Audit - test two solutions

Choose the most correct answer and write its letter in the answer sheet:

1. Which of the following host describes the concept of audit risk?

A. The risk of the auditor being sued because of association with an audit client.

B. The overall risk that a material misstatement exists in the financial statements.

C. The risk that auditors use audit procedures that arc inappropriate.

D. The risk that the auditor will provide an unqualified opinion on financial statements that are in fact, materially misstated.

         ans: [C]

2.    An auditor who accepts an audit engagement and does not possess expertise with respect to the business entity's industry, should

A. Obtain a knowledge of matters that relate to the nature of the entity's business 

B. Engage financial experts familiar with the nature of the business entity.

C. Refer a substantial portion of the audit to another CPA, who will act as the principal auditor.

D. First inform management that an unqualified opinion cannot be issued.

        ans: [B]

3. ISA 315 Identifying and Assessing the Risks of Material Misstatement through understanding the Knurs and Its Environment sets out the five components of internal control.

Which of the following is NOT set out as a component of internal control within ISA 315?

A.    Control environment

B.    The information system relevant to financial reporting

C.    Human resource policies and practices

D.    The risk assessment in Stores department

       ans: [ ]

4. When obtaining an understanding of the entity and its environment, the auditor should obtain an understanding of internal controls primarily to

A. Identify areas of relatively high risk of misstatement and plan the audit accordingly.

B.    Provide suggestions for improvement to the client.

C.    Serve as a basis for setting audit risk and materiality.

D.    Decide whether to perform an audit for the client.

      ans: [A]

5. Before accepting an engagement to audit a new client, an auditor is required to

A. Make inquiries of the predecessor auditor.

B. Tell the client whether or not the auditor is willing to issue a "clean" opinion.

C. Prepare a memorandum setting forth the stalling requirements and documenting the

preliminary audit plan

D. Become a member of the client’s board of directors

     ans: [ ]

6. Preliminary engagement activities include

A. Evaluating internal controls

B. Assessing audit risk at the account balance level.

C. Setting materiality.

D. Performing background checks on top management.

     ans: [ ]

7.  Which of the following is responsible for establishing a private company’s internal control?

A.    Auditors

B.    Management and auditors

C.    Management.

D.    Committee of Sponsoring Organizations

     ans: [ ]

8. Which of the following is not one of the three primary objectives of effective internal control?

A.    Reliability of financial reporting

B.    Assurance of elimination of business risk

C.    Efficiency and effectiveness of operations

D.    Compliance with laws and regulations

    ans: [ ]

9. The Public Company Accounting Oversight Board states that reasonable assurance allows a:

A. High likelihood that material misstatements will not be prevented or detected by internal control

B. Small likelihood of ineffective internal controls.

C. Remote likelihood that material misstatements will not be prevented or detected by internal control

D. Likelihood that material misstatements will not be prevented or detected by internal control.

    ans: [C]

10.    Two key concepts that underlie management’s design and implementation of internal control arc

A.    Costs and materiality.

B.    Absolute assurance and costs.

C.    Collusion and materiality

D.    Inherent limitations and reasonable assurance.

    ans: [ ]

11. Internal controls can never be considered as absolutely effective because.

A. Not all organizations have internal audit departments.

B. Controls are designed to prevent and detect only material misstatements.

C. Their effectiveness is limited by the competency and dependability of employees.

D. Internal controls prevent separation of duties.

    ans: [ ]

12. A major control available in a small company, which might not be feasible in a big company, is:

A. A wider segregation of duties.

B The owner-manager’s personal interest and close relationship with personnel.

C. A voucher system.

D. Fewer transactions to process

    ans: [B]

13. An act of two or more employees to steal assets or misstate records is frequently referred to as.

A.  A material weakness.

B.  A control deficiency.

C.  A significant deficiency 

D.  Collusion.

    ans: [ ]

14. Sarbanes-Oxley requires management to issue an internal control report that includes two specific items. Which of the following is one of these two requirements?

