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AUDITING THEORY
 PSA 300 PLANNING AN AUDIT OF FINANCIAL STATEMENTS
 PSA 315 IDENTIFYING AND ASSEDDING THE RISKS OF MATERIAL MISSTATEMENT THROUGH
UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT

PSA 300
1. Planning an audit involves:
 Establishing the overall audit strategy for the engagement; and
 Developing an audit plan

Preliminary Engagement Activities

2. The auditor shall perform the activities at the beginning of the current audit engagement:
 Perform procedures regarding the continuance of the client relationship and the specific audit
engagement.
 Evaluate compliance with ethical requirements, including independence.
 Establish an understanding of the terms of the engagement.

Planning Activities
3. The auditor shall establish an overall audit strategy for the audit. The overall audit strategy set the
scope, timing and direction of the audit, and guides the development of the more audit plan.

4. The establishment of the overall audit strategy involves:

a) Determining the characteristics of the engagement that define its scope;
b) Ascertaining the reporting objectives of the engagement to plan the timing of the audit and the
nature of the communications required,
c) Considering the important factors that will determine the focus of the engagement team's efforts;
d) Considering the results of preliminary engagement activities and, where applicable, whether
knowledge gained on other engagements performed by the engagement partner for the entity is
relevant; and
e) Ascertaining the nature, timing and extent of resources necessary to perform the engagement.

5. The auditor shall develop an audit plan that shall include a description of:
a) The nature, timing and extent of planned risk assessment procedures, as determined under PSA
315.
b) The nature, timing and exert of planned further audit procedures at the assertion level, as
determined under PSA 330.
c) Other planned audit procedures that are required to be carried out so that the engagement
complies with Plus.

Changes to Planning Decisions During the Course of the Audit

The overall audit strategy and the audit plan shall be updated and changed as necessary during the course
of the audit.

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Direction, Supervision and Review
1. The auditor shall plan the nature, tint and extent of direction and supervision of engagement team
members and review their work.

2. The nature, timing and extent of the direction and supervision of engagement team members and
review of their work vary depending on many factors, including:
 The size and complexity of the entity;
 The area of the audit;
 The risks of material misstatement; and
 The capabilities and competence of the individual team members performing the audit work.

3. The auditor plans the nature, timing and extent of direction and supervision of engagement team
members based on the assessed risk of material misstatement.

Documentation
The auditor shall document the overall audit strategy and the audit plan, including any significant changes
made during the audit engagement

Additional Considerations in Initial Audit Engagements

The auditor shall perform the following activities prior to starling an initial audit:
1. Perform procedures regarding the acceptance of the client relationship and the specific audit
engagement

2. Communicate with the previous &tabor, where there has been a change of auditors, in compliance
with relevant ethical requirements.

PSA 315
IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT THROUGH UNDERSTANDING THE
ENTITY AND ITS ENVIRONMENT
1. The objective of the auditor is to
 Identify and assess the risks of material materials misstatement, whether due to fraud or error,
at the financial statement and assertion levels,
 Through understanding the entity and its environment, including its internal control,
 Thereby providing a basis for designing and implementing responses to the assessed risks of
material misstatement.

2. The auditor shall perform risk assessment procedures to provide a basis for the identification and
assessment of risks of material misstatement at
 the financial statement level; and
 the assertion level for classes of transactions, account balances, and disclosures. To provide a
basis for designing and performing further audit procedures.

3. The auditor shall:

a) identify risks throughout the process or obtaining an understanding of the entity and its
environment, Including relevant controls that relate to re risks, and by considering the classes
of transactions, account balances, and disclosures in the financial statements.’

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b) Assess the identified risks, and evaluate whether they relate more pervasively to the financial
statements as a whole and potentially affect many assertions.
c) Relate the identified risks to what can go wrong at the assertion level, taking account of
relevant controls that the auditor intends to test.
d) Consider the likelihood of misstatement, including the possibility of multiple misstatements,
and whether the potential misstatement is of a magnitude that could result in a material
misstatement.

4. Risk assessment procedures by themselves do not provide sufficient appropriate audit evidence on
which to base the audit opinion.

