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Model Exit Exam - Audit principle and Practice I.docx
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Below is a detailed explanation of the answers to the multiple-choice questions from the Model

Exit Exam - Audit Principle and Practice I.

Detailed Explanations and Answers

1. __________ is a systematic examination of the books and records or a business.

● A. Auditing ✅
● Explanation: Auditing is the systematic examination of financial records to ensure their
accuracy and compliance with laws.

2. Which of the following is not a kind of audit?

● D. None of these ✅
● Explanation: All the options listed (statutory, private, government, continuous, final,
interim, cash, cost, and management audit) are types of audits.

3. An audit which is compulsory by the law is called __________.

● D. Statutory audit ✅
● Explanation: Statutory audit is mandated by law for certain businesses, especially
companies.

4. Audit done by the employees of the business undertaking is called _______.

 ● B. Management audit ✅
● Explanation: Management audits are conducted internally to assess operational
efficiency.

5. Management audit is otherwise called _______.

● B. Efficiency audit ✅
● Explanation: Management audit evaluates how efficiently and effectively management is
operating.

6. A number of checks and controls exercised in a business to ensure its efficient

working are known as ________.

● B. Internal control ✅
● Explanation: Internal control includes processes to ensure operational effectiveness and
compliance.

7. Internal auditor is appointed by ________.

● A. The management ✅
● Explanation: Internal auditors are appointed by the company’s management to review
internal processes.

8. A kind of audit conducted for a part of the accounting year is called _______.

● D. Interim audit ✅
● Explanation: Interim audits are conducted before the final audit to review financial
records.

9. Audit means ___________.

● C. Examination of books, accounts, vouchers etc. ✅

● Explanation: Audit involves inspecting financial records to ensure their accuracy.

10. Audit programme is prepared ____________.

● A. To help the auditor and his staff about the work to be done while auditing. ✅
● Explanation: An audit program guides the auditor on audit procedures.
11. Auditor shall report on the accounts examined by him __________.

● A. To the shareholders ✅
● Explanation: An auditor's report is addressed to shareholders, ensuring transparency.

12. When a transaction has not been recorded in the books of account either wholly or
partially, such errors are called _________.

● B. Error of omission ✅
● Explanation: Errors of omission occur when transactions are not recorded.

13. Verification of the value of assets, liabilities, the balance of reserves, provision, and
the amount of profit or loss suffered by a firm is called _________.

● B. Balance sheet audit ✅

● Explanation: Balance sheet audit ensures the accuracy of assets and liabilities.

14. A sale of Rs. 50,000 to Mr. A was entered as a sale to Mr. B. This is an example of:

● B. Error of commission ✅
● Explanation: This type of error occurs when an entry is made in the wrong account.

15. Recording a transaction twice in the books of original entry is an error of __________.

● C. Duplication ✅
● Explanation: Duplication errors occur when transactions are recorded more than once.

16. Errors and frauds already committed can be discovered under the system of
________.

● D. All of the above ✅

● Explanation: Internal audit, internal check, and internal control all help in detecting fraud.

17. Goods sent on an approval basis have been recorded as credit sales. This is an
example of:

● A. Error of principle ✅
● Explanation: This is an error because revenue should not be recognized before
acceptance.
18. Errors of principle are due to ___________.

● B. Wrong allocation of expenditure between capital and revenue. ✅

● Explanation: This occurs when expenses are incorrectly categorized.

19. The auditor of a government company shall be appointed by ________.

● B. The central government ✅

● Explanation: The government appoints auditors for public sector enterprises.

20. An auditor of a company will be held liable under the Companies Act if _________.

● A. He destroys, mutilates, or hides documents to deceive. ✅

● Explanation: This is considered fraud and is punishable by law.

21. The main object of the audit of the cash book is ________.

● B. To know that all receipts and payments have been properly recorded. ✅
● Explanation: The cash book audit ensures completeness of transactions.

22. A good audit report must at least meet one of the following qualifications __________.

● A. It should offer constructive and timely suggestions to management. ✅

● Explanation: An audit report should be useful to management.

23. Verification is __________.

● C. The act of establishing the accuracy of entries in the books of accounts. ✅

● Explanation: Verification ensures accuracy in accounting records.

24. The main objective of investigation is _________.

● D. All of the above ✅

● Explanation: Investigation may be conducted for fraud detection, prevention, and
verification.

25. Internal controls and internal checks are ____________.

● C. Internal control includes internal check. ✅

 ● Explanation: Internal check is a part of a broader internal control system.

26. The liabilities of an auditor can be _________.

● C. Civil and Criminal ✅

● Explanation: Auditors can be held accountable for negligence and fraud.

