CHAPTER 3

AUDIT PLANNING l
CHAPTER LEARNING OBJECTIVES

1. Identify the different phases of an audit.

The phases of an audit include risk assessment, risk response, and reporting. During the risk
assessment phase, an auditor will gain an understanding of their client in order to make an
informed risk assessment, develop an audit strategy, and set their planning materiality. During
the risk response phase, an auditor will execute their detailed testing of account balances and
transactions. The final phase of every audit involves reviewing all of the evidence gathered
throughout the audit and arriving at a conclusion regarding the fair presentation of the client’s
financial statements. The auditor will then write an audit report that reflects their opinion based
upon their findings.

2. Explain the process used in gaining an understanding of the client.

An auditor will gain an understanding of their client to aid in the risk identification process. This
process involves consideration of issues at the entity level, the industry level, and the broader
economic level. At the entity level, an auditor will identify the client’s major customers, suppliers,
and stakeholders (that is, banks, shareholders, and employees). The auditor will also determine
whether their client is an importer or exporter, who the client’s competitors are, what the client’s
capacity is to adapt to changes in technology, and what the nature of any warranties provided to
customers is. At the industry level, an auditor is interested in their client’s position within its
industry. At the economic level, an auditor will assess how well positioned the client is to cope
with current and changing government policy and economic conditions.

3. Explain how related parties can impact risk.

Related parties include parent companies, subsidiaries, joint ventures, associates, company
management, and close family members of key management. Since related parties are not
independent of each other, these transactions may not be in the normal course of business.
This increases the risk of material misstatement and may impact the overall financial results.
Therefore, related party transactions require some specific consideration throughout the audit
and specific procedures should be performed and documented.

4. Evaluate fraud risk.

Fraud is an intentional act through the use of deception to obtain an unjust or illegal advantage.
The two kinds of fraud are financial reporting fraud and misappropriation of assets. There are a
number of techniques the auditor uses to assess the risk of fraud. The audit file must document
the fraud risk assessment and procedures performed to support that assessment.

5. Explain the going concern assumption.

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3 - 2Auditing: A Practical Approach, Third Canadian Edition

The going concern assumption is made when it is believed that a company will remain in
business for the foreseeable future. An auditor will consider the appropriateness of this
assumption during the risk assessment phase and then throughout the audit.

6. Appraise corporate governance.

Corporate governance is the rules, systems, and processes used to guide and control within
companies. Among other things, governance structures are used to assess the level of risk
faced and to design controls to reduce identified risks.

7. Evaluate how a client’s information technology (IT) can affect risk.

There are a number of risks associated with IT. During the risk assessment phase of the audit,
the auditor will assess the likelihood that their client’s financial statements are misstated due to
limitations in its IT system.

8. Explain how client closing procedures can affect reported results.

There are a number of risks associated with a client’s closing procedures. Closing procedures
are the processes used by a client at year end to ensure that transactions are recorded in the
appropriate accounting period. From an audit perspective, there is a risk that the client’s closing
procedures are inadequate.

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 Audit Planning l 3-3

TRUE-FALSE STATEMENTS

1. The risk assessment phase of an audit involves the performance of detailed tests of controls
and substantive testing of transactions and accounts.

Answer: False

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different stages of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

2. Auditors must gain an understanding of their client at the outset of every audit.

Answer: True

Bloomcode: Knowledge
Difficulty: Easy
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

3. The more competitive an audit client's industry, the less pressure is placed on the client's
profits.

Answer: False

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

4. Fraud is an intentional act to obtain an unjust or illegal advantage through the use of
deception.

Answer: False

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk

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3 - 4Auditing: A Practical Approach, Third Canadian Edition

CPA Competency: Auditing and Assurance

AACSB: Analytic

5. Misappropriation of assets fraud involves intentionally misstating items or omitting important

facts from the financial statements.

Answer: False

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

6. An example of an attitude or rationalization used to justify a fraud is high volume of

transactions close to year-end.

Answer: False

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

7. Under the going concern assumption, assets are valued on the basis that they will continue to
be used for the purpose of conducting a business.

Answer: True

Bloomcode: Knowledge
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

8. Mitigating factors that reduce going concern risk include the ability to raise additional funds
through the sale of shares.

Answer: True

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.