5. The risk assessment procedures shall include the following,

a) Inquiries of management and others within the entity;
b) Analytical procedures; and
c) Observation and inspection

6. The auditor's understanding of the entity and its environment consists of an understanding of the
following aspects:
a) Industry, regulatory, and other external factors, including the applicable financial reporting
framework.
b) Nature of the entity, including the entity’s selection and application of accounting policies.
c) Objectives and strategies and the related business risks that may result in a material
misstatement of the financial statements.
d) Measurement and review of the entity’s financial performance.
e) Internal control

INTERNAL CONTROL
1. Internal control is the process designed, implemented and maintained by those charged with
governance, management and other personnel to provide reasonable assurance about the
achievement of an entity's objectives with regard to:
 Reliability of financial reporting;
 Effectiveness and efficiency of operations; and
 Compliance with applicable laws and regulations.

2. When obtaining an understanding of controls that are relevant to the audit, the auditor shall:
 Evaluate the design of those control; and
 Determine whether they have been implemented by performing procedures in addition to
inquiry of the entity’s personnel.

COMPONENTS OF INTERNAL CONTROL

The control environment includes the governance and management functions and the attitudes,
awareness, and actions of those charged with governance and management concerning the entity's
internal control and its importance in the entity.

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1. Elements of control environment:

a) Communication and enforcement of integrity and ethical values.
b) Commitment to competence.
c) Participation by those charged with governance.
d) Management’s philosophy and operating style
e) Organizational Structure.
f) Assignment of authority and responsibility,
g) Human resource policies and practices.

The auditor shall obtain an understanding of the control environment. As part of obtaining this
understanding, the auditor shell evaluate whether:
a) Management, with the oversight of those charged with governance, has created and maintained a
culture of honesty and ethical behaviour; and
b) The strengths in the control environment elements collectively provide an appropriate foundation
for the other components of internal control, and whether those other components are not
undermined by deficiencies in the control environment.

2. The Entity's Risk Assessment Process

The auditor shall obtain an understanding of whether the entity has a process for:
a) Identifying business risks relevant to financial reporting objectives;
b) Estimating the significance of the risks;
c) Assessing the likelihood of their occurrence; and
d) Deciding about actions to address those risks.

3. The information system, including the related business processes, relevant to financial reporting, aria
communication
The auditor shall obtain an understanding of the Information system, including the related business
processes, relevant to financial reporting, including the following areas: ▪
 The classes or transactions in the entity's operations that are significant to the financial
statements.

 The procedures, within both IT and manual systems, by which the transactions are initiated,
recorded, processed, corrected as necessary, transferred to the general ledger and reported
in the financial statements.

 The related accounting records, whether electronic Cr manual, supporting Information, and
specific accounts in the Potential statements that are used to Initiate, record, process and
report transactions; this includes the correction of Incorrect information and how Information
Is transferred to the general ledger.
 How the information system captures events and conditions, Other than transactions, that are
significant to the financial Statements.

 The financial reporting process used to prepare the entity's financial statements, including
significant accounting estimates and disclosures.

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 Controls surrounding journal entries, including non-standard journal entries used to record
non-recurring, unusual transactions or adjustments.

The auditor shall obtain an understanding of how the entity communicates financial reporting roles and
responsibilities and significant matters eating to financial reporting, including:
 Communications between management and those charged with governance; and
 External communications, such as those with regulatory authorities.

4. Control activities relevant to the audit

 Control activities are the policies and procedures to help ensure that management directives are
carried out. Examples of controls activities include activities include those relating to the following
 Authorization
 Performance reviews
 Information processing
 Physical controls
 Segregation of duties

 The auditor shall obtain a sufficient understanding of control activities to:

 Assess the risks of material misstatement at the assertion level; and
 Design further audit procedures responsive to assessed risks.

5. Monitoring of controls
 Monitoring of controls involves assessing the design and Operation of controls on a timely basis
and taking the necessary corrective actions modified for changes in conditions.
 The auditor shall obtain an understanding of the mayor activities that the entity uses to monitor
internal control over financial reporting, including those related to those control activities relevant
to the audit, and how the entity initiates remedial actions to deficiencies in its controls.
 If the entity has an internal audit function, the auditor shall obtain an understanding of the
following in order to determine whether the internal audit function is likely to be relevant to the
audit:
a. The nature of the internal audit function’s responsibilities and how the internal audit function
fits in the entity's organizational structure; and
b. The activities performed, or to be performed, by the internal audit function.
 The auditor shall obtain an understanding of the sources of the information used in the entity's
monitoring activities, and the basis upon which management considers the information to be
sufficiently reliable for the purpose.

