chapter 03 risk assessment and materialitytestbankcollege.eu/sample/test-bank-auditing-and... ·...

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Chapter 03Risk Assessment and Materiality

Multiple Choice Questions

1. Engagement risk is: A. The risk of issuing an incorrect audit opinionB. The auditor's risk of loss from events arising in connection with financial statements audited and reported uponC. The overall risk of material misstatementsD. The risk of entity financial failure

AACSB: CommunicationsAICPA BB: LegalAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 1

2. Client (or auditee) risk is A. The auditor's risk of loss from events arising in connection with financial statements audited and reported uponB. The overall risk of material misstatementsC. The risk that audit procedures will fail to detect material misstatementsD. The risk of the entity's financial failure

AACSB: CommunicationsAICPA BB: LegalAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 2Learning Objective: 6

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3. Under Statements on Auditing Standards, which of the following would be classified as an error? A. Misappropriation of assets for the benefit of managementB. Misinterpretation by management of facts that existed when the financial statements were preparedC. Preparation of records by employees to cover a fraudulent schemeD. Intentional omission of the recording of a transaction to benefit a third party

AACSB: EthicsAICPA BB: LegalAICPA FN: Decision MakingDifficulty: EasyLearning Objective: 6

4. When assessing the risk of material misstatements, auditors evaluate the reasonableness of an entity's accounting estimates. An auditor normally is concerned about assumptions that are A. Susceptible to biasB. Consistent with prior periodsC. Insensitive to variationsD. Similar to industry guidelines

AACSB: AnalyticsAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 6

5. Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements? A. Turnover of senior accounting personnel is lowB. Insiders recently purchased additional shares of the entity's stockC. Management places substantial emphasis on meeting earnings projectionsD. The rate of change in the entity's industry is slow

AACSB: AnalyticsAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 6

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6. Which of the following is a known misstatement? A. A management estimate that is outside the range of reasonable outcomes determined by the auditorB. A fixed asset being recorded at the incorrect costC. A projected misstatement resulting from errors found during samplingD. Difference in judgment between the auditor and management

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementDifficulty: ModerateLearning Objective: 6

7. Tolerable misstatement is A. Always the same for errors and fraudB. Materiality for the balance sheet as a wholeC. Materiality for the income statement as a wholeD. Materiality allocated to a specific account

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementDifficulty: EasyLearning Objective: 11

8. Which of the following would an auditor most likely use in determining the auditor's planning materiality? A. The anticipated sample size for planned substantive proceduresB. The entity's annualized interim financial statementsC. The results of the internal control questionnaireD. The contents of the management representation letter

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 11Learning Objective: 12

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9. Which of the following is not a qualitative factor that may affect an auditor's establishment of materiality? A. Potential for fraudB. The company is close to violating loan covenantsC. Firm policy sets materiality at 4% of pretax incomeD. A small misstatement would interrupt an earnings trend

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 11Learning Objective: 12

10. Which of the following is not a concern as to whether a misstatement is qualitatively material? A. The misstatement hides a failure to meet analysts' expectationsB. The misstatement is less than 5% of pretax incomeC. The misstatement increases management's compensationD. The misstatement changes a small amount of profit to a small reported loss

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 11Learning Objective: 12

11. Auditors can eliminate engagement risk A. Under no circumstancesB. By establishing policies for client acceptance and continuanceC. By lowering audit riskD. By lowering materiality

AACSB: CommunicationsAICPA BB: LegalAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 1

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12. The achieved (actual) level of audit risk A. Can always be accurately assessed by the auditorB. Should be greater than or equal to acceptable audit riskC. Can never be known with certaintyD. Is the same for all audit clients

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 1

13. An auditor knows that an audit client operates in an industry in which common stock is valued based on the price-earnings ratio soon will have an initial public offering. All of the following are true except: A. Materiality should be reducedB. Risk of material misstatement should increaseC. Fraud risk should increaseD. Audit risk should increase

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 11Learning Objective: 2Learning Objective: 3Learning Objective: 6

14. The risk that an auditor will conclude, based on substantive procedures, that a material error does not exist in an account balance when, in fact, such error does exist is referred to as A. Sampling riskB. Detection riskC. Nonsampling riskD. Inherent risk

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 2Learning Objective: 3Learning Objective: 6

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15. The risk of material misstatement differs from detection risk in that it A. Arises from the misapplication of auditing proceduresB. May be assessed in either quantitative or nonquantitative termsC. Exists independently of the financial statement auditD. Can be changed at the auditor's discretion

