Chapter 9 Test Bank

The risk of material misstatement is a combination of two client-controlled factors: inherent risk and control risk. What is inherent risk and why is it important? Give examples of inherent risk factors.

-auditor's assessment of the likelihood that there are material misstatements in the audit segment before the consideration of internal controls -important bc attempts to predict where misstatements are most and least likely to occur -examples: related parties, nature of the client's business, results of previous audits

Risk assessment procedures are performed to identify and assess the risk of material misstatement. List three risk assessment procedures.

1. Analytical procedures 2. Observation and inspection 3. Discussion among engagement team members

There are several factors that affect engagement risk and, therefore, acceptable audit risk. Discuss three of these factors.

1. The degree to which external users will rely on the statements. 2. The likelihood that a client will have financial difficulties after the audit report is issued. 3. The auditor's evaluation of management's integrity.

An auditor who audits a business cycle that has low inherent risk should

A) increase the amount of audit evidence gathered. B) assign more experienced staff to that area. C) expand planning procedures. (do none of the above)

Risk assessment procedures include inquiries of management and others by the auditor. As part of these procedures, the auditor should talk to

A) internal auditors. B) board of directors. C) individuals involved with regulatory compliance. (all of the above)

A new inventory control system has been installed that reduces the access of unauthorized parties.

A. increases the acceptable level of detection risk

An expert was hired to help determine the value of the ore content in ending materials inventory.

A. increases the acceptable level of detection risk

An internal audit department has been established.

A. increases the acceptable level of detection risk

Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance instead of

ACCEPTABLE audit risk

Which is a true statement about audit risk?

Audit assurance is the COMPLEMENT of acceptable audit risk.

Which of the following is an accurate statement regarding inherent risk?

Auditors are generally CONSERVATIVE in setting inherent risk.

Controls over the sales credit approval process have laxed.

B. decreases the acceptable level of detection risk

Excess cash was used to purchase complex derivatives.

B. decreases the acceptable level of detection risk

Inexperienced accounting personnel were hired in the accounting department.

B. decreases the acceptable level of detection risk

Management has become overly aggressive in reaching target goals.

B. decreases the acceptable level of detection risk

New government regulations now apply to Dracule Industries.

B. decreases the acceptable level of detection risk

Which of the following risks are used in the audit risk model?

Control Risk YES Inherent Risk YES Planned Detection Risk YES

When assessing risk, it is important to remember that

DETECTION risk can only be determined AFTER audit risk, inherent risk, and control risk are determined.

________ is the risk that the auditor or audit firm will suffer harm after the audit is finished, even though the audit report was correct.

ENGAGEMENT risk

Planned detection risk I. determines the amount of substantive evidence the auditor plans to accumulate. II. is dependent on inherent risk and business risk.

I only

The measurement of the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of related internal controls is defined as

INHERENT risk

Which of the following is true regarding audit risk for segments?

In some cases, a LOWER acceptable audit risk may be more appropriate for one account than for others.

Which of the following statements is not true?

Inherent risk is inversely related to the amount of audit evidence whereas detection risk is directly related to the amount of audit evidence required.

Which of the following statements regarding inherent risk is correct?

Most auditors set a HIGH inherent risk in the first year of an audit and reduce it in subsequent years as they gain more knowledge about the company.

Risk assessment procedures include

OBSERVATION of the entity's operations.

Describe the audit risk model and each of its components.

PDR = AAR / (IR x CR)

The risk that audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality levels is

PLANNED DETECTION risk

Acceptable audit risk HIGH Inherent risk LOW Control risk LOW

Planned detection risk HIGH Planned evidence LOW

Acceptable audit risk LOW Inherent risk HIGH Control risk HIGH

Planned detection risk LOW Planned evidence HIGH

Acceptable audit risk HIGH Inherent risk LOW Control risk MEDIUM

Planned detection risk MEDIUM Planned evidence MEDIUM

Acceptable audit risk LOW Inherent risk LOW Control risk LOW

Planned detection risk MEDIUM Planned evidence MEDIUM

Which of the following is a correct relationship?

Planned detection risk and INHERENT risk have an inverse relationship

When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as completely honest in all dealings, auditors normally

REDUCE acceptable audit risk and INCREASE inherent risk.

Which of the following is a correct statement?