MULTIPLE CHOICE QUESTIONS

1. It involves establishing the overall audit strategy for the engagement and developing an audit plan in
order to reduce audit risk to an acceptably low level.
A. Reporting
B. Planning
C. Field work
D. Organizing

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2. Adequate planning of the audit work helps to ennui that
A B C D
 Appropriate attention Is devoted to important areas of Yes No Yes No
the audit
 Potential problems are identified Yes Yes Yes No
 The work is completed expeditiously No Yes Yes No

3. The auditor should plan the audit work so that the audit will be performed in an effective manner. The
extent of planning will vary according to the
A B C D
 Size of the entity Yes Yes No No
 Complexity of the audit Yes No Yes No
 Auditor's experience with the entity and knowledge of Yes Yes Yes No
the business

4. Obtaining knowledge of the entity's business is an important part of planning the audit work.
The auditor's knowledge of the entity's business assists in the identification of events, transactions and
practices which may have a material effect on the financial statement.
A. Both statements are True
B. Both statement are False
C. True; False
D. False; True

5. According to PSA 300, the auditor may discuss elements of planning with those charged with
governance and the entity's management.

The audit plan sets the scope, timing and direction of the audit guides the development of the more
detailed overall audit strategy.

The overall audit strategy is more detailed than the audit plan and includes the nature, timing and
extent of audit procedures to be performed by engagement team members to obtain sufficient
appropriate audit evidence to reduce audit risk to an acceptably low level.
A. False; False; True
B. True; True; False
C. True; False; False
D. False; True; False

6. Which of the following matters should be considered by the auditor in developing the overall audit
strategy?
A. Important characteristics of the entity, its business, its financial performance and its reporting
requirements including changes since the date of the prior audit.
B. Conditions requiring special attention, such as the existence of related parties
C. The setting of materiality levels for audit purposes.

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D. All of the above.

7. A measure of how willing the auditor is to accept that the financial statements may be materially
misstated after the audit is completed and an unmodified opinion has been issued is the
A. Inherent risk.
B. Acceptable audit risk. .
C. Control risk.
D. Detection risk.

8. Which of the following audit risk components may be assessed in quantitative terms?
Inherent Risk Control Rick Detection Risk
A Yes No Yes
B Yes No Yes
C No No No
D No No yes
.
9. A measure of the auditor's assessment of the likelihood that there are material misstatements In an
account before considering the effectiveness of the client's internal control is called
A. Audit risk
B. Detection risk
C. Inherent Risk
D. Control risk

10. When inherent risk is high, there will need A lower

A lower assessment More evidence accumulated by
of audit risk the auditor
A. Yes Yes
B. No No
C. Yes No
D. No Yes

11. It is the process designed and effected by those charged with governance, management, and other
personnel to provide reasonable assurance about the achievement of the entity's objectives
A. Internal auditing
B. Internal control
C. Business strategy
D. Accounting process

12. Which of the following is not one of the three primary objectives of effective internal control?
A. Reliability of financial reporting.
B. Efficiency and effectiveness of operations.
C. Compliance with laws and regulations.
D. Assurance of elimination of business risk.

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13. Which of the following are considered control environment elements?
Commitment to Detection Organizational
Competence Risk Structure
A. No Yes No
B. Yes Yes Yes
C. Yes No Yes
D. No No Yes
14. Which of the following statements concerning the relevance of various types of controls to a financial
statement audit correct?
A. All controls are ordinarily relevant to a financial statement audit
B. Controls over safeguarding of assets and liabilities are of primary importance, white controls over
the reliability of financial reporting may also be relevant
C. Controls over the reliability of financial reporting are ordinarily most directly relevant to a financial
statement audit, but other controls may also be relevant.
D. An auditor may ordinarily ignore a consideration of controls when a substantive audit approach is
taken.

