AA: Planning and risk

Question 1 · Syllabus ref B1a · Acceptance of audit engagements

Greenfield & Co is considering accepting appointment as auditor of Ravenstone Ltd. The previous auditor resigned without completing the audit. What is the most important first action?

1. Contact the previous auditor to enquire whether there are any professional reasons why the appointment should not be accepted
2. Agree the audit fee with Ravenstone Ltd's board
3. Issue the engagement letter immediately to establish the contractual relationship
4. Review Ravenstone Ltd's financial statements from the previous three years

Question 2 · Syllabus ref B1b · Preconditions for audit

Before accepting a new audit engagement, an auditor must determine that preconditions for an audit are present. Which of the following is a precondition under ISA 210?

1. Management acknowledges its responsibility for preparing financial statements in accordance with the applicable financial reporting framework and for designing internal controls
2. The client must have used the same accounting policies for at least three consecutive years
3. The client must have no outstanding legal proceedings
4. The client must be listed on a recognised stock exchange

Question 3 · Syllabus ref B1c · Obtaining an audit engagement

A company invites audit firms to tender for its audit. Which describes the typical process by which an audit firm obtains the engagement?

1. The company sends a request for proposal to interested firms; firms submit tenders; the audit committee evaluates and recommends the preferred firm; shareholders approve the appointment at the AGM
2. The existing auditor automatically retains the engagement without any formal process
3. The audit firm applies directly to the relevant professional body for appointment
4. The company's directors select the auditor without any shareholder involvement

Question 4 · Syllabus ref B1d · Engagement letters

Which of the following is the primary purpose of an engagement letter?

1. To define the terms of the audit engagement and reduce the risk of misunderstandings about the respective responsibilities of the auditor and management
2. To confirm the audit fee agreed between the auditor and the client
3. To satisfy regulatory requirements imposed by the relevant professional body
4. To document the auditor's preliminary risk assessment before planning commences

Question 5 · Syllabus ref B1a · Continuance of audit engagements

An audit firm is considering whether to continue as auditor of an existing client. During the year, the audit team had serious disagreements with management over the accounting treatment of a material transaction, and management overrode the team's recommendations. What is the most appropriate action?

1. Evaluate whether the disagreements and management override indicate management integrity issues; if so, this may be grounds to withdraw from the engagement, having complied with professional and legal requirements for resignation
2. Continue as auditor without further consideration — the client always has the right to override the auditor
3. Immediately resign without any documentation or explanation
4. Agree with management's position to maintain the commercial relationship

Question 6 · Syllabus ref B2a · Overall objectives of the auditor

ISA 200 sets out the overall objectives of the auditor. Which correctly states these?

1. To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to report on the financial statements in accordance with the auditor's findings
2. To obtain absolute assurance about whether the financial statements are free from all misstatements and to express an opinion
3. To detect all instances of fraud and report them to the appropriate regulatory authorities
4. To certify that the financial statements comply with all applicable tax legislation

Question 7 · Syllabus ref B2b · Professional scepticism

During an audit, an auditor receives a management explanation for an unusual journal entry that seems plausible. Which best describes the appropriate application of professional scepticism?

1. Accept the explanation at face value since it is plausible
2. Reject the explanation and qualify the audit report
3. Critically assess the explanation and seek corroborating evidence before accepting it
4. Document the explanation in the working papers and take no further action

Question 8 · Syllabus ref B3a · Components of audit risk

An entity operates in a highly regulated industry and has a complex revenue recognition policy. The auditor has determined that the entity's internal controls over revenue are weak. Which combination of risk components is elevated?

1. Inherent risk and control risk are both elevated, which increases the risk of material misstatement
2. Inherent risk and control risk are both elevated; detection risk is unchanged
3. Control risk is elevated but inherent risk is unaffected by the regulatory environment
4. Detection risk is elevated because of the weak internal controls

Question 9 · Syllabus ref B3b · Identifying audit risks from scenarios

Marlow Engineering Ltd has recently acquired a new subsidiary for £8m including significant intangible assets valued internally by management. Revenue has increased 40% following the acquisition. Which best describes the key audit risks?

1. The valuation of intangible assets is at risk of overstatement; goodwill may be misstated if fair values of identifiable assets are incorrectly determined; the 40% revenue increase creates a risk that revenue is overstated due to cut-off errors or incorrect consolidation
2. No significant risks — acquisitions are routine transactions with low inherent risk
3. The only risk is that the acquisition consideration of £8m is incorrectly recorded
4. Revenue is at risk of understatement because of the acquisition

Question 10 · Syllabus ref B3c · Materiality

An auditor is planning the audit of Clairmont Ltd, which has profit before tax of £400,000 and total assets of £5,000,000. Using a benchmark of 5% of profit before tax, what is planning materiality, and which correctly describes performance materiality?

