Statement Audit: Client Acceptance and Planning

1. In assessing whether to accept a client for an audit engagement,

an auditor should consider the

I. Client’s business risk

II. Auditor’s business risk

A. I only
B. II only
C. Both I and II
D. Neither I nor II

2. Which of the following factors most likely would cause an auditor

to decline a new audit engagement?

A. Conducting that the entity’s engagement probably lacks

integrity.
B. An inability to perform preliminary analytical procedures
before assessing control risk.
C. An inadequate understanding of the entity’s internal control.
D. The close proximity to the end of the entity’s reporting period.

PSQC 1 requires a firm (including sole practitioner) to establish

policies and procedures for the acceptance and continuance of
client relationships and specific engagements, designed to provide
reasonable assurance that it will only accept engagements if it:
1.) Is competent to perform the engagement;

2.) Can comply with relevant ethical requirements; and

3.) Has considered the integrity of the client, and does not have
information to conclude that the entity’s management lacks
integrity.

Answer B is incorrect because the auditor performs analytical

procedures after accepting engagement.

Answer C is incorrect because the auditor obtains an

understanding of the entity’s internal control system subsequent
to the acceptance of the engagement.

Answer D is incorrect because an auditor may accept an

engagement near or after the end of the reporting period.

3. Before accepting an engagement to audit a new client, an

auditor is required to
A. Obtain a copy of the client’s financial statements.
B. Prepare a memorandum setting forth the staffing requirements
and documenting the preliminary audit plan.
C. Make of the predecessor auditor after obtaining the consent of
the prospective client.
D. Discuss the management representation letter with the client’s
audit committee.

PSA 300 (Planning an Audit of Financial Statements) states that

the auditor shall undertake the following activities prior to an
initial audit:
1.) Performing procedures required by PSA 220 (Quality Control
for an Audit of Financial Statements) regarding the acceptance of
the client relationship and the specific audit engagement; and
2.) Communicating with he predecessor auditor, where there has
been a change of auditors, in compliance with relevant ethical
requirements.

Answer A is incorrect because the entity’s annual financial

statements will be prepared after the end of its reporting period
and the auditor’s acceptance of the engagement will likely be prior
to that time.

Answers B and D are incorrect because the procedures described

will be performed only after the acceptance of engagement.

4. Which of the following conditions most likely would pose the

greatest risk in accepting a new audit engagement?

A. There will be a client-imposed scope limitation.

B. The client’s financial reporting system has been in place for 10
years.
C. The firm will have to hire an expert in one audit area.
D. Staff will need to be rescheduled to cover this new client.

According to PSA 210 (Agreeing the Terms of Audit Engagements),

the auditor shall not accept the engagement if management or
those charged with governance impose the limitation on the scope
of the auditor’s work in the terms of a proposed audit engagement
such that the auditor believes the limitation will result in the
auditor disclaiming an opinion on the financial statements.

5. Which of the following circumstances would permit an

independent auditor to accept an engagement after the end of the
reporting period?

A. Expectation of the operating effectiveness of controls.

B. Issuance of a disclaimer opinion as a result of inability to
conduct certain tests required by PSAs due to the timing of
acceptance of the engagement.
C. Remedy the limitations resulting from accepting the
engagement after the end of the reporting period, such as those
relating to the existence of physical inventory.
D. Receipt of an assertion from the predecessor auditor that the
entity will be able to continue as a going concern.
Prior to accepting apropos audit engagement subsequent to the
end of the entity’s reporting period, the auditor should determine
whether the circumstances permit an audit with accordance with
PSAs and expression of an unmodified opinion. Otherwise, the
auditor should discuss with the prospective client the possibility of
rendering a qualified opinion or a disclaimer of opinion. However in
some cases, the auditor may remedy the audit limitations uch as by
observing another physical count of inventories.

Answer A is incorrect because sufficient appropriate evidence

regarding the operating effectiveness of the entity internal control
during the year should be available after the year-end.

Answer B is incorrect because a disclaimer of opinion is

appropriate only if the auditor cannot resolve an issue by
performing alternative procedures.

Answer D is incorrect because there is no need to obtain

representations regarding the prospective client’s ability to
continue as going concern from the predecessor auditor.

6. In an audit based on Philippine Standards of Auditing (PSAs), a

successor auditor would normally become satisfied with opening
balances by
A. Performing analytic review procedures.
B. Reviewing the predecessor’s working paper.
C. Auditing the previous year’s working papers.
D. Interviewing client personnel.

