INTEGRATED ASSESSMENT AUDITING THEORY & PROBLEMS
Overview of Financial Audit and Substantive Audit of Inventories
1. Analytical procedures used in planning and audit should focus on identifying:
a. Material weakness in the internal control system This is tested by understanding and
testing controls.
b. Areas that may represent specific risks relevant to the audit
In planning, auditors use analytical procedures to highlight unusual trends or unexpected
relationships. This helps them identify areas that could pose audit risks (possible
misstatements).
c. The predictability of financial data from individual transactions This is part of
evaluating reasonableness, not the main planning focus.
d. The various assertions that are embodied in the financial statements
Assertions in financial statements → Assertions are always relevant, but the focus in
planning is risk identification, not listing assertions.
2. The auditor identifies a misstatement that is material but not pervasive, and management
refuses to adjust the financial statements. What type of audit opinion should be issued?
a. Qualified opinion describing the nature and impact of the misstatement
If a misstatement is material but not pervasive, the auditor issues a qualified opinion
(“except for”).
b. Unmodified opinion with an emphasis-of-matter paragraph
Wrong, because a material misstatement requires qualification, not just
emphasis. c. Adverse opinion due to the refusal to adjust Only if the
misstatement is pervasive.
d. Qualified opinion with an emphasis-of-matter paragraph
Redundant, emphasis is unnecessary if the misstatement already modifies the opinion.
3. Which of the following is not part of the fundamental principles a CPA should observe?
a. Integrity c. Confidentiality
b. Professional Competence and due care d. Professional standards
CPAs follow ethical principles such as integrity, objectivity, confidentiality, and
professional competence. “Professional standards” are rules to follow, not ethical
principles.
4. I. This permits the provision of an opinion without being affected by influences that
compromise professional judgment, allowing an individual to act with integrity, and exercise
objectivity and professional skepticism.
II. The avoidance of facts and circumstances that are so significant that a reasonable and
informed third party, having knowledge of all relevant information.
a. 1st statement refers to independence in appearance
b. 2nd statement refers to independence of mind
c. A and B is correct
d. None of the choices are correct
Independence of mind = ability to act with integrity, objectivity, and skepticism.
Independence in appearance = avoiding situations that may make third parties doubt
independence.
5. When internal controls are determined to be well-designed but not effectively implemented,
how should this influence the audit strategy?
a. Increase control risk assessment and place greater emphasis on substantive
procedures
If controls are not working in practice, auditors cannot rely on them → they must assume
higher control risk and perform more substantive testing.
b. Continue with a controls-based approach but reduce test sample sizes Wrong,
because controls aren’t effective.
c. Reduce planned substantive testing and rely on internal controls Wrong, must
increase instead.
d. Rely on prior year testing results if no major system changes occurred Not
acceptable; the auditor must test current effectiveness.
6. Which of the following procedures would most effectively test the valuation assertion for
inventory?
a. Recalculate the total inventory balance from physical count sheets Tests
accuracy, not valuation of unit costs. b. Monitoring of usage of programs Not
directly related to valuation.
c. Inspect invoices for recent purchases and review cost buildup
Valuation deals with whether inventory is recorded at the proper cost or NRV. Checking
supplier invoices ensures costs recorded are accurate. d. Observe inventory counts
Tests existence/completeness, not valuation.
7. This threat to independence arises when a member of the assurance team promotes or may
be perceived to promote an assurance client’s position or opinion to the point that objectivity
may, or may be perceived to be compromised.
a. Familiarity Threat too close to the client. b. Advocacy Threat Acting as
client’s advocate. c. Intimidation Threat pressured by a client.
d. Self-interest Threat auditor’s
personal gain.
8. Which of the following best reflects an auditor’s exercise of professional skepticism?
a. Maintaining a questioning mindset and seeking corroborative evidence
b. Limiting evidence collection when assertions appear reasonable
c. Accepting management’s explanations if consistent with prior periods
d. Automatically doubting all representations made by management
Balanced skepticism.
❌ b. Limiting evidence → careless.
❌ c. Accepting past explanations → over-trusting.
❌ d. Automatically doubting → cynicism, not skepticism.
9. The auditor assesses control risk as low based on the results of tests of controls. What is the
impact on the auditor’s planned substantive procedures? a. Substantive procedures must be
increased
b. Substantive procedures must be replaced with walkthroughs
c. The auditor can reduce the extent of substantive procedures
d. Choices B and C are correct
Reduce substantive testing → Rely more on strong controls.
❌ a. Increase substantive testing → opposite.
