Chapter 07

If $15,000 is considered to be material to the income statement, but $25,000 is material to the balance sheet, the auditor should set overall materiality at which of the following dollar amounts? a. $20,000 b. $25,000 c. $40,000 d. $15,000

$15,000

To learn more about a company and its inherent risks, auditors can use which of the following resources? a. Management inquiries. b. Economic statistics. c. Online searches. d. Any of the above could be used.

Any of the above could be used.

As inherent risk increases, and other risk factors remain constant, what happens to the extent of audit work? a. Increases. b. Decreases. c. Stays the same. d. Becomes less reliable.

Increases.

The risk of material misstatement refers to which of the following? a. Inherent risk. b. Control risk and acceptable audit risk. c. The combination of inherent risk and control risk. d. Inherent risk and audit risk.

The combination of inherent risk and control risk.

Which of the following statements best describes what is meant by setting control risk at 100%? a. Controls are effective. b. Controls are relevant. c. Controls are ineffective. d. Cannot be determined from the information given.

Controls are ineffective.

Which of the following ratios provide information about liquidity? a. Net profit margin. b. Current ratio. c. Inventory turnover. d. Sales to assets.

Current ratio.

What procedure has to be completed at or after the end of the period? a. Assessment of control risk. b. Engagement letter. c. Evaluation of adjusting journal entries. d. All procedures must be completed prior to period end.

Evaluation of adjusting journal entries.

Which of the following phrases or terms regarding materiality is used by the Supreme Court of the United States and is not found in FASB Concepts Statement No. 2? a. "amount of a misstatement or omission" b. "in light of surrounding circumstances" c. "probable that the judgement of a reasonable person" d. "significantly altered the total mix of information available"

"significantly altered the total mix of information available"

What is the typical range for the assessment of the risk of material misstatement? a. 0% - 100% b. 0% - 10% c. 0% - 5% d. 1% - 100%

0% - 100%

What is the typical range for the setting of audit risk? a. 1% - 10% b. 1% - 5% c. 0% - 5% d. 0% - 10%

1% - 5%

Detection risk is affected by which aspects of substantive audit procedures? a. Nature. b. Timing. c. Extent. d. All of the above.

All of the above

Which of the following statements is true regarding planning analytical procedures? a. The precision of the auditor's expectation tends to be less precise, and based on more aggregated data, than the auditor's expectation when performing substantive analytical procedures. b. The objective for planning analytical procedures is to identify accounts with heightened risk of misstatement to provide a basis for designing and implementing responses to the assessed risks. c. For planning analytical procedures, significant unexpected differences suggest that substantive procedures for the account/assertion will be increased. d. Two frequently used analytical procedures during risk assessment include trend analysis and ratio analysis. e. All of the above are true.

All of the above are true.

Which of the following statements is true regarding the concept of detection risk? a. After assessing inherent and control risk and determining the level of acceptable audit risk, the auditor determines detection risk. b. Detection risk is under the control of the auditor, and the level of audit effort that the auditor expends on the engagement depends on the level of detection risk. c. When the risk of material misstatement is higher, detection risk is lower in order to reduce audit risk to an acceptable level. d. The auditor controls detection risk through the nature, timing, and extent of substantive audit procedures. e. All of the above are true.

All of the above are true.

When considering responses to risk at the individual assertion level, the auditor should do which of the following? a. Evaluate the reasons for the assessed risk of material misstatement. b. Estimate the likelihood of material misstatement due to the inherent risks of the client. c. Consider the role of internal controls and determine whether control risk is relatively high or low, thereby determining whether the auditor should rely on controls or whether the auditor needs to conduct a more substantive audit. d. Obtain more relevant and reliable audit evidence as the auditor's assessment of the risk of material misstatement increases. e. All of the above.

All of the above.

Which of the following are common brainstorming session guidelines? a. Freedom of expression. b. Respectful communication. c. Suspension of criticism. d. All of the above.

All of the above.

Which of the following characteristics would lead the auditor to assess control risk at a higher level? a. It is difficult for the auditor to determine or gain access to the organization or individuals who own and/or control the entity. b. The organization has inadequate accounting staff, or the staff lacks requisite expertise. c. There exists a lack of supervision of accounting personnel. d. The organization has inadequate information and communication systems. e. All of the above.

All of the above.

Which of the following statements represent the appropriate directional relationships between the concepts of inherent risk, control risk, audit risk, and detection risk? a. As inherent risk goes up, audit risk goes up. b. As inherent risk goes up, audit risk goes down. c. As control risk goes up, detection risk goes up. d. As control risk goes up, inherent risk goes down.

As inherent risk goes up, audit risk goes down.

Which of the following terms best describes the numerical depiction of the relationship between control risk, inherent risk, detection risk, and audit risk? a. Audit risk model. b. Risk of misstatement model. c. Significance model. d. Materiality equation.

Audit risk model.

Which of the following statements is true regarding the concept of materiality? a. Materiality is the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. b. Materiality is the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it possible that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. c. A fact is material if there is a substantial likelihood that the fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. d. Both (a) and (c) are correct. e. Both (b) and (c) are correct.