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 2Learning Objective: 3

16. All of the following are inherent risk factors that are pervasive to the financial statements except A. Highly complex significant transactionsB. Non-routine transactionsC. Classes of transactions are not processed systematicallyD. Supplies inventory is difficult to count

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 2Learning Objective: 3

17. When an auditor increases the assessed level of risk of material misstatement because certain control procedures were determined to be ineffective, the auditor would most likely increase the A. Extent of tests of controlsB. Level of detection riskC. Extent of tests of detailsD. Level of inherent risk


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18. On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of risk of material misstatement from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would A. Decrease substantive procedureingB. Decrease detection riskC. Increase detection riskD. Increase materiality levels


19. The risk of material misstatement includes which of the following: A. Detection riskB. Audit riskC. Inherent riskD. Nonsampling risk

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 2

20. An auditor learns that a client employee in control of inventory gets divorced and is responsible for paying a large amount of child support. All of the following for the audit of inventory likely are true except: A. Fraud risk increasesB. The risk of misappropriation of assets increasesC. Risk of material misstatement increasesD. Detection risk increases

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 2Learning Objective: 3Learning Objective: 6

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21. Which of the following audit risk components may be assessed in nonquantitative terms?

A. A AboveB. B AboveC. C AboveD. D Above


22. When an entity moves into a significant new line of business, all of the following increase except A. Client riskB. Acceptable audit riskC. Risk of material misstatementD. Entity business risk


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23. Which of the following procedures should not be used to obtain an understanding of the entity and its environment? A. Observe entity operationsB. Reperform entity processesC. Verify proper valuation of inventory subject to technological obsolescenceD. Review prior year's audit documentation

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Decision MakingDifficulty: ModerateLearning Objective: 5

24. Which of the following is not an important consideration in an auditor's evaluation of an entity's business risk? A. The specific business risks an entity faces that may result in financial statement errors and fraudB. Business risk factors that impact the ability of the entity to be profitable and surviveC. Audit standards include many entity business risk factors that identify circumstances that increase the likelihood of material misstatementsD. Audit standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability


25. Which of the following relatively small misstatements most likely would have a material effect on an entity's financial statements? A. An illegal payment to a foreign official that was not recordedB. A piece of obsolete office equipment that was not retiredC. A petty cash fund disbursement that was not properly authorizedD. An uncollectible account receivable that was not written off

AACSB: AnalyticAICPA BB: LegalAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 5Learning Objective: 6

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26. The main source of detection risk is: A. Unstable audit environmentB. Poor client controlsC. A non-representative sampleD. Inherent risk assessed too high


27. In general, material frauds perpetrated by which of the following are most difficult to detect? A. Internal auditorB. Keypunch operatorC. CashierD. Controller


28. Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity's financial statements? A. Accounts receivable confirmation requests yield significantly fewer responses than expectedB. Audit trails of computer-generated transactions exist only for a short timeC. The chief financial officer does not sign the management representation letter until the last day of the auditor's fieldworkD. Management consults with other accountants about significant accounting matters


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29. The primary responsibility for preventing fraud in an organization lies with A. The audit committee of the board of directorsB. The internal audit staffC. The external auditorD. The organization's management

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Decision MakingDifficulty: ModerateLearning Objective: 6Learning Objective: 7Learning Objective: 8

30. Which of the following is not a misstatement of the financial statements? A. The client uses different inventory accounting methods for internal and external reportingB. A departure from GAAPC. The footnote for pensions is omittedD. A clerk incorrectly based the allowance for doubtful accounts on 31% of sales as opposed to 13% of sales as determined by the controller

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingDifficulty: ModerateLearning Objective: 6Learning Objective: 7Learning Objective: 8

31. Which of the following does not represent an opportunity to commit fraud? A. Significant related party transactionsB. The auditor's relationship with management is strainedC. Management is dominated by a single personD. The financial statements included highly subjective estimates


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32. The auditor can respond to an increased risk of fraud by doing all of the following except A. Increasing professional skepticismB. Assigning more experienced personnel to the auditC. Increasing acceptable audit riskD. Taking steps to obtain more reliable evidence


33. An auditor discovers a likely fraud during an audit but concludes that the effect of the fraud is not sufficiently material to affect the audit opinion. The auditor should A. Disclose the fraud to the appropriate level of the client's managementB. Disclose the fraud to appropriate authorities external to the clientC. Discuss with the client the additional audit procedures that will be needed to identify the exact amount of the fraudD. Modify the audit program to include tests specifically designed to identify the fraud and its impact on the financial statements

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Decision MakingDifficulty: ModerateLearning Objective: 7Learning Objective: 8