15. Under PSA 315, monitoring of controls is an internal control component that involves a process of
assessing the quality of internal control performance over time. It involves assessing the design and
operation of controls on a timely bass and taking necessary corrective actions. Monitoring of controls
s accomplished through on going monitoring activities, separate evaluations, or a combination of the
two. An entity's ongoing monitoring activities often include
A. Periodic reporting by the entity's internal auditors about the functioning of internal control.
B. Reviewing the purchasing function. .
C. Periodic audits by the audit Committee.
D. The audit of the annual financial statements.

16. An auditor should consider two key issues when obtaining an understanding of a client’s internal
controls. These issues-are
A. The effectiveness and efficiency of the control.
B. The frequency and effectiveness of the controls.
C. The design and implementation of the controls. .
D. The Implementation and efficiency of the controls.

17. Which of the following statements is most correct with respect to separation of duties?
A. Employees should not have temporary and permanent custody of assets
B. Employees who authorize transactions should not have custody of related assets
C. It is permissible to allow an employee topper cash receipts and record those receipts.
D. Employees who authorize transactions should have recording responsibility for these transactions.

18. Authorizations can be either general or specific. Which of the following is not an example of a general
authorization?
A. Automatic reorder points for raw materials inventory.
B. A sales manager's authorization for a sales return.
C. Credit limits for various classes of transactions.
D. A sales price list for merchandise.

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19. When obtaining knowledge about an entity's internal control, It is important for the auditor to consider
the competence of its employees, because their competence bears directly and Importantly upon the
A. Cost-benefit relationship of internal control.
B. Comparison of recorded accountability with assets.
C. Achievement of the objectives of internal control. .
D. Timing of substantive tests to be performed.

20. Control activities are the policies and procedures that help ensure that management directives are
carried out. These include activities relating to authorization, performance reviews, Information
processing, physical controls, and segregation of duties. There Is proper segregation of duties when an
individual who
A. Records a transaction does not compare the accounting record of the asset with the asset itself.
B. Authorizes a transaction records it.
C. Authorizes a transaction maintains custody of the asset that resulted from the transaction.
D. Maintains custody of an asset has access to the accounting records for the asset. ..

21. An auditor should obtain sufficient knowledge of an entity's information system, including the related
business processes relevant to financial reporting, to understand the
A. Policies used to detect the concealment of fraud.
B. Process used to prepare significant accounting estimates.
C. Safeguards used to limit access to computer facilities
D. Procedures used to assure proper authorization of transactions.

22. The primary objective of procedures performed to obtain an understanding of internal control is to
provide an auditor with to the audit.
A. Knowledge necessary to plan the audit.
B. A basis for modifying tests of controls.
C. Information necessary to prepare flowcharts.
D. Evidence to use in reducing detection risk.

23. In obtaining an understanding of internal control relevant to the audit, an auditor is required to obtain
knowledge about the
A. Effectiveness of controls that have been implemented
B. Consistency with which contras are currently being applied.
C. Design of the controls pertaining to internal control components.
D. Controls related to each class of transactions and account balance.

24. After considering a client's internal controls, an auditor has concluded that it is designed well and is
functioning as intended. Under these circumstances the auditor would most likely
A. Perform tests of controls to the extent outlined in the audit program.
B. Determine the control procedures that should prevent or detect errors and fraud.
C. Not increase the extent of predetermined substantive tests.
D. Determine whether transactions arc recorded to permit preparation of finical statements in
accordance with PFRS.

25. Audit evidence concerning proper segregation of duties normally is best obtained by
A. Direct personal observation of the employee who applies control procedures.

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B. Making inquiries of co-workers about the employee who applies control
C. Preparation of a flowchart of duties performed and available personnel.
D. Inspection of third-party documents containing the initials of who applied coned procedures.

26. In conducting an audit in accordance with PSAS, the auditor is required to identity and assess the risks
of material misstatement at the financial statement level, and at the assertion level for classes of
transaction, account balances, and disclosures. Some of these risks, in the auditor's judgment involve
fraud or complex transactions. Such risks are called
A. Business risks
B. Audit risks
C. Significant risks
D. Material risks

27. As a result of obtaining an understanding of an entity's internal control system, the auditor may become
aware of material weaknesses in the design or Implementation of internal control. The auditor is
required to communicate this matter to
A. Those charged with governance or management
B. Chief executive officer
C. Securities and Exchange Commission
D. Board of Accountancy

28. Which of the following controls most likely would provide reasonable assurance that all credit Sales
transactions of an entity are recorded?
A. The accounting department supervisor controls the mailing of monthly statements to customers
and investigates any differences reported by customers.
B. The accounting department supervisor independently reconciles, on a monthly basis, the accounts
receivable subsidiary ledger to the accounts receivable control account.
C. The billing department supervisor matches prenumbered shipping documents with entries in the
sales journal.
D. The billing department supervisor sends copies of approved sales orders to the credit department
for comparison to authorized credit limits and current customer account balances.