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 Audit Planning l 3-5

Section Reference: 3.5 Going concern

CPA Competency: Auditing and Assurance
AACSB: Analytic

9. A client's corporate governance structure is assessed when planning an audit.

Answer: True

Bloomcode: Knowledge
Difficulty: Medium
Learning Objective: Appraise corporate governance.
Section Reference: 3.6 Corporate governance
CPA Competency: Auditing and Assurance
AACSB: Analytic

10. Application controls are policies and procedures that relate to many applications.

Answer: False

Bloomcode: Knowledge
Difficulty: Medium
Learning Objective: Explain how a client’s information technology (IT) can affect risk.
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Analytic

11. An auditor is not concerned with transactions and events being recorded in the correct
accounting period.

Answer: False

Bloomcode: Knowledge
Difficulty: Medium
Learning Objective: Explain how client closing procedures can affect reported results.
Section Reference: 3.8 Closing procedures
CPA Competency: Auditing and Assurance
AACSB: Analytic

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3 - 6Auditing: A Practical Approach, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS

12. Mathias Mousseau was at a client’s offices and was preparing his work for the following
day. He was considering the risk that a material misstatement due to significant error or fraud
could occur in the client's financial statements. Which of the three main stages of the audit was
he performing?

a) risk assessment phase

b) risk response phase
c) reporting phase
d) none of the above

Answer: a

Bloomcode: Comprehension
Difficulty: Easy
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

13. Wilfred Dominic was meeting with his manager to plan audit strategy in order to determine
the amount of time to spend testing the client's internal controls and conducting detailed testing
of transactions and account balances. Determining the audit strategy occurs during which phase
of the audit?

a) client acceptance stage

b) risk assessment phase
c) risk response phase
d) reporting stage

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

14. When Sean Green started the preliminary risk identification process at a local dairy during
the risk assessment phase of the audit he endeavoured to gather sufficient appropriate evidence.
Which of the following elements were involved in the preliminary risk identification?

a) going concern risk

b) client’s corporate governance
c) understanding the IT environment

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 Audit Planning l 3-7

d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

15. During the risk assessment phase of a grocery chain, Seren Dagdeviren tried to determine
which procedures would be appropriate. Which of these procedures, if any, would you use in the
planning phase of the audit?

a) observation and inspection

b) analytical procedures
c) both a and b
d) none of the above

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

16. The risk response phase of an audit involves

a) evaluating the results of the detailed testing and forming an opinion on the fair presentation of
the client's financial statements.
b) the assessment of the audit firm's quality control procedures.
c) the performance of detailed tests of controls and substantive testing of transactions and
accounts.
d) gaining an understanding of the client.

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

17. Preliminary risk identification can be affected by

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3 - 8Auditing: A Practical Approach, Third Canadian Edition

a) fraud risk.
b) corporate governance.
c) both a and b
d) none of the above

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

18. The purpose of planning an audit is to

a) conduct the audit in an efficient and effective manner.

b) reduce audit risk to an acceptably low level.
c) ensure that sufficient appropriate audit evidence is obtained to reach an appropriate audit
opinion.
d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

19. The risk response phase of an audit involves

a) evaluating the results of the detailed testing and forming an opinion on the fair presentation of
the client's financial statements.
b) the assessment of the audit firm's quality control procedures.
c) the performance of detailed tests of controls and substantive testing of transactions and
accounts.
d) gaining an understanding of the client.

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
 Audit Planning l 3-9

20. Preliminary risk identification can be affected by

a) fraud risk.
b) corporate governance.
c) both a and b
d) none of the above

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

21. The purpose of planning an audit is to

a) conduct the audit in an efficient and effective manner.

b) reduce audit risk to an acceptably low level.
c) ensure that sufficient appropriate audit evidence is obtained to reach an appropriate audit
opinion.
d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

22. Kaz Nowakowski performed several procedures, including observation and inspection of the
company’s plans and business strategies. He also made inquiries of those individuals that were
involved in the governance of the company, the internal auditors, and operating personnel.
These procedures will help Kaz to

a) determine fraud possibilities.

b) prepare year end closing procedures.
c) gain an understanding of the client.
d) none of the above

Answer: c

Bloomcode: Comprehension
Difficulty: Medium

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 10

Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

23. When Sheila Copes, CPA audited a new client she asked questions about what the client
does, how the client functions, the ownership structure of the client and its sources of financing.
She was getting an understanding of the client at the

a) entity level.
b) industry level.
c) economy level.
d) all of the above

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

24. Claudia Martel knows that financial reporting fraud transactions require disclosure.
However, she is not sure whether related party transactions require disclosure. You advise her
that related party transactions require

a) disclosure.
b) no disclosure.
c) disclosure only if there is risk of fraud.
d) auditor judgment.