❌ b. Replace with walkthroughs → insufficient.
❌ d. B & C → B is wrong.
10. Which of the following is least likely to be considered a factor when assessing inherent risk?
a. Nature of the client’s industry c. Management’s integrity
b. Strength of internal controls d. Complexity of transactions
b. Strength of internal controls → That’s control risk, not inherent risk.
❌ a. Industry → relevant.
❌ c. Management integrity → relevant.
❌ d. Complexity → relevant.
11. Which of the following best describes the relationship between detection risk and
substantive testing?
a. Higher detection risk leads the auditor to increase substantive testing to reduce overall audit
risk
b. Lower detection risk allows the auditor to rely entirely on analytical procedures
c. When detection risk is high, auditors decrease substantive testing and focus on controls
d. If detection risk increases, the auditor must accept a higher level of audit risk
High detection risk = less substantive testing → Auditor accepts higher risk, tests less.
❌ a. High detection risk = more testing → wrong.
❌ b. Low detection risk → still need more than just analytics.
❌ d. Higher detection risk = higher audit risk → not required.
12. Which of the following best explains why the auditor uses a risk-based approach to auditing?
a. To satisfy regulatory requirements imposed by standards
b. To focus more effort on high-volume transactions
c. To eliminate the need for substantive testing in low-risk areas
d. To improve audit efficiency by prioritizing areas with higher likelihood of material
misstatements Focus resources effectively.
a. Satisfy regulations → partial but not main reason.
b. High-volume transactions → not always risky.
c. Eliminate testing in low risk → wrong.
13. Which of the following scenarios most likely indicates a significant deficiency in internal
control?
a. Sales invoices are matched to shipping documents before recording.
b. Management overrides approval controls for significant journal entries.
c. Purchase orders are sequentially numbered and filed electronically.
d. The CFO reviews bank reconciliations quarterly instead of monthly. Management overrides
approvals → Big red flag.
❌ a. Matching invoices to shipping docs → proper control.
❌ c. Sequential POs → good control.
❌ d. CFO reviews quarterly instead of monthly → weak but not “significant.”
14. When evaluating the sufficiency and appropriateness of audit evidence, which of the
following is most relevant?
a. Whether the evidence was obtained from the client’s internal files
b. Whether the evidence supports management’s opinion
c. The objectivity and source of the evidence
d. The total number of items tested
Objectivity & source → External, independent = most reliable.
❌ a. From client files → less reliable.
❌ b. Supports management opinion → biased.
❌ d. Quantity of tests → quality matters more.
15. Which of the following would be the most persuasive audit evidence of the valuation of
inventory?
a. Observation of inventory counts at year-end
b. Confirmation of inventory quantities from third-party warehouses
c. Inventory aging report prepared by the warehouse supervisor
d. Recalculation of unit costs using supplier invoices and costing records Direct test of cost.
❌ a. Observation → existence only.
❌ b. Confirmation of quantities → existence.
❌ c. Aging report → prepared by client, less reliable.
16. Which of the following best illustrates a control designed to prevent, rather than detect,
material misstatements?
a. Review of bank reconciliations by a supervisor
b. Sequential numbering of purchase orders and access restrictions
c. Surprise audits by internal auditors
d. Post-year-end analytical review of income and expenses Prevent errors before they occur.
❌ a. Review reconciliations → detective.
❌ c. Surprise audits → detective.
❌ d. Post-year-end review → detective.
17. Which of the following audit risks is most directly related to transactions involving complex
estimates?
a. Detection risk c. Control risk
b. Sampling risk d. Inherent risk Natural susceptibility to error.
❌ a. Detection risk → about testing.
❌ b. Sampling risk → about sample.
❌ c. Control risk → about internal controls.
18. I. Evaluating going concern includes assessing both quantitative indicators (e.g., working
capital ratios) and qualitative indicators (e.g., litigation risk or reputational damage).
II. An increase in detection risk leads the auditor to increase the nature, timing, and
extent of substantive testing.
III. All related party transactions are considered material and must be disclosed. a.
Only statements I and III are correct c. Only statements I and II are correct
b. Only statement I is correct d. All statements are correct
I & III → Quant + qual indicators true; all related parties material true.
❌ II is wrong → ↑ detection risk = ↓ substantive testing, not increase.
19. An auditor finds items in the warehouse marked "do not ship." Which assertion is most likely
at risk?
a. Rights and obligations c. Completeness
b. Existence d. Valuation
May be obsolete/damaged, affecting valuation.
