AUDITING THEORY

AT.0106-Understanding the Entity and Its Environment MAY 2020

LECTURE NOTES
Importance of Understanding the Entity and its Much of the information obtained by the auditor’s inquiries
Environment including Internal Control is obtained from management and those responsible for
financial reporting. However, the auditor may also obtain
The auditor’s understanding of the entity and its
information, or a different perspective in identifying risks
environment, including internal control (this will be
of material misstatement, through inquiries of others
discussed next topic, ‘AT.1510B-Understanding the Entity’s
within the entity. Inquiries directed towards with others
Internal Control’), is the foundation of the conduct of an
within the entity are summarized below:
effective audit. It establishes a frame of reference within
which the auditor plans the audit and exercises Those May help the auditor understand the
professional judgment throughout the audit, for example, charged with environment in which the financial
when: governance statements are prepared.
 Assessing ROMM of the financial statements;
 Establishing materiality; Internal audit May provide information about internal
 Considering the appropriateness of the selection and personnel audit procedures performed during the
application of accounting policies, and the adequacy of year relating to the design and
financial statement disclosures; effectiveness of the entity’s internal
 Identifying areas where special audit consideration control and whether management has
 Developing expectations for use when performing satisfactorily responded to findings from
analytical procedures; those procedures.
 Responding to the assessed ROMM and Employees May help the auditor to evaluate the
 Evaluating the sufficiency and appropriateness of audit involved in appropriateness of the selection and
evidence obtained. initiating, application of certain accounting policies.
processing or
The auditor uses professional judgment to determine the recording
extent of the understanding required sufficiently enough to complex or
be able to identify and assess risks of material unusual
misstatements, which is ordinarily less than that possessed transactions
by management in managing the entity. In-house legal May provide information about such
counsel matters as litigation, compliance with laws
Procedures to Obtain an Understanding and regulations, knowledge of fraud or
suspected fraud affecting the entity,
The procedures that the auditor should follow in order to
warranties, post- sales obligations,
obtain an understanding sufficient to assess the risks and
arrangements (such as joint ventures)
consider these risks in designing the audit plans include
with business partners and the meaning
the following:
of contract terms.
a. performing risk assessment procedures;
Marketing or May provide information about changes in
b. considering the use of information obtain in prior
sales the entity’s marketing strategies, sales
period audits; and
personnel trends, or contractual arrangements with
c. having discussion among audit engagement team.
its customers.
Risk Assessment Procedures (RAP)
Analytical Procedures
Risk assessment procedures are the audit procedures
Analytical procedures mean evaluations of financial
performed to obtain an understanding of the entity and its
information through analysis of plausible relationships
environment, including the entity’s internal control, to
among both financial and non-financial data. Analytical
identify and assess the risks of material misstatement,
procedures also encompass such investigation as is
whether due to fraud or error, at the financial statement
necessary of identified fluctuations or relationships that are
and assertion levels, thereby providing a basis for
inconsistent with other relevant information or that differ
designing and implementing responses to the assessed
from expected values by a significant amount.
risks of material misstatement.
It involves comparisons between the auditor’s expectations
The risk assessment procedures shall include the following:
and the recorded (reported) amounts. Examples of
a. Inquiries of management, and of others within the
auditor’s expectations are:
entity.
 Financial information:
b. Analytical procedures.
o Comparable information for prior periods
c. Observation and inspection.
o Anticipated results (budgets or forecasts)
o Industry information
However, risk assessment procedures by themselves do
 Relationships:
not provide sufficient appropriate audit evidence on which
o Elements of financial information expected to have
to base the audit opinion.
a predictable pattern (gross margin)
Inquiries of Management, and of Others within the Entity