27. Special audit is necessary for _________.

● A. Inefficient concern ✅
● Explanation: Special audits assess inefficiencies.

28. Audit of company accounts is _____________.

● A. Compulsory ✅
● Explanation: Companies are legally required to conduct audits.

29. The company’s auditor is expected to give _____________.

● B. A factual position about the accounts. ✅

● Explanation: The auditor provides a neutral and factual report.

30. A company auditor can be removed by _______________.

● D. General meeting ✅
● Explanation: Shareholders in a general meeting can remove an auditor.

These are detailed explanations for the first 30 questions. Would you like me to continue with

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Here are the detailed explanations and answers for the remaining questions:
31. Audit in depth means __________.
● C. Intensive audit of a few items. ✅
● Explanation: An in-depth audit involves a detailed examination of selected transactions.

32. The most difficult type of misstatement to detect is

fraud based on __________.
● D. Omission of a sales transaction from being recorded. ✅
● Explanation: Omission fraud is difficult to detect as there is no recorded evidence.

33. Balance sheet audit includes verification of ________.

● D. All of the above. ✅
● Explanation: A balance sheet audit involves verifying assets, liabilities, and
income/expenditure.

34. Which of the following statements is not true about

continuous audit?
● C. It is needed when the organization has a good internal control system. ✅
● Explanation: A strong internal control system reduces the need for continuous audit.

35. In determining the level of materiality for an audit, what

should not be considered?
● B. The auditor’s remuneration. ✅
● Explanation: Materiality is based on financial significance, not auditor compensation.

36. Analytical procedures used in the planning stage of an

audit generally ___________.
 ● D. All of the above. ✅
● Explanation: Analytical procedures help determine audit risk, detect anomalies, and
guide further audit work.

37. Of the following, which is the least persuasive type of

audit evidence?
● C. Carbon copies of sales invoices inspected by the auditor. ✅
● Explanation: Carbon copies are internal documents that may be manipulated.

38. Which of the following statements is generally correct

about the reliability of audit evidence?
● B. Effective internal control system provides reliable audit evidence. ✅
● Explanation: A strong internal control system enhances the reliability of records.

39. Audit Programme is prepared by ___________.

● D. The auditor and his audit assistants. ✅
● Explanation: The auditor and team prepare an audit program to ensure systematic
execution.

40. Which of the following best describes the primary

purpose of audit programme preparation?
● C. To gather sufficient appropriate evidence. ✅
● Explanation: The main goal of an audit program is to obtain sufficient and reliable
evidence.

41. The auditor has a right to _________.

● D. Both (B) and (C). ✅
● Explanation: The auditor has the right to obtain necessary information and explanations.
42. The part of Government Audit which is concerned with
examining whether the money has been spent for the
purpose specified in the Appropriation Act is called
_____________.
● D. Audit of financial propriety. ✅
● Explanation: This ensures that government funds are used appropriately.

43. Who is the custodian authority for audit working

papers?
● B. Auditor. ✅
● Explanation: The auditor retains audit working papers for reference and evidence.

44. The term “Audit” originated from the Latin word

________.
● A. Audire. ✅
● Explanation: "Audire" means "to hear" in Latin, referring to early practices of financial
checking.

45. Which of the following statements is correct?

● A. Valuation is a part of verification. ✅
● Explanation: Verification includes checking the accuracy of assets' values.

46. Examination of accounting records undertaken for a

special purpose is called __________.
● C. Investigation. ✅
● Explanation: Investigation audits are done for specific concerns like fraud detection.
47. Demand for audit involves all of the following except
one. Which one is it?
● E. None. ✅
● Explanation: All listed reasons (control mechanism, resolving conflicts, regulatory
requirements) justify the need for audits.

48. Which type of audit evaluates efficiency and

effectiveness?
● B. Operational Audit. ✅
● Explanation: Operational audits assess an organization's efficiency and effectiveness.

49. One of the following is a situation that impairs

independence.
● E. All. ✅
● Explanation: Auditor independence is compromised by financial interest, legal disputes,
gifts, and reliance on client fees.

50. __________ is a risk that occurs when an auditor fails to

detect misstatement and errors in a company’s financial
statements.
● B. Detection risk. ✅
● Explanation: Detection risk is the risk that an auditor will not find existing misstatements.

