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AUDIT THEORY 01

AUDITING THEORY

 PREFACE TO THE PHILIPPINE STANDARDS ON QUALITY CONTROL, AUDITING, REVIEW, OTHER


ASSURANCE AND RELATED SERVICE
 PHILLIPINE FRAMEWOR FOR ASSURANCE ENGAGEMENTS
 FRAMEWORK OF THE PHILIPPINES STANDARDS ON AUDITING (PSA 120)
 OVERALL OBJECTIVES OF THE INDEPENDENT AUDITOR AND THE CONDUCT OF AN AUDIT IN
ACCORDANCE WITH PHILIPPINE STANDARDS ON AUDITING (PSA 200)

The Authority Attaching to Philippine Standard Issued by the AASC


Standards Application
1. Philippine Standards on Auditing (PSAs)  Audit of historical financial information
2. Philippine Standards on Review Engagements  Review of historical financial information
(PSREs)
3. Philippine Standards on Assurance  Assurance engagements dealing with subject
Engagements (PSAEs) matters other than historical financial
information
4. Philippine Standards on Related Services  Compilation engagements
(PSRSs)  Engagements to apply agreed-upon
procedures to information
 Other related services engagements as
specified by the AASC

1. PSAs, PSREs, PSAEs and PSRSs are collectively referred to as the AASC’s Engagement Standards.
2. Philippine Standards on Quality Control (PSQC) are to be applied for all services falling under the
AASC’s engagement standards.
3. Philippine Standards are applicable to engagements in the Public Sector.

The Authority Attaching to Practice Statements Issued by the AASC


1. Philippine Practice Statements are issued to:
o Provide interpretive guidance and practical assistance to professional accountants in
implementing Philippine Standards; and
o Promote good practice

2. Professional accountants should be aware of and consider Practice Statements applicable to the
engagement.

3. A professional accountant who does not consider and apply the guidance included in a relevant
Practice Statement should be prepared to explain how the basic principles and essential
procedures in the AASC’s Engagement Standard(s) addressed by the Practice Statement have been
compiled with.

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AASC Bulletins and AASC Alerts


o A regular publication issued by the AASC to provide guidance to auditors in the application of
PSAs.
o Not part of PSAs and do not change the requirements of relevant PSAs.

PHILIPPINE FRAMEWORK FOR ASSURANCE ENGAGEMENTS


1. The Framework does not itself establish standards or provide procedural requirements for the
performance of assurance engagements.
2. In addition to the Framework and PSAs, PSREs and PSAEs, practitioners who perform assurance
engagements are governed by:
 The Philippine Code of Ethics for Professional Accountants; and
 Philippine Standards on Quality Control (PSQCs)

ASSURANCE ENGAGEMENTS
1. “Assurance engagement” means an engagement in which a practitioner expresses a conclusion
designed to enhance the degree of confidence of the intended users other than the responsible
party about the outcome of the evaluation or measurement of a subject matter against criteria.
2. “Subject matter information” refers to the outcome of the evaluation or measurement of a subject
matter.
3. In some assurance engagements, the evaluation or measurement of the subject matter is
performed by the responsible party, and the subject matter information is in the form of an
assertion by the responsible party that is made available to intended users (assertion-based
engagements).
4. In other assurance engagements, the practitioners either directly performs the evaluation or
measurement of the subject matter, or obtains a representation from the responsible party that
has performed evaluation or measurement that is not available to the intended users. The subject
matter information is provided to the intended users in the assurance report (direct reporting
engagements).

Two Types of Assurance Engagement


1. Reasonable assurance engagement – the objective is a reduction in assurance engagement risk to
an acceptable low level in the circumstances of the engagement as the basis for a positive form of
expression of the practitioner’s conclusion.
2. Limited assurance engagement – the objective is a reduction in assurance engagement risk to a
level that is acceptable in the circumstances of the engagement, but where the risk is greater than
for a reasonable assurance engagement, as a basis for negative form of expression of the
practitioner’s conclusion.

Scope of the Framework


The following are non-assurance engagements and therefore are not covered by the Framework:
1. Engagements covered by PSRSs such as agreed-upon procedures engagements and compilations
of financial or other information.
2. The preparation of tax returns where no conclusion conveying assurance is expressed.
3. Consulting (or advisory) engagements, such as management and tax consulting)

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Elements of Assurance Engagements


1. A three-party relationship involving:
 A practitioner:
 A responsible party; and
 Intended users.
2. An appropriate subject matter;
3. Suitable criteria;
4. Sufficient appropriate evidence; and
5. A written assurance report in the form appropriate to a reasonable assurance engagement or a
limited assurance engagement.

