Name: RANNAH JANE S.

RAYMUNDO Date:
Teacher: Score: _______
St. Vincent de Ferrer College of Camarin, Inc.
SVFC Compound,
San Vicente Ferrer St., Area D, Brgy. 178, Camarin, Caloocan City
Telephone Number: 668-25-75; Email address: [email protected]
Website:

MIDTERM EXAM IN ACCOUNTING 16A

TEST 1. QUESTIONS AND PROBLEMS

A. EXPLAIN WHY AUDITOR’S REPORTS ARE IMPORTANT TO USERS OF FINANCIAL STATEMENTS.

- Auditors' reports are important to users of financial statements because they inform users of the
auditor's opinion as to whether or not the financial statements are fairly stated or whether no conclusion
can be made with regard to the fairness of their presentation.

B. IN ADDITION TO AN UNDERSTANDING OF THE BUSINESS AND THE INDUSTRY, WHAT ARE THE REQUIREMENTS
FOR AN EFFECTIVE AUDIT?
- The outcome of an effective audit includes financial statements that present a true and fair view, and
advice on how the company's processes may be improved. An effective audit is completed to schedule,
and with minimal disruption to the company.

C. DIFFERENTIATE BETWEEN THE SCOPE AND OPINION PARAGRAPHS OF THE STANDARD AUDIT REPORT.
- The standard unqualified report consist of three paragraphs. ... The second paragraph describes the
nature of the audit and is called the scope paragraph. The final paragraph is the opinion paragraph, which
is a concise statement of the auditor's opinion based on the audit.

D. WHAT IS AN “ENGAGEMENT LETTER?” WHY IS IT USE RECOMMEND PRIOR TO THE RENDERING OF

PROFESSIONAL SERVICES BY CPAS?
- An engagement letter is the agreement or understanding between the CPA and his/her client concerning
the nature of the engagement.

E. WHAT FUNCTION IS SERVED BY THE AUDIT PROGRAM?

- It documents the procedures an auditor will follow to validate that an organization is in conformance
with compliance regulations. The program which includes both substantive test and test of controls will
enable the auditor to express an opinion on the financial statements taken as a whole.

F. WHO PARTICIPATES IN THE PRE-AUDIT CONFERENCE, AND WHAT TOPIC SHOULD BE COVERED?
- A pre-audit is the first step in the process of an audit. During a pre-audit, a company or individual's
financial documents are examined to ensure that all information is correct before the company or
individual undergoes an official audit. The pre-audit process may be undertaken by employees of the
company being pre-audited, or the company may hire an independent organization to examine its
 finances. Pre-auditing may be used to describe both a single instance of review directly preceding an
official audit as well as the continuous process of monitoring finances throughout the year.

G. WHAT DISTINGUISHES THE INTERN PHASE FROM THE FINAL AUDIT PHASE?
- There are four main phases to an internal audit: Preparation, Performance, Reporting, and Follow Up.
The first two of these phases can be broken down into a series of smaller steps. Selecting team members
and appointing a lead auditor.

H. WHY MUST THE AUDITOR TEST THE INFORMATION SYSTEM PRIOR TO TESTING TRANSACTIONS AND
BALANCES?
- The auditor should determine overall responses to address the risks of material misstatement at the
financial statement level. Such responses may include emphasizing to the audit team the need to
maintain professional scepticism in gathering and evaluating audit evidence, assigning more experienced
staff or those with special skills or using experts,1 providing more supervision, or incorporating additional
elements of unpredictability in the selection of further audit procedures to be performed. Additionally,
the auditor may make general changes to the nature, timing, or extent of audit procedures as an overall
response, for example, performing substantive procedures at period end instead of at an interim date.

I. WHAT PURPOSES IS SERVED BY THE TEN GENERALLY ACCEPTED AUDITING STANDARDS?

- The ten generally accepted auditing standards, along with the related statements on auditing standards,
provide a framework by defining the requisite quality to be achieved in performing an audit.

