Chapter 2: INTRODUCTION TO AUDIT SERVICES AND FINANCIAL STATEMENT AUDIT
CHAPTER 2
INTRODUCTION TO AUDIT SERVICES AND FINANCIAL STATEMENT AUDIT
Chapter Overview and Objectives:
This chapter discusses the fundamental principles of audit services and the financial statement audit. At the end of this chapter, readers should be able to discuss:
1. The concept and importance of audit services
2. The different types of audits
a. As to the nature of assertions
b. As to types of auditors
3. The financial statement audit
a. The definition and objective of a financial statement audit
b. The general principles of financial statement audit
c. The theoretical framework of financial statement audit
d. The elements of a financial statement audit
e. The assurance provided by a financial statement audit
f. The demand for financial statement audit
g. The value of financial statement audit
Relevant references:
PSA 200 - Overall Objectives of the Independent Auditor and the Conduct of an Audit in accordance with Philippine Standards on Auditing
INTRODUCTION TO AUDIT SERVICES
In recent years, auditing has remained the flagship service provided by professional accountants, not only in the Philippines but across the globe. This is primarily due to the public’s perception of the auditor’s responsibility in ensuring market integrity, credible and reliable reporting, together with an effective audit function, fortify confidence in the entire financial system.
As mentioned in the previous chapter, in business, reliable information becomes an essential aspect of decision-making. However, in most instances, this information is prepared and provided by other persons or organizations, whose interests contradict those of the users of the information. This situation created the need for an objective evaluation of the information by an independent professional accountant. Such a service is widely known as an audit.
The primary objective of an audit function is to improve the quality or lend credibility to the information prepared by a particular entity. This objective is met through the expression of an opinion that provides users with reasonable assurance that the subject matter of an audit service is free from material misstatements. Such an opinion is then communicated to the users through the audit report. Attachment of the audit report to the subject matter of an audit engagement means that the information can be relied upon by the users.
AUDITING
Definition
An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results thereof. (American Accounting Association)
The following are key concepts obtained from the definition of an audit:
a. Systematic process
An audit is composed of a logical, ordered, and structured series of steps and procedures. To meet the objectives of an audit engagement, one must follow a sequence of procedures.
b. It involves objectively obtaining and evaluating evidence about assertions
Audit evidence is the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. On the other hand, assertions are representations made by an audit client, explicit or otherwise, about economic actions and events.
Furthermore, in obtaining and evaluating evidence about assertions, auditors shall observe the principle of objectivity. It imposes an obligation on all CPAs not to compromise their professional or business judgment because of bias, conflict of interest, or the undue influence of others.
c. It ascertains the degree of correspondence between assertions and established criteria
To meet the objective of an audit engagement, an auditor must be able to express an opinion. To accomplish this, the auditor uses criteria (standard or benchmark) to verify the validity of the assertions prepared and presented by the audit client.
Simply stated, the auditor determines whether or not assertions are prepared and presented by the audit client following the requirement of specified criteria.
d. It includes communication of the results to interested users
After obtaining sufficient appropriate evidence, the auditor prepares a report containing an overall opinion, which is subsequently communicated to interested users. This aspect is regarded as the most important characteristic of an audit. Failure to communicate the results renders the audit engagement useless and ineffective.
Types of audits
An audit can be categorized in various ways, including legislative controls, objectives, risks involved, subject matter, and the auditor’s affiliation with the audit client. However, for the sake of aligning with the syllabus in Auditing in the Licensure Examination for CPAs in the Philippines, our focus will be on two specific types: (1) As to the nature of assertion or data, and (2) As to the types of auditors involved.
1. Nature of assertion or data
a. Financial statement (FS) audit
• A type of audit pertaining to the gathering of evidence on the assertions embodied in the financial statements of an entity to determine whether the financial statements are fairly presented in accordance with generally accepted accounting principles or another comprehensive and authoritative financial reporting framework
• The results of this type of audit are for the use of external users
b. Operational audit
• A type of audit involving a systematic review of the organization’s activities in relation to specified objectives for the purpose of assessing the performance, identifying opportunities for improvement, and developing recommendations for improvement or further action
• Also known as management audit or performance audit
c. Compliance audit
• A type of audit involving the review of organization’s procedures to determine whether the organization has adhered to specific procedures and rules set down by some higher authority
2. Types of auditors
a. External audit
• A type of audit engagement performed by independent or external auditors on a contractual basis (rendered by CPAs engaged in public practice)
• It requires that the auditors are independent professionals or firms engaged externally by an organization to conduct an impartial audit service
• Can provide financial statements, operational, and compliance audits to private entities
b. Internal audit
• An independent appraisal function, performed by internal auditors, established within an organization to examine, and evaluate its activities as a service to organizations
• Its primary objective is to assist all members of the organization in the effective discharge of their responsibilities, particularly those charged with governance and management
• Can perform operational and compliance audits (for internal use) but not financial statement audit because of independence requirements
To establish the independence of internal auditors, they are required to be independent of the different operating units to be audited. In addition, to emphasize their independence, they shall report to the audit committee, any equivalent supervisory board, or board of directors.
c. Government audit
• A type of audit performed by government auditors designed to determine whether government funds are being handled properly, are in compliance with existing laws, and whether programs are being conducted efficiently and effectively
• Can provide financial statements, operational, and compliance audits to public entities including government-owned and controlled corporations (GOCCs)
Exhibit 2-1 Structure of Internal and External Assurance Activities
Organization Structure:
• Stakeholders
• Board of Directors/Trustees
◦ Audit Committee
Internal Auditors
External Auditors (Outside)
Government Auditors (Outside)
• Management
◦ Operating Departments
Note: The board of directors or trustees are referred to as "those charged with governance."
Comparison of the different types of audits
Financial Statement Audit
• Assertions: Financial statements are fairly presented
• Suitable Criteria: GAAP or any other identified financial reporting framework
• Report: An opinion on whether the financial statements are fairly presented in accordance with an identified financial reporting framework
• Generally performed by: External auditors
Operational Audit
• Assertions: Operations are conducted efficiently and effectively
• Suitable Criteria: Objective set by the management
• Report: Report on efficiency and effectiveness. This will also include recommendations to improve operations
• Generally performed by: Internal auditors
Compliance Audit
• Assertions: Activities complied with applicable laws, rules, regulations, contracts, or management policy
• Suitable Criteria: Applicable contracts, rules, regulations, laws, or management policy
• Report: Degree of compliance with applicable laws, rules, regulations, or management policy
• Generally performed by: Government auditors
IMPORTANT NOTES:
1. Both financial statements and compliance audits use established criteria, whereas internal audit uses specifically developed criteria.