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

25. When gaining an understanding of their client, at which level do auditors not usually
consider the relevant issues?

a) audit committee level

b) economy level
c) entity level

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 Audit Planning l 3 - 11

d) industry level

Answer: a

Bloomcode: Comprehension
Difficulty: Easy
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

26. Which of the following is an example of information used by auditors in gaining an

understanding of a client at the entity level?

a) the level of competition in the client's industry.2

b) whether the client is an importer or exporter of goods
c) the client's ability to withstand currency fluctuations
d) the level of government support in the client's industry

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

27. In assessing the client's relationship with its employees, the auditor will consider

a) the level of unionization among the workforce.

b) the attitude of staff to their employer.
c) how well a client pays its employees.
d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Easy
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

28. Which of the following statements regarding the level of demand for the goods sold or
services provided by companies is correct?

a) If a client's products or services are seasonal, this will affect revenue flow.

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 12

b) If a client operates in an industry subject to changing trends, the client does not risk inventory
obsolescence.
c) If a client's products or services are seasonal, this will not affect revenue flow.
d) When a product or process is subject to technological change, there is never a risk that the
client will be left behind by its competitors.

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

29. Related parties include

a) subsidiaries.
b) management.
c) family members of management.
d) all of the above

Answer: d

Bloomcode: Knowledge
Difficulty: Easy
Learning Objective: Explain how related parties can impact risk.
Section Reference: 3.3 Related parties
CPA Competency: Auditing and Assurance
AACSB: Analytic

30. Monica Marcelloni’s team has been asked to tackle three ongoing frauds and her partner
has asked her to follow up only on the financial reporting fraud. Which of the following items
will she be pursuing?

a) theft of stock by employees or customers

b) employees remaining on the payroll after ceasing employment
c) recording fictitious sales
d) unauthorized refunds to customers

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

Copyright © 2018 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
 Audit Planning l 3 - 13

31. Saad Zuberov is a rookie auditor who has asked you about financial reporting frauds and
how they differ from misappropriation of assets frauds. Identify for Saad Zuberov which one of
the following frauds consists of misappropriation of assets.

a) improper asset valuation

b) unrecorded liabilities
c) both a and b
d) none of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

32. Red flags that auditors can use to alert them to the possibility that a fraud may have
occurred include

a) strong internal controls.

b) routine transactions.
c) a high turnover of key employees.
d) effective internal auditing staff.

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

33. When assessing fraud risk, an auditor will adopt an attitude of

a) confidentiality.
b) professional scepticism.
c) belief in management.
d) none of the above

Answer: b

Bloomcode: Comprehension
Difficulty: Easy
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 14

CPA Competency: Auditing and Assurance

AACSB: Analytic

34. Which of the following is an example of a misappropriation of assets fraud?

a) unauthorized discounts or refunds to customers

b) inappropriate application of accounting principles
c) unrecorded liabilities
d) improper asset valuations

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

35. When assessing the risk of fraud, an auditor can consider

a) attitudes and rationalization to justify a fraud.

b) incentives and pressures to commit fraud.
c) opportunities to perpetuate a fraud.
d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

36. Attitudes and rationalization to justify a fraud include

a) significant related party transactions.

b) an excessive focus on profit maximization.
c) a significant decline in demand for the client's products or services.
d) a high volume of transactions close to year-end.

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk

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 Audit Planning l 3 - 15

CPA Competency: Auditing and Assurance

AACSB: Analytic

37. Eva Islam, CPA is auditing a company where it is experiencing strikes regularly, has been
under investigation with non-compliance with legislation and is falling behind competitors.
What kind of risk is being assessed?

a) fraud risk
b) going concern risk
c) both a and b
d) none of the above

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

38. Gerry Jones has been asked to review manual or automated procedures that typically
operate at a business process level and apply to the processing of transactions by individual
applications. What kind of controls is Gerry going to be assessing?

a) output controls
b) general controls
c) both a and b
d) application controls

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

39. The going concern assumption is made when it is believed that

a) a company will become insolvent within the next accounting period.

b) the board of directors does not believe the company's financial statements are fairly
presented.
c) a company will remain in business for the foreseeable future.
d) a company is a separate legal entity.

