Test Bank for Auditing, 12th Edition John R. Taylor, Alan Millichamp

Multiple-Choice Questions Part 1

The Why of Auditing, Corporate Governance, the Statutory Framework, Accounting Requirements of the Companies Act 2006 and Auditing and Accounting Standards and Guidelines

ANSWERS

1. Below are four statements regarding the appointment and regulation of auditors.

Identify whether each of these statements is true or false

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

True The role of a Recognised Supervisory Body in the UK includes investigating possible breaches of audit regulations.

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The Brydon Report suggested that the purpose of an audit is to encourage and maintain confidence in the company and its directors.

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False

Recognised Qualifying Bodies are responsible for setting auditing standards and guidelines.

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The Theory of Rational Expectations holds that the shareholders can expect the auditors to validate all the transactions by the directors and uncover fraud in the company.

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2. Corporate Governance is defined as ‘the system by which companies are directed and controlled.’ (UK Corporate Governance Code, 2016). This involves several components all of which have a part to play in proper governance.

Which of the following are not classed as part of an entity’s corporate governance? (a) The Audit Committee (b) The Auditors (c) The Regulator (d) The Shareholders (e) The Public Answer: (e) 3. Which of the following best describes the audit expectation gap? (a) Auditors are performing in a manner which is at variance with the beliefs and desires of others who are party to or interested in the audit. (b) The expectation that the primary focus of an audit is detecting fraud. (c) Audits are of a lower quality than shareholders expect given how much they cost. (d) The level of assurance provided by an audit should be “almost certain”.

Answer: (a)

4. Platypus Ltd is a family company with a turnover this year of £12m, up from last year’s figure of £9.8m.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

It is wholly owned and run by two brothers who are the directors and it employs 20 people. The company’s net assets total £6m consisting mostly of machinery, land, agricultural buildings in which the equipment is stored and a small office and parts store.

The directors are not sure about their status as regards an audit. Advice they have been given ranges from: (a) As a small family company with no outside shareholders they do not need an audit, but they could choose to have one. (b) It is a good idea to have an audit in any case as it adds credibility to the figures when they are being looked at by the bank and the taxman. (c) They must have an audit by law. (d) As they are both involved in managing the business and they own all of it, an audit is pointless and will not benefit anyone.

Which of these statements is true?

Answer: (c) 5. Which of the following is NOT a reason provided as to why the chairman and chief executive of a company should not be the same person? (a) Both roles require significant time commitments that would make it difficult for one person to be effective at both. (b) The chairman, as a member of the board of directors, is responsible for the appointment, remuneration and performance of the chief executive. (c) Combining the chairman and the chief executive gives one person considerable power over both the strategic direction and the operations of the company. (d) Because the chief executive and chairman sit on the board of directors this would give one person two votes at the board.

Answer: (d)

6. Which of the following is NOT a responsibility of the board of directors in accordance with the main principles of The UK Corporate Governance Code? (a) The board is responsible for determining the principal risks it is willing to take in achieving its strategic objectives and enacting appropriate risk management. (b) The board should seek out the views of major shareholders. (c) The board should oversee the operational activities of an organization to ensure that they are undertaken in an efficient and effective manner. (d) The board’s roles include challenging and contributing to strategy development.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

Answer: (c) 7. Below are four statements regarding the appointment and regulation of auditors.

Identify whether each of these statements is true or false.

True

False

The work of the auditing profession in the UK is governed primarily by the Companies Act 2006.

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The Financial Reporting Council has the power to discipline auditors who perform their work poorly.

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Auditors do not have to have absolute assurance that the figures they audit are correct.

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Only accountants who are qualified with the Institute of Chartered Accountants in England & Wales or the Association of Chartered Certified Accountants can become Registered Auditors.

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8. Auditors have several rights to enable them to carry out their duties. Which of the following is not an auditor’s right? (a) Right to all explanations and information they consider necessary (b) Right to access all books and records of the company (c) Right to access company information held by third parties (d) Right to attend any meeting of the company Answer: (d) The auditors have right to attend any general meeting of the company i.e. any shareholders meeting.

9. The UK Corporate Governance Code is described as taking a narrow concept of corporate governance.

Which of the following best describes this concept? (a) Corporate governance focuses on the relationship between directly affected stakeholder groups. (b) Assessing corporate governance is the responsibility of the auditor. (c) Corporate governance focuses on ensuring the corporation acts in the best interests of the shareholders. (d) Corporate governance is focussed on ensuring that the corporation follows the appropriate laws and regulations.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

Answer: (c)

10. Complete the definition of the broad concept of good governance using the following terms: • are accountable, fair and transparent • integrity • control • rules and practices • laws • honesty • own • shareholders • provide a maximum return • stakeholders Good governance refers to the framework of ________________ by which those who ________________ a company or organization ensure that they act with _______________ and ________________ to ________________ who have a relationship with the entity.

Answer: Good governance refers to the framework of rules and practices by which those who control a company or organisation ensure that they act with integrity and are accountable , fair and transparent to stakeholders who have a relationship with the entity

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Multiple-Choice Questions Part 2 Ethical Standards and Rules of Professional Conduct, Quality Control in Audit Firms and Accepting Appointment as Auditors ANSWERS

1. Which of the following are examples of general threats to independence?

Advocacy threat The financial statements of Snagglepus Ltd have been prepared by Codd & Co., their audit firm.

Self-review threat

Management Familiarity threat threat

Not a threat

√

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The audit partner of Badger & Co. has been advising their client Highbrow on various management strategies to improve the business.

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The audit partner of Bludger & Co. has been representing their audit client Happlo at a VAT tribunal.

The husband of a partner of Tipto & Co. has been appointed the financial controller of their audit client Bongo.

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2. Identify whether each of these statements is true or false.

True Staff of audit firms should be asked annually to confirm whether or not they have any financial or personal connection with audit clients.