2. Both financial statements and compliance audits generally cater to external users, whereas internal audit assists the members of the organization in the effective discharge of their responsibilities.
3. Internal auditors are generally part of the organization, thus creating an employer-employee relationship. With this, they do not render financial statement audits.
FINANCIAL STATEMENT AUDIT
Financial statement audit remains to be the most common type of audit rendered by CPAs. It involves the examination of the financial statements of a particular entity to determine whether or not they are presented in accordance with a specified criterion.
Financial statements are ordinarily prepared and presented annually and are directed toward the common information needs of a wide range of users. Many of these users rely on financial statements as their major source of information because they do not have the power to obtain additional information to meet their specific information needs. Thus, financial statements need to be prepared in accordance with one, or a combination of:
a. Accounting standards generally accepted in the Philippines (Philippine Financial Reporting Standards - PFRSs),
b. Internationally accepted accounting standards (International Financial Reporting Standards - IFRSs), and
c. Another authoritative and comprehensive financial reporting framework which has been designed for use in financial reporting and is identified in the financial statements.
Objective of financial statement audit
PSA 200 (Revised and Redrafted) states that “in conducting an audit of financial statements, the overall objectives of the auditor 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 material respects, in accordance with an applicable financial reporting framework; and
b. To report on the financial statements, and communicate as required by the PSAs, in accordance with the auditor’s findings.
From these statements, the following key phrases were emphasized:
• Expression of an opinion. The ultimate objective of a financial statement audit is for the auditor to express an opinion regarding the fairness of the preparation and presentation of the financial statements. In forming the audit opinion, the auditor obtains sufficient appropriate audit evidence to be able to draw conclusions on which to base that opinion.
• Financial statements are taken as a whole. The opinion expressed by the auditor applies to the complete set of financial statements prepared and presented by the entity.
• Reasonable assurance. Though the auditor’s opinion enhances the credibility of the financial statements, the user cannot assume that the opinion is a guarantee or an assurance that the presented information is free from any misstatements.
• In all material respects. In rendering a financial statement audit, the auditor is required to adhere to the requirements of Philippine Standards on Auditing. This set of standards applies only to material matters.
• Presence of criteria. The financial statements shall be prepared in accordance with an applicable financial reporting framework.
• Communication of the results. Again, the ultimate objective of an audit engagement is the communication of the results to various interested users.
General principles of a financial statement audit
Whenever financial statement audits are conducted, the following principles must be observed by the auditor:
Comply with the Code of Ethics for Professional Accountants
Conduct an audit in accordance with Philippine Standards on Auditing (PSA)
Maintain an attitude of professional skepticism
Exercise professional judgment
Obtain sufficient and appropriate evidence
Theoretical framework of financial statement audit
Efforts have been made to formally create a conceptual structure for auditing financial statements. To have a favorable result, the conceptual structure includes conditions that should exist whenever a financial statement audit is conducted. The following are some of the assumptions, postulates, or concepts included in this conceptual structure (VIC BP):
All financial data are Verifiable
• An audit involves obtaining and evaluating evidence about assertions, which should be capable of being verified. Verifiability means that different knowledgeable and independent observers could reach a consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.
The auditor should always maintain Independence
• The value and credibility of the auditor’s report lie in the auditor’s independence. If the auditor is not independent of both the client and users, the report is of little or no value.
No long-term Conflict between the auditor and the client's management should exist
• Management may be motivated to present financial information in a manner favorable to them even if it would mean violation of the criterion used. This scenario may create disagreements or conflicts between the auditor and client’s management since auditors are expected to attest to data that is fairly presented.
• Such conflicts may exist temporarily or on a short-term basis but should be resolved prior to or on the completion of the audit. The auditor shall be satisfied on the resolution of the said conflicts; otherwise, it could lead to the modification of auditor’s report.
Audit Benefits the Public
• A financial statement audit shall have the objective of increasing the quality of the information or lending credibility to the items presented in the financial statements which will assist its different users in making economic decisions. This can be done by providing assurance that the financial statements audited are free from material misstatements.
Effective Internal control system reduces the possibility of errors and fraud
• Information presented on the financial statements is more reliable when the internal controls designed and implemented by the entity are effective.
Review of elements of a financial statement audit
An audit service is just a discussion of much wider assurance services. The elements of the latter, as discussed in Chapter 1 Fundamental Principles of Assurance Services, apply to that of the former. To recall, the following are the elements of an assurance service and how it is applied in an audit of financial statements.
Management and Those Charged with Governance → Assertions in financial statements → PFRS/GAAP/Other (Suitable Criteria) → Auditor → Audit Report and Other Responsibilities → Financial Statement Users
Management and Those Charged with Governance → Assertions in financial statements → PFRS/GAAP/Other (Suitable Criteria) → Sufficient Appropriate Evidence: [Materiality, Audit Risk, Cost-Benefit Constraint, Professional Skepticism]
A. A three-party relationship
Auditor (represents the practitioner)
• Formation and expression of an opinion on the financial statements
• Compliance with ethical requirements (e.g., independence and competence)
• Determining the scope of audit in accordance with PSAs and other applicable regulations of professional bodies
Management and those charged with governance (represent the responsible party)
• Preparation and presentation of the financial statements in accordance with the applicable financial reporting framework
• Prevention and detection of fraud and error
• Adoption and implementation of adequate accounting and internal control systems
B. An appropriate subject matter
In a financial statement audit, the assertions embodied in the financial statements represent the subject matter of the engagement. For this engagement to be an appropriate subject matter for an audit engagement, adequate supporting records and documents should be available. This concept is popularly known as “auditability.”
C. Suitable criteria
Criteria used in an audit of financial statements generally include the PFRS/IFRS, GAAP and other applicable financial reporting framework
D. Sufficient appropriate evidence
Concepts discussed in assurance engagements apply to audit engagements. Terms are revised to specifically relate to audit engagements (e.g., assurance engagement risk is changed to audit risk)
E. A written assurance report or conclusion
The auditor provides a written report called an “audit report” which contains the conclusion or opinion conveying the assurance obtained about the financial statements. In addition, the auditor considers other reporting responsibilities, including communicating with those charged with governance.