Answer: c

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 16

Bloomcode: Comprehension
Difficulty: Easy
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

40. If auditors identify risk factors that indicate that the going concern assumption is in doubt,
they will

a) undertake procedures to gather evidence regarding each risk factor.

b) refuse to continue as the auditor of their client.
c) report the client to the Canada Revenue Agency.
d) reduce the extent of further audit testing that they undertake.

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

41. Which of the following is not an example of a mitigating factor that reduces the risk that the
going concern assumption may be in doubt?

a) the ability to raise additional funds via borrowings

b) a letter of guarantee from a parent company
c) the ability to sell an unprofitable segment of the business
d) significant rapid increase in competition

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

42. Risks associated with information technology include

a) loss of data.
b) errors in programs.
c) unauthorized access to computers.
d) all of the above

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 Audit Planning l 3 - 17

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Technology

43. Which statements about the going concern assumption are correct?

a) The company will not be able to continue operating in the next accounting period.
b) The auditor is responsible for the company to be able to continue operating in the
foreseeable future.
c) The company will be able to continue operating in the foreseeable future.
d) none of the above

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

44. The task of assessing the company’s ability to continue as a going concern is the
responsibility of

a) the external auditor.

b) the internal auditor.
c) management.
d) the audit committee.

Answer: c

Bloomcode: Knowledge
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

45. Which of the following is an indicator that the company may not be able to continue as a
going concern?

a) issuing bonus shares to shareholders instead of cash dividends

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 18

b) a high level of borrowing

c) negative cash flows from operating activities
d) introduction of a new product into the market

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

46. Corporate governance means

a) the viability of a company to remain in business for the foreseeable future.

b) the rules, systems and processes within companies used to guide and control them.
c) an intentional act through the use of deception to obtain an unjust or illegal advantage.
d) the processes used by a client when finalizing the accounts for an accounting period.

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Appraise corporate governance.
Section Reference: 3.6 Corporate governance
CPA Competency: Auditing and Assurance
AACSB: Analytic

47. The corporate governance principle of most concern to the auditor is

a) safeguarding the integrity in financial reporting.

b) making timely and balanced disclosures.
c) promoting ethical and responsible decision making.
d) respecting the rights of shareholders.

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Appraise corporate governance.
Section Reference: 3.6 Corporate governance
CPA Competency: Auditing and Assurance
AACSB: Analytic

48. When gaining an understanding of a client, the auditor will consider the risks associated with
information technology. Risks associated with information technology include

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 Audit Planning l 3 - 19

a) unauthorized access to computers, software, or data.

b) errors in programs.
c) lack of back-up procedures.
d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Analytic

49. Which of the following is not a risk associated with the installation of a new IT system?

a) loss of data in transfer to the new system

b) inadequately trained staff
c) data not processed correctly
d) selection of an inappropriate system for reporting needs

Answer: d

Bloomcode: Comprehension
Difficulty: Hard
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Analytic

50. Unauthorized access to a company's data can occur when

a) inadequate backups of data are maintained.

b) there are poor password protection procedures.
c) computer programs are tested thoroughly.
d) there are sufficient security procedures.

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Technology

51. Which of the following is not an example of a risk when a client installs a new IT system?

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 20

a) Client staff are not adequately trained to use the new system effectively.
b) The system may not be appropriate for the client.
c) The client has appropriate procedures for selecting new IT systems.
d) Data may be lost or corrupted.

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Analytic

52. Which of the following statements relating to application controls is correct?

a) They impact on the procedures used for data entry, data processing and output.
b) They include procedures for purchasing new computers.
c) They are not designed to prevent or detect a material misstatement in the financial
statements.
d) They include the use of passwords and other security measures to minimize the risk of
unauthorized access.

