Chapter 4: Risk Assessment

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

Client risk

Many public accounting firms find it appropriate to use ______ in the audit risk model.

qualitative terms

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

Audit risk

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

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

The use of the audit risk model ______.

assists the auditor in determining the scope of audit procedures involves considerable auditor judgment

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

defalcation

Incentive, opportunity and rationalization are three conditions that are sometimes referred to as the _________ ____________ triangle.

fraud risk

Auditing standards state that audit risk must be reduced to at least a ______ level

low

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

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

performing additional audit work modifying the audit opinion

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

pervasive

Observation and inspection audit procedures include ______.

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

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 risk (CR)

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 exists is known as ______ risk

Detection

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

FASLE

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 risk (IR)

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

TRUE

Which of the following statements is correct? To obtain information about an entity's compliance with laws and regulations, the auditor should consult with his or her own legal counsel. Employees not directly responsible for financial reporting should not provide audit information to the auditor. Those charged with governance of the entity may be useful in providing information to the auditor.

Those charged with governance of the entity may be useful in providing information to the auditor.

When an auditor has discovered fraud, ______.

a duty to disclose outside the entity exists in some circumstances

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

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

business operations investments financial reporting financing and financing activities

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

rationalize the acceptability of committing fraud

The formula for the audit risk model is ______.

AR=RMM•DR

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

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

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

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

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

FALSE

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

FALSE

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

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

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

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

Under which of the following circumstances may auditors have a duty to disclose fraud to an outside entity?

To comply with legal and regulatory requirements. To a governmental funding agency. In response to a subpoena.

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

In order to respond to pervasive risks, auditors may ______. assign more experienced or specialized personnel to assess the risk of material misstatement due to fraud increase the amount of audit fees charged for the audit services performed report directly to the board of directors about the pervasive risks identified incorporate an element of unpredictability in the audit procedures evaluate whether the selection and application of accounting policies by the entity may create a material misstatement

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

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

audit committee

Internally generated performance measures include ______.

budgets variance analysis subsidiary information and divisional, departmental, or other level performance reports comparisons of an entity's performance with that of competitors

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

business risks

Business risk ______.

can adversely affect an entity's ability to execute its strategies is a broader concept than the risk of material misstatement

Risk factors relating to opportunities to report fraudulently include ______.

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

If an auditor has determined that material misstatements were or may have been the result of fraud and is unable to determine if the effect is material, the auditor should ______.

consider the implications for other aspects of the audit attempt to obtain evidence in order to determine whether material fraud has occurred and its effect suggest that the appropriate level of management consult with legal counsel

If the results of audit tests indicate a significant risk of fraud, the auditor should ______.

consider withdrawing from the engagement

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 auditor can manipulate ______ risk by changing the scope of the auditor's test procedures.

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 auditor will not discover a material misstatement in the financial statements is known as ______ risk.

detection

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

documentation

Examples of misappropriation of assets include ______. purposely misstating account balances embezzling cash received stealing physical assets and intellectual property the incorrect use of an accounting estimate. using an entity's assets for personal use

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

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

error

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

errors and fraud

The risk of material misstatement refers to misstatements caused by _______ or _______ .

errors or 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

Risk factors relating to incentives/pressures to report fraudulently include ______.

high degree of competition or market saturation need to obtain debt or equity financing profitability expectations of external parties

Which of the following conditions are generally present when material misstatements due to fraud occur? Integrity Incentive Greed Optimism Opportunity Rationalization

incentive opportunity rationalization

Items that may result in significant risks include ______.

industry specific issues assertions identified with fraud risk factors revenue recognition significant accounting estimates and judgments the application of new accounting standards highly complex transactions

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 consideration of unusual or unexpected relationships team member discussions regarding the risk of material misstatement understanding the entity's period-end closing process identification and assessment of fraud risk factors inquiries of management about their views on the risks of fraud

An active and qualified board of directors, proper authorization of transactions and procedures to ensure assets exist are all examples that may be part of an entity's ________ ________.

internal control

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

The auditor should ______.

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. inquire about management's knowledge of fraud within the entit

The responsibility to identify, control and mitigate business risks that may affect the entity's ability to achieve its objectives rests with the ______.

management

To obtain information about an entity and its environment, auditors may make inquires of ______.

marketing and sales personnel Internal auditors in-house legal counsel board of directors

If an entity's response to identified risks are inadequate, the auditor's assessment of the risk of _______ ________

material misstatement

Audit evidence is subject to human error which is referred to as ________ risk.

nonsampling

An objective of brainstorming with the audit team is emphasizing the importance of maintaining __________ _______________ throughout the audit regarding the potential for material misstatement due to fraud.

professional skepticism

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

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

qualified modified adverse

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

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

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

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

senior management audit committee

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