False

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The audit partner for a listed entity audit cannot remain as statutory auditor for more than five years and the role must be rotated among other partners in the firm.

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Audit firms should not accept consultancy work from audit clients.

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Audit files should be subject to a second partner review after the audit is completed to ensure that the firm’s procedures have been complied with and that the audit opinion is valid.

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3. The auditor may be faced with threats to their ethical principles.

Consider the three statements below d decide which of these present an ethical threat to an audit firm.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

Ethical threat

Not an ethical threat

The son of the engagement partner on the audit of Wibble plc has accepted a job as technical manager in the engineering division.

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An audit client has suggested that the audit firm of Tickett & Run should base part of the audit fee on the profits of the client company.

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The audit firm has been asked to carry out an internal audit review and to advise their client on how to set up an internal audit department.

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4 Which of the following is not a fundamental principle of the IFAC Code of Ethics? (a) Objectivity (b) Confidentiality (c) Independence (d) Professional behaviour Answer: (c)

5. Below are four statements regarding the auditor’s professional ethics.

Identify whether each of these statements is true or false.

True Auditors must comply with relevant laws and regulations and not do anything which might bring their profession into disrepute.

False

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Integrity can be defined as the auditor not allowing any conflict of interest, bias or influence of others to override their choice of actions.

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Auditors may use information obtained during the course of their professional work for personal use as long as they do not breach of their duty of confidentiality by disclosing it to others.

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Auditors must keep technically up to date so as to give appropriate advice to clients.

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6. An audit firm taking over an audit from a predecessor firm should write to them for clarification on particular audit matters.

Which of the following should not be included in such a letter? (a) The basis of the fee charged. (b) Doubts about the honesty and trustworthiness of the directors. (c) Whether or not the client tried to withhold information. (d) Confirmation that there is no reason why they might not accept the appointment.

Answer: (a)

7. Which of the following would be part of an audit firm’s internal control environment in respect of audit and assurance services? (a) Appointing an Ethics Partner who is also the senior engagement partner for several key clients’ audits. (b) Establishing policies and procedures defining independence and requiring partners and staff to disclose financial interests in clients. (c) Establishment of a policy for audit partners to develop close social relationships with senior members of client management in order to obtain consultancy and advisory work. (d) Seconding staff to work for clients in specialist or other roles in order to facilitate closer ties with the client. (e) All of the above.

Answer: (b)

8. Below are four statements regarding the appointment and regulation of auditors.

Identify whether each of these statements is true or false.

True The Conduct Committee can investigate a situation where there is the possibility of an allegation affecting public confidence in the auditing profession.

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The relevant RSB approves individuals to be Registered Auditors.

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The maximum number of years an audit firm can retain the audit of a public interest entity (PIE) is seven.

Auditors may charge contingency fees for non-audit work.

False

√ √

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

9. Below are four statements regarding the appointment and regulation of auditors.

Identify whether each of these statements is true or false.

True The very first auditors of a company are appointed by the directors.

False

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Any accountant who is a member of an RSB can sign an audit report.

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Before accepting appointment the prospective auditors should contact any outgoing auditors as a matter of professional courtesy and to find out if there is anything they should know.

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The auditors communicate with the shareholders by means of their Auditor’s Report.

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10. Auditors may be removed by an ordinary resolution of the shareholders at a general meeting. Which of these rights do the auditors not have when a resolution for their removal is presented to the meeting? (a) The right to receive copies of any resolution for their removal. (b) The right to make written representations to the shareholders who have received notice of the meeting and have them circulated to the shareholders by the company. (c) The right to table an alternative resolution at the meeting that they retain their office as auditor. (d) The right to speak at the meeting and make representations concerning their removal.

Answer (c)

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Multiple-Choice Questions Part 3 Accounting Systems and Internal Controls, Audit Planning, Audit Risk and Materiality and Audit Evidence including Using the Work of an Expert ANSWERS 1. Which of the following audit procedures for obtaining audit evidence is correctly described? (a) Recalculation involves the auditor’s independent execution of procedures or controls which were originally performed as part of the entity’s internal control. (b) Confirmation consists of seeking information of knowledgeable persons, within the company or outside the company. (c) Reperformance consists of checking the mathematical accuracy of documents or records. (d) Observation consists of looking at a procedure or process being performed by others

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

Answer: (d) 2. A trainee auditor has listed what she thought were some of the control objectives in the purchases cycle within an entity at the stage of placing a purchase order as: (1) To ensure that the item purchased is not already in inventory.

(2) To ensure that the inventory count is accurate.

(3) To ensure that the order is actually required.

(4) To ensure that all orders are paid for.

Is she correct? Which of these are control objectives? (a) All of the above (b)3 and 4 only (c) 1 only (d)1 and 3 only

Answer: (d)

3. Auditors use tests of control and substantive procedures to gather audit evidence.

For each of the procedures listed below, select whether it is a test of control or a substantive procedure.

Test of control Comparison of the current year’s revenue figure with the previous year’s figure.

Observation of the despatch procedures in respect of goods leaving an entity’s warehouse.

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Check that a sample of purchase invoices have been authorized for payment.

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Vouching of an addition to non-current assets to the supplier’s invoice.

Substantive procedure √

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4. Complete the description of auditing procedures by filling in the gaps with terms from the following list:

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

• • • • • • •

sufficient statements relevant sample truth inquiry sampling

• • • • • •

confirmations observation reliable vouching assertions true

Auditors must gather __________reliable evidence in order to support their conclusions as to the _______and fairness of financial reporting. They use various techniques for gathering evidence including _______, re-performance, re-calculation, _________, analytical procedures, third party __________ and _________. Audit evidence must be __________ and capable of evidencing the effectiveness of internal controls and the __________relating to classes of transactions.

Answer: Auditors must gather sufficient reliable evidence in order to support their conclusions as to the truth and fairness of financial reporting. They use various techniques for gathering evidence including inquiry, re-performance, re-calculation, sampling, analytical procedures, third party confirmations and observation. Audit evidence must be reliable and capable of evidencing the effectiveness of internal controls and the assertions relating to classes of transactions.