29. A sound Internal control procedure should require that defective merchandise returned by customers
be presented initially to the
A. Receiving clerk.
B. Accounts receivable supervisor
C. Billing clerk
D. Shipping department supervisor

30. Macho Dancer Company uses, its sales invoices for posting perpetual inventory records. Inadequate
internal control over the Invoicing function allows goods to be shipped but not invoiced. The
Inadequate controls could cause what type of misstatement in each of the following accounts?
Revenues Receivables Inventories
A. Understatement Understatement Understatement
B. Overstatement Overstatement Understatement
C. Understatement Understatement Overstatement
D. Overstatement Overstatement Overstatement

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31. Which of the following control activities in an entity's revenue/receipt cycle would provide reasonable
assurance that all billed sales are correctly posted to the accounts receivable ledger?
A. Each shipment of goods on credit is supported by a prenumbeced sales Invoice.
B. The accounts receivable subsidiary ledger is reconciled daily to the accounts receivable control
account in the general ledger.
C. Daily sales summaries are compared to daily postings to the accounts receivable ledger.
D. Each sales invoice is supported by a prenumbered Shipping document.

32. The auditor's prime objective in obtaining an understanding of the client's controls over the purchasing
function is to
A. Investigate the recording of unusual transactions regarding raw materials.
B. Determine the reliability of financial reporting by the purchasing function.
C. Observe the annual physical count.
D. Ascertain that raw materials paid for are on hand.

33. Effective controls relevant to purchasing of raw materials should usually include all of the following,
except
A. Determining the need for the raw materials prior to preparing the purchase order.
B. Systematic reporting of product changes that will affect raw materials.
C. Obtaining financial approval prior to making a commitment.
D. Obtaining third-party written quality and quantity reports prior to payment for the raw materials.

34. Which of the following controls is not usually performed in the accounts payable department?
A. Indicating on the voucher the affected asset and expense accounts to be debited.
B. Approving vouchers for payment by having an authorized employee sign the vouchers.
C. Accounting for unused prenumbered purchase orders and receiving reports.
D. Matching the vendors invoice with the related purchase requisition, purchase order, and receiving
report.

35. The following are appropriate questions on an internal control questionnaire concerning purchase
transactions, except
A. Are all goods received in a centralized receiving department and counted, inspected, and
compared with purchase orders on receipt?
B. Are intact cash receipts deposited daily in the bank?
C. Are prenumbered purchase orders and receiving reports used and accounted for?
D. Are an approved purchase requisition and a signed purchase order required for each purchase?

36. Which of the following is of least concern to an auditor in assessing the risks of material misstatement?
A. Signed checks are distributed by the controller to approved payees.
B. Signed by One person.
C. Cash receipts are not deposited intact daily.
D. Treasurer does not verify the names and addresses of check payees.

37. Which of the following is an essential control procedure to ensure the accuracy of the recorded
inventory quantities?

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A. Calculating unit cost and valuing obsolete or damaged inventory items in accordance with
inventory policy.
B. Testing inventory extensions.
C. Performing a gross profit test.
D. Establishing a cut-off for goods received and shipped.

38. Effective internal controls over inventories are designed and implemented for the following reasons,
except
A. Inventories typically represent a large component of an entity's current assets
B. Inventories are the most liquid asset.
C. Inventories directly affect the financial performance of an entity.
D. Inventories typically represent a large portion of an entity's total assets.

39. Your client, a merchandising concern, has annual sales of P30,000,000 and a 40% gross profit rate.
Tests reveal that 2% of the peso amount of purchases do not get into inventory because of breakage
and inventory pilferage by employees. The company estimates that these losses could be reduced to
0.5% of purchases by designing and implementing certain controls costing approximately P350,000.
Should the controls be designed and implemented?
A. Yes, regardless of cost-benefit considerations, because the situation involves employee theft.
B. Yes, because the Ideal system of internal contra is the most extensive one.
C. No, because the cost of designing and implementing the added controls exceeds the projected
savings.
D. Yes, because the expected benefits to be derived exceed the cost of the added controls.

