a surprise basis.
c. Review procedures manuals.
d. Interview Receiving personnel.
11. Which of the following control procedures could prevent or detect payment of goods not received?
a. Counting goods when received.
b. Matching the purchase order, receiving report, and vendors invoice.
c. Comparing goods received with goods requisitioned.
d. Verifying vouchers for accuracy and approval.
12. Which of the following would prevent a paid disbursement from being paid a second time?
a. Individuals responsible for signing checks should prepare vouchers.
b. Disbursements should be approved by at least two responsible officials.
c. The disbursement date should be within a few days of the date the voucher is presented for payment.
d. The official signing the check should cancel the supporting documents.
13. Assume an auditors interim consideration of internal control in the expenditure/disbursement cycle reveals that control risk can
be assessed below the maximum and detection risk above the minimum for some assertions. Which of the following is true
about substantive tests applied to accounts payable?
a. The auditor is more apt to confirm payable balances.
b. The auditor is less apt to perform substantive tests at the balance sheet date.
c. The auditor is more apt to increase the extent of substantive tests.
d. The auditor is more apt to ignore the risk of incorrect acceptance when sampling accounts payable.
14. A CPA learns that his client has paid a vendor twice for the same shipment, once based upon the original invoice and once based
upon the monthly statement. A control procedure that should have prevented this duplicate payment is

a.
b.
c.
d.

Attachment of the receiving report to the disbursement support.

Prenumbering of disbursement vouchers.
Use of a limit or reasonableness test.
Prenumbering of receiving reports.

15. The authority to accept incoming goods in receiving should be based on a(n)
a. Vendors invoice
c. Bill of lading
b. Materials requisitions
d. Approved purchase order
Personnel and Payroll
1.

Which of the following control procedures could best prevent direct labor from being charged to manufacturing overhead?
a. Comparison of daily journal entries with factory labor summary.
b. Examination of routing tickets from finished goods on delivery.
c. Reconciliation of work in process inventory with cost records.
d. Recomputation of direct labor based on inspection of time cards.

2.

For appropriate segregation of duties, journalizing and posting summary payroll transactions should be assigned to
a. The treasurers department
c. Payroll accounting
b. General accounting
d. The timekeeping department
Low Tek, Inc. has changed from a conventional to a computerized payroll clock card system. Factory employees now record
time in and out with magnetic cards, and the computer system automatically updates all payroll records. Because of this
change,
a. The auditor must audit through the computer
b. Internal control has improved
c. Part of the audit trail has been lost
d. The potential for payroll related fraud has been diminished

3.

4.

To minimize the opportunities for fraud, unclaimed cash payroll should be

a. Deposited in a safe deposit box.
b. Held by the payroll custodian.
c. Deposited in a special bank account.
d. Held by the controller.

5.

A common audit procedures in the audit of payroll transactions involves tracing selected items from the payroll journal to
employee time cards that have been approved by supervisory personnel. This procedure is designed to provide evidence in
support of the audit proposition that
a. Only bona fide employees worked, and their pay was properly computed
b. Jobs on which employees worked were charged with the appropriate labor cost
c. Internal controls relating to payroll disbursements are operating effectively
d. All employees worked the number of hours for which their pay was computed

6.

For internal control purposes, which of the following individuals should preferably be responsible for the distribution of payroll
checks?
a. Bookkeeper
c. Cashier
b. Payroll clerk
d. Receptionist

7.

The
a.
b.
c.
d.

8.

Which of the following departments most likely would approve changes in pay rates and deductions from employee salaries?
a. Personnel
c. Controller
b. Treasurer
d. Payroll

9.

Which of the following is not a common activity within personnel and payroll?
a. Initiating terminations.
b. Preparing and updating personnel records.
c. Preparing and recording payroll.
d. Distributing paychecks to employees.

purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the
Human resources function from the controllership function
Administrative controls from the internal accounting controls
Authorization of transactions from the custody of related assets
Operational responsibility from the record keeping responsibility

10. Which of the following best describes proper internal control over payroll?
a. The preparation of the payroll must be under the control of the personnel department.
b. The confidentiality of employee payroll data should be carefully protected to prevent fraud.
c. The duties of hiring, payroll computation, and payment to employees should be segregated.
d. The payment of cash to employees should be replaced with payment by checks.
-END OF EXAMINATION-