5. Which of the following statements are true or false?

True

False

Re-performance is a way of gathering evidence. It involves watching staff repeat a task they have already carried out.

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Evidence should be appropriate which means it should be sufficient and reliable.

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Sufficiency is a measure of the amount of evidence collected. Reliability is a measure of the type of evidence collected.

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Evidence gathered as a result of the auditor’s own procedures is the most reliable.

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6. Misstatements or omissions are material if they could reasonably be expected to influence the _____________ taken on the basis of the financial statements.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

(a) Assessment of audit risk (b) The quantity of audit work carried out (c) Economic decisions of users (d) The audit approach Answer: (c) 7. Which one of the following factors would lead an auditor to question the appropriateness of audit evidence obtained? (a) When interviewed, a payroll manager states that receipts are always issued to staff collecting expense payments in cash. (b) The validity of payroll payments has been tested by checking that all staff on the client’s staff list have received a payment for a particular period. (c) There is no link in the audit schedule between the risks of material misstatement and the amount of audit testing undertaken. (d) Audit matters classified as highly material are not subject to more types of audit testing than those classified as of average materiality.

Answer: (b) Note: (b) This is not an appropriate test for checking the validity of a payroll – how do we know that what they received was correct? In (a) the receipt is appropriate (c) is a documentation issue and for (d) the evidence may not be sufficient but is it appropriate?

8. Materiality and risk are_________ related. (a) Directly (b) Equally (c) Inversely (d) None of the above Answer: (c)

9. When Fidelio plc receives a payables invoice it is checked by the accounts clerk for accuracy, matched against the purchase order, and the goods received note, then authorized by the line manager who signs it to verify that it has been authorized.

How can the auditor test this process? (a) Walk through the whole process with sample of invoices to check the procedures are being evidenced. (b) Identify areas of audit risk within the process and test that area.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

(c) Select a sample from each stage of the process and test for evidence that the procedures are carried out. (d) Observe the processing of invoices and note the process is being carried out in full.

Answer: (c)

10. Wilton Ltd operates a Wages Control Account which they claim is reconciled each month. How can the auditor test this control? (a) For a sample of the reconciliations in the year, re-perform the calculation to ensure accuracy. (b) Check that the payments to the tax authorities for deductions from employees pay agree to the control account. (c) Observe the clerk carrying out the next reconciliation whilst at the client premises. (d) Review the reconciliations file to verify that the reconciliations were carried out each month in the year to be audited.

Answer: (d)

11. Which of the following sets of duties would ordinarily be considered basically incompatible in terms of good internal control?

Being able to: (i) Authorize a new supplier and authorising the payment of invoices from suppliers (ii) Enter details of new employee on the master file database and prepare the payroll (iii) Record cash receipts in the Cash Book and bank the monies (iv) Maintain the Receivables ledger and authorize credit limits for customers (a) All of the above (b) i, ii and iv only (c) i, ii, iii only (d) ii, iii and iv only

Answer: (b)

12. Complete the definition of control risk using the following words • • • • • •

Disclosure Risk Account balance Assertion Shown Internal control

• • • • • •

Singly Financial statement Detected Material Accounting systems Individually

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The _______ that a misstatement that should occur in an ______ about a class of transaction, account balance or _________ and that could be ___________ either __________ or when aggregated with other misstatements will not be prevented or ____________ and corrected on a timely basis by the entity’s _________.

Answer: The risk that a misstatement that should occur in an assertion about a class of transaction, account balance or disclosure and that could be material either individually or when aggregated with other misstatements will not be prevented or detected and corrected on a timely basis by the entity’s internal control.

13. In determining what a significant risk is, the auditor considers a number of matters, including all the following except: (a) How subjective the assessment of the effect of the risk crystallising is. (b) Whether the risk is related to recent changes in accounting standards or guidelines and therefore requires specific attention. (c) The probability of the risk occurring. (d) The complexity of any transactions that may create the risk.

Answer: (b)

14. Which of the following statements are true?

True An example of inherent risk is the failure of the accounts department to ensure that the cash book balances to the bank statements each month.

One of the main causes of the expectations gap is that the public believe that auditors lack independence.

Professional scepticism is an important part of the audit process.

The IAASB requires that auditors give an opinion as to whether a set of financial statements are true and fair.

False √

√

√

√

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

15. Which of the following are components of the internal control environment? (i) The management information system (ii) The internal control procedures (iii) Management policies (iv) Ethical policies (a) i, ii, iii, iv (b) ii, iii, iv (c) i, iii, iv (d) i, ii, iv Answer: (b)

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Multiple-Choice Questions Part 4 Audit Testing, Sampling and Analytical Review Procedures, Systems-Based Auditing and Risk-Based Auditing ANSWERS

1. Which of the phrases below completes the statement? (a) Documents judged to be significant. (b) Source documents such as sales invoices. (c) Less than 100 per cent of items within a population of relevant items. (d) All of the items within a population of relevant items.

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

Audit sampling is the application of audit procedures to __________ such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population.

Answer: (c)

2. The audit manager has asked you to review the results of some statistical sampling testing, which resulted in 20 per cent of the payables balance being tested. Materiality has been set at £100,000.

The testing results indicate that there is a £45,000 error in the sample: £20,000 which is due to invoices not being recorded in the correct period as a result of weak controls and additionally there is a one-off error of £25,000 which was made by a temporary clerk.

What would be an appropriate course of action on the basis of these results? (a) The error is immaterial and therefore no further work is required. (b) The effect of the control error should be projected across the whole population. (c) The company should be asked to adjust the payables figure by $45,000. (d) A different sample should be selected as these results are not reflective of the population.

Answer: (b) Although the error is not material of itself the auditor must reach a conclusion based on the sample so the effect of the error must be considered in relation to the whole population.