Both (a) and (c) are correct.

Which of the following would be a reason that industry and client data were not directly comparable? a. Broad industry. b. Use of different accounting principles. c. Neither of the above. d. Both A & B are correct.

Both A & B are correct.

Appropriateness addresses which aspect of audit procedures? a. Relevance. b. Reasoning. c. Reliability. d. Both A & C.

Both A & C

Which of the following is a reason a predecessor auditor can decline to reply to a firm's current auditor? a. Data is under court order. b. They must always respond. c. The client does not approve of confidential information being shared. d. Both A and C are correct.

Both A and C are correct.

Assume for Client X that inherent risk is assessed at 30%, control risk is assessed at 100%, audit risk is 5%, and detection risk is therefore determined to be 17%. Assume for Client Z that inherent risk is assessed at 100%, control risk is assessed at 100%, audit risk is 1%, and detection risk is therefore determined to be 1%. What is true about the amount of audit work that will need to be conducted? a. Client X will require more audit work than Client Z. b. Client Z will require more audit work than Client X. c. Both clients will require a similar amount of audit work. d. The auditor will most likely resign from the Client Z audit because the inherent risk and control risk are so high.

Client Z will require more audit work than Client X.

As the risk of material misstatement increases, what happens with detection risk? a. Medium increase. b. Stay the same. c. Decrease. d. Severely increase.

Decrease.

Which of the following terms best describes the risk that audit procedures will fail to detect misstatements exceeding tolerable misstatement? a. Audit risk. b. Control risk. c. Detection risk. d. Inherent risk.

Detection risk.

Which of the following statements is false regarding analytical procedures? a. Ratio analysis takes advantage of economic relationships between two or more accounts. b. Ratio and trend analysis are generally carried out through a comparison of client data with expectations based on industry data, prior-period data, and expectations developed from industry trends, client budgets, and so on. c. Developing expectations is not one of the steps in performing planning analytical procedures. d. All of the above are true.

Developing expectations is not one of the steps in performing planning analytical procedures.

What type of relationship exists between audit risk and detection risk? a. Direct. b. Inverse. c. Indirect. d. No relationship.

Direct.

In which of the following situations will auditors typically rely on internal controls over financial reporting? a. If control risk is assessed at a high level. b. If the controls are determined to be designed and operating effectively. c. If the clients asks the auditor to test controls. d. If the controls are sufficient to increase control risk to an acceptable level.

If the controls are determined to be designed and operating effectively.

If the auditor's assessment of audit risk is low (e.g., 1% rather than 5%), what is the effect on the amount of direct testing performed by the auditor? a. Increase in direct testing. b. Decrease in direct testing c. No change in direct testing. d. Direct testing is not needed.

Increase in direct testing.

An increase in the risk of material misstatement would lead to which of the following responses? a. Increase in the extent of auditing procedures. b. Decrease in the extent of auditing procedures. c. No change in the extent of auditing procedures. d. No change in the extent of audit procedures.

Increase in the extent of auditing procedures.

Which of the following statements is false? a. Inherent risk is inversely related to the level of control risk. b. Inherent risk is directly related to the amount of evidence required in account testing. c. Inherent risk is the susceptibility of the financial statements to material misstatement, assuming no internal controls. d. Inherent risk and control risk are assessed by the auditor and controlled by the client.

Inherent risk is inversely related to the level of control risk.

What is the auditor trying to accomplish by varying the timing of audit procedures from the prior year? a. Introduce unpredictability. b. Confuse the client. c. Gather information during different times of the year. d. Finish the audit sooner.

Introduce unpredictability.

What is the nature of the relationship between risk of material misstatement and audit risk? a. Direct. b. None. c. Correlational. d. Inverse.

Inverse

Which of the following is a factor that would cause an increase in the assessment of control risk? a. New products have uncertain likelihood of success b. Little interaction between senior management and operating staff c. A new business strategy is improperly implemented. d. The industry is mature and declining.

Little interaction between senior management and operating staff

Which of the following would be the likely risk results from using a 1% level of detection risk? a. High detection risk and low audit risk. b. High detection risk and high audit risk. c. Low detection risk and high audit risk. d. Low detection risk and low audit risk.

Low detection risk and low audit risk.

Which of the following terms best describes the types and appropriateness of audit procedures used? a. Nature of detection risk. b. Material misstatement risk. c. Nature of auditing procedures. d. Nature of risk response.

Nature of risk response.

Which of the following statements is true concerning the concept of performance materiality? a. Performance materiality is set less than overall materiality and helps the auditor determine the extent of audit evidence to obtain. b. If performance materiality is set too low, the auditor might not perform sufficient procedures to detect material misstatements in the financial statements. c. If performance materiality is set too high, the auditor might perform more substantive procedures than necessary. d. Performance materiality is essentially the same as overall materiality. e. All of the above are true.

Performance materiality is set less than overall materiality and helps the auditor determine the extent of audit evidence to obtain.

Which of the following approaches can be used to introduce unpredictability into the audit? a. Assessing high risk accounts. b. Performing procedures on an unannounced basis. c. Performing the audit in the same location each year. d. Selecting items that would normally be tested.

