Auditing Theory

V. PRELIMINARY ENGAGEMENT ACTIVITIES

Coverage: PSA 210: Agreeing the terms of audit engagements.
PSA 510: Initial Audit Engagements – Opening Balances
Direction: Read and answer the following questions.

___1. Under PSA 210: Agreeing the terms of audit engagements, what is the objective of the auditor?
a. To accept or continue an engagement only when the basis upon which it is to be performed has been
agreed.
b. To accept or continue an engagement only when the audit fee is substantial.
c. To accept or continue an engagement only when the auditor is not independent.
d. To accept or continue an engagement only when the auditor will provide limited assurance.

___2. Under PSA 210, how does an auditor determine when the basis upon the performance of audit
engagement has already been agreed upon?
a. Through establishing whether the preconditions for an audit are present
b. Through confirming that there is a common understanding between the auditor and management and,
where appropriate, those charged with governance of the terms of the audit engagement
c. Both A and B
d. Neither A nor B

___3. It refers to the use by management of an acceptable financial reporting framework in the preparation of
the financial statements and the agreement of management and, where appropriate, those charged with
governance to the premise on which an audit is conducted.
a. Professional judgment
b. Preconditions for an audit
c. Professional skepticism
d. Professional competence and due care

___4. What shall the auditor do in order to establish whether the preconditions of an audit are present?
a. The auditor shall determine whether the financial reporting framework to be applied in the preparation
of the financial statements is acceptable.
b. The auditor shall obtain the agreement of management that it acknowledges and understands its
responsibility.
c. Both A and B.
d. Neither A nor B.

___5. The following are the responsibilities of client’s management and those charged with governance,
except
a. Preparation of the financial statements in accordance with the applicable financial reporting framework,
including where relevant their fair presentation.
b. Establishment of such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement, whether due to fraud or
error.
c. Prevention and detection of illegal acts.
d. Designing audit procedures to reduce audit risk to an acceptable level.

___6. What shall the auditor ideally do if management or those charged with governance impose a limitation
on the scope of the auditor’s work in the terms of a proposed audit engagement such that the auditor believes
the limitation will result in the auditor disclaiming an opinion on the financial statement?
a. The auditor shall still accept the audit engagement and issue a qualified opinion due to scope limitation.
b. The auditor shall still accept the audit engagement and issue a disclaimer opinion.
c. The auditor shall still accept the audit engagement and issue an adverse opinion.
d. The auditor shall not accept such a limited engagement as an audit engagement, unless required by
law or regulation to do so.

___7. What may the auditor do if the preconditions for an audit are not present?
a. The auditor shall discuss the matter with management.
b. Unless required by law or regulation to do so, the auditor shall not accept the proposed audit
engagement if the auditor has determined that the financial reporting framework to be applied in the
preparation of the financial statements is unacceptable.
c. Unless required by law or regulation to do so, the auditor shall not accept the proposed audit
engagement if understanding with management or those charged with governance concerning their
responsibility has not been obtained.
d. Any of the above.

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___8. It refers to the written record or evidence of agreed terms of the audit engagement between auditor and
client’s management or those charged with governance.
a. Comfort letter
b. Management representation letter
c. Engagement letter
d. Confirmation letter

___9. The engagement letter shall include the following, except

a. The objective and scope of the audit of the financial statements
b. The responsibilities of the auditor
c. The responsibilities of management
d. Identification of the applicable financial reporting framework for the preparation of the financial
statements
e. Reference to the expected form and content of any reports to be issued by the auditor and a statement
that there may be circumstance
f. Basis for computation of audit fee and periods of billing
g. Materiality, audit evidence and audit procedures

___10. On recurring audits, the auditor shall assess whether circumstances require the terms of the audit
engagement to be revised and whether there is a need to remind the entity of the existing terms of the audit
engagement. In which of the following would the auditor be unlikely to send a new engagement letter to a
recurring audit or continuing client?
a. A change in terms of the engagement
b. A significant change in the nature or size of the client’s business
c. A recent change of client management
d. A recent change in the partner and/or staff in the audit engagement

___11. After accepting the audit engagement, an engagement letter should be prepared which serves as the
contract between the auditor and client. The letter shall set forth the following, except
a. The forms or any reports or other communication that the auditor expects to issue.
b. Audit procedures, audit evidence and sample size to be used by the auditor.
c. The scope and objective of the audit of financial statements.
d. The management’s responsibility for the presentation of the financial statements and client’s
responsibility to allow the auditor to have unrestricted access to whatever records, documentation and
information requested in connection with the audit.