J. DEFINE ATTESTATIONS. IN WHAT WAY(S) IS AUDITING A FORM OF ATTESTATION?

- Attestation is the act of showing or evidence showing that something is true. Auditing also is an act of
evidence showing that the assertions of the entity's management are true.

K. DISCUSS THE ROLE OF RISK IN THE AUDIT PROCESS AND HOW IT IS EXISTENCE IS COMMUNICATED TO THE
USER IN THE AUDIT REPORT.
- Audit risk is the risk that an auditor will not detect errors or fraud while examining the financial
statements of a client. Auditors can increase the number of audit procedures in order to reduce the level
of audit risk.

L. PRIOR TO NAMING CRUZ AND COMPANY AS ITS AUDITORS, DEL PELAYO OF VERBATIM, INC., MET WITH
GRACIE CRUZ AND INQUIRED ABOUT THE AUDITORS WHO WOULD WORK ON VERBATIM’S AUDIT. PELAYO
WANTS CRUZ TO ASSIGN ONLY PERSONS WHO GRADUATED FROM HIS ALMA MATTER.
REQUIRED: HOW SHOULD GRACIE CRUZ RESPOND?

M. DESCRIBE THE CONDITIONS UNDER WHICH AN AUDITOR IS ASSOCIATED WITH FINANCIAL STATEMENTS.
- An auditor is associated with financial statements when he or she (a) “has consented to the use of
his/her name in a report, document, or written communication containing the statement,” or (b) has
prepared or assisted in preparing the financial statements.

N. WHAT FACTORS SHOULD AN AUDITOR CONSIDER IN DETERMINING WHETHER FINANCIAL STATEMENTS ARE
PRESENTED FAIRLY IN CONFORMITY WITH GAAP?
- An independent auditor's report contains an opinion as to whether the financial statements present
fairly, in all material respects, an entity’s financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles. An identification of the country of origin of
those generally accepted accounting principles also is required (see section 508.08h).
- The purpose of this section is to explain the meaning of "present fairly" as used in the phrase "present
fairly . . . in conformity with generally accepted accounting principles." In applying this section, the
 auditor should look to the requirements of the Securities and Exchange Commission for the company
under audit with respect to the accounting principles applicable to that company.
O. WHY MUST THE AUDITOR CONSIDER IN DETERMINING WHETHER FINANCIAL STATEMENTS ARE PRESENTED
FAIRLY IN CONFORMITY WITH GAAP?
- The representation in the auditor's standard report regarding fair presentation, in all material respects, in
conformity with generally accepted accounting principles indicates the auditor's belief that the financial
statements taken as a whole are not materially misstated.

P. WHY MUST THE AUDITOR REFRAIN FROM EXPLAINING WHY SHE OR HE IS NOT INDEPENDENT?
- The auditor should be independent from the client company, so that the audit opinion will not be
influenced by any relationship between them. If this happens, the auditors can no longer be said to be
independent and the shareholders cannot rely on their opinion

TEST II. DEFINE THE FOLLOWING.

1. AUDIT RISK
- Audit risk is the risk that financial statements are materially incorrect, even though the audit opinion
states that the financial reports are free of any material misstatements. The purpose of an audit is to
educe the audit risk to an appropriately low level through adequate testing and sufficient evidence.
2. INHERENT RISK
- Inherent risk is the risk posed by an error or omission in a financial statement due to a factor other than a
failure of internal control. In a financial audit, inherent risk is most likely to occur when transactions are
complex, or in situations that require a high degree of judgment in regard to financial estimates.
3. CONTROL RISK
- Control risk is the probability that financial statements are materially misstated, due to failures in the
system of controls used by a business. ... The managers of a business are responsible for designing,
implementing, and maintaining a system of controls that is adequate for preventing the loss of assets.
4. DETECTION RISK
- Detection Risk (DR) is the risk that the auditor will not detect a misstatement that exists in an assertion
that could be material (significant), either individually or when aggregated with other misstatements.