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o Between financial and non-financial information, The following are the types of typical analytical procedures
(payroll costs to number of employees) applied in an audit:
 Trend analysis – this type is based on the assumption
The auditor should apply analytical procedures at the that performance will continue in line with previous
planning and overall review stages of the audit. Analytical performance or industry trends unless something
procedures may help identify the existence of unusual unusual is happening in the company.
transactions or events, and amounts, ratios, and trends  Ratio analysis – this type similar to financial statement
that might indicate matters that have audit implications. analysis, and is highly effective technique to highlight
Unusual or unexpected relationships that are identified account balances that are out of line and may signal
may assist the auditor in identifying risks of material the potential for fraud.
misstatement, especially risks of material misstatement  Test of reasonableness – this type tests whether a
due to fraud. recorded amount is reasonable with regards to the
auditor’s expectation.
However, when such analytical procedures use data  Regression analysis – this type involves time-series
aggregated at a high level (which may be the situation analysis by examining trends in relationship with
with analytical procedures performed as risk assessment previous results.
procedures), the results of those analytical procedures only
provide a broad initial indication about whether a material Investigating Results of Analytical Procedures
misstatement may exist. Accordingly, in such cases,
If analytical procedures identified fluctuations or
consideration of other information that has been gathered
inconsistent relationships that differ significantly from
when identifying the risks of material misstatement
expected values, investigate differences by:
together with the results of such analytical procedures may
 Inquiring of management and obtaining appropriate
assist the auditor in understanding and evaluating the
audit evidence relevant to management’s responses;
results of the analytical procedures.
and
 Performing other audit procedures as necessary in the
Types of Analytical Procedures
circumstances.

In summary, analytical procedures are performed in the following areas of audit:

Stage Planning and Risk Assessment Testing (Fieldwork) Completion
Procedure Preliminary analytical Substantive analytical Concluding (Final or overall)
procedures (As part of RAP) procedures analytical procedures
Objective To obtain understanding the To detect material To form an overall conclusion that
entity and its environment in misstatements, about an the financial statements are
order to identify and assess assertion, as part of responses to consistent with the auditor’s
ROMMs ROMMs understanding of the entity
Attention Yes No Yes
directing?
Is it required? Yes No Yes
Results Identification and assessment Obtain reasonable assurance Conclusion that FSs are consistent
of ROMMs about the fairness of an with the auditor’s understanding or
assertion the auditor may identify previously
unrecognized ROMM
current audit. This is because changes in the control
Observation and Inspection
environment, for example, may affect the relevance of
Observation and inspection may support inquiries of information obtained in the prior year. To determine
management and others, and may also provide whether changes have occurred that may affect the
information about the entity and its environment.
Examples of such audit procedures include observation or relevance of such information, the auditor may make
inspection of the following: inquiries and perform other appropriate audit procedures,
 The entity’s operations. such as walk-throughs of relevant systems.
 Documents (such as business plans and strategies),
records, and internal control manuals. Discussion Among the Engagement Team (‘Brainstorming’)
 Reports prepared by management (such as quarterly
The engagement partner and other key engagement team
management reports and interim financial statements)
members shall discuss the susceptibility of the entity’s
and those charged with governance (such as minutes
financial statements to material misstatement, and the
of board of directors’ meetings).
application of the applicable financial reporting framework
 The entity’s premises and plant facilities (tour).
to the entity’s facts and circumstances. The engagement
 Books, periodicals and other publications related to the
partner shall determine which matters are to be
entity and its environment.
communicated to engagement team members not involved
in the discussion.
Information Obtained in Prior Periods
When the auditor intends to use information obtained from Understanding The Entity and Its Environment
the auditor’s previous experience with the entity and from
The auditor shall obtain an understanding of the following:
audit procedures performed in previous audits, the auditor
 Relevant industry, regulatory, and other external
shall determine whether changes have occurred since the
factors including the applicable financial reporting
previous audit that may affect its relevance to the current
framework
audit.
 Nature of the entity
o Its operations;
The auditor is required to determine whether information
o Its ownership and governance structures;
obtained in prior periods remains relevant, if the auditor
o The types of investments that the entity is making
intends to use that information for the purposes of the
and plans to make; and

