Audit Theory and Practice
Exam Solutions
Course Introduction
Audit Theory and Practice provides an in-depth exploration of the concepts, standards, and methodologies underpinning professional auditing. The course examines the role and responsibilities of auditors, principles of audit evidence and risk assessment, and the structure of audit planning, execution, and reporting. Students will study the ethical and legal frameworks that guide auditing, internal control systems, and methods for detecting and preventing fraud. Emphasis is placed on the application of theoretical knowledge to practical scenarios through case studies, critical analysis of real-world audit issues, and the use of auditing tools and techniques, preparing students for professional practice in assurance services.
Recommended Textbook
Auditing The Art and Science of Assurance Engagements 13th Canadian Edition by Alvin A. Arens
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Chapter 1: The Demand for Audit and Other Assurance Services
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69 Verified Questions
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Sample Questions
Q1) Because an external auditor is paid a fee by a client company, he or she
A) is absolutely independent and may conduct an audit.
B) may be sufficiently independent to conduct an audit.
C) is never considered to be independent.
D) must receive approval from the relevant provincial securities commission before conducting an audit.
Answer: B
Q2) What impact is the presence of factors such as real-time information (such as via the Internet) expected to have upon the demand for assurance services?
A) Demand is expected to decline due to the lack of adequate resources.
B) Demand is expected to grow due to the increase in large corporations.
C) Demand is expected to grow due to the need for forward-looking information.
D) Demand is expected to decline as small businesses use the Internet more.
Answer: C
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3
Chapter 2: The Public Accounting Profession and Audit Quality
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Sample Questions
Q1) The most common organizational form used by public accounting firms is
A) sole proprietorship or partnership.
B) professional corporation.
C) corporation.
D) co-operative.
Answer: A
Q2) There are many elements of quality control at the firm level. Which element does the statement "an organizational culture that emphasizes that quality should be present for audit and review engagements" fall under?
A) leadership and responsibilities within the firm
B) general ethical requirements
C) general human resource policies
D) engagement performance
Answer: A
Q3) Canadian Auditing Standards (CASs) require that an audit be conducted using
A) a controls-testing approach.
B) a risk-assessment approach.
C) a substantive approach.
D) a standard approach.
Answer: B
Page 4
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Chapter 3: Legal Liability
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Sample Questions
Q1) Enron and Equity Funding are companies that suffered from large frauds by corporate management. One important lesson with respect to such cases is that
A) when a company does really well financially it is important to suspect that such results are always inflated.
B) an investigation of the integrity of management is an important part of deciding upon the extent of audit work.
C) securities and exchange commissions expect auditors to be perfect in their assessment of management.
D) partners and staff should cooperate in preparing working papers that prove the accuracy of the financial statements.
Answer: B
Q2) There are four major sources of auditors' legal liability. Briefly summarize the four sources.
Answer: The four sources of auditors' legal liability are: liability to clients under contract law (or common law) liability to third parties under common law and statute law liability under provincial securities acts criminal liability
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Chapter 4: Professional Judgment and Ethics
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Sample Questions
Q1) Frank has discovered that his employer is part of a group of banks that is manipulating interest rates. He would like to stop this practice at his employer but is not sure how best to talk to his boss. He has heard of the GVV (Giving Voice to Values) approach and thinks he may be able to use it successfully because his company has recently implemented new initiatives to empower employees to speak of improvements to business practices. The first step of the GVV approach includes
A) identifying the stakeholders, what is at stake for them, and how to connect with them.
B) identifying the values underpinning the different positions in the conflict and the possibilities for action.
C) considering Frank's personal and professional purpose and choices in this situation. D) development and practice of a powerful response that Frank can use with his boss.
Q2) For which of the following engagements is a contingent fee permitted?
A) an audit engagement of a large listed corporation
B) a tax consulting assignment assessing the excise tax payment processes
C) a review engagement of a small manufacturing corporation
D) an assurance engagement of leasehold payments for a rental agreement
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Chapter 5: Audit Responsibilities and Objectives
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Sample Questions
Q1) Bratlett Company has purchased all of the shares of another company but does not want to consolidate its financial statements. Management has drafted a rather long and confusing note to the financial statements that describes the transaction and states that debt has been acquired in a foreign currency. In your view, the transaction and its effect on the company and the accounts have not been properly disclosed.
Required:
List the audit objectives about presentation and disclosure that have been affected and explain how they are affected.