___12. What is the importance of the engagement letter to both the client and auditor?
a. It provides information about the procedures and audit evidence to be obtained by the auditor.
b. It assures that unqualified opinion will be issued by the auditor.
c. It minimizes misunderstandings with respect to the engagement and document/confirm the auditor’s
acceptance of the appointment.
d. It eliminates the risk that the auditor will issue an inappropriate opinion.

___13. The auditor does not normally send new engagement letter every year for recurring audits. However,
the following factors may cause the auditor to send a new engagement letter, except
a. An increase in the number of the newly accepted clients of the auditing firm.
b. Any indication that the client misunderstands the objective and scope of the audit.
c. A recent change of senior management, board of directors or ownership.
d. A significant change in the nature or size of the client’s business or change in legal requirements and
other government pronouncements.

___14. The following are the considerations before accepting an audit engagement, except
a. To determine the whether the auditor has the necessary skills and competence to handle the
engagements.
b. To determine whether there are any threats to the audit team’s independence and objectivity and if so,
whether adequate safeguards can be established.
c. To determine the appropriate opinion to be issued.
d. To determine the whether there are enough qualified personnel to perform the audit.

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___15. What shall be done by the auditor if there is request for change in the terms of audit engagement?
a. The auditor shall not agree to a change in the terms of the audit engagement where there is no
reasonable justification for doing so.
b. If, prior to completing the audit engagement, the auditor is requested to change the audit engagement
to an engagement that conveys a lower level of assurance, the auditor shall determine whether there is
reasonable justification for doing so.
c. If the terms of the audit engagement are changed, the auditor and management shall agree on and
record the new terms of the engagement in an engagement letter or other suitable form of written
agreement.
d. Any of the above.

___16. If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted
by management to continue the original audit engagement, what shall be done by the auditor?
a. Withdraw from the audit engagement where possible under applicable law or regulation.
b. Determine whether there is any obligation, either contractual or otherwise, to report the circumstances
to other parties, such as those charged with governance, owners or regulators
c. Both A and B
d. Neither A nor B

___17. In conducting an initial audit engagement, what is the objective of the auditor with respect to opening
balances?
a. To obtain sufficient appropriate audit evidence about whether opening balances contain misstatements
that materially affect the current period’s financial statements.
b. To obtain sufficient appropriate audit evidence about whether appropriate accounting policies reflected
in the opening balances have been consistently applied in the current period’s financial statements, or
changes thereto are properly accounted for and adequately presented and disclosed in accordance
with the applicable financial reporting framework.
c. Both A and B.
d. Neither A nor B.

___18. What is initial audit engagement?

a. An engagement in which the financial statements for the prior period were not audited.
b. An engagement in which the financial statements for the prior period were audited by a predecessor
auditor.
c. Either A or B.
d. Neither A nor B.

___19. Which of the following statements concerning opening balances is incorrect?

a. Opening balances are those account balances that exist at the beginning of the period.
b. Opening balances are based upon the closing balances of the prior period and reflect the effects of
transactions and events of prior periods and accounting policies applied in the prior period.
c. Opening balances also include matters requiring disclosure that existed at the beginning of the period,
such as contingencies and commitments.
d. Opening balances need not be audited if the last year’s financial statements contain unqualified opinion
issued by a predecessor auditor.

___20. He refers to the auditor from a different audit firm, who audited the financial statements of an entity in
the prior period and who has been replaced by the current auditor.
a. Predecessor auditor
b. Current auditor
c. Existing auditor
d. Potential auditor

___21. The following procedures shall at least be done by the newly appointed auditor concerning opening
balances, except
a. The auditor shall read the most recent financial statements, if any, and the predecessor auditor’s report
thereon, if any, for information relevant to opening balances, including disclosures.
b. The auditor shall determine whether the prior period’s closing balances have been correctly brought
forward to the current period or, when appropriate, have been restated.
c. The auditor shall determine whether the opening balances reflect the application of appropriate
accounting policies.
d. The auditor shall review the audit opinion issued by the predecessor auditor to determine its
correctness.