3. One of the audit tests for Payables balances is to reconcile the balance on the Payables Ledger with the balance shown by a statement sent by the supplier.

When performing such a test during the audit of Winterbottom Ltd a difference was found on the balance due to the supplier Fattybone. According to Winterbottom the balance on the Payables ledger as at 30 June was £48,936 but according to Fattybone it was £61,289.

When questioned the accountant stated that the ledger had been closed early on 28 June and some invoices had not been entered. These were subsequently entered using the journal.

Which of the following would not provide sufficient, appropriate audit evidence over the completeness of the Payables Ledger balance in respect of Fattybone? (a) Review the journal and confirm that all invoices recorded as received from Fattybone between 28 and 30 June have been manually adjusted for. (b) Review the accruals listing to ensure goods received from Fattybone post year end for which an invoice has not been received have been listed and recorded in the financial statements in the correct period. (c) For post year-end cash book payments to Fattybone, confirm date of matching invoice and if pre-year end agree to liability.

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(d) Review a sample of invoices received from Fattybone recorded post year end and match to GRN to determine if they should have been included in payables at the year end.

Answer: (b) 4. State whether the following are true or false in relation to audit sampling True The auditor may decide that it would be more appropriate to examine the entire population (100 per cent examination) of items that make up an account balance if the population comprises a small number of large value items.

√

Audit software can be used to select balances for testing from a large population.

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The lower the tolerable error the greater the sample size.

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Attribute sampling requires only two responses – yes or no.

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False

5. An online business makes and then sells high-value, unique pieces of jewellery designed around Australian opals. Each opal has individual colour and pattern properties that make the pieces highly desirable.

The website allows customers to place a selected piece of jewellery into a virtual shopping cart. Because of the high-value low-volume nature of the business, and as a unique selling point, at this point the item is removed from inventory and held for the customer.

The customer has 72 hours to decide if they wish to proceed with the transaction. If the customer wishes to proceed, they must provide their payment details. Once funds are confirmed as transferred (this can take up to 48 hours) the item is shipped to the customer. Again because of the unique nature of each item, and as part of their commitment to customer service, the customer has a two-week, no questions asked, return window. A significant number of items is returned under this policy.

Which of the following is going to be the most significant risk the auditor is going to want to consider? (a) The risk of fraud by customers (b) The lack of credit checks of customers (c) Return of goods under warranty For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

(d) When the transaction is deemed to have occurred Answer: (d)

6. Which of the phrases below completes the statement? (a) Be different from. (b) Be material to. (c) Not be material to. (d) Be the same as.

Sampling risk is the risk that the auditor’s conclusion based on a sample may __________ the conclusion if the entire population were subjected to the same audit procedure.

Answer: (a)

7. Which of the following sampling methods correctly describes systematic sampling? (a) A sampling method which is a type of value-weighted selection in which sample size, selection and evaluation results in a conclusion in monetary amounts. (b) A sampling method which involves having a constant sampling interval, the starting point for testing is determined randomly. (c) A sampling method in which the auditor selects a block(s) of contiguous items from within the population. (d) A sampling method whereby the population is divided by size to determine the number of transactions tested i.e. the higher the value the more are tested.

Answer: (b)

8. After the initial planning the auditor’s estimate of the risks of a material misstatement in the financial statements of Toro Ltd is low. What audit approach would be appropriate in that situation? (a) No substantive testing but an emphasis on tests of controls within the accounting system and substantive testing of assets and liabilities. (b) Little or no testing of controls because if the efficiency of the system resulting in a low estimate of control risk plus substantive testing of assets and liabilities. (c) Some substantive testing of assets and liabilities plus a risk based approach to a consideration of business risks. (d) Consideration of business risks only with no substantive or compliance testing.

Answer: (c)

9. Which of the following is not a type of statistical sampling? (a) Interval sampling (b) Selective sampling For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

(c) Cluster sampling (d) Monetary unit sampling.

Answer: (b)

10. Judgemental sampling entails: (a) picking a sample using a random number generator. (b) splitting the population into sub-populations and then taking a different sampling approach to each. (c) picking a sample at set intervals in the population e.g.: every 100th invoice. (d) using personal experience and professional discretion to pick unusual items from the population.

Answer: (d)

11. Which of the following statements is not correct about materiality? (a) Performance materiality is an estimate of materiality set lower than the estimate of materiality for the financial statements as a whole. (b) Materiality involves both quantitative and qualitative judgments. (c) Auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of an informed decision maker who will rely on the financial statements. (d) At the planning state, the auditor considers materiality at the financial statement level only.

Answer: (d)

12. Monetary Unit Sampling (also known as Value Weighted Selection) is a statistical sampling method which is useful when sampling populations where the individual balances can vary widely in size Here is a selection from a list of Receivables balances for Wibble: Balance

Cumulative

(i) Robins

3,498

3,498

(ii) Heathcliffe

2,170

5,668

(iii) Attaboy Ltd

96

5,764

(iv) XY & Co.

5,920

11,684

(v) Betterhead

4,882

16,566

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(vi) Masterton

3,975

20,541

(vii) Whittles

1,530

22,071

892

22,963

321,907

321,907

(viii) Naspo & Son …and so on TOTAL The sample size is 100 items.

Which balances will be selected for testing out of the ones shown? (a) i, iii, vi, vii (b) i, iv, v, vi (c) i, iv, vi, viii (d) i, v, vii, viii Answer: (b)

13. You are currently reviewing the audit programme for Receivables.

The audit objective is to verify the total amount of Receivables shown in the Statement of Financial Position.

From the list below decide which two tests will be most effective in meeting this objective. √ Compare total Receivables with the total for the previous year.

Carry out an aged analysis of Receivables balances and review any balances outstanding for more than 60 days.

√

Carry out an analytical review on the Receivables balances to calculate the average trade receivables collection period.

√

Vouch a selection of sales invoices to the Receivables Ledger.