A. A statement that management, the board of directors, and the external auditors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting.

B. A statement that management is responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting.

C. A statement that management and the board of directors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting.

D. A statement that the external auditors are solely responsible.

     ans: [B]

15. Which of management’s concerns with respect to implementing internal controls is the auditor primarily concerned?

A.    Compliance with applicable laws and regulations.

B.    Reliability of financial reporting.

C.    Effectiveness of operations.

D.    Efficiency of operations

     ans: [ ]

16. To issue a report on internal control over financial reporting for a public company, an auditor must

A.  Evaluate management’s assessment process.

B.  Independently assess the design and operating effectiveness of internal control.

C.  Evaluate management’s assessment process and independently assess the design and operating effectiveness of internal control

D.  Test controls over significant account balances

    ans: [ ]

17.    Which of the following activities would be less likely to strengthen a company’s internal control?

A.    Separating accounting from other financial operations.

B.    Maintaining insurance for fire and theft.

C.    Fixing responsibility for the performance of employee duties.

D.    Carefully selecting and training employees.

    ans: [B]

18. Management must disclose material weaknesses in internal control

A. Whenever the weakness is deemed significant to a single class of transactions.

B. Whenever the weakness is significant to overall financial reporting objectives.

C. If the weakness exists at the end of the year.

D. Only if the auditor identifies the weakness as significant.

    ans: [ ]

19. Internal controls can never he regarded as completely effective. Even if company personnel could design an ideal system, its effectiveness depends on the 

A. Adequacy of the computer system.

B. Proper implementation by management.

C. Ability of the internal audit staff to maintain it.

D. Competency and dependability of the people using it.

   ans: [D]

20. The essence of an effectively controlled organization lies in the:

A. Effectiveness of its independent auditor,

B. effectiveness of its internal auditor.

C. Attitude of its employees.

D. Attitude of its management.

  ans: [ ]

21. Which of the following statements is correct with respect to separation of duties?

A. It is permissible to allow an employee to open cash receipts and record those receipts  

B. Employees who authorize transactions should have recording responsibility for these transactions.

C. Employees should not have temporary and permanent custody of assets

D.  Employees who authorize transactions should not have custody of related assets

    ans: [D]

22. The most important type of protective measure for safeguarding assets is

A. The use of physical precautions 

B. Adequate documentation.

C. Adequate separation of duties among personnel 

D. Proper authorization of transactions

    ans: [ ]

23. Which of the following is not one of the levels of an absence of internal controls?    ‘

A. Material weakness

B. Significant deficiency 

C. Control deficiency 

D. Major deficiency

ans: [ ]

24. Smaller public companies face challenges implementing effective internal control due to. 

A Reduced importance

B. Limited resources    _:

C. A lack of expertise

D. Limited available guidance.

ans: [ ]

25. ans: [ ]

26. ans: [ ]

27.  Which of the following best describes the inherent imitations that should be recognized by an auditor when considering the potential effectiveness of internal control?

A. Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against irregularities perpetrated by management.

B. The benefits expected to be derived from effective internal accounting control usually do not exceed the costs of such control.

C. Procedures that depend on segregation of duties can be circumvented by collusion.

D. Competent and honest client personnel provide an environment conducive to accounting control and provide absolute assurance that effective control will be achieved.

   ans: [ ]

28. Which of the following is not one of the sub components of the control environment?

A. Management’s philosophy and operating style

B.  Organizational structure

C.    Commitment to competence 

D. Adequate separation of duties

    ans: [ ]

29 Proper segregation of functional responsibilities calls for separation of

A. Authorization, execution, and payment 

B. Custody, execution, and reporting 

C. Authorization, recording, and custody 

D. Authorization, payment, and recording

    ans: [C]

30. Internal controls are not designed to provide reasonable assurance that

A. Access to assets is permitted only in accordance w ith management's authorization 

B. Company personnel comply with applicable rules and regulations 

C. All frauds will be eliminated

D. Transactions are executed in accordance with management's authorization

     ans: [C]

31. Which of the following statements is correct regarding an accountant’s working papers? 

A. The accountant owns the working papers but generally may not disclose them without the client’s consent or a court order.