7. A predecessor withdrew from the engagement after discovering

that the client’s financial statements are materially misstated that
it would not revise. If asked by the successor auditor about the
termination of the engagement, the predecessor should
A. Suggest that the successor auditor should obtain the client’s
consent to discuss the reasons.
B. Indicate that there was a misunderstanding.
C. State that the audit revealed material misstatement that the
client would not revise.
D. Suggest that the successor auditor ask the client.

8. Which of the following is not correct regarding the

communications between successor/incoming and
predecessor/previous auditors?

A. The burden of initiating the communication rests with

predecessor auditor.
B. The burden of initiating the communication rests with
successor auditor.
C. The predecessor auditor may choose to a limited response to a
successor auditor.
D. The predecessor auditor must received his/her former client’s
permission prior to disclosing client information to the auditor.
 9. The auditor may accept or continue an audit engagement only
when the basis upon which it is to be performed has been agreed,
through

I. Establishing whether the preconditions for audit are present.

II. Confirming that there is a common understanding between the

auditor and management and, where appropriate those charge with
governance of the terms of the audit engagement.

A. I only
B. II only
C. Both I and II
D. Neither I nor II

As defined in PSA 210 (Agreeing the Terms of Audit Engagements),

“preconditions for an audit” refers to:
a.) The use of management of an acceptable financial
reporting framework in the preparation of the financial
statements; and
b.) The agreement of management and, where appropriate
those charged with governance to the premise of which
audit is conducted.

The auditor establishes whether the preconditions for audit are

present by:

1.) Determining whether the financial reporting framework

to be applied in preparation of financial statements is
acceptable; and
2.) Obtaining management’s agreement that it acknowledges
and understands its responsibilities that are fundamental to
the conduct of an audit n accordance with PSAs.
10. An audit is conducted on the premise that management and,
where appropriate, those charged with governance have
acknowledge and understand that they have responsibilities that
are fundamental to the conduct of an audit in accordance with
PSAs. Which of the following is not one of those responsibilities?

A. The preparation of financial statements with accordance with

relevant pronouncements issued by the AASC.
B. The establishment and maintenance of an adequate internal
control system that is necessary to enable the preparation of
financial statements that is free from material misstatement,
whether due to fraud or error.
C. To provide the auditor with access to all information that is
relevant to the preparation of the financial statements such as
records, documentation and other matters.
D. To provide the auditor with unrestricted access to persons
within the entity from which the auditor determines it necessary to
obtain audit evidence.

Management is responsible for the preparation of the financial

statement in accordance with the applicable financial reporting
framework, including where relevant their fair presentation.
11. The auditor shall agree the terms of the audit engagement with
management or those charged with governance, as appropriate.
The agreed terms shall be recorded in a/an

A. Engagement letter
B. Letter of audit inquiry
C. Management representation letter
D. Confirmation letter
The standard states that it is in the interest of both the entity and
the auditor that the auditor sends an audit engagement letter
before the commencement of the audit to help avoid
misunderstandings with respect to the audit. The engagement
letter shall include:

a.) The objective and scope of the audit of the financial

statement;
b.) The responsibilities of the auditor;
c.) The responsibilities of the management;
d.) Identification of applicable financial reporting framework
for the preparation of financial statements; and
e.) Reference to the expected form and content of any
reports to be issued by the auditor and a statement that
there may be circumstances in which a report may differ
from its expected form and content.

Hasslehoff Inc., is a multinational company with divisions

around the world. Division A in the United States
purchases a part from Division G in Canada. There is no
outside market for the part. The part is sold for $12 and
normally receives a 20% markup on cost.

What is the transfer price using the resale price method?

A. $10
B. $9.60
C. $12
D. $14.40
97. Hasslehoff Inc., is a multinational company with
divisions around the world. Division A in the United States
purchases a part from Division G in Canada. There is no
outside market for the part because it is used to
manufacture another product. The manufacturing cost for
the part is $5. Transportation is $1 and commissions are
$.5 but do not need to be paid.

What is the transfer price using the cost-plus method?

A. $5.50
B. $6.50
C. $5
D. $6

98. How are information, responsibility, and accountability

related?