The opinion to be expressed by the auditor depending on the evidence obtained may include either of the following:
Unmodified or unqualified
• Common phrase used: Presents fairly, in all material respect / Give a true and fair view
Qualified
• Common phrase used: Except for
Adverse
• Common phrase used: Do not present fairly, in all material respect
Disclaimer of opinion
• Common phrase used: We do not express a conclusion
To warrant the issuance of an unmodified opinion, the auditor shall conclude that there are no:
a. Material limitation on the scope of the auditor’s work (Qualified or Disclaimer of opinion). There is a limitation on the scope of the audit when the auditor is unable to gather sufficient appropriate evidence.
b. Material disagreement with management regarding the acceptability of the accounting policies selected, the method of their application, or the adequacy of financial statement disclosures (Qualified or Adverse Opinion).
Auditor’s Judgment:
• Circumstance: Financial statements are materially misstated
◦ If effects are Material but Not Pervasive → Qualified opinion
◦ If effects are Material and Pervasive → Adverse opinion
• Circumstance: Inability to obtain sufficient appropriate audit evidence
◦ If effects are Material but Not Pervasive → Qualified opinion
◦ If effects are Material and Pervasive → Disclaimer of opinion
Refer to Chapters 14 Audit Reporting and 15 Reporting on Other Professional Engagements for a more detailed discussion of audit reporting.
Assurance provided by the auditor
In an audit, assurance refers to the auditor’s satisfaction as to the reliability of the financial statements prepared and presented by a particular entity to address the common needs of a wide range of users.
To provide such assurance, the auditor assesses the evidence collected as a result of procedures conducted and expresses an opinion. The auditor’s opinion is intended to enhance the credibility of financial statements by providing a high, but not absolute, level of assurance.
Reasonable assurance and the inherent limitations of an audit
An auditor conducting an audit in accordance with PSAs obtains reasonable assurance that the financial statements, taken as a whole, are free from material misstatement, whether due to fraud or error.
To obtain reasonable assurance, the auditor shall obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level and thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s opinion.
The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute assurance that the financial statements are free from material misstatement due to fraud or error. This is because there are inherent limitations of an audit, which result in most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive.
Conventionally, the inherent limitations of an audit that affect the auditor’s ability to detect material misstatements includes the following (SEPIA):
1. Use of Selective testing (exposure to sampling risk)
◦ Auditing standards do not require auditors to examine all available information supporting a particular assertion for practical reasons (time and cost constraints), as long as the auditor has sufficient appropriate evidence that can serve as a basis for expressing his/her opinion.
2. Inherent limitations of Internal control (exposure to control risk)
◦ The effectiveness of internal control influences the conduct of an audit. However, such controls cannot fully guarantee the validity and accuracy of items generated from them because of the inherent limitations (e.g., cost-benefit consideration, management overriding the controls, circumvention through collusion among employees, and human errors).
3. Fact that most of the audit Evidence is persuasive rather than conclusive
◦ While performing evidence-gathering procedures, auditors are exposed to persuasive evidence that leave some doubts rather than conclusive (very convincing) evidence.
4. Work undertaken by the auditor to form an opinion is Permeated by Judgment (exposure to non-sampling risk)
◦ Through the course of the audit, the auditor exercises his/her judgment. It is inherent that whenever he/she exercises judgment, there is a great possibility that he/she might commit mistakes due to carelessness, fatigue, misinterpretation of facts, and other human weaknesses.
5. Nature/characteristics of Assertions (exposure to inherent risk)
In some instances, it may be necessary to rely heavily on representation made by the entity's management. If the management lacks integrity, they may provide materially misleading information causing the auditor to rely on unreliable information.
However, PSA 200 specifically enumerates the following items where the inherent limitations of an audit could arise:
Items in the box:
1. Nature of financial reporting
2. Nature of audit procedures
3. Cost-benefit consideration
1. The nature of financial reporting
Preparing financial statements requires management to use judgment based on the entity’s financial reporting framework and specific circumstances. Many items in financial statements involve subjective decisions or assessments, leading to a degree of uncertainty. This variability can’t always be eliminated by additional auditing procedures, especially for accounting estimates.
PSAs mandate auditors to carefully assess if accounting estimates align with the financial reporting framework and disclosures. They also need to consider the quality of the entity's accounting practices, including signs of potential bias in management's decisions.
2. The nature of audit procedures
Auditors face practical and legal constraints when gathering audit evidence.
PSA 200 lists the following examples:
• There is the possibility that management or others may not provide, intentionally or unintentionally, the complete information that is relevant to the preparation of the financial statements or that has been requested by the auditor. Accordingly, the auditor cannot be certain of the completeness of information, even though the auditor has performed audit procedures to obtain assurance that all relevant information has been obtained.
To sum up, management or others may withhold relevant information, making it hard for auditors to ensure completeness despite their efforts.
• Fraud may involve sophisticated and carefully organized schemes designed to conceal it. Therefore, audit procedures used to gather audit evidence may be ineffective for detecting an intentional misstatement that involves, for example, collusion to falsify documentation which may cause the auditor to believe that audit evidence is valid when it is not. The auditor is neither trained nor expected to be an expert in the authentication of documents.
In simple terms, fraud can be complex and well-hidden, making standard audit procedures ineffective in detecting intentional misstatements, especially if there’s collusion.
• An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not given specific legal powers, such as the power of search, which may be necessary for such an investigation.
Simply stated, auditors lack legal authority for official investigations or powers like search warrants, which limits their ability to uncover wrongdoing.
3. The need for the audit to be conducted within a reasonable period of time and at a reasonable cost
The matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than persuasive.
Proper planning ensures enough time and resources for the audit. Consequently, it is necessary for the auditor to:
• Plan the audit so that it will be performed in an effective manner,
• Direct audit effort to areas most expected to contain risks of material misstatement, whether due to fraud or error, with correspondingly less effort directed at other areas, and
• Use testing and other means of examining populations for misstatements.
However, the value of information decreases over time, so there’s a balance between reliability and cost, as acknowledged in financial reporting frameworks. Users expect the auditor to give an opinion on the financial statements within a reasonable time and cost, understanding that it’s impractical to address all information exhaustively or assume everything is erroneous or fraudulent until proven otherwise.