14. If the auditors have established that an assessed risk of a material misstatement at the assertion level is a significant risk they should:

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

√ Change the level of materiality and performance materiality.

Increase tests of controls.

Review the assertions to establish that those set are appropriate.

Perform substantive testing in order to assess the size and implications of the risk.

√

15. As part of verification techniques in respect of payables an auditor inspects copy purchase invoices.

The auditor will gain assurance about different assertions depending on the information on the invoice.

In respect of the information below, select the assertion for which that information will provide assurance.

Accuracy

Classification

Invoice date

Existence

√

Description of item bought Value

Cut-off

√ √

Evidence the invoice has been entered in the Payables Ledger

√

For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

Multiple-Choice Questions Part 5 Internal Audit, Errors, Frauds and Unlawful Acts, Related Parties and Use of Service Organizations ANSWERS 1. Complete the definition of internal audit using the terms below: • absolute • provide financial safeguards and reporting • a systematic, disciplined • governance, risk management and • add value and improve an control processes organization’s operations • identify and eliminate risks associated • an independent with fraud and errors • internal controls • independent, objective • reasonable • limited, internal For use with Auditing 12th edn, Alan Millichamp and John Taylor, ISBN 9781473778993 © Cengage Learning EMEA 2022

An activity that provides ________________ assurance and consulting services designed to ________________. The internal audit activity helps an organization accomplish its objectives by bringing ________________ approach to evaluate and improve the effectiveness of ________________.

Answer: An activity that provides independent, objective assurance and consulting services designed to add value and improve an organization’s operations . The internal audit activity helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of governance, risk management and control processes.

2. Which of the following is not work you would expect to see an internal auditor undertaking? (a) Monitoring internal control systems. (b) Overseeing work undertaken by the external auditor. (c) Reviewing compliance with laws and regulations. (d) Reviewing the efficiency and effectiveness of operating activities.

Answer: (b)

3. During the course of the audit of Pastureland Ltd, a construction company, you discover that the company may be paying bribes in order to obtain work. Your evidence is based on various unexplained ‘round sum’ cash payments which have been included as ‘site running costs’ in the nominal ledger. Some of these payments amount to several thousand pounds and there does not appear to be any documentation to support the amounts paid. There does not appear to be any commercial reason why such substantial cash payments are being made.

When you questioned the management and staff you were told that the Sales Director was responsible for making these payments and has all the relevant paperwork as these items were confidential. The Sales Director is proving difficult to track down and is constantly avoiding the auditors.

In this situation, decide which course of action you should take.

√ (a)

Do nothing, except continue to pursue the Sales Director. To go any further would breach your duty of confidentiality to your client.

(b)

Report the matter to the police anonymously.

(c)

Contact Pastureland Ltd’s customer to inform them that there may be bribery of their employees.

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√

(d)

Contact the press and reveal the whole story publicly.

4. Which of the following would support the effective operation of the internal audit team? (a) A good working relationship with the audit committee. (b) Reporting directly to the Chief Accountant (or equivalent). (c) Ensuring all internal auditors have a strong external audit background. (d) All of the above.

Answer: (a)

5. To what extent can an external auditor rely on the work of the internal auditors? (a) No reliance should be placed on the work of the internal auditors. (b) Internal auditors can only be used to support inventory counts. (c) If the internal auditors are assessed to be competent and objective their work may form a part of gathering sufficient and appropriate evidence. (d) If the internal auditors are assessed to be competent and objective their work may be relied upon to form an opinion.

Answer: (c)

6. The auditor should obtain a good understanding of the internal controls of any service organization used by the client firm by using from one or more of the following procedures except: (a) Contacting the service organization’s auditor. (b) Obtaining a Type 1 or Type 2 report. (c) Using another auditor to perform procedures that will provide the necessary controls information at the service organization. (d) Visiting the service organization and performing procedures.

Answer: (d)

7. When auditing the use of a service organization an auditor could request a Type 1 or Type 2 report.

The difference between a Type 1 and Type 2 internal control report is that the Type 2 report and not a Type 1 report includes: (a) The report on internal controls given to those charged with corporate governance. (b) A description of the service auditor’s tests of the controls and the results thereof. (c) A report by the service auditor conveying their opinion on the description of the service organization’s system, etc. and the operating effectiveness of the controls.

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(d) Management’s description of the service organization, service organization’s system, control objectives and related controls.

Answer: (b) 8. When auditing financial statements, which approach should the auditor take with regards to fraud? (a) They should consider the possibility of the financial statements containing a material misstatement because of fraud. (b) They are not responsible to detect fraud and therefore can ignore it. (c) If the client is new, they should assume fraud is probable. (d) They should only consider fraud if they uncover evidence that it is actually occurring.

Answer: (a)

9. Which of the following would most strongly suggest that an organization is engaged in dishonest income smoothing? (a) An organization has an employee bonus scheme that pays higher wages when higher profits are earned (b) An organization selling copper had benefited significantly from an increase in world copper prices. To match revenues and expenses it increases its depreciation rates of fixed assets by a proportional amount. (c) In order to expand their business an organization has started selling a new range of products .

This has been successful, but they have also increased their provision for warranty costs to a higher level than in previous years. (d) All of the above strongly indicate dishonest income smoothing.

Answer: (b)

10. Which of the following actions would be least effective in a case where the auditor believes there is the risk of material misstatement from fraud? (a) Increasing the variety of tests performed (b) Ensuring that tests contain an element of unpredictability (c) Focus on areas that involve management judgement (d) Placing greater reliance on analytical procedures Answer: (d)

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Multiple-Choice Questions Part 6 Subsequent Events, Going Concern , Representations to Management and Final Review ANSWERS

1. In accordance with international accounting standards complete the sentence: An entity is a going concern: (a) if its current assets exceed its current liabilities. (b) unless within the next 12 months the entity will liquidate. (c) unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. (d) if management believes the entity will be able to operate for at least the next 12 months.