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Analytic

53. Auditors can assess the adequacy of their client's closing procedures by

a) checking the accuracy of accrual calculations around year-end.

b) looking at earnings trends to assess whether reported income is in line with similar periods in
prior years.
c) both a and b
d) none of the above

Answer: c

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain how client closing procedures can affect reported results.
Section Reference: 3.8 Closing procedures
CPA Competency: Auditing and Assurance
AACSB: Analytic

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 Audit Planning l 3 - 21

54. If auditors believe there is a risk that expenses incurred before year-end will be excluded
from the current year's expenses, they will

a) send out confirmation requests to a sample of the client's debtors.

b) trace transactions recorded close to year-end to source documentation.
c) perform analytical review analysis on the client's statement of financial position.
d) none of the above

Answer: b

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain how client closing procedures can affect reported results.
Section Reference: 3.8 Closing procedures
CPA Competency: Auditing and Assurance
AACSB: Analytic

55. The auditor is concerned about the audit client's closing procedures to ensure

a) transactions and events have been recorded in the correct accounting period.
b) closing procedures have been correctly applied.
c) the financial statements accurately reflect the results of the audit client’s closing procedures.
d) all of the above

Answer: d

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain how client closing procedures can affect reported results.
Section Reference: 3.8 Closing procedures
CPA Competency: Auditing and Assurance
AACSB: Analytic

56. In order to report strong results, an audit client may

a) include revenue earned in the next income year in the current year’s income.
b) bring forward expenses to the current income year.
c) defer revenue earned in the current year to the next income year.
d) omit closing procedures.

Answer: a

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain how client closing procedures can affect reported results.
Section Reference: 3.8 Closing procedures
CPA Competency: Auditing and Assurance
AACSB: Analytic

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 22

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 Audit Planning l 3 - 23

SHORT ANSWER QUESTIONS

57. Explain the three main phases of an audit of financial statements.

Answer: The main phases of an audit are the risk assessment phase, the risk response phase,
and the reporting phase. The risk assessment phase involves gaining an understanding of the
client, identifying factors that may impact the risk of a material misstatement in the financial
statements, performing a risk and materiality assessment and developing an audit strategy.
The risk of a material misstatement is the risk that the financial statements include a significant
error or fraud. The risk response phase (or performing) of the audit involves the performance of
detailed tests of controls and substantive testing of transactions and accounts. The reporting
phase involves evaluating the results of the detailed testing in light of the auditor's
understanding of their client and forming an opinion on the fair presentation of the client's
financial statements.

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

58. Why must auditors gain an understanding of their client at the start of every audit?

Answer: The purpose of auditors gaining an understanding of their client is to assess the risk
that the financial statements contain a material misstatement due to: the nature of the client's
business, the industry in which the client operates, the level of competition within that industry,
the client's customers and suppliers, and the regulatory environment in which the client
operates.

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Section Reference: 3.2 Gaining an understanding of the client
CPA Competency: Auditing and Assurance
AACSB: Analytic

59. Indicate whether you agree or disagree with the following statements and explain your
reasoning.

a) Related party transactions require proper identification and consideration when considering
risk. However, there is no requirement to disclose related party transactions unless they
have an impact on material misstatements.

b) When assessing fraud risk, auditors should adopt an attitude of professional scepticism to
ensure that any indicator of a potential fraud is properly investigated.

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 24

c) The responsibility for preventing and detecting fraud rests with those charged with
governance at the client as well as the auditors.

d) The auditor should not ask management and those charged with governance if they are
aware of a known fraud or suspect there has been fraud.

e) Elvie Lee explained to her friend how application controls work: “Application controls are
designed to prevent and detect a material misstatement in the financial statements.”

Answer:
a) Disagree. It is the responsibility of the auditor to ensure that related parties are identified
and appropriately disclosed, in line with relevant accounting standards.
According to the CPA Handbook, related parties include parent companies, subsidiaries,
joint ventures, associates, company management and close family members of key
management. Since related parties are not independent of each other, these transactions
may not be in the normal course of business. This not only increases the susceptibility of
the financial statements to material misstatement due to fraud and error, it may also impact
the overall financial statement results. Therefore, financial statement users need sufficient
information to assess the impact of these transactions on the financial statements overall.

b) Agree. Adopting an attitude of professional scepticism implies that auditors must remain
independent of their client, maintain a questioning attitude and search thoroughly for
corroborating evidence to validate information provided by the client. Auditors must not
assume that their past experience with client management and staff is indicative of the
current risk of fraud.

