Auditing Chapter 4

Which of the following conditions are generally present when material misstatements due to fraud occur?

- Incentive - Rationalization - Opportunity

Which of the following areas require documentation related to the auditor's risk assessment and response? a. Auditor education and training related to risk assessment. b. Nature, timing and extent of procedures performed to identify risks. c. Evaluation of management's response to identified risk. d. Discussion among the engagement team. e. Communication about error and fraud made to management and others.

- Nature, timing and extent of procedures performed to identify risks. - Evaluation of management's response to identified risk. - Discussion among the engagement team. - Communication about error and fraud made to management and others.

Identify the three steps involved in the auditor's use of the audit risk model at the assertion level.

- Solving the audit risk equation for the appropriate level of detection risk. - Setting a planned level of audit risk. - Assessing the risk of material misstatement.

If the auditor assesses the _____________ level of audit risk as being less than or equal to the _______________ level of audit risk, an unqualified report can be issued.

- actual or achieved - planned

When auditing a public company, the auditor is generally responsible to disclose fraud to the ______.

- audit committee - senior management

Internally generated performance measures include ______.

- comparisons to industry competitors - budgets - departmental performance reports - variance analysis

Risk factors relating to opportunities to report fraudulently include ______.

- complex or unstable organizational structure - financial numbers based on subjective judgments or uncertainties - significant related party transactions

Understanding and assessing the effectiveness of an entity's internal control assists the auditor in ______.

- designing appropriate audit procedures - recognizing factors that affect the risks of material misstatements - identifying types of potential misstatements

Steps auditors perform as part of the fraud risk assessment process include ______.

- identification and assessment of fraud risk factors - understanding the entity's period-end closing process - inquiries of management about their views on the risks of fraud

In order to respond to pervasive risks, auditors may ______.

- incorporate an element of unpredictability in the audit procedures - assign more experienced or specialized personnel to assess the risk of material misstatement due to fraud - evaluate whether the selection and application of accounting policies by the entity may create a material misstatement

Risk factors relating to attitudes/rationalizations to report fraudulently include ______.

- ineffective communication and enforcement of ethical values - excessive management interest in increasing entity stock prices - claims against board members alleging fraud

The auditor should ______.

- inquire about management's knowledge of fraud within the entity - make direct inquiries of the audit committee when assessing risk of fraud - make inquiries of the internal audit function to assess their risk of fraud.

Steps auditors perform as part of the fraud risk assessment process include ______.

- inquiries of the audit committee about their views on the risks of fraud - team member discussions regarding the risk of material misstatement - consideration of unusual or unexpected relationships

To understand the nature of the entity, auditors should obtain information about the entity's: ______.

- investments - financial reporting - business operations - financing and financing activities

If management chooses not to eliminate an identified material misstatement, appropriate audit opinions include ______.

- modified - qualified - adverse

If the achieved level of audit risk is greater than the planned level, auditor options include ______.

- modifying the audit opinion - performing additional audit work

The PCAOB states that, as a part of understanding the entity, auditors should consider ______.

- reading public information about the effectiveness of the company's internal control over financial reporting - observing earnings calls conducted by management

The PCAOB states that, as a part of understanding the entity, auditors should consider ______.

- reading relevant public information about the company - obtaining an understanding of compensation arrangements with senior management - obtaining information about significant unusual developments regarding trading activity in the company's securities

Observation and inspection audit procedures include ______.

- tracing transactions through the information system - visits to the entity's premises and plant facilities - reading management reports

Examples of misappropriation of assets include ______.

- using an entity's assets for personal use - stealing physical assets and intellectual property - embezzling cash received

The possibility that an auditor will issue an unqualified opinion on materially misstated financial statement is called ______________.

Audit Risk

The formula auditors use to determine the appropriate level of detection risk is ______.

DR = AR ÷ RMM

True or false: Observation and inspection audit procedures should be limited to current activities performed inside the organization without considering outside sources.

F: Information from outside as well as from previous audits may also be considered.

True or false: At the completion of the audit, the actual or achieved level of audit risk is known with certainty by the auditor.

F: The actual or achieved level of audit risk is not known with certainty.

True or false: Professional skepticism is not a way to reduce judgment errors.

F: This is one of many ways that judgment errors can be reduced.

Who addresses business risks by implementing a risk assessment process?

Management

Audit Scope

Nature, timing, and extent of audit procedures. Nature - type of evidence Timing - when evidence will be examined Extent - how much of the type of evidence

True or false: Detection risk has an inverse relationship to inherent and control risk.

T: If inherent and control risk are high, the auditor will accept a lower level of detection risk.

Risk of Material Misstatement

The combined probability that a material misstatement (error or fraud) will occur and not be prevented or detected on a timely basis by the entity's internal controls. IR & CR

Control Risk (CR)

The risk that a misstatement that could occur in an assertion about an account or disclosure and that could be material, either individually or when aggregate with other misstatements, will not be prevented, or detected and corrected, on a timely basis y the entity's internal control.

Nonsampling risk

The risk that auditors will make judgment errors caused by the use of inappropriate audit procedures or misinterpretation of audit evidence and failure to recognize a misstatement or deviation.

Audit Risk

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

Engagement risk

The risk that the auditor is exposed to financial loss or damage to his or her professional reputation from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on.

Detection Risk

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements. -inverse of IR & CR: example if IR&CR are low, DR is high

Inherent Risk (IR)

The susceptibility of an assertion an account or disclosure to a misstatement due to error or fraud that could be material, either individually or when aggregated with other misstatements before consideration of any related controls.