Chapter 1: Audit of Sales and Collection Cycle

Covers the process of auditing revenue transactions, sales, and accounts receivable.
Discusses fraud risks, internal controls, and audit procedures for detecting misstatements.
Chapter 2: Audit of Acquisition and Payment Cycle
Focuses on purchases, accounts payable, and related transactions.
Explains internal controls over procurement, risk assessment, and audit tests.
Chapter 3: Audit of Inventory and Warehousing Cycle
Discusses auditing inventory valuation, movement, and recording.
Explains fraud risks, stock counting procedures, and audit techniques.
Chapter 4: Audit of Payroll and Personnel Cycle
Covers auditing payroll transactions and related internal controls.
Discusses fraud risks, payroll testing, and verification of employee records.
Chapter 5: Audit of Capital Acquisition and Repayment Cycle
Examines long-term liabilities, equity transactions, and financing activities.
Explains procedures for auditing loans, bonds, and dividend payments.
Chapter 6: Audit of Cash and Financial Instruments
Focuses on cash management, bank reconciliations, and cash fraud risks.
Discusses financial instruments and audit procedures for investments.
Chapter 7: Completing the Audit and Issuing the Report
Covers final audit steps, including analytical procedures and review of financial statements.
Explains the auditor’s report, types of opinions, and post-audit activities.
Chapter 1: Audit of Sales and Collection Cycle
Covers sales transactions, accounts receivable, and cash collections.
Focuses on internal controls over revenue recognition and fraud risks.
Key audit procedures:
Tracing sales invoices to financial statements.
Testing accounts receivable balances for accuracy.
Confirming customer balances through direct communication.
Assessing bad debt provisions and write-offs.
Chapter 2: Audit of Acquisition and Payment Cycle
Focuses on purchases, accounts payable, and cash disbursements.
Discusses fraud risks like fictitious vendors and overpayments.
Key audit procedures:
Verifying supplier invoices and approvals.
Tracing purchases to receiving reports and payments.
Reviewing expense recognition policies.
Testing accounts payable cutoff to prevent understatement.
Chapter 3: Audit of Inventory and Warehousing Cycle
Covers inventory valuation, movement, and controls.
Explains risks like theft, obsolescence, and misstatements.
Key audit procedures:
Physical stock counts and reconciliations.
Testing inventory valuation methods (FIFO, LIFO, etc.).
Examining production and warehouse controls.
Checking obsolete/damaged inventory write-offs.
Chapter 4: Audit of Payroll and Personnel Cycle
Focuses on wages, salaries, employee benefits, and fraud risks.
Key fraud risks include ghost employees, unauthorized raises, and incorrect tax deductions.
Key audit procedures:
Reviewing payroll approvals and authorization.
Testing accuracy of salary payments and deductions.
Confirming payroll tax payments.
Verifying employee existence and job roles.
Chapter 5: Audit of Capital Acquisition and Repayment Cycle
Deals with loans, bonds, dividends, and shareholder transactions.
Ensures proper recording and disclosure of liabilities and capital.
Key audit procedures:
Verifying loan agreements and repayment schedules.
Checking interest expense calculations.
Reviewing compliance with loan covenants.
Examining share issuance and dividend payments.
Chapter 6: Audit of Cash and Financial Instruments
Covers cash management, bank reconciliations, and investments.
Discusses risks like cash theft, misstatements, and fraud.
Key audit procedures:
Reviewing bank statements and reconciliations.
Testing cash transactions and journal entries.
Confirming cash balances with banks.
Evaluating financial instrument valuation methods.
Chapter 7: Completing the Audit and Issuing the Report
Final review of audit evidence before issuing an audit opinion.
Covers types of audit reports:
Unqualified (clean) opinion – No material misstatements.
Qualified opinion – Some misstatements but not widespread.
Adverse opinion – Financial statements are misleading.
Disclaimer of opinion – Auditor lacks enough evidence.
Key audit steps:
Performing final analytical procedures.
Reviewing financial statement disclosures.
Assessing subsequent events and contingencies.
Conclusion
This module provides a structured approach to auditing different business cycles, ensuring
financial accuracy, fraud detection, and compliance. Auditors must apply proper procedures to
verify transactions, test controls, and issue reliable audit reports.

Chapter 1: Audit of Sales and Collection Cycle

Which of the following is the primary objective of auditing the sales and collection cycle?
a) To check inventory valuation
b) To verify accounts payable accuracy
c) To ensure revenue is properly recorded ✅
d) To detect payroll fraud
Explanation: The primary goal of auditing sales and collections is to confirm that revenue is
recognized correctly, in line with accounting standards.

Which document is most commonly used to confirm accounts receivable balances?

a) Invoice
b) Bank statement
c) Sales order
d) Customer confirmation letter ✅

Explanation: External confirmations from customers help auditors verify outstanding balances.

What is the main risk associated with revenue recognition?

a) Overstatement of expenses
b) Understatement of sales
c) Premature or fictitious revenue recognition ✅
d) Payroll misstatements

Explanation: Fraudulent revenue recognition can mislead stakeholders by inflating earnings.