Other Matters that Affect the Inherent Limitations of an Audit
In the case of certain assertions or subject matters, the potential effects of the inherent limitations on the auditor’s ability to detect material misstatements are particularly significant. Such assertions or subject matters include:
a) Fraud, particularly fraud involving senior management or collusion.
b) The occurrence of non-compliance with laws and regulations.
c) The existence and completeness of related party relationships and transactions.
d) Future events or conditions that may cause an entity to cease to continue as a going concern.
Relevant PSAs identify specific audit procedures to assist in mitigating the effect of the inherent limitations. For example, items (a) and (b) are discussed in PSAs 240 and 250 (Chapter 9 Consideration of Fraud, Error, and Non-compliance), whereas items (c) and (d) are addressed in PSAs 550 and 570 (Chapter 12 Completing the Audit).
Existence of audit risk
In summary, due to the above limitations, all financial statement audit engagements are exposed to risk termed as audit risk (which is the equivalent of assurance engagement risk for assurance engagements), which is the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated. The concepts related to audit risk and its components are discussed in detail in Chapter 5 Planning an Audit of Financial Statements.
THE DEMAND FOR FINANCIAL STATEMENT AUDIT
Investors, creditors, and other users of financial information demand high-quality, relevant, and reliable information. Such information will enable them to come up with educated financial decisions that will assist them in managing business and information risks.
Business risk
There are countless decisions made each and every day by businesses in order to appropriately manage business risk, which is any event or activity that will prevent the entity from meeting its business objectives such as wealth and profit maximization. If an entity is exposed to significant business risk, such risk may ultimately lead the entity to fail. This is the primary reason why decisions to be made must be carefully evaluated and should be founded on a suitable basis.
Information risk
A further complication in decision-making is the presence of information risk.
Definition
Information risk is the risk that the information prepared and presented by the entity contains misstatements.
Information risk is the mathematical complement of reliability level. This means that as information risk increases (from 5% to 10%), reliability level decreases (from 95% to 90%).
Exhibit 2-2 Information Risk Factors
Voluminous data
• As the number of transactions entered into by the entity grows, the risk that misstatements may have occurred also increases.
Complexity of Transactions
• The more complicated the transactions entered into by the entity, the higher the probability that the transactions will not be recorded properly.
Remoteness of information
• Decision makers do not have first-hand information prepared by another party. They must rely on the representations and documents which may or may not present the truth and validity.
Conflicts of interest
• Users of FSs may have different interests from the entity whose information is being presented by management. This may lead management to present their version of the truth that may be better than what actually may be.
Because of information risk, users had been more skeptical of the information presented by management. They even find ways to reduce the said risk. To reduce information risk users do the following:
Information is verified
• Under this approach, users directly verify the validity of the information by examining supporting records and documents held by the entity. However, major problems are commonly encountered by users relying on this approach. These are:
a. users are separated from entity’s records by distance and time,
b. users do not possess the necessary skill and competence to appropriately verify the information, and
c. more often than not, users cannot directly access the company’s records (see, mentioned above).
Financial statements are audited
• The users rely on the evaluation made by an independent auditor. This approach addresses the problems encountered by users in the “verify the information” approach since the auditor
a. monitors the financial information reported by management and would include direct examination of records and documents; and
b. is equipped with skills and competence in objectively obtaining and evaluating evidence.
• Information risk is shared with the management. This approach dictates that in the event users fail or incur a loss because of incorrect decisions based on inaccurate data, users may seek reimbursements (fully or partially) from the entity.
Additional conditions that create the need for a financial statement audit
Below is a list of circumstances that contribute to the need for FS audit (CERF):
• Conflict of interest between the responsible party and the intended users of the financial statements.
• Expertise. The complexity of accounting and auditing requires expertise.
• Remoteness of users. Users of information frequently are prevented from directly assessing the quality of information.
• Financial consequence. Misleading financial information could have substantial economic consequences for a decision-maker.
Regulatory requirements
Local laws and regulations may also require business entities to submit audited financial statements. Examples of these requirements include the following:
1. General Financial Reporting Requirements (Revised Securities Regulation Code (SRC) Rule 68)
The following shall submit financial statements audited by an independent Certified Public Accountant to the Securities and Exchange Commission:
• Stock corporations
◦ Basis: Total Assets or Total Liabilities
◦ Threshold: P600,000 or more¹
• Nonstock corporations
◦ Basis: Total Liabilities
◦ Threshold: P600,000 or more¹
• Branch offices/representative offices of stock foreign corporations
◦ Basis: Assigned capital
◦ Threshold: P600,000 or more¹
• Branch offices/representative offices of non-stock foreign corporations
◦ Basis: Total assets
◦ Threshold: P1,000,000 or more
• Regional operating headquarters of foreign corporations
◦ Basis: Total revenues
◦ Threshold: P1,000,000 or more
Note: Corporations that do not meet the threshold may submit their annual financial statements accompanied by a duly notarized treasurer’s certificate only (rather than an auditor’s report).
2. Tax Compliance Requirements
The National Internal Revenue Code, as amended, states the requirement for audited books of accounts under Section 232 (A) as follows:
• Corporations, Companies
◦ Basis: Gross annual sales, earnings, receipts, or outputs
◦ Threshold: Exceed P3,000,000
• Partnerships, or Persons
◦ Basis: Gross annual sales, earnings, receipts, or outputs
◦ Threshold: Exceed P3,000,000
For entities that meet the above threshold, they are required to:
• Have their books of accounts audited and examined yearly by independent Certified Public Accountants, and
• Their income tax returns are accompanied by a duly accomplished Account Information Form (AIF) which shall contain, among others, information from certified balance sheets, profit and loss statements, schedules listing income-producing properties, and the corresponding income therefrom, and other relevant statements.
Further details of tax compliance requirements are discussed in your respective taxation courses.
Value of financial statement audits
Based on the discussions of the demand for a financial statement audit, the following may be construed as the value of this assurance engagement:
Items in the box:
1. Reduces information risk
2. Deters inefficiency and fraud
3. Enhances systems of internal controls
Reduces information risk
• Audit reduces information risk that may lead to a lower cost of capital. One of the focuses of an audit is to enhance the quality of information, thus, reducing information risk. With high-quality, relevant, and reliable information, users may come up with educated financial decisions which minimize the possibility of incurring losses or resources invested.