34. Which of the following is the most important qualitative factor that auditors should consider when making materiality judgments? A. A misstatement exceeded five percent of net incomeB. The auditor also provides consulting services to the audit clientC. The misstatement will cause the client to fail to meet an earnings forecastD. The audit committee is not well educated about the accounting principle in question


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35. The acceptable level of detection risk is inversely related to the A. Assurance provided by substantive proceduresB. Risk of misapplying auditing proceduresC. Planning materialityD. Risk of failing to discover material misstatements

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: HardLearning Objective: 2Learning Objective: 3

36. As the acceptable level of detection risk decreases, an auditor may change the A. Timing of substantive procedures by performing them at an interim date rather than at year-endB. Nature of substantive procedures from less effective to more effective proceduresC. Timing of tests of controls by performing them at several dates rather than at one timeD. Assessed level of risk of material misstatement to a higher amount


37. As the acceptable level of detection risk decreases, the assurance directly provided from A. Substantive procedures should increaseB. Substantive procedures should decreaseC. Tests of controls should increaseD. Tests of controls should decrease


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38. As the acceptable level of detection risk increases, an auditor may change the A. Assessed level of risk of material misstatement from below the maximum to the maximum levelB. Assurance provided by tests of controls by using a larger sample size than plannedC. Timing of substantive procedures from year-end to an interim dateD. Nature of substantive procedures from less effective to more effective procedures


39. Increased fraud risk could also result in all of the following except A. Lower detection riskB. Higher inherent riskC. Lower control riskD. Higher client risk

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: HardLearning Objective: 2Learning Objective: 6Learning Objective: 7Learning Objective: 8

40. The objectives of the engagement partner's communication with the audit team include A. Turning the audit team against managementB. Complying with SEC rulesC. Complying with FASB rulesD. Emphasizing the importance of professional skepticism

AACSB: CommunicationsAICPA BB: Resource ManagementAICPA FN: Decision MakingDifficulty: HardLearning Objective: 6

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41. The auditor is most likely to presume that a high risk of a fraud exists if A. The entity is a multinational company that does business in numerous foreign countriesB. The entity does business with several related partiesC. Inadequate segregation of duties places an employee in a position to perpetrate and conceal theftD. Inadequate employee training results in lengthy EDP exception reports each month

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: HardLearning Objective: 6Learning Objective: 7Learning Objective: 8

42. Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting? A. Inability to generate cash flows from operations while reporting substantial earnings growthB. Management's lack of interest in increasing the entity's earnings trendC. Large amounts of liquid assets that are easily converted into cashD. Inability to borrow necessary capital without granting debt covenants

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: HardLearning Objective: 6Learning Objective: 7Learning Objective: 8

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43. A properly planned and performed audit may fail to detect a material misstatement resulting from fraud because A. Audit procedures that are effective for detecting an error may be ineffective for fraud that is concealed through collusionB. An audit is planned and performed to provide reasonable assurance of detecting material misstatements caused by errors but not by fraudC. The factors considered in assessing control risk indicated an increased risk of error but only a low risk of fraud in the financial statementsD. The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole


44. Which of the following is correct concerning SAS No. 99's requirements concerning auditor communications about fraud? A. Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involvedB. Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange CommissionC. Any requirement to disclose fraud outside the entity is the responsibility of management and not that of the auditorD. The professional standards provide no requirements related to the communication of fraud, but the auditor should use professional judgment in determining communication responsibilities

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: HardLearning Objective: 10

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45. Which of the following underly(ies) the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? A. The elements of materiality and audit riskB. The element of internal controlC. The element of corroborating evidenceD. The element of reasonable assurance

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingDifficulty: HardLearning Objective: 11

46. Which of the following statements is not correct about materiality? A. The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not importantB. An auditor considers materiality for the aggregate level of misstatements that could be material to any one of the financial statementsC. Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgmentsD. An auditor's consideration of materiality is influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements


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Short Answer Questions

47. What is the difference between audit risk and engagement risk?

Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated. It can be directly controlled by the scope of the auditor's test procedures. Engagement risk, on the other hand is the auditor's exposure to loss or injury to professional practice from litigation, adverse publicity or other events arising in connection with financial statements audited and reported on. It cannot be directly controlled by the auditor, but some control can be exercised through the careful acceptance and continuance of clients.


48. You are teaching a class of new hires at your international accounting firm. Explain the audit risk model using a mathematical formula.

AR = RMM X DRAR = Audit riskRMM = Risk of material misstatementDR = Detection riskAudit risk consists of1) The risk that the balance or class and related assertions contain misstatements that could be material to the financial statements when aggregated with misstatements in other balances or classes. These risks exist independently of the audit.2) The risk that the auditor will not detect such misstatements (detection risk). This risk can be controlled by the auditor through the scope of the audit procedures performed.