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o The way that the entity is structured and how it is

financed. The Entity’s Selection and Application of Accounting
 The entity’s selection and application of accounting Policies
policies, including the reasons for changes thereto. The
An understanding of the entity’s selection and application
auditor shall evaluate whether the entity’s accounting
of accounting policies may encompass such matters as:
policies are appropriate for its business and consistent
 The methods the entity uses to account for significant
with the applicable financial reporting framework and
and unusual transactions.
accounting policies used in the relevant industry.
 The effect of significant accounting policies in
 The entity’s objectives and strategies, and those
controversial or emerging areas for which there is a
related business risks that may result in risks of
lack of authoritative guidance or consensus.
material misstatement.
 Changes in the entity’s accounting policies.
 The measurement and review of the entity’s financial
 Financial reporting standards and laws and regulations
performance
that are new to the entity and when and how the
entity will adopt such requirements.
Industry, Regulatory and Other External Factors
Industry Factors Objectives and Strategies and Related Business Risks
Relevant industry factors include industry conditions such The entity conducts its business in the context of industry,
as the competitive environment, supplier and customer regulatory and other internal and external factors. To
relationships, and technological developments. Examples respond to these factors, the entity’s management or
of matters the auditor may consider include: those charged with governance define objectives, which
 The market and competition, including demand, are the overall plans for the entity. Strategies are the
capacity, and price competition. approaches by which management intends to achieve its
 Cyclical or seasonal activity. objectives. The entity’s objectives and strategies may
 Product technology relating to the entity’s products. change over time.
 Energy supply and cost.
Business risk is a risk resulting from significant conditions,
The industry in which the entity operates may give rise to events, circumstances, actions or inactions that could
specific risks of material misstatement. Hence, it is adversely affect an entity’s ability to achieve its objectives
important that the engagement team include members and execute its strategies, or from the setting of
with sufficient relevant knowledge and experience. inappropriate objectives and strategies. Business risk is
broader than the risk of material misstatement of the
Regulatory Factors financial statements, though it includes the latter.
Relevant regulatory factors include the regulatory
Business risk may arise from change or complexity. A
environment. The regulatory environment encompasses,
failure to recognize the need for change may also give rise
among other matters, the applicable financial reporting
to business risk. Business risk may arise, for example,
framework and the legal and political environment.
from:
Examples of matters the auditor may consider include:
 The development of new products or services that may
 Accounting principles and industry specific practices.
fail;
 Regulatory framework for a regulated industry.
 A market which, even if successfully developed, is
 Legislation and regulation.
inadequate to support a
 Taxation (corporate and other).
 product or service; or
 Government policies currently affecting the conduct of
 Flaws in a product or service that may result in
the entity’s business.
liabilities and reputational risk.
 Environmental requirements affecting the industry and
the entity’s business.
An understanding of the business risks facing the entity
increases the likelihood of identifying risks of material
Other External Factors
misstatement, since most business risks will eventually
Examples of other external factors affecting the entity that have financial consequences and, therefore, an effect on
the auditor may consider include the general economic the financial statements. However, the auditor does not
conditions, interest rates and availability of financing, and have a responsibility to identify or assess all business risks
inflation or currency revaluation. because not all business risks give rise to risks of material
misstatement.
Nature of the Entity
Examples of matters that the auditor may consider when
An understanding of the nature of an entity enables the obtaining an understanding of the entity’s objectives,
auditor to understand such matters as: strategies and related business risks that may result in a
 Whether the entity has a complex structure. risk of material misstatement of the financial statements
 The ownership, and relations between owners and include:
other people or entities. This understanding assists in  Industry developments (a potential related business
determining whether related party transactions have risk might be, for example, that the entity does not
been identified and accounted for appropriately. have the personnel or expertise to deal with the
Examples of matters that the auditor may consider when changes in the industry).
obtaining an understanding of the nature of the entity  New products and services (a potential related
include: business risk might be, for example, that there is
 Business operations increased product liability).
 Investments and investment activities  Expansion of the business (a potential related business
 Financing and financing activities risk might be, for example, that the demand has not
 Financial reporting been accurately estimated).
 New accounting requirements (a potential related
Significant changes in the entity from prior periods may business risk might be, for example, incomplete or
give rise to, or change, risks of material misstatement. improper implementation, or increased costs).