Deters inefficiency and fraud
• Audit may be used to deter inefficiency and fraud. An audit involves objective accumulation and evaluation of evidence which could lead to the identification of material misstatements presented in the financial statements.
Enhances systems of internal controls
• Audit may be used to enhance systems of internal controls. An audit includes an understanding of the entity and its environment which incorporates the internal controls of the entity. During the course of this evaluation, deficiencies may be identified which may help management in formulating actions to improve its controls that help them achieve their objectives.
CHAPTER 2: SELF-TEST EXERCISES
DISCUSSION QUESTIONS
1. What are the key concepts in the definition of auditing?
2. What are the main differences between a financial statement audit, operational audit, and compliance audit?
3. How are assurance activities integrated into a business organization?
4. What is the objective of a financial statement audit?
5. What are the general principles surrounding financial statement audits?
6. What are the concepts present in the theoretical framework of financial statement audit?
7. What are the different elements of a financial statement audit?
8. Why can auditors not provide absolute assurance to information users?
9. What are the factors that give rise to information risk?
10. What is the value provided by a financial statement audit?
2 – 1 TRUE OR FALSE
1. An audit is an evaluation of a reporting entity's financial statements by an independent party.
2. A financial audit is a comprehensive assessment of a company's operations, systems, and processes.
3. An audit aims to increase the intended users' confidence in financial statements.
4. The financial statements under audit are prepared by those charged with governance with oversight of management.
5. A compliance audit is a means of independently assessing that a company complies with external rules, regulations, and laws.
6. External auditors examine financial accounts to verify whether past financial performance and current financial status are fairly presented.
7. To maintain the independence of internal auditors, the head of internal audit should report directly to the Chief Financial Officer.
8. The most commonly used criteria of internal auditors in the Philippines are Philippine Financial Reporting Standards.
9. Financial statement audits, operational audits, and compliance audits are comparable in that they all gather evidence to assess the reliability of information.
10. The criteria used by government auditors consist of company standards for departmental efficiency and effectiveness.
2 – 2 TRUE OR FALSE
1. Auditing refers to the process of recording, classifying, and summarizing economic events in a logical manner for the purpose of providing financial information to users.
2. Attestation services are services that require a CPA to issue a report about the reliability of an assertion that is made by another party.
3. Audits, reviews, and compilation services are the three common types of attestation services.
4. The scope of a financial statement audit commonly includes the statement of financial position, statement of financial performance, statement of retained earnings, and related notes.
5. The overall objective of the auditor of financial statements is to obtain reasonable assurance about the reliability of the information and communicate the results thereof.
6. The auditor shall comply with all PSAs relevant to the audit.
7. The auditor shall have an understanding of the full text of a PSA to understand its objectives and to apply its requirements properly.
8. An added value of the auditor's opinion is its assurance with regard to the future viability of the entity and the effectiveness of its management.
9. Professional judgment can be evaluated based on whether the judgment reached reflects a competent application of auditing and accounting principles.
10. Maintaining professional judgment throughout the audit is necessary to reduce the risk of overgeneralizing when drawing conclusions.
2 – 3 TRUE OR FALSE
1. Verifiable information is complemented by proof that may be used to validate its reliability.
2. By maintaining the integrity of financial statements, external audits safeguard the public interest and boost confidence in the financial markets.
3. The auditor cannot reduce audit risk to zero and cannot therefore obtain absolute assurance.
4. Due to the inherent limitations of an audit, most evidence on which the auditor draws conclusions is conclusive rather than persuasive.
5. Financial statement items are subject to an inherent level of variability which can be eliminated by the application of auditing procedures.
6. Audit risk is a function of the risks of material misstatement and detection risk.
7. The matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative.
8. The inherent limitations of an audit are not a justification for the auditor to be satisfied with less than persuasive audit evidence.
9. Branch offices of non-stock foreign corporations with total assets of P50,000 must submit audited financial statements to the Securities and Exchange Commission.
10. Corporations with gross annual sales of P3,000,000 must have their financial statements audited by a CPA.
2 – 4 MULTIPLE CHOICE QUIZZERS
1. The predominant type of attestation service performed by CPAs is
A. Audit
B. Review
C. Compilation
D. Management consulting
2. Which of the following statements refers to the definition of auditing?
A. A service activity which function is to provide quantitative information primarily financial in nature about economic entities that is intended to be useful in making economic decisions.
B. The art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are in part at least of a financial character and interpreting the results thereof.
C. The process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information.
D. A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results thereof.
3. Which of the following is not among the characteristics of auditing?
A. A systematic process
B. It involves objectively obtaining and evaluating evidence about assertions.
C. It ascertains the degree of correspondence between assertions and established criteria
D. It includes communication of the results to the management
4. The word auditing comes from the Latin audire, which means:
A. To see
B. To test
C. To hear
D. To detect
5. The trait that distinguishes auditors from accountants is the:
A. auditor's ability to interpret accounting principles generally accepted in the Philippines.
B. auditor's education beyond the Bachelor's degree.
C. auditor's ability to interpret accounting and auditing standards.
D. auditor's accumulation and interpretation of evidence related to a company's financial statements.
6. Which of the following does not belong to the group?
A. Financial statement audit
B. Independent external audit
C. Internal audit
D. Government audit
7. The following are types of audits as to the nature of assertions, except
A. Financial statement audit
B. Performance audit
C. Compliance audit
D. Government audit
8. These audits are similar in most respects.
A. Operational and compliance
B. Operational and government
C. Financial and compliance
D. Financial and operational
9. This type of audit involves a review of an organization's procedures and methods for the purpose of evaluating efficiency and effectiveness of operations, identifying areas for improvement, and making recommendations to improve performance.
A. Financial statement audit
B. Operational audit
C. Compliance audit
D. Internal audit
10. Which of the following types of audits uses as its criteria laws and regulations?
A. Operational audit
B. Financial statement audit
C. Compliance audit
D. Financial audit
2 – 5 MULTIPLE CHOICE QUIZZERS
1. Which one of the following is more difficult to evaluate objectively?
A. Presentation of financial statements in accordance with generally accepted accounting principles.
B. Compliance with government regulations.
C. Efficiency and effectiveness of operations.
D. All three of the above are equally difficult.
2. Which of the following types of audits is performed to determine whether an entity's financial statements are fairly stated in conformity with generally accepted accounting principles?