c) Disagree. The responsibility for preventing and detecting fraud rests with those charged
with governance at the client.
It is the responsibility of the auditor to assess the risk of fraud and the effectiveness of the
client's attempts to prevent and detect fraud through their internal control system.

d) Disagree. The auditor should ask management and those charged with governance these
key questions. If the company being audited has an internal audit department, the internal
auditors should also be asked this question. The results of these enquiries should be
documented.

e) Agree. These controls are designed to prevent and/or detect a material misstatement in the
financial statements by ensuring all transactions are recorded only once and rejected
transactions are identified and corrected. Application controls impact on the procedures
used for data entry, data processing and output or reporting. They include reconciliations
between input and output data and automated checks on data entered to ensure accuracy.

Bloomcode: Application
Difficulty: Medium
Learning Objective: Explain how related parties can impact risk.
Learning Objective: Evaluate fraud risk.
Learning Objective: Appraise corporate governance.
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.3 Related parties
Section Reference: 3.4 Fraud risk
Section Reference: 3.6 Corporate governance

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 Audit Planning l 3 - 25

Section Reference: 3.7 Information technology

CPA Competency: Auditing and Assurance
AACSB: Analytic

60. What is fraud and what are some of the red flags that can alert auditors to the possibility that
a fraud may have occurred?

Answer: Fraud is an intentional act to obtain an unjust or illegal advantage through the use of
deception. An auditor can use red flags to alert them to the possibility that a fraud may have
occurred. These red flags include: a high turnover of key employees, key finance personnel
refusing to take leave, overly dominant management, poor compensation practices, inadequate
training programs, a complex business structure, no (or ineffective) internal auditing staff, a high
turnover of auditors, unusual transactions, weak internal controls.

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

61. Bill Dodds was the accounts payable manager of Big Build Property Management Ltd. Bill
started with the company as a bookkeeper and worked up to his current management position.
He was promoted due to his dedication to the company and his reliability- he often worked
evenings and weekends, rarely called in sick and he never took holidays. Despite making a
good wage, Bill enjoyed living large, and the majority of his paycheque went to pay for his luxury
car and designer clothes. As Bill was living paycheque to paycheque he was disappointed he
did not have a “nest egg” set aside for retirement or emergency purposes.

Big Build Property Management had a history of profitability. To reward its employees, the
company had established a bonus scheme for meeting profit targets. It was a shock to all
employees when at the end of 2020, the company announced it had had the worst year in the
company’s history. The losses were significant and the company planned significant lay-offs in
an attempt to turn this situation around. As a result, the accounting department was reduced by
35%, and the remaining staff was asked to do more. Bill found not only was he managing an
unhappy accounts payable group, he was also now signing cheques, processing payables, and
reconciling the bank account. This meant Bill was required to work even more without any pay
increase or bonus in sight. For the first time in his career at Big Build, Bill was unhappy. While
he was fearful further lay-offs may be coming, he also felt unappreciated and after all of his hard
work, he was unhappy he was being asked to do more.

Required:
Discuss the incentives, opportunities and rationalizations to commit fraud in this case.

Answers:
Incentives and Pressures — While few employees would take the opportunity to commit fraud,
adding an element of pressure could sway an honest worker. Pressure may come from the
individual’s personal life. In this case, the following incentives / pressures exist:
• Management has a focus on the need to reach target profits.

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 26

• There are falling profits at the company.

• Bill also lives paycheque to paycheque and likes to live large. With the fear of losing his job, he
may feel pressure to commit fraud to maintain his standard of living.

Opportunity — This is where the client has an opportunity to perpetrate a fraud due to weak or
non-existent internal controls.
• Bill rarely called in sick, and never took holidays. This makes it easier to cover up any fraud
that could be taking place.
• Lack of segregation of duties. Bill now processes accounts payable, signs cheques, and
performs the bank reconciliation. As a result he can make fraudulent payments to himself and
cover them up.
• With fewer staff now in place to perform the work required, there is likely less focus on internal
controls and more focus on getting the job done. Again there is evidence of this with the lack of
segregation of duties in the accounting department. This would make it easier to commit fraud
and cover it up.