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 Regulatory requirements (a potential related business

risk might be, for example, that there is increased Measurement and Review of the Entity’s Financial
legal exposure). Performance
 Current and prospective financing requirements (a
Management and others will measure and review those
potential related business risk might be, for example,
things they regard as important. Performance measures,
the loss of financing due to the entity’s inability to
whether external or internal, create pressures on the
meet requirements).
entity. These pressures, in turn, may motivate
 Use of IT (a potential related business risk might be,
management to take action to improve the business
for example, that systems and processes are
performance or to misstate the financial statements.
incompatible).
Accordingly, an understanding of the entity’s performance
 The effects of implementing a strategy, particularly
measures assists the auditor in considering whether
any effects that will lead to new accounting
pressures to achieve performance targets may result in
requirements (a potential related business risk might
management actions that increase the risks of material
be, for example, incomplete or improper
misstatement, including those due to fraud.
implementation).
Documentation
A business risk may have an immediate consequence for
the risk of material misstatement for classes of The auditor shall document:
transactions, account balances, and disclosures at the  The risk assessment procedures performed, as part of
assertion level or the financial statement level. For detailed audit plan.
example, the business risk arising from a contracting  The discussion among the engagement team, and the
customer base may increase the risk of material significant decisions reached (normally in a
misstatement associated with the valuation of receivables. memorandum or minutes of meeting)
However, the same risk, particularly in combination with a  Key elements of the understanding obtained regarding
contracting economy, may also have a longer-term each of the aspects of the entity and its environment
consequence, which the auditor considers when assessing including the sources of information from which the
the appropriateness of the going concern assumption. understanding was obtained (normally in a
Whether a business risk may result in a risk of material ‘understanding the business template’)
misstatement is, therefore, considered in light of the
entity’s circumstances. For recurring audits, certain documentation may be carried
forward, updated as necessary to reflect changes in the
Usually, management identifies business risks and entity’s business or processes.
develops approaches to address them as an entity’s risk
assessment process, which is part of the entity’s internal - done -
control.
MULTIPLE CHOICE
Risk Assessment Procedures 4. Which of the following procedures would an auditor
1. The main purpose of risk assessment procedures is to least likely perform while obtaining an understanding
a. Obtain an understanding of the entity and its of a client in a financial statement audit?
environment, including its internal control, to a. Coordinating the assistance of entity personnel in
assess the risks of material misstatement at the data preparation.
financial statement and assertion levels. b. Discussing matters that may affect the audit with
b. Test the operating effectiveness of controls in firm personnel responsible for non-audit services
preventing, or detecting and correcting, material to the entity.
misstatement at the assertion level. c. Selecting a sample of vendors' invoices for
c. Detect material misstatements at the assertion comparison to receiving reports.
level. d. Reading the current year's interim financial
d. All of the above statements.
2. Which of the following is least likely to be considered a 5. Which one of the following is a valid source of
risk assessment procedure? information about the client's processes?
a. Analytical procedures. a. Management inquiry
b. Confirmation of ending accounts receivable. b. Review of the client's budget
c. Inspection of documents. c. Tour of client’s plant and operations
d. Observation of the performance of certain d. All are valid sources.
accounting procedures.
6. Each of the following may be relevant to an auditor
3. Inquiries directed towards internal audit personnel may when obtaining knowledge about the client’s business
most likely and industry, except
a. Relate to their activities concerning the design and a. Performing a walkthrough tests
effectiveness of the entity’s internal control and b. Publications related to the industry
whether management has satisfactorily responded c. Visits the entity’s premises
to any findings from those activities d. Discussion with people within or outside the entity
a. Help the auditor in understanding the environment
in which the financial statements are prepared 7. An understanding of a client’s business and industry
b. Relate to changes in the entity’s marketing and knowledge about operations are essential for
strategies, sales trends or contractual performing an adequate audit. For a new client, most
arrangements with its customers of this information is obtained:
c. Help the auditor in evaluating the appropriateness a. from the predecessor auditor.
of the selection and application of accounting b. from the Securities and Exchange Commission.
policies c. from the permanent file.
d. at the client’s premises.