A. Operational audit
B. Financial statement audit
C. Compliance audit
D. Performance audit
3. An auditor's overall objective in a financial statement audit is to
A. Determine that all individual accounts and footnotes are fairly presented.
B. Employ the audit risk model.
C. Express an opinion on the fair presentation of financial statements in accordance with generally accepted accounting principles.
D. Detect all errors and fraud.
4. Operational auditing is primarily oriented toward
A. Future improvements to accomplish the goals of management.
B. The accuracy of the data reflected in the management's financial records.
C. The verification that a company's financial statements are fairly presented.
D. Past protection provided by existing internal control.
5. An objective of an operational audit is to assess whether
A. Specific units of the entity are functioning effectively and efficiently
B. Financial statements fairly reflect the results of operations
C. An organization's procedure adheres to specific procedures, rules or regulations set by an authoritative body
D. Internal control structure is designed and implemented
6. An operational audit has as one of its objectives to:
A. determine whether the financial statements fairly present the entity's operations.
B. evaluate the feasibility of attaining the entity's operational objectives.
C. make recommendations for improving performance.
D. report on the entity's relative success in attaining profit maximization.
7. Which of the following best describes the operational audit?
A. It requires constant review by internal auditors of the administrative controls as they relate to the operations of the company.
B. It concentrates on implementing financial and accounting control in a newly organized company.
C. It attempts and is designed to verify the fair presentation of a company's results of operations.
D. It concentrates on seeking out aspects of operations in which waste would be reduced by the introduction of controls.
8. AAA Corp. has engaged a public accounting firm to issue a report on the accuracy of product quality specifications included in trade sales agreements. This is an example of a(n):
A. Financial statement audit
B. Attestation service
C. Compliance audit
D. Operational audit
9. 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
10. Which of the following audits can be regarded as generally being a compliance audit?
A. BIR examiners' examinations of taxpayer return.
B. COA auditor's evaluation of the computer operations of governmental units.
C. An internal auditor's review of a company's payroll authorization procedures.
D. A CPA firm's audit of the local school district.
2 – 6 MULTIPLE CHOICE QUIZZERS
1. Which of the following types of auditing is performed most commonly by CPAs on a contractual basis?
A. Internal auditing
B. BIR auditing
C. Government auditing
D. External auditing
2. Internal auditing often extends beyond examinations leading to the expression of an opinion on the fairness of financial statement presentation and includes audits of efficiency, effectiveness, and
A. Internal control.
B. Evaluation.
C. Accuracy.
D. Compliance.
3. The best description of the scope of internal auditing is that it encompasses
A. Primarily operational auditing.
B. Primarily financial auditing.
C. Both financial and operational auditing.
D. Primarily the safeguarding of assets and verifying the existence of such assets.
4. What is the proper organizational role of internal auditing?
A. To serve as an independent, objective assurance and consulting activity that adds value to operations.
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.
5. To maximize independence, the director of internal auditing should report to the
A. Audit committee.
B. Controller.
C. Chief financial officer.
D. Director of information systems.
6. To operate effectively, an internal auditor must be independent of
I. The line functions of the organizations
II. The entity
III. The employer-employee relationship which exists for other employees in the organization
A. I only
B. II only
C. III only
D. I, II, and III
7. The scope and objectives of internal auditing vary widely and depend on the size and structure of the entity and the requirements of management. Ordinarily, internal auditing includes one or more of the following:
I. Review of the accounting and internal control systems
II. Examination of financial and operating information
III. Review of the economy, efficiency, and effectiveness of operations
IV. Review of compliance with laws, regulations, and other external requirements
A. I, II and III
B. II, III, and IV
C. I, II, and IV
D. I, II, III, and IV
8. Which statement is correct regarding the relationship between internal auditing and the external auditor?
A. Some judgments relating to the audit of the financial statements are those of the internal auditor.
B. The external audit function's objectives vary according to management's requirements.
C. Certain aspects of internal auditing may be useful in determining the nature, timing, and extent of external audit procedures.
D. The external auditor is responsible for the audit opinion expressed, however that responsibility may be reduced by any use made of internal auditing.
9. Government auditing beyond examinations leading to the expression of opinion on the fairness of financial presentation and includes audits of efficiency, economy, effectiveness, and also
A. Accuracy
B. Evaluation
C. Compliance
D. Internal control
10. Auditors of the Commission on Audit perform the role of
A. Internal auditors.
B. Management accountants.
C. Independent auditors.
D. Financial consultants.
2 – 7 MULTIPLE CHOICE QUIZZERS
1. The objective of the ordinary audit of financial statements is the expression of an opinion on:
A. the fairness of the financial statements.
B. the accuracy of the annual report.
C. the accuracy of the financial statements.
D. the balance sheet and income statement.
2. An audit of historical financial statements most commonly includes the:
A. Statement of Cash Flows, the Statement of Financial Position, and the Retained Earnings Statement.
B. Statement of Financial Position, the Statement of Comprehensive Income, and the Statement of Cash Flows.
C. Statement of Comprehensive Income, the Statement of Cash Flows, and the Statement of Net Working Capital.
D. Statement of Financial Position, the Statement of Comprehensive Income, the Statement of Cash Flows, and the Statement of Changes in Equity.
3. An audit of historical financial statements is most often performed to determine whether:
I. organization is operating efficiently and effectively.
II. entity is following specific procedures or rules set down by some higher authority.
III. management team is fulfilling its fiduciary responsibilities to shareholders.
A. Only one of the above items
B. Only two of the above items
C. All of the above items
D. None of the above items
4. In "auditing" accounting data, the concern is
A. Determining whether recorded information properly reflects the economic events that occurred during the accounting period.