1. Planning materiality £20,000; performance materiality is set lower than planning materiality to reduce the probability that uncorrected and undetected misstatements in aggregate exceed materiality
2. Planning materiality £20,000; performance materiality is set higher than planning materiality
3. Planning materiality £200,000; performance materiality is set lower than planning materiality
4. Planning materiality £250,000; performance materiality equals planning materiality

Question 11 · Syllabus ref B3d · Materiality — aggregate misstatements

An auditor identifies three uncorrected misstatements: (1) inventory overstatement £12,000; (2) accrual understatement £8,000; (3) prepayment overstatement £6,000. Planning materiality is £20,000. Which correctly describes the auditor's evaluation?

1. Each misstatement is individually below materiality but the aggregate (£26,000) exceeds materiality — the auditor must consider whether the aggregate is material and request management to correct the misstatements
2. All three are below materiality and can be ignored
3. Only misstatement (1) is relevant as it is the largest
4. The auditor should average the three misstatements and assess the average against materiality

Question 12 · Syllabus ref B4a · Understanding the entity

ISA 315 requires auditors to obtain an understanding of the entity and its environment. Which source of information would be most useful for understanding external factors affecting a pharmaceutical entity?

1. Industry publications, regulatory body reports, and information about patent expiry dates and pipeline products
2. The client's internally prepared management accounts for the current year
3. The personal views of the audit manager who has audited the client for ten years
4. The prior year audit working papers only

Question 13 · Syllabus ref B4b · Analytical procedures in planning

Harwich Co's revenue has increased by 30% year on year, but its gross profit margin has fallen from 42% to 31%. Which best describes how an auditor would use this information in planning?

1. This combination identifies a potential risk that costs have been overstated or revenue understated, warranting increased audit attention on cost of sales and revenue
2. No action required as revenue growth is a positive indicator
3. The auditor should qualify their report based on this analytical finding alone
4. The auditor should reduce substantive testing on revenue as it has clearly increased

Question 14 · Syllabus ref B4c · Key ratios in analytical procedures

During planning, an auditor calculates: receivables days increased from 32 to 58; inventory days increased from 45 to 89; payables days decreased from 60 to 41. Which best describes the audit implications?

1. All three movements are adverse, raising risks of receivables overstatement, inventory overstatement, payables understatement, and possible going concern issues
2. The ratios indicate improved efficiency — no audit action required
3. The ratios only indicate that the business has grown significantly during the year
4. The deterioration in ratios confirms the financial statements are misstated

Question 15 · Syllabus ref B5a · Fraud and the audit strategy

During an audit, the auditor discovers that a senior finance manager has been diverting customer payments into a personal bank account. Which best describes the effect on the audit strategy?

1. The auditor should increase substantive testing on cash receipts and receivables, consider whether other areas are affected, and communicate the matter to those charged with governance
2. No change to the audit strategy — fraud is management's problem
3. The auditor should immediately issue a qualified audit report without further work
4. The auditor should report the fraud directly to the police without informing management or those charged with governance

Question 16 · Syllabus ref B5b · Auditor responsibilities for fraud

Which correctly describes the respective responsibilities of management and external auditors for the prevention and detection of fraud under ISA 240?

1. Both management and auditors share equal primary responsibility for preventing fraud
2. The auditor has primary responsibility for preventing fraud; management is responsible for detection
3. Management has primary responsibility for preventing and detecting fraud; the auditor's responsibility is to obtain reasonable assurance that the financial statements are free from material misstatement whether caused by fraud or error
4. Neither management nor auditors are responsible for fraud — this is the role of the audit committee

Question 17 · Syllabus ref B5b · Fraud triangle

ISA 240 identifies fraud risk factors under three categories of the 'fraud triangle'. Which correctly identifies these categories?

1. Planning, performance and reporting
2. Risk assessment, control activities and monitoring
3. Incentive/pressure, opportunity and rationalisation
4. Material misstatement, scope limitation and emphasis of matter

Question 18 · Syllabus ref B5c · Laws and regulations

An auditor becomes aware that an audit client may have breached environmental regulations, potentially resulting in a significant fine. Which correctly describes the auditor's responsibilities under ISA 250?

1. The auditor has no responsibility regarding laws and regulations
2. The auditor should immediately report the breach to the environmental regulator without informing management
3. The auditor should consider the effect of the non-compliance on the financial statements, discuss the matter with management, and communicate with those charged with governance; the auditor should also consider whether there is a duty to report to regulatory authorities
4. The auditor should include details of the breach in the audit opinion

Question 19 · Syllabus ref B6a · Benefits of audit planning

Which of the following is NOT a benefit of planning an audit?