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8. To obtain an understanding of a continuing client's c. Study of the relationships of financial data with
business, an auditor most likely would relevant nonfinancial data.
a. Perform tests of details of transactions and d. Tracing transactions through the system to
balances. determine whether procedures are being applied as
b. Review prior year working papers and the prescribed.
permanent file for the client.
14. In performing an audit, which one of the following
c. Read current issues of specialized industry
procedures would be considered an analytical
journals.
procedure?
d. Reevaluate the client's internal control
a. Comparing last year’s interest expense with this
environment.
year’s interest expense.
9. Which of the following statements is correct, when b. Comparing signatures on checks with the
obtaining understanding about the client’s business? signatures of authorized check signers.
a. For continuing engagements, the auditor may no c. Reviewing initials on received documents
longer obtain knowledge about the client’s d. Reviewing procedures followed in receiving,
business. depositing, and disbursing cash.
b. The level of knowledge required of the auditor is
15. Which of the following is not an example of analytical
ordinarily more than the level of knowledge
evidence?
possessed by management.
a. Compared inventory turnover by major class with
c. Preliminary knowledge about the entity’s industry
the prior year on a monthly and quarterly basis.
must be obtained after accepting the engagement
b. Compared gross profit percentages by major
to determine whether the auditor has the
product classes with the prior year.
necessary knowledge to perform the audit.
c. Examined invoices for plant asset additions to
d. Following the acceptance of the engagement, the
determine whether the client had erroneously
auditor should obtain detailed knowledge about the
recorded ordinary repairs as plant assets.
client’s business preferably at the start of the
d. Examined monthly performance reports and
engagement.
investigated significant variations from budgeted
10. The auditor’s understanding of the entity and its amounts.
environment assists the auditor in
16. An auditor compares year-to-year account balances in
a. Assessing the risks and identifying potential
order to perform analytical procedures. This is an
problems.
example of:
b. Planning and performing the audit effectively and
a. Ratio analysis
efficiently.
b. Trend analysis
c. Evaluating the audit evidence, determining
c. Internal control analysis
materiality and in developing expectations for use
d. Vertical analysis
when performing analytical procedures.
d. All of the above. 17. What analysis best considers the economic
relationships among account balances?
Analytical procedures a. Altman "Z" Analysis
11. Evaluations of financial information made by a study of b. Ratio analysis.
plausible relationships among both financial and non- c. Vertical analysis.
financial data. It also encompasses the investigation of d. Horizontal analysis.
identified fluctuations and relationships that are
inconsistent with other relevant information or that 18. For all audits of financial statements made in
differ from expected values by a significant amount. accordance with PSAs, the use of analytical procedures
a. Audit planning is required to some extent
b. Audit evidence In the As a As an overall in
c. Analytical procedures assessment of substantive the completion
d. Inspection Risk of MM test stage
a. Yes No Yes
12. Analytical procedures are used in an audit because it is b. No Yes No
assumed of financial statements that c. No Yes Yes
a. management fraud can be discovered using such d. Yes No No
procedures.
b. it is plausible that no relationship among data 19. Analytical procedures used in planning an audit should
exists. focus on
c. analytical procedures are used as tests of controls. a. Reducing the scope of tests of controls and
d. plausible relationships among data may reasonably substantive tests.
be expected to exist and continue in the absence of b. Providing assurance that potential material
known conditions to the contrary. misstatements will be identified.
c. Enhancing the auditor’s understanding of the
13. Analytical procedures enable the auditor to predict the client’ s business required to identify areas of
balance or quantity of an item under audit. heightened risk.
Information to develop this estimate can be obtained d. Assessing the adequacy of the available evidence.
from all of the following, except
a. Comparison of financial data with data for 20. The auditor notices significant fluctuations in key
comparable prior periods, anticipated results (e.g., elements of the company's financial statements. If
budgets and forecasts), and similar data for the management is unable to provide an acceptable
industry in which the entity operates. explanation, the auditor should
b. Study of the relationships of elements of financial a. Consider the matter a scope limitation.
data that would be expected to conform to a b. Perform additional audit procedures to investigate
predictable pattern based upon the entity’s the matter further.
experience. c. Intensify the examination with the expectation of
detecting management fraud.