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Answer: (c)

2. According to ISA(UK)570 what is the recommended future minimum period that should be considered when assessing whether the entity is a going concern? (a) 12 months after the balance sheet date (b) 12 months from the date at which the financial statements are approved (c) Up to the point at which the financial statements are signed (d) The foreseeable future

Answer: (b)

3. After the completion of the audit and signing of the financial statements by the directors, but before the annual general meeting, the auditor becomes aware that the company being audited has just launched a major takeover bid for a significant competitor. The auditor should: (a) Undertake additional audit work and include a letter with the financial statements explaining the additional event that has occurred. (b) Require the directors to amend the financial statements and issue a new opinion. (c) Revise their opinion of the financial statements, possibly issuing a qualified opinion. (d) None of the above.

Answer: (d)

4. You are reviewing the financial statements of a company that is currently the plaintiff in a large civil action. They are very confident that they will win and be awarded a material amount of damages in the next financial year.

How should this be recorded in the financial statements? (a) They should recognize a provision for legal award as a current asset in their financial statements. (b) They should disclose the information in a note to the financial statements. (c) They should take no action until the money is received. (d) They should treat this as an adjusting event.

Answer: (b)

5. Which of the following is NOT an example of audit work that should be undertaken by the auditor in the period leading up to signing the audit report? (a) Reviewing minutes from the audit committee meetings. (b) Reviewing cash flow forecasts for the period subsequent to the balance sheet date.

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(c) Reviewing press coverage of the company. (d) None of the above - they are all audit work that should be undertaken.

Answer: (d)

6. Which of the following is a role of the management letter of representation? (a) To reduce the liability of the auditors. (b) To place liability on management for the accuracy of the financial statements. (c) To support the audit evidence relevant to the financial statements. (d) All of the above.

Answer: (c)

7. Audit documentation should be sufficient enough to: (a) enable an experienced auditor, unconnected to the audit, to understand it. (b) enable the audit partner to reconstruct the audit if required. (c) allow the engagement team to plan the following year’s audit. (d) allow management to understand how the opinion has been formed.

Answer: (a)

8. Who is responsible for undertaking the final review of an audit file? (a) The internal audit quality reviewer. (b) A partner independent of the audit. (c) The audit committee. (d) The engagement partner.

Answer: (d)

9. Complete the partial definition of a contingent liability using the options below: • able to be measured reliably • possible • current • uncertain future events • unlikely future events • within the control of the entity A ________________ obligation that arises from past events and whose existence will be confirmed only by the occurrence of one or more ________________ not wholly ________________.

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Answer: A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the control of the entity.

10. Auditors have been criticized in the past for not paying enough attention to the issue of going concern. How has ISA(UK)570 Going Concern addressed this expectation gap? (a) Auditors must get external verification that the entity is a going concern. (b) Auditors must look at a longer time frame when assessing going concern. (c) Auditors must qualify the accounts if there is significant uncertainty that the entity is a going concern. (d) Auditors must specifically obtain sufficient appropriate audit evidence about management's use of the going concern assumption.

Answer: (d)

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Multiple-Choice Questions Part 7 Auditors Reports to Shareholders, Auditors’ Reports to Directors and Management ANSWERS

1. In an auditor’s report on financial statements an unmodified opinion is issued when the auditor is satisfied in all material respects that: (a) The view presented by the financial information as a whole is consistent with the auditor's knowledge of the business of the entity. (b) There are no disagreements with management. (c) Internal controls are consistent in design and operation. (d) The audit has been conducted in accordance with International Standards on Auditing.

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Answer: (d)

2. Wallis & Co. has just been audited and the auditor has found that management have understated provisions for potential losses when valuing work in progress for the current year. The error is material to the financial statements but not pervasive and the directors have refused to correct it.

What action should the auditor take? (a) The auditor should issue an unmodified audit report with an Emphasis of Matter Paragraph. (b)The auditor should issue a modified audit report with an adverse audit opinion. (c) The auditor should issue a modified audit report with an ‘except for’ paragraph. (d)The auditor should immediately resign and inform the shareholders.

Answer: (c)

3. Abacus has just been audited by new auditors and they have found that management have incorrectly calculated the amortisation of goodwill for several years. The previous auditors have failed to detect the error. The error is such that if corrected, the accumulated profits will be turned into an accumulated loss. The directors have refused to correct the error on the grounds that the previous auditors accepted the calculations.

What action should the auditor take? (a) The auditor should issue an unmodified audit report with an Emphasis of Matter Paragraph. (b)The auditor should issue a modified audit report with an adverse audit opinion. (c) The auditor should issue a modified audit report with an ‘except for’ paragraph. (d)The auditor should immediately resign and inform the shareholders.

Answer: (c)

4. You are drafting the auditor’s report for Happytime Trading. You understand that the report will need to reflect the requirements of ISA(UK)701 Communicating Key Audit Matters in the Independent Auditor’s Report.

According to ISA(UK)701, which of the following should be included in the ‘Key Audit Matters’ paragraph in the Auditor’s Report? (a) Matters which required significant auditor attention. (b)Matters which result in a modification to the audit opinion. (c) All matters which were communicated to those charged with governance. (d)All matters which are considered to be material to the financial statements.

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Answer: (a)

5. Blinkhorn is currently being audited and the auditor has discovered that the payroll function is outsourced to a third party contractor called Wages ‘R’ Us The auditor has contacted Wages ‘R’ Us but they state that are unable to provide them with the payroll records of Blinkhorn as a recent fire has caused a catastrophic loss of data. The wages figure is material to the calculation of the profit or loss for the year.

What action should the auditor take? (a) The auditor should issue an unmodified audit report with an Emphasis of Matter Paragraph. (b)The auditor should issue a modified audit report with an adverse audit opinion (c) The auditor should issue a modified audit report with an ‘except for’ paragraph. (d)The auditor should immediately resign and inform the shareholders.