5. HOW DOES AUDIT PLANNING ASSIST IN ASSESSING INHERENT RISK?

- Inherent risk is one factor, along with control risk, that an auditor uses to assess the risk of material
misstatement associated with a particular financial statement line item or audit area. Usually, an auditor
assesses each audit area as either low, medium or high in inherent risk.

6. NAME THREE SOURCES OF BUSINESS AND INDUSTRY INFORMATION.

- Basic reference sources such as guides, bibliographies, dictionaries, almanacs, encyclopaedias,
handbooks, yearbooks and internet resources.

7. WHAT IS THE AUDIT RISK MODEL?

- Audit risk model is a tool used by auditors to understand the relationship between various risks arising
from an audit engagement enabling them to manage the overall audit risk. Audit risk model suggests that
overall audit risk of an engagement is the product of the following three component risks.

8. HOW CAN AN AUDITOR USE THE AUDIT RISK MODEL?

- Auditor's goal is to reduce overall audit risk to an acceptable level. In order to do that, they will first
assess the levels of each component risk of the model. The risk values are not readily quantifiable though
and auditors use professional judgement to assess the risks.
9. DESCRIBE THE RELATIONSHIP BETWEEN DETECTION RISK AND EVIDENCE ACCUMULATION.
- The amount of audit evidence an auditor must gather varies inversely with allowable detection risk. As
allowable detection risk decreases, the amount of evidence required increases, and vice versa.

10. ANALYTICAL PROCEDURES CONSIST OF EVALUATIONS OF FINANCIAL INFORMATION MADE BY A STUDY OF

PLAUSIBLE RELATIONSHIPS AMONG BOTH FINANCIAL AND NONFINANCIAL DATA. THEY ARE RANGER FROM
SIMPLE COMPARISONS TO THE USE OF COMPLEX MODELS INVOLVING MANY RELATIONSHIPS AND ELEMENTS
OF DATA. THEY INVOLVE COMPARISONS OF RECORDED AMOUNTS, OR RATIOS DEVELOPED FROM RECORDED
AMOUNTS, TO EXPECTATIONS DEVELOPED BY THE AUDITORS.
REQUIRED:

a. DESCRIBE THE BROAD PURPOSE OF ANALYTICAL PROCEDURES.

 Analytical procedures are used for the following purposes: To assist the auditor in planning
the nature, timing, and extent of other auditing procedures. As a substantive test to obtain
evidential matter about particular assertions related to account balances or classes of
transactions.
b. IDENTIFY THE SOURCES OF INFORMATION FROM WHICH AN AUDITOR DEVELOPS EXPECTATIONS.
 Financial information for comparable prior periods giving consideration to known changes.
Anticipated results—for example, budgets, forecasts, and extrapolations.
c. DESCRIBE THE FACTORS THAT INFLUENCE AN AUDITOR’S CONSIDERATION OF THE RELIABILITY OF
DATA FOR PURPOSES OF ACHIEVING AUDIT OBJECTIVES.
 The following factors influence the auditor's consideration of the reliability of data for
purposes of achieving audit objectives: Whether sources within the entity were
independent of those who are responsible for the amount being audited. Whether the data
was developed under a reliable system with adequate controls.

11. THE FOLLOWING QUESTIONS DEAL WITH MATERIALITY. CHOOSE THE BEST RESPONSE.
a. 2
b. 4

12. THE FOLLOWING QUESTIONS CONCERN MATERIALITY AND RISK. CHOOSE THE BEST RESPONSE.
a. 2
b. 4
c. 3

13. THE FOLLOWING QUESTIONS DEAL WITH MATERIALITY AND RISK, AND THEIR EFFECT ON AUDIT REPORTS.
CHOOSE THE BEST RESPONSE.
a. 2
b. 3
c. 4