Rationalization — This is when fraudsters justify their actions to themselves. In this case as Bill
is being asked to do more for the same remuneration, he has an attitude of ‘I deserve more
money’ and “they owe it to me”

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Evaluate fraud risk.
Section Reference: 3.4 Fraud risk
CPA Competency: Auditing and Assurance
AACSB: Analytic

62. What should auditors do if there are risk factors that indicate that the going concern
assumption is at risk?

Answer: If the auditor identifies risk factors that indicate that the going concern assumption is in
doubt, they will undertake procedures to gather evidence regarding each risk factor.
For example, if a client has lost a number of key, long-standing personnel, an auditor may
assess the quality of the remaining staff and the likelihood that the client will be able to hire
suitable replacements in the near future. If the auditor believes there is an unresolved going
concern issue outstanding, an assessment is made of the appropriateness of management
disclosures in the notes to the financial statements regarding that issue. An auditor will assess
the process used by management to evaluate the extent of the going concern risk. If a company
has a history of losses and difficulties, an auditor will expect management to take a great deal of
time and care in their going concern assessment. Once the auditor has an understanding of the
process used by management, which may include the careful preparation of detailed cash flow
projections and budgets, they will assess the adequacy of that process and conduct additional
procedures if necessary.

Bloomcode: Application
Difficulty: Medium
Learning Objective: Explain the going concern assumption.
Section Reference: 3.5 Going concern
CPA Competency: Auditing and Assurance
AACSB: Analytic

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 Audit Planning l 3 - 27

ESSAY QUESTIONS

63. CAS 300 Planning an Audit of Financial Statements requires that auditors plan their audits.
Why is planning such an important stage of every audit and explain the various aspects of the
preliminary risk identification process?

Answer: Answers may vary.

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Identify the different phases of an audit.
Section Reference: 3.1 Phases of an audit
CPA Competency: Auditing and Assurance
AACSB: Analytic

64. When gaining an understanding of their clients, auditors consider the particular information
technology risks faced by their clients. Explain the particular risks associated with information
technology and discuss the main controls that companies can have in place to mitigate these
risks.

Answer: Answers may vary.

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.
Section Reference: 3.2 Gaining an understanding of the client
Section Reference: 3.7 Information technology
CPA Competency: Auditing and Assurance
AACSB: Analytic

65. Corporate governance is the rules, systems and processes within companies used to guide
and control them. Why are auditors concerned with the corporate governance structures of their
clients and what is the current status of corporate governance regulation in Canada?

Answer: Answers may vary.

Bloomcode: Comprehension
Difficulty: Medium
Learning Objective: Appraise corporate governance.
Section Reference: 3.6 Corporate governance
CPA Competency: Auditing and Assurance
AACSB: Analytic

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 28

CASE QUESTION

66. Last year the review of Lethbridge Broadcasting did not go well for Bossy & Bossier CPAs.
In an attempt to meet budget, Mike Bossy, the auditor-in-charge, left out the review of closing
procedures. His Group Partner’s review notes were professional but his annual review
commentary was not as complimentary. Mike was not convinced that he was at fault and felt
that according to his firm’s mandate, as spelled out in the engagement letter, it was the client’s
responsibility to ensure the adequacy of closing procedures.

This year the firm will be starting the audit of a new broadcasting client and the partner is
planning the risk assessment procedures. His partner’s review note reads: “Ensure that Mike
Bossy gains a detailed knowledge of the Quebecor Media broadcasting operations at the entity
level.”

Required:
a) Comment on the partner’s Lethbridge Broadcasting concerns and explain how the closing
process is supposed to work.
b) Discuss the entity-level audit procedures Mike will have to follow in order to gain an
understanding of Quebecor Media operations and why the entity-level procedures you
identify are important.

Answer:
a) Although the closing procedures are the responsibility of the client, the auditor has a
responsibility to ensure that material misstatements do not occur. Reviewing closing
procedures is important because from an audit perspective there is a risk that the client's
closing procedures are inadequate.

Discussion on Mike Bossy’s and his firm’s responsibilities:

(i) Auditors are concerned that transactions and events have been recorded in the correct
accounting period. Although this is the responsibility of those charged with governance,
it is the responsibility of the auditors to ensure that their client has applied its closing
procedures appropriately.
(ii) If an auditor determines that the client's closing procedures are weak, an auditor will
plan on spending more time conducting detailed testing around year-end.
(iii) There are a number of ways that Mike Bossy can assess the adequacy of the client's
closing procedures.
- checking the accuracy of accrual calculations around year-end.
- look at earnings trends to assess whether the reported income is in line with similar
periods in prior years.
- trace transactions recorded close to year-end to source documentation and confirm
that all transactions are recorded in the appropriate accounting period.

b) Knowledge about the entity is gained through interviews with client personnel, including
those charged with governance. Mike Bossy will ask questions about what the client does,
how the client functions, the ownership structure of the client and its sources of financing.

