Chapter 38

Answer: a. When the auditor expresses an opinion on those statements

Explanation:

An independent auditor's opinion increases the credibility of the financial statements because users gain confidence that they have been audited in accordance with auditing standards. The auditor does not guarantee absolute accuracy.

1. Users’ confidence in the financial statements is enhanced

a. When the auditor expresses an opinion on those statements

b. When they contain all business transactions

c. When an unmodified opinion is expressed

d. When they are prepared by a CPA

Answer: a. Equally to a complete set of financial statements and to an individual financial statement.

Explanation:

The auditor expresses an opinion on the financial statements as a whole. The phrase also applies when the engagement involves a single financial statement.

2. The expression "financial statements, taken as a whole" applies:

a. Equally to a complete set of financial statements and to an individual financial statement.

b. Only to a complete set of financial statements.

c. Equally to each item in each financial statement.

d. Equally to each material item in each financial statement.

Answer: b. No material misstatements exist in the financial statements.

Explanation:

Reasonable assurance is a high—but not absolute—level of assurance. Because of the inherent limitations of an audit, some material misstatements may remain undetected.

3. The term "reasonable assurance" in the auditor’s responsibility paragraph indicates that

a. No misstatements exist in the financial statements.

b. No material misstatements exist in the financial statements.

c. There is a possibility that material misstatements still exist in the financial statements.

d. There is a possibility that immaterial misstatements still exist in the financial statements.

Answer: d. All material disagreements between the company and external auditor on the application of accounting principles were resolved in the satisfaction of the external auditor.

Explanation:

An unmodified opinion indicates that the auditor concluded the financial statements are fairly presented. It does not guarantee absence of fraud, financial health, or effective internal controls.

4. If a company's external auditor expresses an unmodified opinion as a result of the audit of the company's financial statements, readers of the audit report can assume that:

a. The external auditor found no fraud.

b. The company is financially sound and the financial statements are accurate.

c. Internal control is effective.

d. All material disagreements between the company and external auditor on the application of accounting principles were resolved in the satisfaction of the external auditor.

Answer: b. Opinion section

Explanation:

Under the revised audit reporting standards (PSA 700 Revised), the Opinion section is presented first to highlight the auditor's conclusion.

5. The first section in the new auditor's report

a. Introductory paragraph

b. Opinion section

c. Addressee

d. Title

Answer: b. Title

Explanation:

PSA 700 requires the report to bear the title "Independent Auditor's Report" to emphasize the auditor's independence.

6. To distinguish it from reports that might be issued by others, the auditor’s report should have an appropriate

a. Addresses

b. Title

c. Signature

d. Opinion

Answer: a. Identification of the financial statements audited, including the date of and period covered by the financial statements

Explanation:

The Opinion section identifies the financial statements being audited and expresses the auditor's opinion on them. The auditor's responsibilities and audit standards are discussed in later sections.

7. Which of the following is included in the opinion section of the auditor's report?

a. Identification of the financial statements audited, including the date of and period covered by the financial statements

b. A statement that the financial statements are the responsibility of the entity's management.

c. A statement that the audit was conducted in accordance with Philippine Standards on Auditing.

d. A statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit.

Answer: d. Either to the shareholders or the board of directors, or both, of the entity whose financial statements are being audited.

Explanation:

The addressee depends on legal or regulatory requirements. The report may be addressed to shareholders, the board of directors, or both.

8. The auditor's report should be addressed

a. Only to the shareholders of the entity.

b. Only to the board of directors of the entity.

c. Either to the shareholders or the board of directors.

d. Either to the shareholders or the board of directors, or both, of the entity whose financial statements are being audited.

Answer: b. Both I and II

Explanation:

The Opinion section identifies the applicable financial reporting framework (e.g., PFRS) and states the auditor's opinion regarding whether the financial statements are fairly presented.

9. The opinion section of the auditor's report I. Identifies the applicable financial reporting framework on which the financial statements are based. II. Expresses an opinion on the financial statements.

a. I only

b. Both I and II

c. II only

d. Neither I nor II

Answer: a. The company applied a new standard before its effectivity date.

Explanation:

An Emphasis of Matter paragraph is used to highlight matters that are appropriately presented or disclosed and are fundamental to users' understanding, such as early adoption of a new accounting standard. The other situations generally require a modified opinion.

10. In which of the following circumstances would an auditor most likely add an Emphasis of Matter paragraph while expressing an unmodified opinion?

a. The company applied a new standard before its effectivity date.

b. Management's estimates of the effects of future events are unreasonable.

c. No depreciation has been provided in the financial statements.

d. Certain transactions cannot be tested because of management's records retention policy.

Answer: b. Auditor's Responsibility: PSA | Management's Responsibility: PFRS | Opinion: PFRS

Explanation:

The Auditor's Responsibilities section states that the audit was conducted in accordance with Philippine Standards on Auditing (PSAs). Management is responsible for preparing the financial statements in accordance with Philippine Financial Reporting Standards (PFRSs), and the Opinion section concludes whether the financial statements comply with PFRSs.