Answer: (c)

6. State whether the following are true or false in relation to audit reporting.

True In the UK the auditor should include reference in their report that the company (if applicable) has complied with the provisions of the UK Corporate Governance Code.

False

√

The auditor would have to issue a modified audit report if items of administrative expenditure have been misclassified.

√

A limitation of scope modification arises when

√

accessing certain records is difficult for the auditors because they have been retained by an overseas subsidiary.

Failing to properly disclose the correct figures for directors’ remuneration is always material and the auditors have to take this into account in deciding on their audit opinion.

√

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7. Audit matters of governance interest to be communicated by the auditor to the board or audit committee ordinarily include all the following except: (a) Non-compliance with management objectives. (b) Fraud involving management. (c) The general approach and overall scope of the audit. (d) Questions regarding management integrity.

Answer: (a) 8. The draft financial statements of BronteCo currently show a profit before tax of £4.8m and revenue of £18m for the financial year ended 31 March 2019.

You have been informed that the finance director left BronteCo on 31 May 2018. As part of the subsequent events audit procedures, you reviewed post year-end board meeting minutes and discovered that a legal case for unfair dismissal has been brought against BronteCo by the finance director.

BronteCo’s lawyers believe that the finance director’s claim is likely to be successful but estimate that £150,000 is the maximum amount of compensation which would be paid.

Management does not intend to make any adjustments or disclosures in the financial statements. Which of the following audit opinions will be issued if the unfair dismissal case is not adjusted for or disclosed within the financial statements? (a) A qualified audit opinion as the financial statements are materially misstated. (b) A qualified audit opinion as the auditor is unable to obtain sufficient appropriate evidence. (c) An unmodified opinion with an emphasis of matter paragraph. (d) An unmodified audit opinion.

Answer: (d) The amount involved is not material. Although the case has been brought it has not been resolved so the full amount of compensation has not been established and the result of the case is based only on an opinion, If the amount had been material it would be disclosed as an Emphasis of Matter

9. State whether the following are true or false in relation to audit reporting.

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True The Auditors’ Rreport should contain a reference as whether the going concern basis of accounting is appropriate.

False

√

All audit reports must by law contain a disclaimer to the effect that the report is intended only for the use of the shareholders and no one else.

√

An Emphasis of Matter paragraph is a form of audit modification which is less severe than an ‘except for’ opinion.

√

The auditors are not required to report on any other matters apart from the financial information.

√

10. The auditor should disclaim an opinion under certain circumstances. In which one of the following situations would the auditor not be justified in disclaiming their opinion? (a) The auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive. (b) The auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive. (c) It is not possible to form an opinion on the financial statements due to the potential interaction of the uncertainties and their possible cumulative effect on the financial statements. (d) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion.

Answer: (b)

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Multiple-Choice Questions Part 8 Group Accounts and Auditor’s Liability ANSWERS

1. In the case of ADT Ltd vs BDO Binder Hamlyn (1996) where Binder Hamlin was found negligent and ordered to pay £105 million in damages (though the case was ultimately settled for £50 million), what specific action by the auditor was found to make them liable? (a) The auditor signed an unmodified audit opinion. (b)The auditor became aware of misstatements in the financial statements but failed to withdraw their opinion. (c) The auditor facilitated the takeover agreement.

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(d) The auditor, in a meeting with ADT directors, verbally confirmed that the financial statements provided a true and fair view.

Answer: (d)

2. State which of the following statements are true or false regarding auditors’ liability?

True Forming a limited liability partnership results in disclosure of partners earnings to the public.

False

√

Auditors are able to limit liability by agreement with the directors.

√ With the shareholders √

The Caparo case reinforces the opinion in Kingston Cotton Mill case that the auditor is a watchdog not a bloodhound.

ISA(UK)700 includes the Bannerman wording to be incorporated into the audit opinion.

√

3. Is compliance with the auditing standards a complete defence against auditor negligence? (a) Yes. The courts have determined that failure to comply with the standards is a necessary precondition for a negligence action to be successful. (b) No. The court would expect the auditors to look beyond the specific wording of the auditing standards (c) Yes. Legislation contains protections for auditors that comply with the auditing standards. (d) No. The auditing standards are not recognized at law.

Answer: (b) 4 State which of the following statements are true or false regarding auditors’ liability?

True Auditors owe a duty of care to stakeholders The leading case on this subject is the Caparo case

False √

√

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To prove a claim against the auditors they have to have known about the involvement of a third party before the audit report is signed The Bannerman wording will ensure that no claims are possible against the auditors for negligence

√

√

5. Auditors may be sued for negligence under civil law if their standard of work is below that which is expected. A key element that needs to be proved in an action of negligence is: (a) the existence of a contract. (b) intention to act negligently. (c) prior knowledge of the cause of the harm. (d) that the auditor owed a duty of care to the plaintiff.

Answer: (d)

6. State which of the following are true or false in relation to the audit of group accounts.

True A group engagement partner is one who is responsible for the audit engagement either for a specific audit or at a component level or group level and/or is one who signs the audit report.

The group engagement team who sign the group audit report are responsible for all matters arising from the audit, even in respect of subsidiaries not audited by them.

Group materiality should be the sum of the materiality limits for the individual components.

Any audit qualification at the subsidiary company level should be repeated at group level and included in the Auditors’ Report for the consolidated financial statements.

False √

This is the key audit partner.

√

√ It should be greater. √ Only if material.

7. Holding companies often provide a support letter to a subsidiary company which is or is about to become insolvent. Auditors must take into account:

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(a) the ability of the holding company to liquidate the subsidiary without any adverse consequences to the group. (b) the ability of the holding company to meet any liabilities arising from the guarantee. (c) any personal liability incurred by the directors in giving the guarantee. (d) the effect of including the financial statements of the insolvent subsidiary in the group financial statements.