Procedures to gain understanding of client:

Major customers are identified so that the auditor may consider whether those customers
have a good reputation, are on good terms with the client (that is, likely to remain a

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 Audit Planning l 3 - 29

customer in future) and are likely to pay the client on a timely basis. Dissatisfied customers
may withhold payment, which affects the allowance for doubtful accounts and the client's
cash flow, or decide not to purchase from the client in the future, which can affect the going
concern assumption. If a client has only one or a few customers, this risk is increased. The
auditor also considers the terms of any long-term contracts between their client and their
client's customers.

Major suppliers are identified to determine whether they are reputable and supply quality
goods on a timely basis and payment on a timely basis. If the client is having trouble paying
its suppliers, it may have trouble sourcing goods as suppliers may refuse to transact with a
company that does not pay on time.

The client's capacity to adapt to changes in technology and other trends is assessed. If the
client is not well positioned to adjust to such changes, it risks falling behind competitors and
losing market share, which in the longer term can affect the going concern assumption.
The nature of any warranties provided to customers is assessed. If the client provides
warranties on products sold, the auditor needs to assess the likelihood that goods will be
returned and the risk the client has underprovided for that rate of return (adequacy of the
warranty provision).

The terms of discounts given by the client to its customers and received by the client from
its suppliers are reviewed. An assessment is made of the client's bargaining power with its
customers and suppliers to determine whether discounting policies are putting profit
margins at risk, which may place the future viability of the client at risk.
An assessment is made of the client's reputation with its customers, suppliers, employees,
shareholders and the wider community. A company with a poor reputation places future
profits at risk. It is also not in the best interests of the auditor to be associated with a client
that has a poor reputation.

An understanding is gained of client operations. The auditor will note where the client
operates, the number of locations it operates in and the dispersion of these locations. The
more spread out the client's operations are, the harder it is for the client to effectively
control and coordinate its operations, increasing the risk of errors in the financial
statements. The auditor will need to visit locations where the risk of material misstatement
is greatest to assess the processes and procedures at each site. If the client has operations
interstate or overseas, the auditor may plan for a visit to those sites by staff from affiliated
offices at those locations where risk is greatest. For example, an auditor is more likely to
visit client operations if the client opens a new, large site, or if the business is located in a
country where there is a high rate of inflation or where there is a high risk of theft.

An understanding is gained of the nature of employment contracts and the client's relations
with its employees. The auditor will consider how a client pays its employees, the mix of
wages and bonuses, the level of unionization among the workforce and the attitude of staff
to their employer. The more complex a payroll system, the more likely that errors can occur.
When staff are unhappy, there is greater risk of industrial action, such as strikes, which
disrupt client operations.

The client's sources of financing are reviewed. An assessment is made of a client's debt
sources, the reliability of future sources of financing, the structure of debt and the reliance
on debt versus equity financing. An auditor assesses whether their client is meeting interest
payments on funds borrowed and repaying funds raised when they are due. If the client

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 Auditing: A Practical Approach, Third Canadian Edition
3 - 30

does not meet the conditions of a debt covenant, the borrower may recall the debt, placing
the client's liquidity position at risk, and increasing the risk that the client may not be able to
continue as a going concern.

The client's ownership structure is assessed. The auditor is interested in the amount of debt
funding relative to equity, the use of different forms of shares and the differing rights of
shareholder groups. The client's dividend policy and its ability to meet dividend payments
out of operating cash flow are also of interest.

Bloomcode: Application
Difficulty: Medium
Learning Objective: Explain the process used in gaining an understanding of the client.
Learning Objective: Explain how client closing procedures can affect reported results.
Section Reference: 3.2 Gaining an understanding of the client
Section Reference 3.8 Closing procedures
CPA Competency: Auditing and Assurance
AACSB: Analytic

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 Audit Planning l 3 - 31

LEGAL NOTICE

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