Managers are responsible for making decisions about

segments of business. The manager is accountable for the
results of a specified set of activities. Information is
collected to measure the results and the expected
outcomes. Without information measures, no comparisons
can be made that make managers accountable for their
actions and decisions. Managers must explain deviations.
Information, responsibility, and accountability are
essential ingredients of responsibility accounting and
performance measurement.
99. Discuss the differences between centralized and
decentralized decision making. Why would a firm
decentralize its operations?

Decentralization is the delegation of decision-making

authority to lower levels. In centralized decision making,
decisions are made at the very top level and lower-level
managers are responsible for implementing these
decisions. For decentralized decision making, decisions
are made and implemented by lower-level managers.

Reasons for decentralization: access to local information,

cognitive limitations, more timely response, focusing of
central management, training and evaluation, motivation,
and enhanced competition.
100. Compare and discuss the advantages and
disadvantages of the following performance measures:
ROI, EVA, and Residual Income.

The return on investment measure is a ratio of operating

income to average operating assets. It encourages
efficiency, discourages excessive investment, forces
managers to pay attention to relationships among
variables, and allows comparison of different size
ventures. It discourages investments in ventures that
have a lower ROI than the division currently has and
encourages short-run focus.

The residual income is the excess earning over the

minimum expected return on operating assets. It has the
advantage of accepting projects that add contribution
beyond the hurdle rate. However, residual income is an
absolute measure and does not foster comparison of
different size projects. It also does not discourage myopic
behavior.

The EVA is a measure that looks at the value added by

current operations by determining the excess of after-tax
operating income over the actual cost of capital employed.
It looks at the wealth created from operations. However, it
also is subject to manipulation by managers and is an
absolute measure, making comparisons of different size
divisions difficult.
101. Provide the missing data in the following situations:

Sigma Tau Gamma

Division Division Division
Sales $ (a) $250,000 $ (g)
Operating assets $ (b) $ (d) $800,000
Net operating income $400,000 $10,000 $144,000
Margin 0.08 (e) 0.12
Turnover (c) (f) 1.5
Return on investment 16% 10% (h)

jimbie

a. $400,000/a = 0.08 a = $5,000,000

b. $400,000/b = 0.16 b = $2,500,000

c. c = $5,000,000/$2,500,000 = 2.0

d. $10,000/d = 0.10 d = $100,000

e. e = $10,000/$250,000 = 4%

f. f = $250,000/$100,000 = 2.5 times

g. $144,000/g = 0.12 g = $1,200,000

h. 0.12 ´ 1.5 = 18%

102. Sprint Company has the following data for 2011:

Division A Division B
Sales $400,000 $300,000
Contribution margin 160,000 125,000
Operating income 80,000 30,000
Average operating assets 320,000 200,000
Weighted average cost of capital 15% 15%

Sprint Company has a target ROI of 20 percent.

Required:

Calculate the following amounts for each division:

a. Margin ratio
b. Turnover ratio
c. ROI
d. Residual income
e. EVA

Division A:

a. Margin ratio = $80,000/$400,000 = 20%

b. Turnover ratio = $400,000/$320,000 = 1.25

c. ROI = 0.20 ´ 1.25 = 25%

d. Residual income = $80,000 - 0.20($320,000) = $16,000

e. EVA = $80,000 - 0.15($320,000) = $32,000

Division B:

a. Operating income margin = $30,000/$300,000 = 10%

b. Turnover ratio = $300,000/$200,000 = 1.50

c. ROI = 0.10 ´ 1.50 = 15%

d. Residual income = $30,000 - 0.20($200,000) = $(10,000)

e. EVA = $30,000 - 0.15($200,000) = $0

12. The following matters are generally included in the auditor

engagement letter, except

A. The factors to be considered in determining the overall

materiality.
B. The fact that because of the test nature and other inherent
limitations of an audit, together with the inherent limitations of
internal control, there is an unavoidable risk that even some
material misstatements may remain undiscovered.
C. The scope of the audit
D. Management’s responsibility for the financial statements.

13. The following are usually included in an auditor’s engagement

letter, except
A. List of audit procedures to be used in inventory observation.
B. The financial statements are the responsibility of the company’s
management. C. A reference to PFRS.
D. A reference to PSAs.
14. Which of the following statements would least likely appear an
auditor’s engagement letter?

A. Our audit will be made with the objective of our expressing an

opinion on the financial statements.
B. We remind you that the responsibility for the preparation of
financial statements including adequate disclosure is that of the
management of the entity.
C. After performing our preliminary analytical procedures, we will
discuss with you the other procedures we consider necessary to
complete the engagement.