❌ a. Rights → ownership not at issue.
❌ b. Existence → items exist.
❌ c. Completeness → items are recorded.
20. When testing inventory obsolescence, which audit procedure is most appropriate?
a. Observe physical count c. Analyze inventory turnover ratios
b. Examine purchase orders d. Confirm inventory quantities with suppliers
Analyze turnover ratios → Detect slow/obsolete stock.
❌ a. Physical count → existence only.
❌ b. Purchase orders → not relevant. ❌
d. Confirm quantities → existence.
21. All of the following statements are correct, except?
a. Tracing receiving reports to the inventory ledger is a test of the completeness assertion.
b. High current ratios combined with falling inventory turnover may indicate inflated inventory
balances.
c. The inclusion of FOB destination goods in year-end inventory before legal title has passed
would result in an overstatement of inventory.
d. When a client uses estimation models for inventory measurement, observing physical counts
becomes the primary audit procedure.
Wrong, still need more than just observation.
❌ a. Tracing receiving → completeness.
❌ b. Current ratio + falling turnover → possible inflation.
❌ c. FOB destination goods included → overstatement.
22. Which of the following most directly tests the completeness assertion in inventories?
a. Vouching from ledger to physical inventory
b. Reviewing aging schedule
c. Tracing receiving reports to inventory ledger
d. Confirming inventory with customers
Ensures all received goods recorded.
❌ a. Vouch ledger to physical → tests existence.
❌ b. Aging schedule → valuation.
❌ d. Confirm with customers → existence.
23. Which of the following procedures provides evidence for both existence and valuation of
inventory?
a. Observation of physical count
b. Confirmation with suppliers
c. Test of internal controls over procurement
d. Recalculation of inventory prices
Confirms items exist and are in usable condition.
❌ b. Supplier confirmations → ownership, not valuation.
❌ c. Internal control test → indirect.
❌ d. Recalculation → valuation only.
24. The following statements are incorrect, except?
a. Inventory recorded on the books but stored at a third-party location must always be
excluded from inventory balances.
b. Inventory transactions are typically low-risk and can be sufficiently audited using only
analytical procedures.
c. When inventory is held as collateral for a loan, the auditor must consider whether
additional disclosure is needed in the financial statements.
d. The auditor is required to perform a physical inventory count at every location where
inventory is stored.
True.
❌ a. Excluded if at 3rd party → wrong, can still be included if owned.
❌ b. Low risk → wrong, inventory = high risk.
❌ d. Count at every location → not always required.
25. An auditor is concerned about inventory held off-site by a third party. Which procedure
provides the strongest evidence?
a. Relying on last year’s audit findings
b. Reviewing internal reports
c. Obtaining a direct confirmation from the third party
d. Inspecting the inventory remotely
Most reliable.
❌ a. Prior year audit → not valid now.
❌ b. Internal reports → biased.
❌ d. Remote inspection → less persuasive.
26. The auditor notes that purchase invoices were recorded in the period after year-end, but the
related inventory was received before year-end. This indicates a risk of: a. Inventory
overstatement and cut-off error
b. Understated purchases and liabilities
c. Classification error in inventory
d. Overstated revenue
Expenses/liabilities cut off wrongly.
❌ a. Overstatement inventory → wrong, goods already included.
❌ c. Classification error → not main issue.
❌ d. Revenue → not affected.
27. During observation of inventory count, the auditor notes that obsolete inventory is stored
together with salable inventory and not separately identified. What is the implication? a.
Inventory is understated
b. Completeness of inventory is compromised
c. Risk of inclusion of obsolete inventory in the final inventory valuation
d. Physical controls are strong
May overstate inventory.
❌ a. Understatement → opposite.
❌ b. Completeness compromised → not about completeness. ❌
d. Physical controls strong → false.
28. The auditor finds that the client included goods shipped to the FOB destination in inventory,
but they were already in transit to the customer. What is the implication?
a. Inventory is overstated; violates cutoff and rights assertions
b. Inventory is understated; cost of goods sold is understated
c. Inventory is overstated; revenue is understated
d. Only two choices are correct
. Inventory overstated; cutoff & rights violated → Title not yet passed.
❌ b. Inventory understated → opposite.
❌ c. Revenue understated → irrelevant.
❌ d. Only two correct → no, just A correct.
29. I. Inventory held in a politically unstable country raises significant concerns about the
existence of the inventory.
II. If inventory is physically present but has not moved in several years, the auditor should
consider a possible write-down due to impairment.