B. The accountant owns the working papers and generally may disclose them as the accountant sees fit.

C. The client owns the working papers hut the accountant has custody of them until the accountant's bill is paid in full.

D. The client owns the working papers hut, in the absence of the accountant's consent, may not disclose them without a court order

      ans: [A]

32.    What is the responsibility of an incoming auditor with respect to communicating with the outgoing auditor in connection with a prospective new audit client?

A. The incoming auditor should contact the outgoing auditor regardless       of whether the prospective client authorized contact

B. The incoming auditor has no responsibility to contact the outgoing auditor

C. The incoming auditor should obtain permission from the prospective client to contact the predecessor auditor

D. The incoming auditor need not contact the outgoing auditor if the incoming auditor is aware of all available relevant facts.

      ans: [ ]

33.    The first auditors of a company are usually appointed by

A. Directors of the Company

B.    Shareholders of the Company

C.    Members of the audit committee

D.    Corporate Affairs Commission

     ans: [A]

34. Which one of the following is NOT a duty of the auditor?

A. Duty to report to the members

B. Duty to sign the audit report

C. Duty to report on any violation of law

D. Duty to report to the company’s bankers

      ans: [ ]

35.  Assuming that it is not the first appointment of the auditor, who is responsible for the appointment of the auditor?

A. The board of directors in a board meeting

B. The audit committee

C. The shareholders in a general meeting

D. The managing director

    ans: [C]

36. The independent auditor's primary responsibility is to

A. The directors

B The shareholders

C.    The company's creditors (payables)

D.    The company's bank

     ans: [B]

34. If the independent auditors decide that the work performed by the internal auditor may have a bearing on their own procedures, they should consider the internal auditor's

A.    Independence and review skills

B.    Competence and objectivity

C.    Efficiency and experience

D.    Training and supervisory skills

     ans: [ ]

38.    In assessing the objectivity of internal auditors, an independent auditor should

A.    Evaluate the quality control program in effect for the internal auditors.

B.    Examine documentary evidence of the work performed by the internal auditors.

C.    Determine the organizational level to which the internal auditors report.

D.    Test a sample of the transactions and balances that the internal auditors examined

      ans: [ ]

39.    The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the

A. Human resources function from the controllership function

B. Operational responsibility from the recordkeeping responsibility.

C. Authorization of transactions from the custody of related assets  

D. Administrative controls from the internal accounting controls'

      ans: [ ]

40.   Internal auditing is most appropriately described as if

A.    A management control

B.    An extension of the accounting process

C.    An evaluation methodology for the controller

D.    A service to the board of directors       

      ans: [A]

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AUDIT TEST 1 on threats to independece (answers/solution)

      

TEST ONE
with solution 

ACADEMIC YEAR 2015/2016

You are an audit manager in Mtavangu & Associates (an Auditing Firm) responsible for allocating staff to the following three audits of financial statements for the year ending 31 December 2014:

(a)    Hapa Kazi Co is a new audit client. This private company is a local manufacturer and distributor of sportswear. The company’s finance director, John, sees little value in the audit and put it out to tender last year as a cost-cutting exercise. In accordance with the requirements of the invitation to tender your firm indicated that there would not be an interim audit.

(b)   Makontena Co, a long-standing client, operates a national supermarket chain. Your firm provided Makontena Co with corporate financial advice on obtaining a listing on a recognised stock exchange in 2013. Senior management expects a thorough examination of the company’s computerised systems, and are also seeking assurance that the annual report will not attract adverse criticism.