Q2) The audit process has three categories of audit phases: risk assessment, risk response, and reporting. Which of the following are part of the risk assessment process?
A) preplanning, design further audit procedures, tests of control
B) client risk profile, plan the audit, design further audit procedures
C) client acceptance, understand the entity, plan the audit
D) preplanning, plan the audit, design further audit procedures
Q3) A financial statement audit typically consists of three sections. Identify the three sections and discuss the major activities performed by the auditor in each section.
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Chapter 6: Client Acceptance and Planning the Audit
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Sample Questions
Q1) An important reason for adequately planning the audit engagement is to
A) help decide whether the engagement should be accepted.
B) enable the auditor to obtain sufficient appropriate audit evidence.
C) properly design the contents of the engagement letter.
D) keep audit risk as low as possible.
Q2) There are many types of analytical procedures that the auditor can conduct during the planning stage of the financial statement audit. What is the purpose of comparing prepaid expenses and related expense accounts with those of prior years?
A) to understand the client's industry and business
B) to assess going concern
C) to identify possible misstatements
D) to reduce tests of controls
Q3) A code of ethics is an important document for organizational conduct. In response to the Sarbanes-Oxley Act in the United States, the SEC requires which of the following actions for organizations that have not adopted a code of ethics?
A) explanation of why it has not done so
B) disclosure of actions undertaken to prevent and detect fraud
C) disclosure of all related parties in management and discussion documents
D) a cost-benefit analysis for immediate implementation of one
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Page 8
Chapter 7: Materiality and Risk
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Sample Questions
Q1) A) Explain how auditors use the audit risk model when planning an audit.
B) Describe the audit risk model and each of its components.
Q2) Assessing design effectiveness and conducting tests of controls are required when the auditor
A) chooses to set control risk below 100 percent and relies on the controls.
B) chooses to set control risk below 100 percent even if there is no reliance placed on controls.
C) is planning the audit.
D) tests the design effectiveness.
Q3) When external users place heavy reliance on the financial statements it is appropriate that
A) audit risk be increased.
B) inherent risk be decreased.
C) inherent risk be increased.
D) audit risk be decreased.
Q4) All other factors held constant, if the auditor decreases audit risk then
A) there will be less documentation in the audit file.
B) total audit evidence and audit costs will increase.
C) it will also be necessary to decrease either control risk or inherent risk.
D) less supervision of the audit team will be required.
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Chapter 8: Internal Controls and Control Risk
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Sample Questions
Q1) An example of general computer control systems that provide reasonable assurance of authorization of application systems is
A) operations and information systems support.
B) systems, acquisition, development, and maintenance controls.
C) organization and management controls.
D) application system control procedures.
Q2) The procedures to test effectiveness of control policies and procedures in support of a reduced assessed control risk are called
A) tests of details of balances.
B) tests of controls.
C) analytical procedures.
D) a walk-through.
Q3) An act of two or more employees to work together to misstate records is called A) malfeasance.
B) collusion.
C) defalcation.
D) felony.
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Chapter 9: Audit Evidence
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Sample Questions
Q1) Last year, the client's internal controls were weak. This year, the internal controls are stronger. This means that information recorded on internal documentation is
A) more timely.
B) less reliable.
C) more reliable.
D) less timely.
Q2) Audit evidence can come in different forms with different degrees of persuasiveness. Which of the following is the least persuasive type of evidence?
A) bank statement obtained from the client
B) computations made by the auditor
C) prenumbered client sales invoices
D) a vendor's invoice
Q3) Which of the following is an example of subjective evidence?
A) a positive confirmation of an account receivable
B) a bank confirmation
C) inquiries of the credit manager about the collectability of noncurrent accounts receivable
D) the physical count of securities and cash
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Chapter 10: Audit Strategy and Audit Program
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Sample Questions
Q1) Symco Inc. has a policy that all cash disbursements of $2000 or more must be approved by the treasurer. While performing a test of controls on a sample of disbursements, Craig discovered that the assistant controller had authorized a cash disbursement of $3500 while the treasurer was on vacation. This control deviation is significant only if
A) it is determined that the assistant controller is not qualified to approve cash disbursements of this size.
B) it occurred with sufficient frequency to cause the auditor to believe there may be material dollar misstatements in the statements.
C) the amount of the deviation identified is larger than the planning materiality.