1. It ensures that appropriate attention is devoted to important audit areas
2. It helps identify and resolve potential problems on a timely basis
3. It guarantees that no material misstatements will remain undetected
4. It helps organise and manage the audit engagement so that it is performed effectively

Question 20 · Syllabus ref B6b · Audit strategy and audit plan

Which correctly distinguishes between the overall audit strategy and the audit plan?

1. The audit strategy and audit plan are the same document covering identical content
2. The audit plan is produced first; the overall audit strategy is derived from it
3. The overall audit strategy sets the scope, timing and direction of the audit and guides development of the audit plan; the audit plan is more detailed and describes the nature, timing and extent of planned audit procedures
4. The overall audit strategy is prepared by the client; the audit plan is prepared by the auditor

Question 21 · Syllabus ref B6c · Updating the audit strategy

During an audit, the auditor discovers that the client's key internal control system for revenue contains a significant deficiency. How does this affect the audit strategy and plan?

1. No effect — the audit strategy and plan are fixed at the start of the engagement
2. The auditor should reduce substantive testing because the control deficiency confirms controls are unreliable
3. The auditor should update the audit strategy to reflect increased control risk for revenue, and revise the audit plan to increase the extent of substantive testing on revenue
4. The audit plan should be abandoned and replaced entirely with a new strategy

Question 22 · Syllabus ref B6d · Interim vs final audit

Which correctly describes the purpose of an interim audit?

1. The interim audit is performed after the year end and focuses entirely on the financial statements
2. The interim audit replaces the need for a final audit in small entities
3. The interim audit is performed before the year end and typically focuses on controls testing and some substantive testing, with the objective of reducing the work required at the final audit stage
4. The interim audit is performed only for listed companies

Question 23 · Syllabus ref B6e · Walkthrough procedures

An auditor performs walkthrough procedures on the client's sales cycle during the interim visit. What is the primary purpose of a walkthrough?

1. To perform detailed substantive testing on the entire sales population
2. To test a large sample of controls to provide sufficient evidence of operating effectiveness
3. To confirm the auditor's understanding of the system by tracing a single transaction from initiation through all processing stages to its final recording in the accounting records
4. To replace the need for tests of controls at the final audit stage

Question 24 · Syllabus ref B6g · Audit documentation

Which best describes the primary purpose of audit documentation under ISA 230?

1. To provide a record of hours spent on the engagement for billing purposes
2. To enable the client to review the auditor's work at any time
3. To provide evidence that the audit was planned and performed in accordance with ISAs and applicable legal requirements, and to support the audit opinion
4. To allow junior members of the audit team to avoid involvement in complex judgements

Question 25 · Syllabus ref B6i · Custody and retention of working papers

Which correctly describes an auditor's obligations regarding the custody and retention of audit working papers?

1. Working papers may be shared freely with any third party on request
2. Working papers must be destroyed within one year of the audit being completed
3. Working papers must be kept confidential and retained for a sufficient period (commonly at least five years from the date of the auditor's report) in accordance with legal and professional requirements
4. Working papers should be handed to the client upon completion of the audit

Question 26 · Syllabus ref B3b · Identifying audit risk — construction contracts

Bridford Construction Ltd uses the percentage-of-completion method to recognise revenue on long-term contracts. Two contracts are 60% and 75% complete respectively based on management estimates. Total contract revenue recognised this year is £12m. Which best describes the key audit risks?

1. No significant risks — the percentage-of-completion method is an accepted accounting policy
2. Revenue recognition is at risk of overstatement if the stage of completion is overestimated; costs to complete may be understated, reducing the accuracy of profit recognised; contract losses may not be recognised promptly if management is optimistic about outcomes
3. The only risk is whether the contracts have been approved by the board
4. Revenue is likely to be understated as construction companies are conservative

Question 27 · Syllabus ref B6f · Audit documentation — form and content

Which should be included in audit working papers relating to a significant audit area?

1. Only the final conclusion on each area — detailed workings are not required
2. The objective of the audit work, the procedures performed, the evidence obtained, the significant judgements made and the conclusions reached
3. A copy of the client's financial statements with the auditor's signature
4. Only the matters that support the audit opinion — contrary evidence need not be recorded

Question 28 · Syllabus ref B4b · Planning analytical procedures — overall review

An auditor performs overall analytical procedures at the planning stage and notes that Ravenbrook Ltd's receivables days have increased from 28 to 67 days, while its revenue has been stable and its credit policy has not changed. Which best describes the audit implication?

1. No action required — receivables days fluctuate naturally from year to year
2. The significant increase in receivables days without a corresponding change in revenue or credit policy is unusual and may indicate: overstatement of receivables (fictitious sales, debtors who cannot pay); understatement of the irrecoverable debt allowance; or cut-off issues at the year end; the auditor should increase substantive testing on receivables and revenue
3. The increase in receivables days confirms that the business is growing strongly
4. The auditor should accept management's explanation that customers are slower to pay in the current economic environment without seeking corroborating evidence