QB Chapter 3: Process of assurance: Planning the assignment

Question 1

1 Which three of the following are objectives of audit planning?
A To determine the scope of the engagement
B To ensure appropriate attention is devoted to the important areas of the audit
C To identify potential problems and resolve them on a timely basis
D To assign work to members of the audit team

Answer 1

B,C,D
The answer is not option A as to determine the scope of the engagement should have
been done in the engagement letter.

Question 2

2 With respect to ISA (UK) 315, Identifying and Assessing the Risks of Material Misstatement
Through Understanding of the Entity and Its Environment, which three of the following
procedures shall be used in understanding the entity and its environment?
A Inquiries of management and others within the entity
B Inquiries of third parties
C Analytical procedures
D Observation and inspection

Answer 2

A,C,D
The standard states that inquiries of third parties may be carried out if useful, but lists
options A, C and D as procedures that shall be carried out.

Question 3

3 Which three of the following constitute analytical procedures?
A Consideration of comparable information for prior periods
B Consideration of relationships between elements of financial information that are
expected to conform to a predicted pattern
C Consideration of whether a balance has been calculated correctly
D Consideration of similar industry information

Answer 3

A,B,D
The answer is not option C as consideration of whether a balance has been correctly
calculated will require a procedure of recalculation as opposed to analytical
procedure

Question 4

4 Which three of the following are auditors helped to decide by setting a preliminary
materiality threshold?
A What audit staff to assign to the audit
B How many items to examine
C Whether to use sampling
D What level of misstatement is likely to lead to the auditor not being able to give an
unmodified opinion

Answer 4

B,C,D
What audit staff to assign to the audit would depend more on the risks associated with
the engagement than the level of materiality.

Question 5

5 Which three of the following would normally be included in the overall audit strategy?
A Details of economic factors and industry conditions
B The results of initial analytical procedures
C Confirmation of management’s responsibility for the financial statements
D Identification of specific audit risks

Answer 5

A,B,D
Option C is incorrect as confirmation of management’s responsibility for the financial
statements is contained in the letter of engagement.

Question 6

6 In each of the following cases, select whether inherent risk is higher or lower than normal.
The company operates a profit-related pay scheme.
A Inherent risk higher than normal
B Inherent risk lower than normal
The business of the company is cash-based.
C Inherent risk higher than normal
D Inherent risk lower than normal
Financial statements contain balances with straightforward financial accounting
requirements.
E Inherent risk higher than normal
F Inherent risk lower than normal

Answer 6

A,C,F
A profit-related scheme means that directors have the incentive to overstate profit and
hence the accounts are susceptible to material fraud/error. Therefore inherent risk is
higher than normal. A cash-based business is more inherently risky than a non-cashbased business, as cash is susceptible by its nature to theft and omission. Where
balances in the financial statements have straightforward financial accounting
requirements, the susceptibility to material error or misinterpretation is reduced

Question 7

7 For each of the following statements about materiality, select whether they are true or false.
Materiality may depend on the size of the error in the context of its omission or
misstatement.
A True
B False
Materiality should be considered when planning audit procedures and when evaluating
discovered misstatements.
C True
D False
Materiality is always expressed as a proportion of profits.
E True
F False

Answer 7

A,C,F
Option A is correct as the concept of materiality does not exist in a void, but depends
on the context of the omission or misstatement. Option C is correct as materiality acts
as a form of guidance in the amount of work required to be performed, and so when
planning audit procedures. It is also made reference to in evaluating discovered
misstatements (both individual misstatements and in aggregate). Option F is correct as
materiality is not a fixed percentage of profits or other measure but depends on the
audit risks faced for the particular client. Further, materiality is not only measured
quantitatively but also qualitatively

Question 8

8 Audit risk can be split into three components: inherent risk, control risk and detection risk.
For each of the following examples, select the type of risk illustrated.
The organisation is seeking to raise finance for a new venture.
A Inherent
B Control
C Detection
The organisation has a number of estimates in its financial statements.
D Inherent
E Control
F Detection

Answer 8

A,D Both the examples increase the susceptibility of the accounts to material fraud and
error. The fact the organisation is seeking to raise finance for a new venture represents
a risk at the company level, whereas the estimates present a risk at the individual
account level where those estimates are found.

Question 9

9 Audit risk can be split into three components: inherent risk, control risk and detection risk.
For each of the following examples, select the type of risk illustrated.
The organisation has a high turnover of staff in the accounts department.
A Inherent
B Control
C Detection
The auditor will be using samples in testing.
D Inherent
E Control
F Detection

Answer 9

B,F High staff turnover increases the risk that the internal controls in place will not be
effective. The use of samples in testing, represents a sampling risk: that the sample
tested will not represent the population as a whole. Sampling risk is part of detection
risk.