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___22. The following audit procedures may be done by the newly appointed auditor regarding opening
balances, except
a. Where the prior year financial statements were audited, reviewing the predecessor auditor’s working
papers to obtain evidence regarding the opening balances.
b. Evaluating whether audit procedures performed in the current period provide evidence relevant to the
opening balances.
c. Performing specific audit procedures to obtain evidence regarding the opening balances.
d. Revising the audit opinion issued by the predecessor auditor for last year’s financial statements if
revision is necessary.

___23. If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances,
a. The auditor shall express a qualified opinion or a disclaimer of opinion, depending on the
pervasiveness of material scope limitation.
b. The auditor shall express a qualified opinion or a adverse of opinion, depending on the pervasiveness
of material misstatements.
c. The auditor shall express an unqualified opinion regardless of materiality of scope limitation.
d. The auditor shall withdraw from the engagement despite the possible breach of contract.

___24. If the auditor concludes that the opening balances contain a misstatement that materially affects the
current period’s financial statements, and the effect of the misstatement is not properly accounted for or not
adequately presented or disclosed
a. The auditor shall express a qualified opinion or a disclaimer of opinion, depending on the
pervasiveness of material scope limitation.
b. The auditor shall express a qualified opinion or a adverse of opinion, depending on the pervasiveness
of material misstatements.
c. The auditor shall express an unqualified opinion regardless of materiality of scope limitation.
d. The auditor shall withdraw from the engagement if there will be no civil damages.

__25. Who shall initiate the communication between a successor and predecessor auditor in case there is
change in the auditor of a company?
a. Successor auditor upon obtaining permission from the client
b. Predecessor auditor upon obtaining permission from the client
c. The client’s management
d. The SEC and BOA representatives

___26. Before accepting a new client, the auditor should make inquiries with the client’s predecessor auditor
regarding the following, except
a. The predecessor’s understanding as to the reasons for the change of auditors.
b. Any disagreements between the predecessor auditor and the client.
c. Any facts that might have a bearing on the integrity of the prospective client’s management.
d. Schedule of the audit procedures to be performed.

QUIZZER

___1. Before accepting an engagement to audit a new client, a CPA is required to obtain
a. A preliminary understanding of the prospective client’s industry and business
b. The prospective client’s signature to the engagement letter
c. An understanding of the prospective client’s control environment
d. A representation letter from the prospective client

___2. An engagement letter would not normally include

a. Billing arrangement
b. Arrangement concerning client’s assistance
c. Details of the procedure that will be performed
d. Expectation of receiving a representation letter from management

___3. If an auditor believes that an understanding with the client has not been established, he or she should
ordinarily
a. Perform the audit with increased professional skepticism
b. Decline to accept or perform the audit
c. Assess the control risk at the maximum level and perform a primarily substantive audit
d. Modify the scope of the audit to reflect an increased risk of material misstatement due to fraud

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___4. After preliminary audit, arrangements have been made, an engagement confirmation letter should be
sent to the client. The letter usually would not include
a. A reference to the auditor’s responsibility for the detection of errors or irregularities
b. An estimate of the time to be spent on the audit work by audit staff and management
c. A statement that management advisory services would be made available upon request
d. A statement that a management letter will be issued outlining comments and suggestions as to any
procedures requiring the client’s attention

___5. PSA 200 provides that an auditor should conduct a background investigation of the prospective client in
order to
a. Determine the capability of the client to pay the audit fees.
b. Minimize the likelihood of association with clients whose management lacks integrity.
c. Discover the auditability of the financial statements of the company.
d. Provide assurance that the client is the leader in the industry.

___6. Which of the following factors most likely would influence an auditor’s determination of the auditability of
the entity’s financial statements?
a. The complexity of the accounting system
b. The existence of related party transactions
c. The adequacy of the accounting records
d. The operating effectiveness of control procedures

___7. An auditor requested permission to communicate with the predecessor auditor and review certain
portions of the latter’s working papers. Upon request from the client, the latter refused to allow the successor
auditor. Such refusal will bear directly on the successor auditor’s decision concerning the
a. Adequacy of the preplanned audit program
b. Ability to establish consistency in application of accounting principles between years
c. Apparent scope limitation
d. Integrity of management

___8. Which of the following factors most likely would cause an auditor to decline a new audit engagement?
a. Concluding that the entity’s management probably lacks integrity.
b. An inability to perform preliminary analytical procedures before assessing control risk.
c. An inadequate understanding of the entity’s internal control.
d. The close proximity to the end of the entity’s reporting period.