B. Determining if fraud has occurred.
C. Determining if taxable income has been calculated correctly.
D. Analyzing the financial information to be sure that it complies with government requirements.
5. Third-party users of the audit report expect the auditor to do all of the following except:
A. To evaluate measurements and disclosures made by management
B. To provide a biased evaluation of the FSs
C. To determine whether financial statements are presented in accordance with GAAP
D. To gather sufficient evidence to support their opinion
6. Primary responsibility for the assertions in financial statements rests with the:
A. Audit partner assigned to the engagement
B. Senior auditor in charge of field work
C. Staff auditor who drafts the statements
D. Client's management
7. It refers to the audit procedures deemed necessary in the circumstances to achieve the objective of the audit.
A. Reasonable assurance
B. Objective of an audit
C. Audit program
D. Scope of an audit
8. The auditor communicates the results of his or her work through the medium of the
A. Engagement letter
B. Management letter
C. Audit report
D. Financial statements
9. The auditor's opinion
A. Enhances the credibility of financial statements.
B. Is an assurance as to the future viability of the entity.
C. Is an assurance as to the efficiency with which management has conducted the affairs of the entity, but not effectiveness.
D. Certifies the correctness of the financial statements.
10. If the auditor believes that the financial statements are not fairly stated or is unable to reach a conclusion because of insufficient evidence, the auditor:
A. should withdraw from the engagement.
B. should request an increase in audit fees so that more resources can be used to conduct the audit.
C. has the responsibility of notifying financial statement users through the auditor's report.
D. should notify regulators of the circumstances.
2 – 8 MULTIPLE CHOICE QUIZZERS
1. Which of the following best describes the objective of an audit of financial statements?
A. To express an opinion whether the financial statements are prepared in accordance with prescribed criteria.
B. To express an assurance as to the future viability of the entity whose financial statements are being audited.
C. To express an assurance about the management's efficiency or effectiveness in conducting the operations of entity.
D. To express an opinion whether the financial statements are prepared, in all material respect, in accordance with an identified financial reporting framework.
2. The level of assurance provided by an auditor when auditing financial statements is
A. Absolute
B. High
C. Moderate
D. None
3. The concept of reasonable assurance indicates that the auditor is:
A. not an insurer of the correctness of financial statements.
B. not responsible for the fairness of the financial statements.
C. responsible only for issuing an opinion on the financial statements.
D. responsible for finding all misstatements.
4. Absolute assurance cannot be provided in an audit because of: (Choose the exception)
A. Human errors in judgment
B. The need to obtain conclusive evidence
C. The employment of test procedures
D. Limitations inherent in the client's internal controls
5. Which of the following statements does not properly describe a limitation of an audit?
A. Many financial statement assertions cannot be audited.
B. Many audit conclusions are made on the basis of examining a sample of evidence.
C. Some evidence supporting peso representations in the financial statements may be obtained by oral or written representations of management.
D. Fatigue and carelessness can cause auditors to overlook pertinent evidence.
6. The risk that the client's financial statements may be materially false, and misleading is referred to as the
A. Business risk
B. Risk assessment
C. Client risk
D. Information risk
7. Which of the following can be significantly affected by an audit?
A. Business risk
B. Information risk
C. The risk-free interest rate
D. Inherent risk
8. When the auditor issues an erroneous opinion as the result of an underlying failure to comply with the requirements of generally accepted auditing standards, it results in
I. Audit failure
II. Audit risk
III. Business failure
A. I only
B. I and II
C. II and III
D. I, II and III
9. Which of the following statements does not properly describe an element of the theoretical framework of auditing?
A. The data to be audited can be verified.
B. Short-term conflicts may exist between managers who prepare data and auditors who examine the data.
C. Auditors act on behalf of management.
D. An audit benefits the public.
10. Statement 1: All financial data are verifiable through existence of supporting documents and records
Statement 2: There should be no conflict, whether short-term or long-term, should exist between the auditor and the client's management.
Statement 3: Financial information is more reliable when the internal controls of the entity are effective, as such, external auditors also express an opinion over the effectiveness of these controls.
A. Only one statement is correct
B. Only two statements are correct
C. All statements are correct
D. All statements are incorrect
2 – 9 MULTIPLE CHOICE QUIZZERS
1. Which is not a theoretical postulate framing an audit?
A. Financial data can be subjected to verification.
B. Long-term conflict between the auditor and client may exist.
C. An audit benefits the public.
D. The auditor is independent of the client.
2. Auditing is based on the assumption that the financial data are verifiable. Data are verifiable when two or more qualified individuals,
A. Working together can prove, beyond doubt, the accuracy of the data.
B. Working independently, each reaches essentially similar conclusions.
C. Working independently can prove, beyond reasonable doubt, the truthfulness of the data.
D. Working together, can agree upon the accuracy of the data.
3. The need for an independent auditor arises due to the following reasons. (Choose the exception)
A. Expertise of auditors
B. Competing interests
C. Remoteness of users
D. Complexity of decision-making
4. Which of the following statements does not describe a condition that creates a demand for auditing?
A. Conflict between an information preparer and a user can result in biased information.
B. Information can have substantial economic consequences for a decision maker.
C. Expertise is often required for information preparation and verification.
D. Users can directly assess the quality of information.
5. The market for auditing services is driven by
A. The regulatory authority of the Securities and Exchange Commission.
B. A demand by external users of financial statements.
C. Pronouncements issued by the Auditing Standards Board.
D. Congress at the federal level and elected legislative bodies at the state level.
6. Financial statement users often receive unreliable financial information from companies. Which of the following is not a common reason for this?
I. Complex business transactions.
II. Large amounts of data.
III. Lack of firsthand knowledge about the business.
A. I and II
B. II and III
C. I and III
D. I, II, and III
7. Which of the following best describes the reason why an independent auditor reports on financial statements?
A. A poorly designed internal control system may be in existence.
B. Management fraud may exist, and it is more likely to be detected by independent auditors.
C. Different interests may exist between the company preparing the statements and the people using the statements.
D. A misstatement of account balances may exist and is generally corrected as the result of the independent auditor's work.
8. Underlying conditions that create demand by users for reliable information include the following, except
A. Transactions that are numerous and complex
B. Users separated from accounting records by distance and time
C. Financial decisions that are important to investors and users
D. Decisions are not time sensitive
9. There are four conditions that give rise to the need for independent audits of financial statements. One of these conditions is consequence. In this context, consequence means that:
A. Users of the statements may not fully understand the consequences of their actions.
B. Auditor must anticipate all possible consequences of the report issued.
C. The impact of using different accounting methods may not be fully understood by the users of the statements.
D. Financial statements are used for important decisions.
10. Which of the following is incorrect regarding the general principles of an audit?
A. The auditor should comply with the "Code of Ethics for Professional Ethics for Certified Public Accountants" promulgated by the Philippine Professional Regulation Commission.
