ICAEW ARF · Chapter 1
The concept of and need for assurance MCQs with Answers
10 multiple-choice questions on The concept of and need for assurance for ICAEW ARF Assurance and Risk Fundamentals. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following is NOT one of the elements of an assurance engagement?
- A) A three-party relationship between the practitioner, the responsible party and the intended users
- B) Suitable criteria against which the subject matter is evaluated
- C) A written assurance report containing the practitioner's conclusion
- D) A guarantee from the practitioner that the subject matter is free from fraud
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Answer: D) A guarantee from the practitioner that the subject matter is free from fraud
An assurance engagement has five elements: a three-party relationship, an appropriate subject matter, suitable criteria, sufficient appropriate evidence and a written assurance report. No assurance engagement provides a guarantee, and absolute assurance about the absence of fraud is never possible. The other three options are all recognised elements.
Question 2
In the statutory audit of a UK limited company, which party is the 'responsible party' in the three-party relationship?
- A) The company's directors
- B) The company's shareholders
- C) The audit engagement partner
- D) The Registrar of Companies
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Answer: A) The company's directors
The responsible party is the party responsible for the subject matter, which for financial statements is the directors who prepare them. The shareholders are the intended users, and the audit partner represents the practitioner. The Registrar simply receives the filed accounts and is not a party to the engagement.
Question 3
Which of the following wordings would be typical of the conclusion in a limited assurance engagement?
- A) In our opinion, the information is prepared, in all material respects, in accordance with the criteria
- B) Based on our procedures, nothing has come to our attention that causes us to believe that the information is not prepared, in all material respects, in accordance with the criteria
- C) We certify that the information is free from all error and fraud
- D) We confirm that every transaction underlying the information has been checked and found to be correct
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Answer: B) Based on our procedures, nothing has come to our attention that causes us to believe that the information is not prepared, in all material respects, in accordance with the criteria
Limited assurance is expressed in a negative form: the practitioner states that nothing has come to their attention suggesting the information is materially misstated. A positive 'in our opinion' conclusion is used for reasonable assurance engagements such as an audit. No assurance engagement certifies freedom from all error, and procedures are never performed on every transaction.
Question 4
What is the main reason why the shareholders of a large company need an independent audit of its financial statements?
- A) Shareholders are legally responsible for preparing the financial statements and need help to do so
- B) Ownership is separated from management, so shareholders need independent assurance on information prepared by the directors who run the business
- C) An audit guarantees that the company will pay a dividend
- D) An audit allows shareholders to avoid having to read the financial statements themselves
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Answer: B) Ownership is separated from management, so shareholders need independent assurance on information prepared by the directors who run the business
In most large companies the shareholders do not manage the business, so the directors act as their agents and prepare financial statements reporting on their own stewardship. Because directors may have incentives to present results favourably, an independent audit adds credibility to the information. Directors, not shareholders, prepare the statements, and an audit gives no guarantee about dividends.
Question 5
Which of the following is NOT an inherent limitation of an audit?
- A) Much of the audit evidence available is persuasive rather than conclusive
- B) The financial statements are prepared under a recognised financial reporting framework
- C) The auditor usually tests a sample of items rather than the whole population
- D) Internal controls can be overridden by management or circumvented by collusion
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Answer: B) The financial statements are prepared under a recognised financial reporting framework
Inherent limitations mean an auditor can give only reasonable, not absolute, assurance. They include the persuasive nature of evidence, the use of sampling and judgement, and the possibility of management override or collusion. Preparing the statements under a recognised framework is a precondition for an audit rather than a limitation, because it provides suitable criteria.
Question 6
Which of the following public perceptions is an example of the 'expectation gap' in auditing?
- A) The directors are responsible for preparing the financial statements
- B) An unmodified audit opinion means the financial statements are guaranteed to be completely accurate
- C) The auditor provides reasonable assurance rather than absolute assurance
- D) The auditor's report is addressed to the company's members
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Answer: B) An unmodified audit opinion means the financial statements are guaranteed to be completely accurate
The expectation gap is the difference between what users believe auditors do and what auditors actually do. Believing that an audit guarantees complete accuracy is a common misunderstanding, because an audit provides reasonable assurance only and materiality means small errors may remain. The other three statements are accurate descriptions of the audit.
Question 7
Which of the following engagements is NOT an assurance engagement?
- A) A review of a listed company's interim financial information
- B) An examination of a client's profit forecast for a bank loan application
- C) Preparing a client's VAT return from its accounting records
- D) The statutory audit of a company's annual financial statements
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Answer: C) Preparing a client's VAT return from its accounting records
Preparing a VAT return is a compilation or tax service: the accountant prepares information but does not evaluate it against criteria or express a conclusion. Reviews of interim information, examinations of prospective financial information and statutory audits all involve the practitioner gathering evidence and giving a conclusion to intended users, so they are assurance engagements.
Question 8
Which of the following statements about an agreed-upon procedures engagement is correct?
- A) The practitioner expresses a limited assurance conclusion on the subject matter
- B) The practitioner chooses the procedures to perform based on an assessment of risk
- C) The practitioner reports factual findings and the users draw their own conclusions from them
- D) The practitioner gives reasonable assurance because the procedures are agreed in advance
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Answer: C) The practitioner reports factual findings and the users draw their own conclusions from them
In an agreed-upon procedures engagement the practitioner performs procedures agreed with the engaging party and reports what was found. No conclusion is expressed, so no assurance is given and the engagement is not an assurance engagement. The procedures are set by agreement, not by the practitioner's own risk assessment.
Question 9
A small company is exempt from statutory audit but its directors are considering a voluntary audit. Which of the following is a genuine benefit of a voluntary audit?
- A) Lenders and suppliers may place greater reliance on the financial statements when deciding whether to extend credit
- B) Responsibility for the financial statements transfers from the directors to the auditor
- C) The audit guarantees that the company will continue as a going concern
- D) The company no longer needs to keep adequate accounting records
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Answer: A) Lenders and suppliers may place greater reliance on the financial statements when deciding whether to extend credit
An independent audit adds credibility to the financial statements, which can help when negotiating finance or credit terms; the auditor may also highlight control weaknesses. The directors remain responsible for the financial statements and for keeping accounting records whether or not there is an audit. An audit does not guarantee the future viability of the business.
Question 10
Which of the following statements correctly compares reasonable assurance and limited assurance engagements?
- A) Engagement risk is eliminated entirely in a reasonable assurance engagement
- B) Engagement risk is reduced to a lower level in a reasonable assurance engagement, so the procedures performed are generally more extensive
- C) A limited assurance engagement requires more evidence because its conclusion is expressed negatively
- D) Both types require the same procedures and differ only in the wording of the report
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Answer: B) Engagement risk is reduced to a lower level in a reasonable assurance engagement, so the procedures performed are generally more extensive
In a reasonable assurance engagement the practitioner reduces engagement risk to an acceptably low level, which requires more extensive evidence and supports a positive opinion. In a limited assurance engagement the risk is higher, the procedures (often inquiry and analytical review) are more restricted and the conclusion is negative. Risk can never be eliminated completely.