OVERALL OBJECTIVES OF THE INDEPENDENT AUDITOR AND THE CONDUCT OF AN AUDIT IN ACCORDANCE
WITH PSAs
1. In conducting an audit of financial statements, the auditor’s OVERALL OBJECTIVES are:
a) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error, thereby enabling the auditor to express an
opinion on whether the financial statements are prepared, in all materials respects, in accordance
with an applicable financial reporting framework; and
b) To reports on the financial statements, and communicate as required by the PSAS in accordance
with the auditor’s findings.

2. The auditor SHALL:


• Comply with all PSAS relevant to the audit.
• Comply with relevant ethical requirements, including those pertaining to independence relating to
financial statement audit engagements.
• Plan and perform an audit with professional scepticism recognizing that circumstances may exist
that cause the financial statements to be materially misstated.
• Exercise professional judgment in planning and performing an audit of financial statements.
• Obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level.

ENGAGEMENTS TO REVIEW FINANCIAL STATEMENTS?


1. The objective of a review of financial statements Is to enable a practitioner to state whether, on
the basis of procedures which do not provide all the evidence that would be required in an audit,
anything has come to the practitioner’s attention that causes the practitioner to believe that the
financial statements are not prepared, in all material respects, in accordance with an identified
financial reporting framework (negative assurance).

2. A review comprises INQUIRY and ANALYTICAL PROCEDURES which are designed to review the
reliability of an assertion that is the responsibility of one party for use by another party.

3. A review does not ordinarily involve an assessment of accounting and internal control systems, test
of records and of responses to inquiries by obtaining corroborating evidence through inspection,

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observation, confirmation and computation, which are procedures ordinarily performed during an
audit.

4. The level of assurance provided in a review report less than that given in an audit report.

ENGAGEMENTS TO PERFORM AGREED-UPON PROCEDURES REGARDING FINANCIAL INFORMATION


1. In an engagement to perform agreed-upon procedures, an auditor is engaged to carry out those
procedures of an audit nature to which the auditor and the entity and any appropriate third
parties have agreed to report on FACTUAL FINDINGS.
2. The recipients of the report must form their own conclusion from the report of the auditor.
3. The report is restricted to those parties that have agreed to the procedures to be performed since
others, unaware of the reasons for the procedures, may misinterpret the results

ENGAGEMENTS TO COMPILE FINANCIAL INFORMATION


1. In a compilation engagement, the accountant is engaged to use accounting expertise as opposed
to auditing expertise to collect, classify, and summarize financial information.
2. It ordinarily entails reducing detailed data to manageable and understandable form without a
requirement to test the assertions underlying that Information.
3. The procedures performed are not designed and do not enable the accountant to express any
assurance on the financial information.
4. Users of compiled financial information derive same benefit as a result of the accountant’s
involvement because the service has been performed with due professional skill and care.

SUMMARY
Nature of Service Audit Review Agreed-upon Compilation
Procedures
Level of Assurance High, but not Moderate assurance No assurance No assurance
Provided absolute
assurance
Report Provided Positive assurance Negative assurance Factual Identification of
on assertion (s) on assertion (s) findings of information
(Audit Report) (Review Report) procedures complied
(Compilation
Report)

MULTIPLE CHOICE QUESTIONS


1. Which of the following statements best describes assurance services?
A. Independent professional services that are intended to enhance the credibility of information
to meet the needs of an intended user.
B. Services designed to express an opinion on the fairness of historical financial statements based
on the results of an audit.
C. The preparation of financial statements or the collection, classification, and summarization of
other financial information.
D. Services designed for the improvement of operations, resulting in better outcomes.