11. The independent auditor refers to both PFRS and PSA when writing the standard audit report. These terms are mentioned in which section?

a. Auditor's Responsibility: PSA | Management's Responsibility: PFRS | Opinion: PFRS

b. Auditor's Responsibility: PSA | Management's Responsibility: PFRS | Opinion: PFRS

c. Auditor's Responsibility: PFRS | Management's Responsibility: PFRS | Opinion: PFRS

d. Auditor's Responsibility: PSA | Management's Responsibility: PFRS | Opinion: PSA

Answer: c. The date of the auditor's report should not be later than the date on which financial statements are signed or approved by management.

Explanation:

The auditor's report is normally dated after management has approved the financial statements because the auditor cannot issue the report until sufficient appropriate audit evidence has been obtained. Thus, statement C is false, making it the correct answer.

12. The following statements relate to the date of the auditor's report. Which is false?

a. The auditor should date the report as of the completion date of the audit.

b. The date of the auditor's report should not be earlier than the date on which the financial statements are signed or approved by management.

c. The date of the auditor's report should not be later than the date on which financial statements are signed or approved by management.

d. The date of the auditor's report always be later than the date of the financial statement (i.e., the statement of financial position).

Answer: a. Unmodified

Explanation:

When a material uncertainty (such as pending litigation) is adequately disclosed in the financial statements, the auditor may issue an unmodified opinion. If emphasis is needed, an Emphasis of Matter paragraph may be added, but the opinion itself remains unmodified.

13. An explanatory paragraph following an opinion section describes an uncertainty involving pending litigation. What type of opinion should the auditor express?

a. Unmodified

b. Qualified

c. Disclaimer

d. Adverse

Answer: c. Explicitly represented in the "Auditor's Responsibility" paragraph of the auditor's report.

Explanation:

The Auditor's Responsibilities section clearly states that the auditor's responsibility is to express an opinion on the financial statements based on the audit conducted in accordance with PSAs.

14. An auditor's responsibility to express an opinion on the financial statements is

a. Implicitly represented in the auditor's report.

b. Explicitly represented in the opinion paragraph of the auditor's report.

c. Explicitly represented in the "Auditor's Responsibility" paragraph of the auditor's report.

d. Explicitly represented in the "Management's Responsibility" paragraph of the auditor's report.

Answer: b. The auditor does not express an opinion on the financial statements.

Explanation:

A disclaimer of opinion is issued when the auditor cannot obtain sufficient appropriate audit evidence and therefore does not express an opinion on the financial statements.

15. Which of the following statements indicates a disclaimer of opinion?

a. The financial statements do not present fairly in all material respects the financial position, results of operations, and cash flows in conformity with PFRS.

b. The auditor does not express an opinion on the financial statements.

c. The financial statements present fairly in all material respects the financial position, results of operations, and cash flows in conformity with PFRS.

d. Except for the effects of a matter, the financial statements present fairly in all material respects the financial position, results of operations, and cash flows in conformity with PFRS.

Answer: c. An unmodified opinion.

Explanation:

The absence of backup systems is a business risk, but since it is adequately disclosed and does not result in a material misstatement of the financial statements, the auditor ordinarily issues an unmodified opinion.

16. A note to the financial statements indicates that no emergency backup systems or duplicate disks are maintained because management considers the risk of catastrophe remote. Based upon this note, the auditor should express

a. A qualified opinion.

b. An adverse opinion.

c. An unmodified opinion.

d. Scope qualification.

Answer: c. Either I or II

Explanation:

Under PSA 705, a modified opinion is required either when there is a material misstatement or when the auditor cannot obtain sufficient appropriate audit evidence.

17. A modified opinion on the financial statements is necessary when I. The auditor concludes, based on the audit evidence obtained, that the financial statements as a whole are not free from material misstatement. II. The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

a. I only

b. II only

c. Either I or II

d. Neither I nor II

Answer: b. Pervasive

Explanation:

PSA 705 uses the term pervasive to describe misstatements or possible misstatements that are not confined to specific elements or are so significant that they affect the financial statements as a whole.

18. Which of the following terms is used in the standards to describe the effects on the financial statements of misstatements or possible undetected misstatements?

a. Persuasive

b. Pervasive

c. Material

d. Extensive

Answer: d. I, II and III

Explanation:

Scope limitations may result from circumstances beyond the entity's control, the nature or timing of the audit, or restrictions imposed by management. Any of these may prevent the auditor from obtaining sufficient appropriate audit evidence.

19. A limitation on the scope of the audit may arise from I. Circumstances beyond the control of the entity. II. Circumstances relating to the nature and timing of the auditor's work. III. Limitations imposed by management.

a. I and II

b. I and III

c. II and III

d. I, II and III

Answer: b. The financial statements fail to disclose information that is required by Philippine Financial Reporting Standards.

Explanation:

Failure to make required disclosures under PFRS constitutes a material misstatement. If the omission is material but not pervasive, a qualified opinion is appropriate. If it is material and pervasive, the auditor issues an adverse opinion. Thus, the auditor chooses between these two opinions depending on the pervasiveness of the omission.