___9. Before accepting an engagement to audit a new client, an auditor is required to

a. Obtain a copy of the client’s financial statements.
b. Prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit
plan.
c. Make inquiries of the predecessor auditor after obtaining consent of the prospective client.
d. Discuss the management representation letter with the client’s audit committee.

___10. Which of the following conditions most likely would pose the greater risk in accepting a new audit
engagement?
a. There will be a client-imposed scope limitation.
b. The client’s financial reporting system has been in place for 10 years.
c. The firm will have to hire an expert in one audit area.
d. Staff will need to be rescheduled to cover this new client.

___11. Which of the following circumstances would permit an independent auditor to accept an engagement
after the end of the reporting period?
a. Expectation of the operating effectiveness of controls.
b. Issuance of a disclaimer of opinion as a result of inability to conduct certain tests required by PSAs due
to the timing of the acceptance of the engagement.
c. Remedy the limitations resulting from accepting the engagement after the end of the reporting period,
such as those relating to the existence of physical inventory.
d. Receipt of an assertion from the predecessor auditor that the entity will be able to continue as a going
concern.

___12. In an audit based on Philippine Standards on Auditing, a successor auditor would normally become
satisfied with opening balances by
a. Performing analytical procedures
b. Reviewing the predecessor’s working papers
c. Auditing the previous year’s working papers

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 d. Interviewing client personnel
___13. A predecessor auditor withdrew from the engagement after discovering that a client’s financial
statements are materially misstated that it would not revise. If asked by the successor auditor about the
termination of the engagement, the predecessor should
a. Suggest that the successor auditor should obtain the client’s consent to discuss the reasons.
b. Indicate that there was a misunderstanding.
c. State that the audit revealed material misstatement that the client would not revise.
d. Suggest that the successor auditor ask the client.

___14. An audit conducted on the premise that management, and where appropriate, those charged with
governance, have acknowledged and understood that they have responsibility that are fundamental to the
conduct of an audit in accordance with PSAs. Which of the following is not one of those responsibilities?
a. The preparation of financial statements in accordance with relevant pronouncements such as PSAs.
b. The establishment and maintenance of an adequate internal control system that is necessary to enable
the preparation of financial statements that are free from material misstatements, whether due to fraud
or error.
c. To provide the auditor with access to all information that is relevant to the preparation of the financial
statements such as records, documentation, and other matters.
d. To provide the auditor with unrestricted access to persons within the entity from which the auditor
determines it necessary to obtain audit evidence.

___15. The auditor shall agree the terms of the audit engagement with management or those charged with
governance, as appropriate. The agreed terms shall be recorded in a/an
a. Engagement letter
b. Letter of audit inquiry
c. Management representation letter
d. Confirmation letter

___16. The following matters are generally included in an auditor’s engagement letter, except
a. The factors to be considered in determining the overall materiality.
b. The fact that because of the test nature and other inherent limitations of an audit, together with the
inherent limitations of internal control, there is an unavoidable risk that even some material
misstatements may remain undiscovered.
c. The scope and purpose of the audit.
d. Management’s responsibility for the preparation of financial statements.

___17. Which of the following statements would least likely appear in an auditor’s engagement letter?
a. Our audit will be made with the objective of our expressing an opinion on the financial statements.
b. We remind you that the responsibility for the preparation of financial statements including adequate
disclosure is that of the management of the entity.
c. After performing our preliminary procedures, we will discuss with you the other procedures we consider
necessary to complete engagement.
d. Our fees, which will be billed as work progresses, are based on the time required by the individuals
assigned to the engagement plus out of pocket expenses.

___18. An auditor’s engagement letter most likely will include

a. A request for permission to contact the client’s lawyer for assistance in identifying litigation, claims, and
assessments.
b. A reminder that management is responsible for illegal acts committed by employees.
c. The auditor’s preliminary assessment of the risk factors relating to misstatements arising from
fraudulent financial reporting.
d. Management’s acknowledgment of its responsibility for such internal control as it determines is
necessary to enable the preparation of financial statements that are free from material misstatement.