Which of the following statements are correct? a. Most fraudulent financial reporting involves management override of controls. b. An auditor may unknowingly rely on fraudulent audit evidence. c. Withholding evidence or misrepresenting information may conceal fraud. d. Honest individuals cannot be pressured into committing fraud.

a. Most fraudulent financial reporting involves management override of controls. b. An auditor may unknowingly rely on fraudulent audit evidence. c. Withholding evidence or misrepresenting information may conceal fraud.

Evaluations of financial information made through the study of plausible relationships among both financial and non-financial data are referred to as _______________ ____________

analytical procedures

The auditor should develop expectation about plausible relationships that are expected to exist when performing preliminary _____________ ________________

analytical procedures

Auditors assess the risk of material misstatement at the ______ level.

assertion

Auditors should perform audits to reduce ______ risk to a sufficiently low level before expressing an opinion on the financial statements.

audit

An active role in the oversight of the assessment of the risk of fraud should be assumed by the ______.

audit committee

Whenever the auditor finds evidence of fraud that causes a material misstatement of the financial statements, it should be reported directly to the ______.

audit committee

Which of the following statements are correct? a. Comparing an entity's performance with competitors is an example of an external performance measure. b. A deviation in the entity's performance measures may indicate a risk of misstatement in the related financial information. c. Internal performance measures provide information about progress towards meeting entity objectives. d. Auditors must consider the reliability of internal performance measures before using them for purposes of the audit.

b. A deviation in the entity's performance measures may indicate a risk of misstatement in the related financial information. c. Internal performance measures provide information about progress towards meeting entity objectives. d, Auditors must consider the reliability of internal performance measures before using them for purposes of the audit.

Internal performance measures include ______.

both financial and nonfinancial indicators

The audit team is required to hold discussions, referred to as _______________ ____________ , about the entity's financial statements' susceptibility to fraud.

brainstorming sessions

Threats from significant events that could adversely affect an entity's ability to achieve its objectives and execute its strategies are _____________ ____________

business risks

Which of the following statements are correct? a. All audit team members should be included in the fraud brainstorming session. b. The audit team is encouraged but not required to hold discussions about the entity's financial statements' susceptibility to fraud. c. The engagement partner or manager should communicate the potential for misstatements from fraud to the audit team. d. The fraud discussion can be part of the discussion of understanding the entity and its environment.

c. The engagement partner or manager should communicate the potential for misstatements from fraud to the audit team. d. The fraud discussion can be part of the discussion of understanding the entity and its environment.

The risk of material misstatement is also referred to as _____________ risk because it stems from decisions made by the entity.

client

The risk that a material account or disclosure assertion will not be prevented, detected or corrected on a timely basis by the entity's internal control is ___________________ risk.

control

The risk that a misstatement could occur in an assertion and would not be prevented, or detected and corrected, on a timely basis by the entity's internal control is known as ______ risk.

control

Misstatements arising from the misappropriation of assets is sometimes referred to as ____________

defalcation

The effectiveness of the audit procedures and how well the procedures are applied by the auditor determines the ___________ risk.

detection

The effectiveness of the audit procedures and how well the procedures are applied by the auditor determines the ____________ risk.

detection

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists is known as ______ risk.

detection

Standards require extensive ______________ of the auditor's risk assessment procedures and audit responses to identified risks.

documentation

Unintentional misstatements of amounts or disclosures in financial statements are referred to as __________

errors

The primary distinction between ____________ and ____________ is whether the misstatement was intentional or unintentional.

errors fraud

The risk of material misstatement refers to misstatements caused by _____________ or ______________

errors fraud

An auditor tests an invoice for services provided and determines that the amount charged is incorrect. This is an example of a ______ misstatement.

factual

Misstatements about which there is no doubt are called ___________ misstatements.

factual

Incentive, opportunity and rationalization are three conditions that are sometimes referred to as the ______________ ______________ triangle

fraud risk

The susceptibility of a material account or disclosure assertion to a misstatement due to fraud or error, before considerations of any related controls is _________________ risk

inherent

The susceptibility of an assertion in an account or disclosure to a misstatement due to error or fraud that could be material is known as ______ risk.

inherent

The entity's policies and procedures designed to provide reasonable assurance about the achievement of the entity's objectives is labeled ._______________ ______________

internal control

Auditors should ask the ______ about its assessment of the risk of fraud, including whether management has satisfactorily responded to internal audit findings during the year.

internal audit function

An auditor determines that the percentage of allowance for bad debts set by management is unreasonably low based on past experience. This is an example of a ______ misstatement.

judgmental

When an auditor considers management's selection of an accounting policy to be inappropriate, a(n) ______________ misstatement arises.

judgmental

If an entity's response to identified risks are inadequate, the auditor's assessment of the risk of _______________ ____________ may increase.

material misstatement

The combination of inherent risk and control risk is referred to in auditing standards as the risk of _____________ _______________

material misstatement

The auditor should obtain information about the conduct of operations, joint ventures, planned acquisitions, and major subsidiaries as part of learning about the ______.

nature of the entity

Audit evidence is subject to human error which is referred to as __________ risk

nonsampling

Financial statement level risks are _____________ risks in that they apply to multiple components of the financial statements.

pervasive

An auditor uses the misstatements identified in an audit sample to estimate the misstatements in the entire population. This is an example of a ______ misstatement.

projected

The auditor's best estimate of misstatements in populations are called ____________ misstatement

projected

The greater the incentive or pressure, the more likely an individual will be able to ______.

rationalize the acceptability of committing fraud

If an entity's response to identified risks is adequate, the risk of material misstatement may be ______.

reduced

If inherent and control risks are high, in order to achieve the planned level of audit risk, the auditor will ______ level of detection risk.

set a lower

If the uncorrected total misstatements identified during the audit process do not cause the financial statements to be materially misstated, auditors should issue a(n) ______ opinion.

unqualified