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2. Which of the following engagements is covered by the Framework for Assurance Engagements?
A. Consulting engagements.
B. Agreed-upon procedures engagement.
C. Preparation of tax returns.
D. Independent financial statements audit

3. Assurance services differ from consulting services In that they


I. Focus on providing advice.
II. Involve monitoring of one party by another.
A. I only C. Both I and II
B. II Only D. Neither I nor II

4. How many separate parties are involved in an assurance engagement?


A. 2 C. 4
B. 3 D. 5

5. An assurance engagement should have which of the following elements?


Subject matter Criteria
A. Yes No
B. No Yes
C. Yes Yes
D. No No

6. The subject matter of an assurance engagement may include


Internal Compliance Internal Controls Compliance With-Regulation
A. Yes Yes Yes
B. No Yes No
C. Yes No Yes
D. No Yes No

7. Suitable criteria are required for reasonably consistent evaluation or measurement of the subject
matter of an assurance engagement. Which of the following statements concerning the
characteristics of suitable criteria is correct?
A. Reliable criteria contribute to conclusions that are clear, comprehensive, and not subject to
significantly different interpretations.
B. Relevant criteria allow reasonably consistent evaluation or measurement of the subject matter
including, where relevant, presentation and disclosure, when used in similar circumstances by
similarly qualified practitioners.
C. Neutral criteria contribute to conclusions that are free from bias.
D. Criteria are sufficiently complete when they contribute to conclusions that are clear,
comprehensive, and not subject to different Interpretations.

8. Criteria that are embodied In laws or regulations, or issued by authorized or recognized bodies of
experts that follow a transparent due process are called
A. Suitable criteria
B. Established criteria

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C. Specifically developed criteria


D. General criteria

9. In an assurance engagement, the outcome of the evaluation or measurement of a subject against


criteria is called
A. Subject matter information
B. Subject matter
C. Assurance
D. Conclusion

10. In some assurance engagements, the evaluation or measurement of the subject matter is
performed by the responsible party, and the subject matter information is in the form of an
assertion by the responsible party that is made available to intended users. These engagements
are called
A. Direct reporting engagements
B. Assertion-based engagements
C. Non-assurance engagements
D. Recurring engagements

11. ______________is the risk that the practitioner expresses an inappropriate conclusion when the
subject matter information is materially misstated.
A. Assurance engagement risk.
B. Business risk.
C. Client risk.
D. Information risk.

12. Which of the following is the objective of a reasonable assurance engagement?


A. A reduction in assurance engagement risk to a level that Is acceptable in the circumstances of
the engagement as a basis for a negative form of expression of the practitioner’s conclusion.
B. A reduction in assurance engagement risk to a very low level in the circumstances of the
engagement as a basis for a disclaimer of the practitioner’s conclusion.
C. A reduction in assurance engagement risk to a level that is acceptable in the circumstances of
the engagement as a basis for a qualified form of expression of the- practitioner’s conclusion.
D. A reduction in assurance engagement risk to an acceptably low level in the circumstances of
the engagement as a basis for a positive form of expression of the practitioner’s conclusion.

13. Which of the following statements is true concerning evidence in an assurance engagement?
A. Sufficiency is the measure of the quantity of evidence.
B. Appropriate is the measure of the quality of evidence, that is, its reliability and per suaveness.
C. The reliability of evidence is Influenced nut by its nature nut by its source.
D. Obtaining more evidence may compensate far is poor quality.

14. Reducing assurance engagement risk to zero is very rarely attainable or cost beneficial as a result
of the following factors, except
A. The use of selective testing.
B. The fact that much of the evidence available to the practitioner is persuasive rather than
conclusive.
C. The practitioner may n

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D. To have the required assurance knowledge and skills to gather and evaluate evidence.
E. The use of limit in gathering anti evaluating evidence and farming conclusions based on that
evidence.

15. The Philippines Framework for Assurance Engagements


A. Contains basic principles, essential procedures, and related guidance for the performance of
assurance engagements.
B. Defines and describes the elements and objectives of an assurance engagement, and
identifies engagements to which PSAs, PSREs, and PSAEs apply.
C. Provides a frame of reference for CPAs on public practice when performing audits, reviews,
and compilations of historical financial information.
D. Establishes standards and provides procedural requirements tor the performance of
assurances engagements.

16. After accepting an assurance engagement, a practitioner is not allowed to change the engagement
to non-assurance engagement, or from a reasonable assurance engagement to a limited assurance
engagement, except when there is reasonable justification for the change. Which of the following
ordinarily will justify a request for a change in the engagement?
I. A change in circumstances that affects the intended users' requirements.
II. A misunderstanding concerning dilemma of the engagement.
A. I only
B. II only
C. Both 1 and II
D. Neither I nor II

17. Which of the following standards are to be applied, as appropriate, in the audit of historical
financial information?
A. PSRES
B. PSAB
C. PSRSs
D. PSAs

18. PSRE 2400 (Engagements to Review Financial Statements), as amended by the AASC in February
2008, applies to|
A. Review of any historical financial Information of an audit client.
B. Reviews of any historical financial Information by a practitioner other than the entity’s auditor
C. Reviews of historical financial or other information by a practitioner other than the entity’s
auditor
D. Reviews of historical financial or other information of an audit client.