Which of the following controls helps prevent fictitious sales?

a) Matching invoices with shipping documents ✅
b) Increasing sales targets
c) Delaying revenue recognition
d) Relying on verbal orders

Explanation: Matching invoices to shipping records ensures that revenue is recognized only for
actual sales.

What is the key assertion tested in accounts receivable confirmation?

a) Existence ✅
b) Rights and obligations
c) Completeness
d) Valuation

Explanation: Confirming receivables ensures that reported balances actually exist.

Chapter 2: Audit of Acquisition and Payment Cycle

Which document serves as the best evidence for verifying purchases?
a) Sales invoice
b) Receiving report ✅
c) Vendor listing
d) Customer order

Explanation: Receiving reports confirm that goods were actually received.

Which fraud risk is most common in the acquisition and payment cycle?
a) Overstatement of revenue
b) Creation of fictitious vendors ✅
c) Duplicate customer orders
d) Inventory shrinkage

Explanation: Fake vendors allow fraudsters to process unauthorized payments.

What assertion is tested when auditors verify completeness of accounts payable?

a) Occurrence
b) Rights and obligations
c) Completeness ✅
d) Classification

Explanation: Auditors ensure that all liabilities have been recorded.

Which control reduces the risk of duplicate payments?

a) Automated invoice matching ✅
b) Approving payments verbally
c) Relying on cash payments
d) Using handwritten records

Explanation: Automated matching of invoices to purchase orders prevents duplicate payments.

Which type of confirmation is most effective for auditing accounts payable?

a) Positive confirmation
b) Negative confirmation
c) Vendor statement review ✅
d) Customer confirmation

Explanation: Vendor statements provide a reliable external verification of payables.

Chapter 3: Audit of Inventory and Warehousing Cycle

What is the biggest risk in auditing inventory?
a) Inventory overstatement ✅
b) Duplicate vendor payments
c) Payroll misclassification
d) Delayed revenue recognition
Explanation: Overstating inventory increases reported assets and profits.

Which audit procedure ensures inventory existence?

a) Counting physical inventory ✅
b) Reviewing purchase orders
c) Examining invoices
d) Verifying bank statements
Explanation: Physical counts confirm that inventory actually exists.

Which method is used to value inventory?

a) FIFO and LIFO ✅
b) Straight-line depreciation
c) Accrual accounting
d) Discounted cash flow
Explanation: FIFO and LIFO are common inventory valuation methods.

Chapter 4: Audit of Payroll and Personnel Cycle

Which fraud risk is most common in payroll audits?
a) Overstating inventory
b) Ghost employees ✅
c) Duplicate invoices
d) False bank reconciliations
Explanation: Ghost employees allow unauthorized payroll payments.

Which document confirms payroll tax payments?

a) Pay stub
b) Tax remittance form ✅
c) Vendor invoice
d) Purchase order
Explanation: Tax remittance forms verify compliance with tax regulations.

Chapter 5: Audit of Capital Acquisition and Repayment Cycle

Which account is most critical in capital acquisition audits?
a) Accounts receivable
b) Loan payable ✅
c) Prepaid expenses
d) Inventory
Explanation: Loans and debt financing require verification for completeness and accuracy.

Chapter 6: Audit of Cash and Financial Instruments

Which document is used for cash reconciliation?
a) Bank statement ✅
b) Vendor invoice
c) Sales order
d) Trial balance
Explanation: Bank statements confirm cash balances.

What is a common fraud risk in cash audits?

a) Inventory misstatement
b) Check kiting ✅
c) Duplicate payroll payments
d) Depreciation errors
Explanation: Check kiting inflates cash balances by moving funds between accounts.

Chapter 7: Completing the Audit and Issuing the Report

What type of opinion is issued when financial statements are fairly presented?
a) Qualified opinion
b) Adverse opinion
c) Disclaimer of opinion
d) Unqualified opinion ✅
Explanation: An unqualified (clean) opinion means financial statements are free from material
misstatements.

When is a disclaimer of opinion issued?

a) When there are material misstatements
b) When the auditor lacks sufficient evidence ✅
c) When revenue is misstated
d) When a company has excessive inventory
Explanation: A disclaimer is given when an auditor cannot obtain enough evidence.

More General Questions

Which principle ensures that auditors remain independent?
a) Integrity
b) Objectivity ✅
c) Competence
d) Confidentiality

Which organization establishes audit standards?

a) FASB
b) PCAOB ✅
c) SEC
d) IRS

What is the final step before issuing an audit report?

a) Testing transactions
b) Reviewing financial statement disclosures ✅
c) Performing an inventory count
d) Checking payroll records

What does "material misstatement" mean in auditing?

a) A small error
b) An error that affects financial decisions ✅
c) An intentional fraud
d) A typo in financial statements