Answer: (b) The auditors must consider the effect of giving the guarantee on the holding company’s own financial statements.

8. Complete the definition of auditor objectives in the audit of group financial statements using the options below: • • • • • • • •

group engagement partners key audit partner overseas auditors component auditors scope cost reliable sufficient appropriate

• • • • •

consolidation accounting Companies Act 2005 international standards on auditing an applicable financial reporting framework

If acting as the auditor of the group financial statements: (i) To communicate clearly with ___________ about the _________ and timing of their work on financial information related to components and their findings; and (ii) To obtain ____________ audit evidence regarding the financial information of the components and the __________ process to express an opinion on whether the group financial statements are prepared, in all material respects, in accordance with ________________.

Answer: If acting as the auditor of the group financial statements: (i) To communicate clearly with component auditors about the scope and timing of their work on financial information related to components and their findings; and (ii) To obtain sufficient appropriate audit evidence regarding the financial information of the components and the consolidation process to express an opinion on whether the group financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

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9. Which of these defences would not be available to an auditor being sued for negligence where the plaintiff claims they relied on the audited financial statements? (a) Lack of proximity (b) No duty of care (c) Plaintiff failed to carry out a proper investigation (d) Audits were conducted in accordance with ISAs and properly performed

Answer: (c)

10. State which of the following are true or false.

True Component auditors must confirm their independence to the group engagement team in writing.

√

Any limitation of auditors’ liability in a Liability Limitation Agreement cannot be less than what is considered to be ‘fair and reasonable’.

√

A Limited Liability Partnership has no restriction on its activities.

√

Auditors have to verify all consolidation adjustments as a result of inter group trading or investments in subsidiaries or other related entities.

√

Where the client group includes special purpose vehicles or other related parties auditors should consider why they are being used and what transactions pass through them.

√

False

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Multiple-Choice Questions Part 9 Review Engagements and Non-Audit Assurance Assignments, Public Sector Audit, Value for Money Auditing, Performance Evaluation, Environmental Reporting and Corporate Social Responsibility Reporting Assignments

ANSWERS

1. In a review engagement the auditor is able to provide what level of assurance? (a) No assurance (b) Limited assurance (c) Reasonable assurance (d) Complete assurance.

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2. Complete the definition of assurance engagement using the terms below: • enhance the degree of confidence of • limited • financial statements • provide assurance to • reliable • subject matter information • a degree of • sufficient appropriate An engagement in which a practitioner aims to obtain ________________ evidence in order to express a conclusion designed to ________________ the intended users ,other than the responsible party, about the ________________.

Answer: An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to express a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the subject matter information.

3. In accordance with ISAE 3000 there are a number of factors an auditor should consider before accepting an assurance engagement.

Which of the following is NOT a factor mentioned? (a) The relevant ethical requirements are met, including independence. (b) There is a rational purpose for the engagement. (c) The auditor is certain the report will be understood. (d) None of the above, they are all factors that should be considered.

Answer: (d)

4. In a limited assurance engagement when might the auditor need to undertake detailed procedures? (a) If analytical procedures had detected unexpected and material variations from expectations. (b) Never, they are not required for a limited assurance engagement. (c) Always, they should form part of any engagement. (d) Only if evidence of fraud is uncovered.

Answer: (a)

5. Which of the following conclusions would be appropriate for a limited assurance engagement?

In our opinion, the entity has complied, in all material respects, with the identified laws and regulations. (a) Based on the procedures performed and evidence obtained, we believe it is probable that the entity has complied, in all material respects, with the identified laws and regulations.

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(b) Based on the procedures performed and evidence obtained, nothing has come to our attention that causes us to believe that the entity has not complied, in all material respects, with the identified laws and regulations. (c) None of the above.

Answer: (c)

6. The ultimate responsibility for ensuring Value for Money within a public services organization lies with (a) Internal Audit and External Audit together (b) Management and shareholders (c) Management and Internal Audit together (d) Management

Answer: (d)

7. State which of the following are true or false in relation to public sector audit.

True Public sector audit is broadly similar to private sector audit as it relates to the audit of the financial statements of public sector bodies.

Regularity is a requirement in the public sector and means that reports must be delivered on time and in the appropriate format.

Public sector accounting complies with IFRS where appropriate.

Going concern isn’t an issue in the public sector because it’s all public money.

False √

√

√ √

8. In Value for Money (VFM) auditing which of these would be a measure of “Efficiency”? (a) The number of payments made by an organization per member of staff employed. (b) The total value of payments made in a financial year. (c) The increase in numbers of patients treated in a new hospital. (d) The cost per tonne of building materials purchased to build a new hospital.

Answer: (a)

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9. CitizenAid is a department of a local authority which provides free advice to local residents on council issues. There is a high demand for the service. Each staff member works a seven hour day with five hours involved in client contact work and two generally in administration. One of the department’s main objectives is to produce a high level of quality and customer satisfaction.

The Internal Audit department has carried out a review and recommended the following objectives for the next year as follows: (1) Reduce departmental expenditure by 5% (2) Increase the number of contact hours from five hours to 5.5 or 6 (3) Obtain a score of 7 or above out of 10 in customer satisfaction surveys Which of the following options allocates the above targets to the correct value for money performance category?

Economy (a) (b) (c) (d)

2 1 1 2

Efficiency 1 2 3 3

Effectiveness 3 3 2 1

Answer: (b) (1) is a financial target and relates to economy i.e. achieving more with less. (2) is an efficiency measure by improving the number of contact hours for the same cost and (3) assesses the effectiveness of what the department is doing.

10. State which of the following are true or false in relation to public sector audit.

True Internal audit in the public sector is governed by a specific set of rules called the Public Sector Internal Audit Standards.

Auditors in the UK have to include references to VFM in their Auditors’ Reports.

Fraud is not a major problem in the public sector as the hierarchical nature of organizations makes it very difficult.

In England electors have a right to question the auditors.

False

√ √ √ √

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