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d. Withdraw from the engagement. III. Objectives and strategies and the related business
risks that may result in a material misstatement of
21. Which of the following statements is not correct with
the financial statements
respect to analytical procedures?
IV. Measurement and review of the entity’s financial
a. Auditing standards emphasize the need for
performance.
auditors to develop and use expectations.
V. Internal control
b. Analytical procedures must be performed
a. All of the above
throughout the audit.
b. I, II and III only
c. Analytical procedures may be performed at any
c. I and II, III and IV only
time during the audit.
d. I and III only
d. Analytical procedures use comparisons and
relationships to assess whether account balances 26. Nature of the entity refers to
appear reasonable. a. The entity’s operations, its ownership and
governance, the types of investments that it is
The Entity and Its Environment
making and plans to make, the way that the entity
22. The audit team gathers information about a new
is structured and how it is financed
client's business and industry in order to obtain:
b. The overall plans for the entity
a. an understanding of the clients internal control
c. The operational approaches by which management
system for financial reporting.
intends to achieve its objectives
b. an understanding of how economic events and
d. The result of significant conditions, events and
transactions have an effect on the company's
circumstances, actions or inactions that could
financial statements.
adversely affects the entity’s ability to achieve its
c. information about engagement risk.
objectives and execute the strategies or the setting
d. information regarding whether the company is
of inappropriate objectives and strategies
engaging in financial statement fraud.
27. The result of significant conditions, events and
23. Which statement is incorrect regarding obtaining an
circumstances, actions or inactions that could
understanding of the entity and its environment?
adversely affects the entity’s ability to achieve its
a. Obtaining an understanding of the entity and its
objectives and execute the strategies or the setting of
environment is an essential aspect of performing
inappropriate objectives and strategies
an audit in accordance with PSAs.
a. Audit risk c. Significant risk
b. That understanding establishes a frame of
b. Business risk d. Sampling risk
reference within which the auditor plans the audit
and exercises professional judgment about 28. Which statement is correct regarding business risk?
assessing risks of material misstatement of the a. The risk of material misstatement of the financial
financial statements and responding to those risks statements is broader than business risk, though it
throughout the audit. includes the latter
c. The auditor’s primary consideration is whether the b. The auditor should identify or assess all business
understanding that has been obtained is sufficient risks
to assess the risks of material misstatement of the c. All business risks give rise to risks of material
financial statements and to design and perform misstatements
further audit procedures. d. A business risk may have an immediate
d. The depth of the overall understanding that is consequence for the risk of misstatement for
required by the auditor in performing the audit is classes of transactions, account balances, and
equal to that possessed by management in disclosures in the assertion level or the financial
managing the entity. statements as a whole
24. An initial audit requires more audit time to complete 29. A potential business risk created by industry
than a recurring audit. One of the reasons for this is developments may most likely include
that a. Increased product liability
a. new auditors are usually assigned to an initial b. Increased legal exposure
audit. c. The entity does not have the personnel or
b. predecessor auditors need to be consumed. expertise to deal with the changes in the industry.
c. the client's business, industry and internal control d. Loss of financing due to the entity’s inability to
are unfamiliar to the auditor and need to be meet financing requirements.
carefully studied.
d. a larger proportion of customer accounts 30. A potential business risk created by new products may
receivable need to be confirmed on an initial audit. most likely include
a. Increased product liability
25. The auditors’ understanding of the entity and the b. Increased legal exposure
environment consists of the following aspects c. The entity does not have the personnel or
I. Industry, regulatory, and other external factors, expertise to deal with the changes in the industry.
including the applicable financial reporting d. Loss of financing due to the entity’s inability to
framework meet financing requirements.
II. Nature of the entity, including the entity’s selection
and application of accounting policies - now do the DIY drill -

DO-IT-YOURSELF (DIY) DRILL

1. The objective of performing analytical procedures in d. Recorded transactions that were not properly
planning an audit is to identify the existence of authorized.
a. Unusual transactions and events.
2. Which of the following is not an information source for
b. Illegal acts that went undetected because of
developing analytical procedures used in the audit?
internal control weaknesses.
a. Relationships among financial statement elements
c. Related-party transactions.