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 2Learning Objective: 3

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49. Stacey, the partner in charge of the audit of RIF Enterprises, sets the planned level of audit risk for the audit of accounts payable at .06. The risk of material misstatement is assessed at .65. What is the detection risk for this audit and what is the significance determining that risk.

Substituting the values into the audit risk model, the detection risk is around 9%.DR = AR / (RMM)DR = .06/ .65DR = 9.2%


50. Your classmate asserts, "Accountants shouldn't need to take business courses besides accounting, because they are only interested in the financial statements of a company." Defend or refute this statement.

The classmate is misguided. Auditors need to develop a deep understanding of business. Most business concepts and risks have the potential to affect the financial statements either immediately or in the long run. In addition, a thorough understanding of business risks increases the likelihood of identifying material misstatements in the financial statements. Therefore, an auditor should be familiar with a client's business environment for numerous reasons, including evaluating the going concern assertion.

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 5Learning Objective: 6

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51. You are the senior on an audit of Two Be Gone, a large publicly held company. The company recently completed an acquisition of its fifth largest competitor. What risks might this present? As an auditor, what actions should you take related to this acquisition?

Student answers for the first question will vary. After identifying possible risks, the auditor should determine which ones may result in material misstatements in the financial statements. Once those are identified, the auditor should evaluate how those risk may impact financial reporting and then design the audit to obtain evidence that addresses whether those risk have adversely impacted financial reporting. If the entity does not respond adequately to business risks that may affect financial reporting, the auditor will have to expanding audit tests to determine if any misstatements are present in the related account balances or class of transactions.


52. Define misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets in one sentence each.

Misstatements arising from fraudulent financial reporting are intentional misstatements or omissions of amounts or disclosures in financial statements intended to deceive financial statement users. Misstatements arising from misappropriation of assets involve the theft of an entity's assets where the theft causes the financial statements to be misstated.

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisDifficulty: EasyLearning Objective: 6

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53. DATRIX, Inc, a Fortune 500 company, has been experiencing poor performance. Industry analysts have been issuing negative reports and the company's stock price has been steadily declining. As an auditor, what would concern you about the audit engagement of DATRIX, Inc.

An auditor should be concerned because of the apparent incentive the management of DATRIX may have to commit financial statement fraud. For instance, the company's management may be tempted to change accounting estimates or use other means to falsely increase the company's book profits. The auditor should exercise professional skepticism in this engagement and addresses carefully the risk of financial statement fraud.

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisDifficulty: ModerateLearning Objective: 6

54. During the course of the audit of FF Financial, you find that some accounting entries have been altered. You believe this may be the result of management fraud and you have determined that the effect of this could be material to the financial statements. What are appropriate steps to take?

In this situation, the auditor should attempt to obtain audit evidence to determine whether material fraud has occurred and, if so, its effect. The auditor should consider the implications for other aspects of the audit. If fraud is found in one account, there are chances the auditor will find fraud in other accounts, as well. The auditor needs to discuss the matter and the approach to further investigation with an appropriate level of management that is at least one level above those involved in committing the fraud and with senior managements. If appropriate, the auditor could suggest that the client consult with legal counsel. If the results of the audit tests indicate a significant risk of fraud, the auditor should consider withdrawing from the engagement and communicating the reasons for withdrawal to the audit committee or others with equivalent authority and responsibility.

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Decision MakingDifficulty: ModerateLearning Objective: 10Learning Objective: 8Learning Objective: 9

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55. Often in an audit, total combined tolerable misstatement is greater than overall materiality. Why does this make sense?

Answers may vary, but could include:This makes sense for a number of reasons. First, not all accounts will be misstated by the full amount of their tolerable misstatement allocation. In addition, audits of the individual accounts are conducted simultaneously. If accounts were audited sequentially, unadjusted misstatements observed during testing would count against materiality and theoretically the auditor could carry the unused portion of materiality to the next account and so forth.In addition, when control weaknesses or misstatements are identified in an account, the auditors typically perform additional procedures in that and related, accounts. Thus, the actual testing will often achieve a much smaller margin for misstatement than planned tolerable misstatement.

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementDifficulty: HardLearning Objective: 11Learning Objective: 12

56. Provide some examples of qualitative factors auditors would consider when determining tolerable misstatement for an account.

Relevant qualitative factors include the size and complexity of the account, the importance of changes in the account to key performance indicators, debt covenants and meeting published forecasts or estimates.


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chapter 03 risk assessment and materialitytestbankcollege.eu/sample/test-bank-auditing-and... ·...

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