D) the amount of the deviation identified is larger than the planning materiality and no compensating control exists.
Q2) Risks of fraud are assessed at which level(s) of the audit?
A) overall audit, transaction-related audit objectives
B) balance-related audit objectives only
C) overall audit, cycle, and account
D) cycle, account, and transaction-related audit objectives
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Page 12
Chapter 11: Audit Sampling Concepts
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Sample Questions
Q1) During the audit of the fixed asset section, the auditor decided to inspect source documents supporting all fixed asset additions exceeding $3000. This type of audit procedure is called a A) census of the strata over $3000.
B) analytical review.
C) attribute sample.
D) monetary unit sample.
Q2) The final step in the evaluation of the audit results is the decision to A) determine the acceptability of the population.
B) determine sampling error and calculate the estimated total population error. C) analyze exceptions or misstatements.
D) determine the error in each sample.
Q3) When the auditor goes through a population and selects items for the sample without regard to their size, source, or other distinguishing characteristics, it is called A) block selection.
B) haphazard selection.
C) systematic selection.
D) statistical selection.
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Chapter 12: Audit of the Revenue Cycle
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Sample Questions
Q1) A document that describes which accounts receivable accounts are to be written off and why is called a(n)
A) uncollectible account authorization form.
B) journal entry authorization form.
C) master file change form.
D) sales returns and allowances journal.
Q2) Three presentation and disclosure audit objectives are not affected by assessed control risk for the sales transactions. These are
A) rights and obligations, valuation, and understandability.
B) understandability, valuation, and occurrence.
C) valuation, rights and obligations, and classification.
D) classification, understandability, and rights and obligations.
Q3) Stefano is performing a review of the accounts receivable for large and unusual amounts. Of the following accounts receivables, Stefano should pay special attention to an account receivable
A) from a related party.
B) for a large dollar amount.
C) recorded close to year end.
D) that is recurring.
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Page 14
Chapter 13: Audit of the Acquisition and Payment Cycle
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Sample Questions
Q1) Describe the audit procedures typically used to test for out-of-period liabilities (also referred to as the search for unrecorded accounts payable).
Q2) Because of the importance of tests of controls for acquisitions and cash disbursements, it is common in this audit area to use
A) attributes sampling. B) variables sampling.
C) probability-proportional-to-size sampling.
D) block sampling.
Q3) ZyCo has recently converted to a new online accounts payable system. To test that only authorized vendors have been converted to the vendor master file (occurrence), the auditor would
A) conduct cutoff tests for receiving reports and vendor invoices.
B) on a test basis, agree vendor file details for each vendor from the new (online) system to the old (batch) system.
C) on a test basis, agree vendor file details for each vendor from the old (batch) system to the new (online) system.
D) conduct tests of programs to verify that programs in the new systems are functioning as designed.
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Chapter 14: Audit of the Inventory and Distribution Cycle
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Sample Questions
Q1) Receipt of ordered materials by the receiving department will generate the completion of a form called the
A) receiving report.
B) materials requisition.
C) bill of lading.
D) inventory acquisition summary.
Q2) Segregation of duties between production, inventory control, and accounting are important controls in the inventory and distribution cycle. How would the auditor test these controls?
A) using inquiry and reperformance
B) using observation and inquiry
C) using observation and reperformance
D) using discussion with management
Q3) State the six functions that make up the inventory and distribution cycle and, for each function, identify the related documents and/or records that would be used by a manufacturing company.
Q4) Identify three analytical procedures commonly used when auditing accounts in the inventory and distribution cycle.
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Chapter 15: Audit of the Human Resources and Payroll Cycle
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Sample Questions
Q1) A) There are several internal controls in the human resources and personnel function that are important from an audit perspective. For example, there should be an adequate investigation of the competence and trustworthiness of new employees. Discuss other internal controls in the personnel and employment function that are important from an audit perspective.
B) There are several key internal controls over the timekeeping and payroll preparation function that should be present. For example, adequate control over the time on employees' time records includes the use of a time clock or other method of making certain that employees are paid for the number of hours they worked. Discuss other key internal controls over the timekeeping and payroll preparation function.
C) There are several key internal controls over the payment of payroll function that should be present. For example, the payroll should be distributed by someone who is not involved in the other payroll functions. Discuss other key internal controls over the payment of payroll function.
Q2) State the six specific transactions-related audit objectives as related to payroll and for each objective state one common test of controls that can be used to test the objective.