The COMBINATION of performance materiality and the audit risk model factors determines planned audit evidence.

a measure of how much risk the auditor is willing to take that the financial statements may be materially misstated AFTER THE AUDIT is completed and an unqualified audit opinion has been issued

acceptable audit risk

Inherent risk and control risk

are INVERSELY related to DETECTION risk.

When the auditor is attempting to determine the extent to which external users rely on a client's financial statements, they may consider several factors except for

assessment of DETECTION risk

This term is SYNONYMOUS with acceptable audit risk.

audit assurance

When considering the risk of misstatement due to fraud,

auditing standards outline procedures the auditor should perform to obtain information from management about their consideration of fraud.

If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk for the auditor, acceptable audit risk would likely

be REDUCED

Auditors respond to risk primarily by I. changing the extent of testing. II. changing the types of audit procedures.

both I and II

a measure of the auditor's assessment of the likelihood that misstatements exceeding a performance materiality in a segment will NOT BE PREVENTED or detected by the client's internal controls

control risk

Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk 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

decrease DETECTION risk.

If the auditor decides to reduce acceptable audit risk, planned detection risk

decreases

Risk of material misstatement at the assertion level

determines the NATURE, TIMING, and EXTENT of further auditing procedures.

Which of the following would not increase the risks of material misstatement at the overall financial statement level?

effective oversight by the BOARD OF DIRECTORS

Which of the following is not a primary consideration when assessing inherent risk?

effectiveness of INTERNAL CONTROLS

To what extent do auditors typically rely on internal controls of their public company clients?

extensively

A ________ risk represents an identified and assessed risk of material misstatement that, in the auditor's professional judgment, requires special audit consideration.

financial statement

Why do auditors use the audit risk model when planning an audit?

helps decide how much evidence to accumulate in each cycle

If planned detection risk is reduced, the amount of evidence the auditor accumulates will

increase

________ risk represents the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of the client's internal controls.

inherent

a measure of the auditor's assessment of the likelihood that there are material misstatements BEFORE considering the effectiveness of internal control

inherent risk

Inherent risk is often high for an account such as

inventory

Inherent risk is ________ related to planned detection risk and ________ related to the amount of audit evidence.

inversely; directly

When using the audit risk model,

many auditors use BROAD and SUBJECTIVE measurement terms.

the MAGNITUDE of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person would have been changed

materiality

When taken together, the concepts of risk and materiality in auditing

measure the uncertainty of amounts OF A GIVEN magnitude.

Assessing the risk of material misstatement is closely related to each of the following except

not a CRTICAL consideration in most financial statement audits.

Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in assessing inherent risk during the planning phase?

obtaining client's AGREEMENT on the engagement letter

Auditors typically rely on internal controls of their private company clients

only if the controls are determined to be EFFECTIVE.

the materiality allocated to any given ACCOUNT balance

performance materiality level

a measure of the risk that audit evidence for a segment will FAIL TO DETECT MISSTATEMENTS exceeding the performance materiality amount, should such misstatements exist

planned detection risk

a decrease in control risk

planned evidence decreases

an increase in acceptable audit risk

planned evidence decreases

an increase in performance materiality

planned evidence decreases

an increase in planned detection risk

planned evidence decreases

an increase in inherent risk

planned evidence increases

the MAXIMUM amount by which the auditor believes that the statements could be misstated and still not affect the decisions of reasonable users

preliminary judgment about materiality

The auditor's responsibility section in an audit report states that "...the standards require that we plan and perform the audit to obtain ________ assurance about whether the financial statements are free of material misstatement." What type of assurance is given?

reasonable

The risk of material misstatement refers to

the COMBINATION of inherent risk and control risk.

In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?

the SUSCEPTIBILITY of a financial statement assertion to a material misstatement, assuming there are no related controls

When dealing with audit risk,

the audit risk model HELPS the auditor to decide how much and what types of evidence to accumulate.

Which of the following will generally be considered a significant risk?

the determination of the amount of BAD DEBT expense

Name some examples where the auditor accepts some level of uncertainty in performing the audit function.

• The inherent uncertainty about the appropriateness of evidence obtained. • The uncertainty about the effectiveness of a client's internal controls • Assessing risks is a matter of professional judgment rather than a precise measurement.