19. The Philippine Standards on Assurance Engagements (PSAEs) are to be applied in


A. Assurance engagements dealing with subject matters other than historical financial
information
B. Compilation engagements and agreements to apply agreed-upon procedures to information.
C. The audit or review of historical financial information.
D. Assurance engagements dealing with historical financial information.

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20. The Philippine Standards on Quality Control (PSQCs) are to be applied to


A. Assurance engagements only
B. Review engagements only
C. Compilations and review engagements only.
D. All services that fall under the AASC’s engagement standards.

21. These statements are issued by the AASC to provide interpretive guidance and practical assistance
to auditors in the implementation of PSAs ad to promote good practice.
A. PREPSs C. PAEPs
B. PAPSs D. PRSPSs

22. What level of assurance is provided by the auditor in an audit engagement?


A. Absolute C. Moderate
B. High, but not absolute D. No assurance

23. What level of assurance is provided by the practitioner in a review engagement?


A. No assurance C. Reasonable
B. High, but not absolute D. Moderate

24. When performing a compilation engagement, the accountant is required to


A. Assess internal controls.
B. Make inquiries of management to assess the reliability and completeness of the information
provided.
C. Verify matters and explanations.
D. Obtain a general knowledge of the business and operations of the entity.

25. What assurance is provided by the auditor in an agreed-upon procedures engagement?


A. Reasonab1e C. Moderate
B. Absolute D. No assurance

26. The review of a company’s financial statements by a CPA firm


A. Is substantially less in scope of procedures than an audit.
B. Requires detailed analysis of the major accounts.
C. Is of similar scope as an audit and adds similar credibility to the statements.
D. Culminates In issuance of a report expressing the CPA’S opinion as to the fairness of the
statements.

27. An engagement o perform agreed upon procedures may involve the auditor in performing certain
procedures concerning
I. Individual items of financial data.
II. A single financial statement.
III. A complete set of financial statements.
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III

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28. A summary of findings rather that assurance is most likely to be included in a/an
A. Agreed-upon procedures report.
B. Compilation report.
C. Examination report.
D. Review report.

29. Inquiries and analytical procedures ordinarily form the basis for which type of engagement?
A. Agreed-upon procedure.
B. Audit
C. Examination
D. Review

30. Independence is not a requirement for which of the following engagements,


Compilation Review Agreed-upon Procedures
A. No Yes No
B. No No No
C. Yes No Yes
D. Yes Yes Yes

31. A practitioner should agent an assurance engagements?


A. The subject matter MTh the form of financial information.
B. The criteria to be used are not available to the intended users
C. The practitioner’s conclusion is to be contained in a written report.
D. The subject matter is the responsibility of either the intended users or the practitioner.

32. A practitioner is associated with financial information when


I. The practitioner attaches a report to that financial information.
II. The practitioner consents to the use of his/her name in a professional connection
A. I only
B. II only
C. Either I or II
D. Neither I nor II

33. The auditor is required to comply with all PSAs relevant to the audit of an entity's financial
statements. A PSA is relevant to the audit when
I. The PSA is in effect.
II. The circumstances addressed by the PSA exist.
A. I only C. Either I or II
B. II only D. Both I and II

34. The overall objectives of the auditor in conducting an audit of financial statements are
I. To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether caused by fraud or error.
II. To report on the financial statements.
III. To obtain conclusive rather than persuasive evidence.
IV. To detect all misstatements, •whether clue to fraud or error.
A. I and II only
B. II and IV only

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C. I, II, and III only


D. I, II, III, and IV

35. The auditor is required to maintain professional scepticism throughout the audit. Which of
following statements concerning professional scepticism is false?
A. A belief that management and those charged with governance are honest and have integrity
relieves the auditor of the need to maintain professional scepticism.
B. Maintaining professional scepticism throughout the audit reduces the risk of using
inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the result: thereof.
C. Professional scepticism is necessary to the critical assessment of audit evidence.
D. Professional scepticism is an attitude that includes questioning contradictory audit evidence
obtained.