Question 10

Adam has been given the following draft figures for Imperious Ltd for the year ended
30 June 20X7 to analyse. Materiality has been set at £35,000 and the finance director has
told Adam in a planning meeting that there have been few changes in the year. Budgets
were set at 20X6 levels and there have been no major movements in non-current assets.
20X7 20X6
£ £
Revenue 3,497,284 3,487,286
Cost of sales 1,867,294 2,008,967
Salaries 467,900 420,975
Repairs and renewals 3,645 3,800
Depreciation 4,598 4,365
Advertising 37,945 37,283
For each item identified below, state whether it warrants further testing to analytical
procedures or not.
Cost of sales
A Warrants further testing
B No further testing required
Repairs and renewals
C Warrants further testing
D No further testing required
Advertising
E Warrants further testing
F No further testing required

Answer 10

A,D,E
Warrants further testing – both the balance in the Cost of Sales account and the annual
decrease of 7% are significant and therefore further work is required to explain the
movement in the gross margin.
No further testing – the balance of repairs and renewals and the year on year decrease
of 4% is not significant (immaterial).
Warrants further testing – although an increase of 2% is not significant, the balance in
the advertising account is material and so further testing to analytical procedures is
warranted.

Question 11

Which two of the following would be used in understanding the entity in accordance with
ISA (UK) 315, Identifying and Assessing the Risks of Material Misstatement Through
Understanding of the Entity and Its Environment?
A Industry, regulatory and other external factors
B A preliminary review of internal controls
C The results of tests of details
D The results of a review of events after the date of the financial statements

Answer 11

A,B Options C and D are incorrect as tests of details and review of events after the date of
the financial statements are normally performed after the initial planning stage of the
audit.

Question 12

Which one of the following is normally designed to detect possible material monetary
errors in the figures in financial statements?
A Test of control
B Walk-through test
C Analytical procedure
D Observation of a procedure

Answer 12

C Analytical procedures help identify material monetary errors in the financial statements
(which could be due to changes in account balances or key ratios as a result of
mispostings, misclassification errors or under/overstatements). The other techniques
are all concerned with systems assessment or testing of controls.

Question 13

For each of the following statements, select whether they are true or false in respect of the
concept of materiality.
Materiality should be calculated at the planning stage of all audits.
A True
B False
Once established, the materiality level initially set cannot be revised during the course of
the audit.
C True
D False
Materiality will influence the audit opinion given.
E True
F False

Answer 13

A,D,E
Option A is correct as materiality needs to be calculated at the audit planning stage to
provide a guide as to the extent of audit procedures required. Option D is correct as
materiality can be revised during the course of the audit, as the assessment of audit risk
changes. With regards to option E, the materiality level set will have an impact on the
audit opinion as the existence of material unadjusted errors and misstatements will
lead to a qualified audit opinion.

Question 14

Audit risk can be split into three components: inherent risk, control risk and detection risk.
For each of the following examples, select the type of risk illustrated.
Senior management regularly override the system of controls.
A Inherent
B Control
C Detection
Directors’ pay is related to company profitability.
D Inherent
E Control
F Detection

Answer 14

B,D The existence of management override increases control risk as controls may be
ignored leading to an increased risk of material fraud or error. Profit related pay may
motivate the directors to distort the financial information, so constituting an inherent
risk.

Question 15

Which three of the following would increase inherent risk?
A Sample sizes have been calculated incorrectly by the auditor and are too small
B A significant number of balances are based on estimates
C The financial statements include complex transactions
D Audit staff are inexperienced
E The company is seeking to raise finance

Answer 15

B,C,E
Options A and D are incorrect as sample sizes and inexperienced audit staff will affect
detection risk.

Question 16

Which three of the following would increase inherent risk?
A Sample sizes have been calculated incorrectly by the auditor and are too small
B A significant number of balances are based on estimates
C The financial statements include complex transactions
D Audit staff are inexperienced
E The company is seeking to raise finance

Answer 16

B,C If detection risk is low this means that the auditor must have a higher expectation of
identifying errors and misstatements. Materiality is lower as the financial statements are
more sensitive and sample sizes are increased so that more work is performed.