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Page 17
Chapter 16: Audit of the Capital Acquisition and Repayment Cycle
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Sample Questions
Q1) Control risk for notes payable is usually assessed as low. This occurs because internal controls are normally good for notes payable and A) creditors would complain if the notes are not paid.
B) interest expense can easily be distinguished from bank service charges.
C) there are a small number of large transactions for this type of transaction.
D) inclusion in the accounts payable listing helps track the notes.
Q2) There is a direct relationship between the interest and dividend accounts and debt and equity. This means that in the audit of interest-bearing debt, it is desirable to simultaneously verify
A) the related dividends declared and dividends payable.
B) the related interest expense and interest payable.
C) contracts and commitments that are long-term.
D) details provided in the board of directors' minutes.
Q3) The test of details of balances procedure that requires the auditor to recalculate accrued interest will satisfy the audit objective of A) existence.
B) completeness.
C) classification.
D) accuracy.
Page 18
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Chapter 17: Audit of Cash Balances
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Sample Questions
Q1) What is an important benefit of independent preparation of bank reconciliations?
A) an opportunity to independently check that cheques have two signatures
B) the client being able to check that the bank is processing transactions correctly
C) the ability to internally verify cash receipt and disbursement transactions
D) the best time to carefully account for cheques issued
Q2) A major consideration in the audit of the general cash balance is the possibility of fraud. The auditor must extend his or her procedures in the audit of year-end cash to determine the possibility of a material fraud when there are
A) large cash balances at the end of the year.
B) large cash receipts and disbursements during the year.
C) no imprest accounts used for payroll.
D) material internal control weaknesses.
Q3) The starting point for the verification of the balance in the general bank account is to obtain
A) the client's December bank statement and reconcile it.
B) a bank reconciliation from the client.
C) a cutoff bank statement directly from the bank.
D) the client's cash account balance from the general ledger.
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Page 19
Chapter 18: Completing the Audit
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Sample Questions
Q1) Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued?
A) sale of long-term debt or capital stock
B) loss of a plant as a result of a flood
C) major purchase of a business that is expected to double the sales volume
D) settlement of litigation in excess of the recorded liability
Q2) The audit procedures for the subsequent events review can be divided into two categories: 1) procedures normally integrated as a part of the verification of year-end account balances, and 2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures would be in the second category?
A) Examine subsequent-period sales and purchases transactions to determine whether the cutoff is accurate.
B) Correspond with lawyers.
C) Test the collectability of accounts receivable by reviewing subsequent period cash receipts.
D) Compare the subsequent period purchase price of inventory with the recorded cost as a test of lower-of-cost-or-market valuation.
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Chapter 19: Audit Reports on Financial Statements
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Sample Questions
Q1) ProForce Inc. is facing a large lawsuit from its employees. The contingency is significant and may lead to a going concern issue if ProForce is found guilty. ProForce took the adequate measures, as prescribed by IFRS (International Financial Reporting Standards), to account, disclose, and present the contingency in the financial statements. The auditor should
A) add an emphasis of matter paragraph after the opinion paragraph.
B) issue a standard unqualified report.
C) issue a qualified report.
D) deny an audit opinion.
Q2) If inventory is the largest balance on the financial statements, a large misstatement would be so material that the auditor should issue
A) an unqualified opinion.
B) a qualified opinion.
C) an adverse opinion.
D) a disclaimer of opinion.
Q3) There are two conditions requiring a departure from an unqualified audit report. Discuss each of these conditions and state the appropriate audit report for each condition.
Q4) Discuss how materiality affects audit reporting decisions.
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Chapter 20: Other Assurance and Nonassurance Services
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Sample Questions
Q1) A financial statement review emphasizes four broad areas, one of which is to "perform analytical procedures." State the other three areas emphasized.
Q2) Which of the following techniques would be conducted by a practitioner when conducting a review of compliance with agreements and regulations?
A) use of a specialist to ensure that the terms of the agreement are complied with B) inquiring about how the client monitors its compliance with the provisions
C) testing control procedures throughout the year that pertain to the provisions of the agreement
D) discussing with client's legal counsel to identify any legal liabilities with respect to potential violations of the agreements
Q3) Define "assurance engagements."
Q4) Richard is performing a compilation engagement. Richard is concerned that the information is
A) arithmetically correct.
B) accurate.
C) complete.
D) in accordance with ASPE.
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