20. In which of the following situations would an auditor ordinarily choose between expressing a qualified opinion or an adverse opinion?

a. The auditor wishes to emphasize an unusually important subsequent event.

b. The financial statements fail to disclose information that is required by Philippine Financial Reporting Standards.

c. Events disclosed in the financial statements cause the auditor to have substantial doubt about the entity’s ability to continue as a going concern.

d. The auditor did not observe the entity’s physical inventory and is unable to become satisfied as to its balance by other auditing procedures.

Answer: b. Except for the omission of the information included in the Basis for Opinion section.

Explanation:

A qualified opinion due to inadequate disclosure uses the phrase "Except for..." to indicate that, aside from the specific omission described in the Basis for Qualified Opinion section, the financial statements are fairly presented.

21. Which of the following phrases would an auditor most likely include in the auditor's report when expressing a qualified opinion because of inadequate disclosure?

a. Do not present fairly in all material respects.

b. Except for the omission of the information included in the Basis for Opinion section.

c. With the foregoing explanation of these omitted procedures.

d. Subject to the departure from generally accepted accounting principles, as described above.

Answer: d. Adverse opinion.

Explanation:

The phrase "do not present fairly" indicates that the financial statements are materially and pervasively misstated, which requires an adverse opinion.

22. An auditor's report includes the following statement: "In our opinion, because of the effects of the matters discussed in the subsequent paragraph, the financial statements do not present fairly, in all material respects, the financial position of ABC Company..."

a. Qualified opinion.

b. Disclaimer of opinion.

c. Unmodified opinion.

d. Adverse opinion.

Answer: c. Key Audit Matters.

Explanation:

Key Audit Matters (KAMs) are those matters that required significant auditor attention and were of most significance during the audit. They are communicated in accordance with PSA 701.

23. It refers to those matters that, in the auditor's professional judgment, were of most significance in the audit of the financial statements of the current period.

a. Emphasis of Matter.

b. Other Matter.

c. Key Audit Matters.

d. What's the matter.

Answer: a. Unmodified opinion.

Explanation:

The misappropriation of ₱50,000 is immaterial relative to the company's total assets and income before tax. Since it does not materially affect the financial statements, the auditor would ordinarily issue an unmodified opinion.

24. An independent auditor discovers that a payroll supervisor has misappropriated ₱50,000. The company's total assets are ₱70 million and income before tax is ₱15 million. Assuming no other issues affect the report, the auditor's report will most likely contain a/an

a. Unmodified opinion.

b. Adverse opinion.

c. Disclaimer of opinion.

d. Scope qualification.

Answer: b. Disclosed in the notes to the financial statements of the current year.

Explanation:

When an accounting change has no current material effect but is expected to affect future periods materially, note disclosure is sufficient. The auditor ordinarily does not modify or refer to the matter in the audit report.

25. If an accounting change has no material effect on the financial statements in the current year but is reasonably certain to have a material effect in later years, the change should be

a. Treated as a consistency modification in the auditor's report for the current year.

b. Disclosed in the notes to the financial statements of the current year.

c. Disclosed in the notes to the financial statements and referred to in the audit report for the current year.

d. Treated as a subsequent event.

Answer: a. Listed entities only.

Explanation:

Under PSA 701, communication of Key Audit Matters is required for audits of listed entities, although it may be voluntarily included in other engagements if appropriate.

26. Key Audit Matters are required to be included in the new audit report for

a. Listed entities only.

b. Listed and non-listed entities.

c. Listed entities and SMEs.

d. SMEs only.

Answer: d. True, true.

Explanation:

Both statements are correct. A material inconsistency involves conflicting information between the audited financial statements and other information, while a material misstatement of fact refers to incorrect statements in other information that are unrelated to the audited financial statements.

27. S1: Material inconsistency exists when other information contradicts information contained in the financial statements. S2: Material misstatement of fact exists when other information, not related to matters appearing in the audited financial statements, is incorrectly stated or presented.

a. True, false.

b. False, true.

c. False, false.

d. True, true.

Answer: d. True, true.

Explanation:

Both statements are the standard definitions found in PSA 706. An Emphasis of Matter relates to matters disclosed in the financial statements, whereas an Other Matter relates to matters outside the financial statements that are relevant to users.

28. S1: An Emphasis of Matter paragraph refers to a matter appropriately presented or disclosed in the financial statements that is fundamental to users' understanding. S2: An Other Matter paragraph refers to a matter other than those presented or disclosed in the financial statements that is relevant to users' understanding of the audit, the auditor's responsibilities, or the auditor's report.

a. True, false.

b. False, true.

c. False, false.

d. True, true.

Answer: d. Misstatement.

Explanation:

A misstatement is any difference between what is reported in the financial statements and what is required by the applicable financial reporting framework. Misstatements may arise from error or fraud and include incorrect amounts, classifications, presentations, or disclosures.

29. Per the Glossary of Terms, it is a difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure required by the applicable financial reporting framework.

a. Fraud.

b. Error.

c. Departure.

d. Misstatement.