14. AUDIT RISK AND MATERIALITY SHOULD BE CONSIDERED WHEN PLANNING AND PERFORMING AN AUDIT IN
ACCORDANCE WITH GAAS. BOTH AUDIT RISK AND MATERIALITY SHOULD ALSO BE CONSIDERED IN
DETERMINING THE NATURE, TIMING AND EXTENT OF AUDITING PROCEDURES AND EVALUATING THE RESULT
OF THOSE PROCEDURES.
 REQUIRED:
A. DEFINE AUDIT RISK
- Audit risk refers to the risk that an auditor may issue an unqualified report due to the auditor's failure to
detect material misstatement either due to error or fraud. This risk is composed of: Inherent risk, the risk
involved in the nature of business or transaction.

B. DESCRIBE IS COMPONENTS OF INHERENT RISK, CONTROL RISK, AND DETECTION RISK.

- Inherent Risk is the risk of a material misstatement in the financial statements arising due to error or
omission as a result of factors other than the failure of controls (factors that may cause a misstatement
due to absence or lapse of controls are considered separately in the assessment of control risk). Control
Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in
the operation of relevant controls of the entity. Detection Risk is the risk that the auditors fail to detect a
material misstatement in the financial statements.

C. EXPLAIN HOW THIS COMPONENTS ARE INTERRELATED.

- Audit risk model is used by the auditors to manage the overall risk of an audit engagement. Auditors
proceed by examining the inherent and control risks pertaining to an audit engagement while gaining an
understanding of the entity and its environment. Detection risk forms the residual risk after taking into
consideration the inherent and control risks pertaining to the audit engagement and the overall audit risk
that the auditor is willing to accept. Where the auditor's assessment of inherent and control risk is high,
the detection risk is set at a lower level to keep the audit risk at an acceptable level. Lower detection risk
may be achieved by increasing the sample size for audit testing. Conversely, where the auditor believes
the inherent and control risks of an engagement to be low, detection risk is allowed to be set at a
relatively higher level.

D. DEFINE MATERIALITY.
- Materiality is a concept or convention within auditing and accounting relating to the
importance/significance of an amount, transaction, or discrepancy

E. DISCUSS THE FACTORS AFFECTING ITS DETERMINATION

- Factors affecting Supply. Supply refers to the quantity of a good that the producer plans to sell in the
market. Supply will be determined by factors such as price, the number of suppliers, the state of
technology, government subsidies, weather conditions and the availability of workers to produce the
good.

15. LAST YEAR YOU WERE ASSIGNED TO MINOR PARTS OF THE AUDIT OF THE SALE AND COLLECTIONS CYCLE FOR
PATRICH CORPORATION. THIS YEAR YOU HAVE BEEN ASSIGNED SIGNIFICANT RESPONSIBILITY IN THE AUDIT
OF THE SA LE AND COLLECTION CYCLE. YOU RECALL THAT LAST YEAR, THE CREDIT MANAGER, JOSIE TAN,
TREATED YOU AS IF YOU WERE ONE THE CLERKS. IN FACT, YOU HAD TO CALL HER “MISS TAN” WHEN YOU
WENT TO ASK HER SEVERAL QUESTIONS. THIS YEAR, SHE HAS BECOME VERY FRIENDLY. JOSIE, AS SHE WANTS
NOW YOU TO CALL HER, HAS JUST INVITED YOU TO JOIN HER FOR DINNER AT A VERY EXCLUSIVE PRIVATE
CLUB IN TOWN. YOU WERE CALLED AWAY BEFORE YOU COULD GIVE JOSIE A REPLY BUT INDICATE TO YOU
THAT LAST YEAR SHE TOOK YOUR PREDECESSOR TO SUCH A DINNER.

REQUIRED: HOW DO YOU RESPOND TO JOSIE?

- Last year you were assigned to minor parts of the audit of the sales and collections cycle for Patrick
Corporation. This year you have been assigned significant responsibility in the audit of the sales and
collections cycle. You recall that last year, the credit manager, Josie Tan, treated you as if you were one of
the clerks.