40. Which of the following controls most likely would be implemented to achieve the production cycle
control objective of maintaining accurate inventory records?
A. Periodic inventory counts are used to adjust the perpetual inventory records.
B. A just-In-time inventory ordering system keeps inventory levels to a desired minimum.
C. Perpetual inventory records are periodically compared with the net realizable value of individual
inventory items.
D. Purchase requisitions, receiving reports, purchase orders, and vendor invoices are independently
matched before payment is approved.

41. Which of the following is the most likely procedure an auditor would perform in obtaining an
understanding of a manufacturing entity's internal control for Inventory balances?
A. Perform test counts of inventory when observing the entity's physical count.
B. Perform analytical procedures designed to identify significant cost variances.
C. Analyse the liquidity and turnover ratio of the inventory.
D. Review the entity's description of inventory policies and procedures.

42. The following controls are appropriate for property, plant, and equipment (PPE), except
A. Written policies for capitalization and expenditure and review of application of depreciation
methods.
B. Disposal of fully depredated PPE items.
C. Proper authority for acquisition and retirement of PPE items.
D. Detailed PPE records and physical contras over PPE Items

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43. An internal control objective concerning property, plant, and equipment (PPE) acquisitions is that they
be recorded at the correct amounts and in the proper period, and properly classified. In which of the
following conditions would an auditor most likely assess a high level of risk of material misstatement?
A. All material acquisitions of PPE are required to be approved by the board of directors.
B. Most additions are self-constructed by the entity
C. Recently acquired loans Include covenants that preclude further plant acquisitions for 5 years.
D. Gross PPE increased 30% during the current period.

44. Which of the following controls would an entity-most likely use in safeguarding against the loss of
trading securities?
A. The independent audit traces all purchases and sales of trading securities through the subsidiary
ledgers to the general ledger.
B. An independent trust company that has no direct contact with the employees who have record-
keeping responsibilities has possession of the securities.
C. The internal auditor inspects the trading securities in the entity's safe each year on the balance
sheet date.
D. A designated member of the board of directors controls the securities in a bank safe-deposit box.

45. The following controls are designed to protect investment securities, except
A. Investment securities should be properly controlled physically in order to prevent unauthorized
usage.
B. Custody over investment securities should be limited to personnel having record-keeping
responsibility over the securities.
C. Securities should be registered in the entity's name.
D. Access to securities should be vested in two Individuals.

46. Effective controls over the payroll function may include

A. Custody of rate authorization records by the supervisor of the payroll department.
B. Preparation of payroll transaction journal entries by an employee who reports to the supervisor of
the personnel department.
C. Verification of agreement of job time tickets with employee dock card hours by a payroll
department employee.
D. Reconciliation of totals on job time tickets with job reports by employees responsible for those
specific jobs.

47. Organizational independence in the processing of Payroll can be achieved by segregating the functions
of authorization, record-keeping, and custody of assets. Which one of the following functional
separations is not tired for internal control purposes?
A. Separation of payroll preparation and payer distribution.
B. Separation of personnel function from payroll preparation. Separation of timekeeping from payroll
preparation.
C. Separation of payroll preparation and maintenance of year-to-date records.

48. Which of the following situations represents an internal control department?

A. The timekeeping function is independent of the payroll department.
B. Payroll records are periodically reconciled with tax reports.

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C. Pay checks are distributed by the employees immediate supervisor
D. Payroll department personnel are rotated in their duties.

49. Which of the following personnel department procedures reduces the risk of payroll fraud and
represents an appropriate responsibility for the department?
A. Authorizing the addition or deletion of employees from the payroll.
B. Authorizing overtime hours.
C. Collection and retention of unclaimed pay checks.
D. Distributing pay checks.

50. Employees of a manufacturing entity are often required to use time carts and Job time tickets. Which
of the following statements concerning the use of these documents is incorrect?
A. Time reported on job time tickets should be reconciled to time cards.
B. Payroll should be calculated based on job time tickets.
C. Each employee should have only one time card.
D. An employee may have one or many job time tickets in a day.

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