36. Which of the following best describes the reason why independent auditors report on financial
statements?
A. A management fraud may exist and it is more likely to be detected by independent auditors.
B. Different interests may exist between the company preparing the statements and the
Persons using the statement.
C. A misstatement of account balances may exist and is gene.), corrected as the result of the
independent auditors' work.
D. Poorly designed internal control may be in existence.

37. Which of the following professionals has primary responsibility for the performance of an audit?
A. The managing partner of the firm.
B. The senior assigned to the engagement.
C. The manager assigned to the engagement.
D. The partner in charge of the engagement

38. What is the proper organizational role of internal auditing?


A. To serve as an independent, objective, assurance and consulting activity that adds value to
operation
B. To assist the external auditor in order to reduce external audit fees.
C. To perform studies to assist in the attainment of more efficient operations.
D. To serve as the investigative arm of the audit committee of the board of directors.

39. Operational audits generally have been conducted by Internal and COA auditors, but may be
performed by certified public accountants. A primary purpose of an operational audit is provide
A. A measure of the management performance in meeting organizational goals.
B. The results of internal examinations of financial and accounting matters to a company’s top-
level management.
C. Aid to the independent auditor, who conducting the examination of the financial statements.
D. A means of assurance that internal accounting controls are functioning as Planned.

40. Governmental auditing often extends beyond examinations leading to the expression of opinion
on the fairness of financial presentation and includes audit of efficiency, economy, effectiveness,
and also
A. Accuracy.

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B. Evaluation.
C. Compliance.
D. Internal control.

41. Which of the following terms best describes the audit of a taxpayer's return by a BIR auditor?
A. Operational audit.
B. Internal audit.
C. Compliance audit.
D. Government audit.

42. Which of the following statements concerning consulting services is false?


A. The performance of consulting services for audit clients does not, in and of itself, impair the
auditor's independence.
B. Consulting services differ fundamentally from the CPA's function of attesting to the assertions
of other parties.
C. Consulting services ordinarily involve external reporting.
D. Most CPAs, including those who provide audit and tax services, also provide consulting services
to their clients.

43. Operational auditing is primarily oriented toward


A. Future improvements to accomplish the goals of management.
B. The accuracy of data reflected in management's financial records.
C. The verification that a company's financial statements are fairly presented.
D. Past protection provided by existing internal control.

44. An audit to determine whether an entity is following specific procedures or rules set down by some
higher authority is classified as a/an
A. Audit of financial statements.
B. Compliance audit.
C. Operation audit.
D. Product. Audit.
.
45. Which of the following is the most appropriate action to be taken by a CPA who has been asked to
perform a consulting services engagement concerning the analysis of a potential if he/she has little
experience with the industry involved?
A. Accept the engagement but he/she should conduct research or consult with others to obtain
sufficient competence.
B. Decline the engagement because he/she lacks sufficient knowledge
C. Accept the engagement and issue a report that contains his/her opinion on the achieve ability
of the results of the merger.
D. Accept the engagement and perform it in accordance with Philippine Standards on Auditing
(PSAs).

46. An objective of a performance audit is to determine whether an entity's


A. Operational information is in accordance with government auditing standards.
B. Specific operating units are functioning economically and efficiently.
C. Financial statements present fairly the results-c3Foperations.
D. Internal control is adequately operating as designed.

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47. Internal auditors should renew the means of physically safeguarding assets from losses
A. Exposure to the elements.
B. Under usage of physical facilities.
C. Misapplication of accounting principles.
D. Procedures that are not cost justified

48. The internal auditing department's responsibility for deterring fraud is to


A. Establish an effective internal control system.
B. Maintain internal control.
C. Examine and evaluate the system of internal control.
D. Exercise operating authority over fraud prevention activities.

49. Internal auditors review the adequacy of the company's internal control system primarily to
A. Help determine the nature, timing, and extent of tests necessary to achieve audit objectives.
B. Determine whether the internal control system provides reasonable assurance that the
company's objectives and goals are met efficiently and economically.
C. Ensure that material weaknesses in the system of internal control are corrected.
D. Determine whether the internal control system ensures that financial statements are fairly
presented.

50. Which of the following services, if any, may a practitioner who is not independent provide?
A. Compilations but not reviews.
B. Reviews but not compilations.
C. Reviews but not financial statement audits.
D. Agreed-upon procedures but not compilations.

--END--

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