III. If the client applies selling costs to inventory valuation, the inventory might be
overstated. a. All statements are true
b. Only statement II is true
c. Only statements I is true
d. Only statement II and II are true
30. Which audit evidence would be least persuasive in verifying the ownership of inventory? a.
Bill of lading
b. Management representation letter
c. Vendor invoice
d. Title documentation Weakest form of evidence. a. Bill of lading → strong.
c. Vendor invoice → strong
d. Title docs → strong.
31. Which of the following would be a red flag for inventory fraud??
a. Increase in sales returns
b. Consistent gross profit margin
c. Rising inventory levels without corresponding increase in sales
d. Excessive credits to inventory accounts
Indicates inflation.
❌ a. Sales returns → can happen but not always fraud. ❌
b. Consistent margins → not suspicious.
❌ d. Excessive credits → unusual but not main fraud signal.
32. When evaluating whether inventory is properly classified, the auditor is primarily concerned
with?
a. The method of physical count
b. Whether inventory is current or non-current
c. The stage of completion
d. The net realizable value
Classification relates to balance sheet placement.
❌ a. Physical count method → irrelevant.
❌ c. Stage of completion → valuation, not classification.
❌ d. NRV → valuation, not classification.
33. An entity has significant inventory held for long periods. Which audit risk is most
heightened?
a. Overstatement due to obsolescence
b. Inventory cut-off error
c. Completeness of disclosure
d. Inventory cut-off error
Main risk = too high valuation.
❌ b. Cutoff error → unrelated.
❌ c. Disclosure completeness → not main.
❌ d. Cutoff repeated → still wrong.
34. When testing the completeness of inventory, the auditor would:
a. Start from the inventory ledger and trace to physical count
b. Examine purchase requisitions
c. Review the aged inventory report
d. Start from physical items and trace to inventory records
Ensures all existing items recorded.
❌ a. Ledger to count → tests existence.
❌ b. Requisitions → not relevant.
❌ c. Aged report → valuation.
35. During testing of inventory valuation, an auditor notices that management capitalized costs
that appear to be selling expenses. Which assertion is most at risk and what should the auditor
do?
a. Completeness: extend inventory testing
b. Rights and obligations: obtain legal representation
c. Completeness: extend inventory testing
d. Valuation: analyze the composition of inventory costs and propose reclassification
Inventory overstated.
❌ a. Completeness → not issue.
❌ b. Rights → irrelevant.
❌ c. Completeness again → still wrong.
36. A client experienced a fire after year-end, destroying a significant portion of inventory.
Management did not disclose this. What is the auditor's responsibility? a.
Disclose in the audit report as a going concern issue
b. Require a subsequent events disclosure
c. Adjust inventory valuation to reflect the loss
d. All of the above
Fire after year-end = Type II event → disclose, not adjust.
❌ a. Going concern → not necessarily.
❌ c. Adjust valuation → wrong, happened after year-end.
❌ d. All of above → not all apply.
Problem Solving: Please refer to the problem below for questions 37-40.
Clear Care Corporation, a beauty product wholesaler operates under a perpetual inventory
system, with FIFO method used to assign costs to its inventory items. The entity implored the
services of Predictions Audit Firm for an interim audit, and the following information related to
their two products: Facial Wash and Facial Toner were noted:
Description Facial Wash Facial Toner
Inventory – June 1 25,000 tubes @ P20.60 52,500 tubes @ P28.40
Purchases Jun. 10:10,000 tubes (P20.50/tube)
Jun.19: 37,000 tubes (P10.70/tube)
Terms: 2/10, n/30, FOB destination
Jun.13:5,000 tubes(P28.45/tube)
Jun.15:10,000tubes(P28.45tube)
Jun. 29: 12,000 tubes (P29.00)
n/30, FOB destination
June sale 63,000 tubes @ P29.50 55,000 tubes @ P30.00
Returns and
allowances
4,000 tubes erroneously shipped As June 15 purchase was
unloaded, 2,000 tubes were
damaged. A credit of P28,450
was received by Customer B.
Physical count June 30 11,600 tubes 9,700 tubes
Explanation of
variance
Assumed stolen
Assumed stolen
NRV – June 30 P19.00/tube P30.50/tube
37. How much is the adjusted inventory at cost of Facial Toner as of June 30, 2025? ₱275,925
38. How much is the adjusted inventory at cost of Facial Wash as of June 30, 2025? ₱124, 120
39. Is there any shortage/overage? How much? ₱1,400 & ₱800
40. How much is the total inventory reportable in the interim statement of Financial Position?
₱400,085