___19. Early appointment of the independent auditor will enable

a. A more thorough examination to be performed.
b. A proper study and evaluation of internal control to be performed.
c. Sufficient competent evidential matter to be obtained.
d. A more efficient examination to be planned.

___20. An auditor who accepts an audit engagement and does not possess the industry expertise of the
business entity, should
a. Engage financial experts familiar with the nature of the business entity.
b. Obtain knowledge of matters that relate to the nature of the entity’s business.
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.

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___21. Engagement letters are widely used in practice for professional engagement of all types. The primary
purpose of the engagement letter is to
a. Remind management that the primary responsibility for the financial statements rests with
management.
b. Satisfy the requirements of the CPA’s liability insurance policy.
c. Provide a starting point for the auditor’s preparation of the preliminary audit program.
d. Provide a written record of the agreement with the client as to services to be provided.

___22. Before accepting an audit engagement, a successor auditor should make specific inquiries of the
predecessor auditor regarding
a. Disagreements of the predecessor had with the client concerning auditing procedures and accounting
principles.
b. The predecessor’s evaluation of matters of continuing accounting significance.
c. The degree of cooperation the predecessor received concerning the inquiry of the client’s lawyer.
d. The predecessor’s assessments of inherent risk and judgments about materiality.

___23. Which of the following factors would most likely cause a CPA to decide not to accept a new audit
engagement?
a. The CPA’s lack of understanding of the prospective client’s internal auditor’s computer-assisted audit
techniques.
b. Management’s disregard of its responsibility to maintain an adequate internal control environment.
c. The CPA’s inability to determine whether related-party transactions were consummated on terms
equivalent to arm’s length transaction.
d. Management’s refusal to permit the CPA to perform substantive tests before the year-end.

___24. Which of the following is not normally performed in the preplanning or pre-engagement phase?
a. Deciding whether to accept or reject an audit engagement
b. Inquiring from predecessor auditor
c. Preparing an engagement letter
d. Making a preliminary estimate of materiality

___25. The following are considered by a CPA firm in deciding whether to accept a new client, except
a. The client’s probability of achieving an unmodified opinion
b. The client’s financial ability
c. The client’s relations with its previous CPA firm
d. The client’s standing in the business community

___26. If a change in the type of engagement from higher to lower level of assurance is reasonably justified,
the report based on the revised engagement
a. Omits reference to the original engagement
b. Should always refer to any procedures that may have been performed in the original engagement.
c. Should refer to the original engagement in a separate paragraph preceding the opinion paragraph.
d. Should qualify the opinion due to a scope limitation.

___27. One of the first things that the auditor will do after accepting a new client is
a. Tour the client’s facilities
b. Study the client’s internal control structure
c. Communicate with predecessor auditor
d. Contact client’s attorney to discover legal obligations

___28. An audit engagement letter

a. May not be prepared each period for a recurring audit engagement
b. Is prepared for the benefit of the audit, audit client and general public
c. Shall include specific audit procedures to be performed by the auditor
d. Is usually sent by auditor to the client upon the commencement of the audit

___29. The engagement letter

a. Can affect legal responsibility to the client
b. Can be used to alter the auditor’s responsibilities under the standards on auditing
c. Is used only if it is an engagement, but has no effect for review or compilation services
d. Affects the CPA firm’s responsibility to external users of audited financial statements

___30. Which of the following is not involved during pre-planning phase?

a. Obtaining information about client’s legal obligation
b. Obtaining an engagement letter

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 c. Selecting staff for engagement
d. Deciding whether to accept or continue an audit engagement

___31. Which of the following matters is least likely to be discussed in an engagement letter?
a. The fact that the auditor does not plan to detect material irregularities
b. The fact that the financial statements are the responsibility of management
c. Assistance to be provided by client personnel
d. Timing of the performance of the examination

___32. To obtain an understanding of a continuing client’s business in planning an audit, an auditor most likely
would
a. Review prior year working papers and the permanent file for the client
b. Read specialized industry journals
c. Perform tests of details of transactions and balances
d. Reevaluate the client’s internal control environment

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