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b. Relationships between financial and relevant a. Relate to their activities concerning the design and
nonfinancial data effectiveness of the entity’s internal control and
c. Comparison of financial data with anticipated whether management has satisfactorily responded
results (e.g., budgets and forecasts) to any findings from those activities
d. Comparison of current year financial data with b. Help the auditor in understanding the environment
projections for next year's financial results in which the financial statements are prepared
c. Relate to changes in the entity’s marketing
3. What type of analytical procedure would an auditor
strategies, sales trends or contractual
most likely use in developing relationships among
arrangements with its customers
balance sheet accounts when reviewing the financial
d. Help the auditor in evaluating the appropriateness
statements of a nonpublic entity?
of the selection and application of certain
a. Trend analysis.
accounting policies
b. Regression analysis.
c. Ratio analysis. 11. Analytical procedures are used for the following
d. Risk analysis. purposes except
a. To assist the auditor in planning the nature, timing
4. Analytical procedures are used for the following
and extent of other auditing procedures.
purposes:
b. As a substantive test to obtain evidential matter
a. To assist the auditor in assessing the risk of
about a particular assertion related to account
material misstatements of the FS
balances or classes of transactions.
b. As a substantive test to obtain evidential matter
c. As an overall review of financial information in the
about particular assertion related to account
final review stage of the audit.
balances or classes of transaction.
d. To evaluate the effectiveness of the client’s
c. As an overall review of financial information in the
internal control.
final review stage of the audit.
d. All of the above. 12. Which of the following is not a typical analytical review
procedure?
5. The preliminary use of analytical review procedures by
a. Study of relationships of the financial information
the auditor is
with relevant non-financial information.
a. required to identify areas of heightened risk
b. Comparison of the financial information with
b. optional in accordance with auditor judgment.
similar information regarding the industry in which
c. only used when other planning procedures cannot
the entity operates.
be applied.
c. Comparisons of recorded amounts of major
d. used to assist the auditor in documenting internal
disbursements with appropriate invoices.
control.
d. Comparisons of the financial information with
6. Which of the following are the most common budgeted amounts.
techniques used in obtaining knowledge of a client in
13. As a result of analytical procedures conducted during
the planning phase of an audit engagement?
the planning phase, the independent auditor
a. Confirmation, enquiry, analysis, reperformance
determines that the gross profit percentage has
b. Enquiry, analysis, observation, inspection
declined from 30% in the preceding year to 20% in the
c. Enquiry, analysis, observation, reperformance
current year. The auditor should
d. Vouching, tracing, discussion, analysis
a. Express an opinion which is qualified due to the
7. The purpose of risk assessment procedures is to inability of the client company to continue as a
a. Obtain an understanding of the entity and its going concern
environment b. Evaluate management's performance in causing
b. Reduce detection risk this decline
c. Evaluate management ability c. Require footnote disclosure
d. Determine the operating effectiveness of controls d. Consider the possibility of an error in the financial
statements
8. The auditor uses knowledge gained from the
understanding of the client's business and industry to 14. Jennings and Company has repositioned the firm's
assess: business strategy from the basis of competing on costs
a. Client business risk to competing on product differentiation. All the
b. Control risk following will increase, except:
c. Inherent risk a. Audit risk.
d. Audit risk b. Business Risk.
c. Financial risk.
9. An auditor has accessed client business risk and the d. Risk of Material Misstatements.
risk to material misstatements to the clients financial 15. An auditor who accepts an audit engagement and does
statements. These are done in order to: not possess the industry expertise of the business
a. apply the audit risk model in determining the entity should:
appropriate audit procedures to perform. a. engage financial experts familiar with the nature of
b. determine the reliance on the company's internal the business entity.
control systems for financial reporting. b. obtain a knowledge of matters that relate to the
c. determine the test of balances to be performed by nature of the entity’s business.
the audit team. c. refer a substantial portion of the audit to another
d. assure the CPA firm that they can perform the CPA who will act as the principal auditor.
audit effectively and efficiently, d. first inform management that an unqualified
10. Inquiries directed towards those charged with opinion cannot be issued.
governance may most likely
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