Question 17

For each of the following situations, select the most appropriate approach which should be
used by the assurance firm.
The audit of a new client, recently started up, with few employees in its accounting
department
A Tests of control only
B Substantive procedures only
C A mix of tests of control and substantive procedures
The audit of a long-standing client with a sophisticated IT system and an internal audit
department
D Tests of control only
E Substantive procedures only
F A mix of tests of control and substantive procedures

Answer 17

B,F Substantive procedures only – a new client with few employees implies a lack of
segregation of duties and hence high control risk. Therefore reliance should not be
placed on the internal control system. Audit evidence should be gathered using
substantive procedures.
A mix of tests of control and substantive procedures may be used for the audit of a
long-standing client with a sophisticated IT system and an internal audit department as
it will be possible to rely on internal controls and then perform reduced substantive
procedures.

Question 18

As part of your analytical procedures on the financial statements of Dreamy Desserts Ltd
you have identified that the gross profit margin has fallen from 27% to 24%.
Which two of the following could be a valid explanation for this decrease?
A Unusually high sales at the end of the year resulted in lower levels of closing inventory
as compared to the previous year
B Increased competition resulted in sales prices being cut
C A bank overdraft resulted in a higher interest expense than in previous years
D There was a significant change in the mix of products sold

Answer 18

B,D If sales prices are cut but costs remain the same gross profit margins will fall. If the
company sells a greater proportion of goods with a lower margin than in previous
years the overall margin will be reduced. Increased levels of sales (and therefore lower
closing inventory) will not affect gross profit margins provided selling prices are
maintained. Interest expense is not deduc

Question 19

In each of the following cases, select whether inherent risk is higher or lower than normal.
The company has recently listed on the local stock exchange with high profit expectations
from analysts.
A Inherent risk higher than normal
B Inherent risk lower than normal
Inventory is the largest balance on the statement of financial position.
C Inherent risk higher than normal
D Inherent risk lower than normal
The company operates in a slow-moving, stable industry.
E Inherent risk higher than normal
F Inherent risk lower than normal

Answer 19

A,C,F
With a recent listing on the stock exchange and high profit expectations, inherent risk
is higher than normal as accounts are more susceptible to material fraud and error.
Inventory is by its nature more inherently risky as it is susceptible to theft, omission and
misstatement. The fact that the company operates in a slow-moving, stable industry,
decreases the susceptibility of the financial statements to material fraud and error

Question 20

For each of the following statements, select whether they are true or false in respect of the
concept of materiality.
Materiality depends only on the monetary amount of an item.
A True
B False
Materiality may depend on either the nature of an item or its monetary amount.
C True
D False
Materiality is a matter of professional judgement.
E True
F False

Answer 20

B,C,E
False – materiality can be both quantitative and qualitative.
True – materiality may depend on either the nature of an item or its monetary amount.
True – materiality is determined by the external auditor and he will use his professional
judgement in setting a level of materiality which best addresses the audit risk.
SAMPLE PAPER

Question 21

Audit risk can be split into three components: inherent risk, control risk and detection risk.
For each of the following examples, select the type of risk illustrated.
The organisation has few employees in its accounting department.
A Inherent
B Control
C Detection
The organisation operates in a fast-moving, high-tech environment.
D Inherent
E Control
F Detection

Answer 21

B,D Control – few employees indicates limited segregation of duties, which is a control
deficiency.
Inherent – a fast-moving, high-tech environment presents inherent risks both at the
company level but also at individual account levels (eg, inventory). SAMPLE PAPER

Question 22

Which two of the following options are signs of overtrading?
A Inventory decreasing
B Cash decreasing
C Payables decreasing
D Receivables increasing

Answer 22

B,D Cash would be decreasing in a situation of overtrading as cash flows out to fund the
increases in working capital.
Receivables would be increasing as the company expands without the resources to
support the expansion.

Question 23

Deteriora Ltd’s quick ratio has fallen from 1.9:1 to 1.6:1.
Which one of the following might help to explain this decline?
A The allowance for receivables has been reduced
B Credit control has been poor
C The entity has purchased a property for cash
D Inventory levels have fallen

Answer 23

C If the entity has purchased a property for cash, this would reduce current assets without
any corresponding reduction in current liabilities.

Question 24

An electrical store and a cake shop have the same mark-up on cost. However, the gross
profit margin of the electrical store is significantly higher than that of the cake shop.
Which one of the following is a possible reason for this?
A The cake shop’s revenue is increasing, while that of the electrical shop is decreasing.
B The cake shop has a higher level of wastage of inventory than the electrical store.
C The electrical shop takes advantage of trade discounts for bulk buying.
D The cake shop has a higher turnover of inventory than the electrical store

Answer 24

B If the cake shop has a higher level of wastage of inventory than the electrical shop, then
the cost of wasted inventory will be treated as an expense in cost of sales. This will
reduce its cost of sales independently of the mark-up applied. Cost of sales will
therefore be high in relation to revenue, so the cake shop’s gross margin will be lower.