(c)    Uraisi Co has been an audit client since 2005 after your firm advised management on a successful buyout. Uraisi provides communication services and software solutions. Your firm provides Uraisi with technical advice on financial reporting and tax services. Most recently you have been asked to conduct due diligence reviews on potential acquisitions.

Required:

For these assignments, compare and contrast:

(i)       the threats to independence (60 Marks)

(ii)     the other professional and practical matters that arise; and (20 Marks) 

(iii) the implications for allocating staff. (20 Marks)

             

Threats to independence

Self-interest

Tutorial note: This threat arises when a firm or a member of the audit team could benefit from a financial interest in, or other self-interest conflict with, an assurance client.

•       A self-interest threat could potentially arise in respect of any (or all) of these assignments as, regardless of any fee restrictions (e.g. per NBAA’s ‘Code of Ethics for Professional Accountants’), the auditor is remunerated by clients for services provided.

•       This threat is likely to be greater for Makontena Co (larger/listed) and Uraisi Co (requires other services) than for Hapa Kazi Co (audit a statutory necessity).

•       The self-interest threat may be greatest for Makontena Co. As a company listed on a recognised stock exchange it may give prestige and credibility to

Mtavangu&Associates (though this may be reciprocated). Mtavangu&Associates could be pressurised into taking evasive action to avoid the loss of a listed client (e.g.

concurring with an inappropriate accounting treatment).

Self-review

Tutorial note: This arises when, for example, any product or judgment of a previous engagement needs to be re-evaluated in reaching conclusions on the audit engagement.

•       This threat is also likely to be greater for Makontena and Uraisi where Mtavangu&Associates is providing other (non-audit) services.

•       A self-review threat may be created by Mtavangu&Associates providing Makontena with a ‘thorough examination’ of its computerised systems if it involves an extension of the procedures required to conduct an audit in accordance with International Standards on Auditing (ISAs).

•       Appropriate safeguards must be put in place if Mtavangu&Associates assists Makontena in the performance of internal audit activities. In particular, Mtavangu&Associates’s personnel must not act (or appear to act) in a capacity equivalent to a member of Makontena’ management (e.g. reporting, in a management role, to those charged with governance).

•       Mtavangu&Associates may provide Uraisi with accounting and bookkeeping services, as Uraisi is not a listed entity, provided that any self-review threat created is reduced to an acceptable level. In particular, in giving technical advice on financial reporting, Mtavangu&Associates must take care not to make managerial decisions such as determining or changing journal entries without obtaining Uraisi’s approval.

•       Taxation services comprise a broad range of services, including compliance, planning, provision of formal taxation opinions and assistance in the resolution of tax disputes. Such assignments are generally not seen to create threats to independence.

Tutorial note: It is assumed that the provision of tax services is permitted in the jurisdiction (i.e. that Mtavangu &Associates are not providing such services if prohibited).

•       The due diligence reviews for Uraisi may create a self-review threat (e.g. on the fair valuation of net assets acquired).However, safeguards may be available to reduce these threats to an acceptable level.

•       If staff involved in providing other services are also assigned to the audit, their work should be reviewed by more senior staff not involved in the provision of the other services (to the extent that the other service is relevant to the audit).

•       The reporting lines of any staff involved in the audit of Makontena and the provision of other services for Makontena should be different. (Similarly for Uraisi.) Familiarity

Tutorial note: This arises when, by virtue of a close relationship with an audit client (or its management or employees) an audit firm (or a member of the audit team) becomes too sympathetic to the client’s interests.

•       Long association of a senior member of an audit team with an audit client may create a familiarity threat. This threat is likely to be greatest for Makontena, a long-standing client. It may also be significant for Uraisi as Mtavangu&Associates have had dealings with this client for seven years now.

•       As Hapa Kazi is a new audit client this particular threat does not appear to be relevant.

•       Senior personnel should be rotated off the Makontena and Uraisi audit teams. If this is not possible (for either client), an additional professional accountant who was not a member of the audit team should be required to independently review the work done by the senior personnel.