B. The auditor should conduct an audit in accordance with PSAs.
C. The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated.
D. The auditor would ordinarily expect to find evidence to support management representations and assume they are necessarily correct.
2 – 10 MULTIPLE CHOICE QUIZZERS
1. Which of the following is an incorrect phrase?
A. Auditing is a systematic process.
B. Auditing objectively obtains and evaluates evidence.
C. Auditing evaluates evidence regarding assurance.
D. Auditing communicates results to interested users.
2. Which of the following is/are correct?
Statement 1: The primary purpose of a compliance audit is to determine whether the financial statements are prepared in compliance with generally accepted accounting principles.
Statement 2: Results of compliance audits are typically reported to someone within the organizational unit being audited rather than to a broad spectrum of outside users.
A. Only Statement 1 is correct
B. Only Statement 2 is correct
C. Both statements are correct
D. Both statements are incorrect
3. Which is incorrect regarding internal auditing?
A. It encompasses both financial and operational auditing.
B. An internal audit department reports to the audit committee and senior management.
C. It provides assistance primarily to management and those charged with governance.
D. It can be performed only by internal auditors.
4. To provide for the greatest degree of independence in performing internal auditing functions, an internal auditor most likely should report to
A. Board of Directors.
B. Corporate Controller.
C. Vice-President for Finance.
D. Corporate Stockholders.
5. Which of the following statements is not a distinction between independent auditing and internal auditing?
A. Independent auditors represent third party users external to the auditee entity, whereas internal auditors report directly to management.
B. Although independent auditors strive for both validity and relevance of evidence, internal auditors are concerned almost exclusively with validity.
C. Internal auditors are employees of the auditee, whereas independent auditors are independent contractors.
D. The internal auditor's span of coverage goes beyond financial auditing to encompass operational and performance auditing.
6. Statement 1: Providers of external audits and internal audits are both independent from the management which allows them to perform financial statement audit.
Statement 2: External auditors enhance credibility of information by helping the management in preparing the financial statements and designing and implementing internal controls.
A. Only Statement 1 is correct
B. Only Statement 2 is correct
C. Both statements are correct
D. Both statements are incorrect
7. The overall objective of the independent auditor in conducting financial statement audit is:
A. To prove accuracy and reliability of financial statements
B. To prepare and present financial statements in accordance with PFRS
C. To obtain reasonable assurance about whether the financial statements are free from material misstatements, due to fraud and error
D. To report on the financial statements and communicate as required by PAS
8. In the audit of historical financial statements, which of the following accounting bases is the most common?
A. Regulatory accounting principles.
B. Cash basis of accounting.
C. Generally accepted accounting principles.
D. Liquidation basis of accounting.
9. Which of the following statements is/are correct?
Statement 1: Financial statements benefit the public by lending credibility to the items presented in the financial statements.
Statement 2: Auditors serve numerous parties, but most importantly the public, as exemplified by investors, creditors, and other stakeholders.
Statement 3: Financial statements should not favor one user over another, as such, the interest of the users must not have conflicts.
A. I and II
B. II and III
C. II and III
D. I, II, and III
10. 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
B. II only
C. Either I or II
D. Both I and II
2 – 11 MULTIPLE CHOICE QUIZZERS
1. 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 due to fraud or error.
II. To report on the financial statements.
III. To obtain conclusive rather than persuasive evidence.
IV. To detect all misstatements, whether due to fraud or error.
A. I and II only
B. II and IV only
C. I, II and III
D. I, II, III and IV
2. Management of a company is responsible for
A. Hiring the auditor
B. The audit workpapers
C. Preparing the financial statements
D. Independence and obtaining evidence
3. The term that describes the role of persons entrusted with the supervision, control and direction of an entity is
A. Management
B. Administration
C. Governance
D. Government
4. Statement 1: The audit of financial statements relieves the management and/or those charged with governance of their responsibilities with the financial statements.
Statement 2: The auditor is not, and cannot, be held responsible for fraud and error.
Statement 3: An audit, when carried out, may act as a deterrent for fraud and error.
A. Only one statement is correct
B. Only two statements are correct
C. All statements are correct
D. All statements are incorrect
5. The auditor's judgment concerning the overall fairness of the presentation of financial position, results of operations, and changes in financial position is applied within the framework of
A. Generally accepted accounting principles.
B. Generally accepted auditing standards.
C. Internal control.
D. Information systems control.
6. Which of the following items represents an inherent limitation of an audit?
I. The nature of financial reporting
II. The nature of audit procedures and the audit risk
III. The need for the audit to be conducted within a reasonable period of time and at a reasonable cost
A. I and II
B. II and III
C. I and III
D. I, II, and III
7. Absolute assurance is rare in practice due to limitations of assurance engagement. Which of the following does not describe such limitation?
A. Use of selective testing
B. Inherent limitation of internal controls
C. The fact that most evidence are merely persuasive
D. The procedures applied to reasonable assurance engagement are usually comprehensive
8. Statement 1: When the auditor is unable to gather sufficient appropriate evidence, he or she ordinarily selects between qualified and adverse opinions.
Statement 2: An auditor may provide an absolute level of assurance in extremely rare circumstances.
Statement 3: Inherent limitations of an audit arise due to the auditor's exposure to inherent risks, control risks, and detection risks.
A. Only one statement is correct
B. Only two statements are correct
C. All statements are correct
D. All statements are incorrect
9. Statement 1: External audits provide value to organizations through reduction of information risk that may lead to lower cost of capital.
Statement 2: One of the ways to reduce information risk is to share such risk with the preparer of the information.
Statement 3: The high demand for audits present is because it is required by law.
A. Only one statement is correct
B. Only two statements are correct
C. All statements are correct
D. All statements are incorrect
10. Which of the following is/are correct?
Statement 1: The financial statements most commonly audited by external auditors are the Statement of Financial Position, the Statement of Comprehensive Income, and the Statement of Changes in Retained Earnings.
Statement 2: Only companies that file annual statements with the Securities and Exchange Commission are required to have an annual external audit.
A. Only Statement 1 is correct
B. Only Statement 2 is correct
C. Both statements are correct
D. Both statements are incorrect