Question 25

Thatch plc’s current ratio this year is 1.33:1 compared with 1.25:1 last year.
Which two of the following would be possible explanations of this?
A Thatch paid its payables earlier than usual out of a bank overdraft
B Thatch made an unusually large sale immediately before the year end
C Thatch made an unusually large purchase of goods for cash immediately before the
year end, and these goods remain in inventory
D Thatch paid its payables earlier than usual out of a positive cash balance

Answer 25

B,D An unusually large sale would increase receivables and the current ratio.
If payables are paid out of a positive cash balance then this will reduce both cash
(assets) and payables by the same absolute amount. However, since the current ratio is
positive (assets are greater than liabilities), the ratio will increase.

Question 26

Which one of the following statements correctly describes the principal purpose of an
external audit of a limited company?
A To help in the preparation of the company’s financial statements
B To prevent fraud within the company
C To examine and express an opinion on the company’s financial statements
D To help the directors in improving the company’s financial reporting process

Answer 26

C It is management’s responsibility to prevent fraud within a company (option B). There
are auditor independence issues with regard to external auditors being involved in the
preparation of financial statements and in helping management to improve reporting
processes (options A and D). It should therefore be apparent that option C is correct.

Question 27

Which one of the following best describes the principal difference between fraud and
error?
A Fraud may result in the financial statements being material misstated
B Fraud is an intentional act whereas error is unintentional
C A misstatement can be material whether it is caused by fraud or by error
D Fraud may be the result of negligence whereas error is unintentional

Answer 27

B It is true that fraud may result in a material misstatement, but this is also true of error so
option A is incorrect. It is also true that a misstatement can be material whether it is
caused by fraud or by error, but this does not help us to distinguish between them
(option B). Option D is incorrect, since fraud is an intentional act. Option B is correct –
fraud is an intentional act but error is not.

Question 28

Which two of the following are true in respect of related party transactions?
A Related party transactions tend to be low-risk to the auditor
B Disclosure of related party transactions is unlikely to be material to the financial
statements
C Related party transactions must be completely disclosed in the financial statements
D There may be a significant control risk in relation to related party transactions

Answer 28

C,D Option A is incorrect, as related party transactions tend to be a high-risk area. Option B
is incorrect because misstatements of disclosure may well be material, especially if they
relate to eg, directors’ remuneration. Option C is correct – disclosure should be
complete. Option D is correct, because it is commonly the case that management has
not put in place reliable internal controls to identify related party transactions.

Question 29

ISA (UK) 300, Planning an Audit of Financial Statements distinguishes the audit strategy from
the audit plan.
For each of the following examples, select the document in which the information would be
found.
Understanding of the entity’s accounting policies
A Audit strategy
B Audit plan
Assessment of the principal risks of material misstatement
C Audit strategy
D Audit plan
Planned timetable for the financial statements to be ready for discussion with client
E Audit strategy
F Audit plan

Answer 29

A,C,E
Understanding of the entity’s accounting policies is included in the audit strategy
document.
The assessment of the principal risks would be included in the audit strategy
document.
The planned timetable would be included in the audit strategy document

Question 30

Rasvi LLP has been informed by its client, Wilson Ltd, that it has discovered that a payroll
fraud was in operation during the previous financial year, a year in respect of which Rasvi
LLP gave a ‘clean’ auditor’s opinion.
Wilson Ltd says that Rasvi LLP was responsible for preventing the fraud. A review of the
previous year’s audit working papers shows that Rasvi LLP failed to perform any procedures
at all in relation to the payroll.
For each of the following statements, select whether the statement is true or false.
Rasvi LLP was responsible for preventing the fraud
A True
B False
Rasvi LLP failed to discharge its responsibilities as auditor
C True
D False

Answer 30

B,C The prevention of fraud is the responsibility of management, not the auditor. However,
the auditor is responsible for obtaining evidence to address the risks of material
misstatement, which it failed to do in relation to payroll.

Question 31

Which two of the following are true of the auditor’s objectives in relation to fraud, in line
with ISA (UK) 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements?
A The auditor performs the audit with the aim of deterring fraud.
B The auditor must identify and assess the risks of material misstatement due to fraud.
C The auditor must obtain evidence regarding the risks of material misstatement due to
fraud.
D The auditor must only obtain evidence regarding the risks of material misstatement
due to error

Answer 31

B,C Although deterrence of fraud may be a consequence of the audit, the auditor does not
perform the audit with this aim – their aim is to obtain evidence regarding the truth and
fairness of the financial statements.
The auditor is responsible for assessing the risks of material misstatement, which
includes the risk of misstatements resulting from fraud, and for obtaining evidence in
relation to this risk.