•       The familiarity threat of using the same lead engagement partner on an audit over a prolonged period is particularly relevant to Makontena, which is now a listed entity. IFAC’s ‘Code of Ethics for Professional Accountants’ requires that the lead engagement partner should be rotated after a pre-defined period, normally no more than seven years. Although it might be time for the lead engagement partner of Makontena to be changed, the current lead engagement partner may continue to serve for the 2006 audit.

Tutorial note: Two additional years are permitted when an existing client becomes listed, since it may not be in the client’s best interests to have an immediate rotation of engagement partner. Intimidation

Tutorial note: This arises when a member of the audit team may be deterred from acting objectively and exercising professional skepticism by threat (actual or perceived), from the audit client.

•       This threat is most likely to come from Hapa Kazi as auditors are threatened with a tendering process to keep fees down.

•       John may have already applied pressure to reduce inappropriately the extent of audit work performed in order to reduce fees, by stipulating that there should not be an interim audit.

•       The audit senior allocated to Hapa Kazi will need to be experienced in standing up to client management personnel such as John.

Tutorial note: ‘Correct’ classification under ‘ethical’, ‘other professional’, ‘practical’ or ‘staff implications’ is not as important as identifying the matters. 

(ii) Other professional and practical matters

Tutorial note: ‘Other professional’ includes quality control.

•       The experience of staff allocated to each assignment should be commensurate with the assessment of associated risk. For example, there may be a risk that insufficient audit evidence is obtained within 

the budget for the audit of Hapa Kazi.Makontena, as a listed client, carries a high reputational risk.

•       Sufficient appropriate staff should be allocated to each audit to ensure adequate quality control (in particular in the direction, supervision, review of each assignment). It may be appropriate for a second partner to be assigned to carry out a ‘hot review’ (before the auditor’s report is signed) of:

– Hapa Kazi, because it is the first audit of a new client; and – Makontena, as it is listed.

•       Existing clients (Makontena and Uraisi) may already have some expectation regarding who should be assigned to their audits. There is no reason why there should not be some continuity of staff providing appropriate safeguards are put in place (e.g. to overcome any familiarity threat).

•       Senior staff assigned to Hapa Kazi should be alerted to the need to exercise a high degree of professional skepticism (in the light of John’s attitude towards the audit).

•       New staff assigned to Makontena and Uraisi would perhaps be less likely to assume unquestioned honesty than staff previously involved with these audits.

Logistics (practical)

•       All three assignments have the same financial year end, therefore there will be an element of ‘competition’ for the staff to be assigned to the year-end visits and final audit assignments. As a listed company, Makontena is likely to have the tightest reporting deadline and so have a ‘priority’ for staff.

•       Hapa Kazi is a local and private company. Staff involved in the year-end visit (e.g. to attend the physical inventory count) should also be involved in the final audit. As this is a new client, staff assigned to this audit should get involved at every stage to increase their knowledge and understanding of the business.

•       Makontena is a national operation and may require numerous staff to attend year-end procedures. It would not be expected that all staff assigned to year-end visits should all be involved in the final audit.

Time/fee/staff budgets

•       Time budgets will need to be prepared for each assignment to determine manpower requirements (and to schedule audit work).

(iii)   Implications for allocating staff

•       Mtavangu&Associates should allocate staff so that those providing other services to Makontena and Uraisi (that may create a self-review threat) do not participate in the audit engagement.

Competence and due care (Qualifications/Specialisation)  All audit assignments will require competent staff.

•       Makontena will require staff with an in-depth knowledge of their computerised system.

•       Uraisi will require senior audit staff to be experienced in financial reporting matters specific to communications and software solutions (e.g. in revenue recognition issues and accounting for internally-generated intangible assets).

•       Specialists providing tax services and undertaking the due diligence reviews for Uraisi may not be required to have any involvement in the audit assignment.

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