Performing procedures on an unannounced basis.

Which of the following are two frequently used preliminary analytical procedures? a. Reasonableness tests and economic analyses. b. Trend analyses and reasonableness tests. c. Ratio analyses and economic analyses. d. Ratio analyses and trend analyses.

Ratio analyses and trend analyses.

Which item is correct concerning the risk of material misstatement? a. Risk of material misstatement arises because audit procedures have been misapplied. b. Risk of material misstatement can be controlled and changed by the auditor. c. Risk of material misstatement must be assessed in non-quantitative terms. d. Risk of material misstatement is controllable by the client

Risk of material misstatement is controllable by the client

When an auditor chooses not to rely on a client's internal controls because the control design is ineffective, which of the following tests are eliminated? a. Substantive testing. b. Tests of controls. c. Tests of details of balances. d. Substantive analytical procedures.

Tests of controls.

Which of the following factors would lead an auditor to assess inherent risk at a higher level? a. The account balance is easily determined without estimation. b. The account balance is composed of a high v volume of nonroutine transactions. c. The account balance is composed of simple transactions. d. All of the above would lead the auditor to assess a higher level of inherent risk.

The account balance is composed of a high volume of nonroutine transactions

Assume that the auditor sets audit risk at a low level, equal to 1%. What is the appropriate interpretation of this level of audit risk? a. The auditor is willing to take only a 1% chance that audit procedures will not detect a material misstatement. b. The auditor is 99% confident that the audit procedures will detect a material misstatement. c. The auditor is willing to take only a 1% chance of expressing an audit opinion that the financial statements are fairly presented when they are materially misstated. d. The auditor is 99% confident that the audit opinion is correct.

The auditor is willing to take only a 1% chance of expressing an audit opinion that the financial statements are fairly presented when they are materially misstated.

Which of the following characteristics would lead the auditor to assess inherent risk at a higher level for financial reporting at the financial statement level? a. The account balance represents an asset that is relatively easily stolen. b. The controls over the account balance are weak. c. The company has a history of exactly meeting analyst estimates. d. The company is in an industry that is mature and declining.

The company has a history of exactly meeting analyst estimates.

Which of the following risk factors suggests a heightened level of risk of material misstatement? a. Having a stable product. b. The departure of key personnel of a company. c. Few immaterial related-party transactions. d. Declining a merger with another company.

The departure of key personnel of a company.

Which of the following factors will result in control risk being assessed at a higher level? a. Controls are well designed. b. There is a lack of supervision of accounting personnel. c. Accounting staff are well trained and educated. d. The control environment is operating effectively.

There is a lack of supervision of accounting personnel.

If materiality judgments change during the audit opinion formulation process, what happens to previous audit decisions that were based on the evidence obtained using the initial material setting? a. They need to be reassessed. b. They need to be noted in the footnotes. c. No action is required. d. None of the above.

They need to be reassessed

What is the main reason to establish guidelines for brainstorming sessions? a. To not hurt feelings. b. It is required by the SEC. c. To encourage interactive and constructive group dialogue and idea exchange. d. To pass information up to top-level management efficiently.

To encourage interactive and constructive group dialogue and idea exchange.

Which of the following statements is false regarding brainstorming? a. Brainstorming is an audit team discussion designed to encourage auditors to creatively assess client risks, particularly those relevant to the possible existence of fraud in an organization. b. Brainstorming predominantly occurs during the planning/risk assessment phase of the audit. c. To facilitate the generation and evaluation of quality ideas during the brainstorming session, a typical practice during brainstorming is to invite criticism and value judgments about ideas generated. d. Participants are encouraged to provide more ideas rather than fewer, with the intent to generate a variety of possible risk assessment scenarios that can be explored during the conduct of the audit. e. All of the above are true.

To facilitate the generation and evaluation of quality ideas during the brainstorming session, a typical practice during brainstorming is to invite criticism and value judgments about ideas generated.

Which of the following best describes the amount of misstatement an auditor is willing to accept and still judge that an account balance is not materially misstated? a. Tolerable misstatement. b. Performance materiality. c. A clearly trivial amount. d. Significant risk.

Tolerable misstatement

Which of the following best describes year-to-year comparisons of account balances? a. Time analyses. b. Reasonableness tests. c. Ratio analyses. d. Trend analyses.

Trend analyses.

Which of the following statements is true regarding the concept of control risk? a. When control risk is high, the auditor is concerned that a material misstatement may not be prevented, or that if a material misstatement exists in the organization's financial statements that it will not be detected, and therefore corrected by management. b. Some organizations have zero control risk because they have made a significant commitment to the effective design and operation of controls. c. Control risk relates to the susceptibility of an assertion to a misstatement, due to either error or fraud, before consideration of any related controls. d. All of the above are true.

When control risk is high, the auditor is concerned that a material misstatement may not be prevented, or that if a material misstatement exists in the organization's financial statements that it will not be detected, and therefore corrected by management.

Which of the following best describes what is meant by the timing of risk response? a. Where procedures are conducted. b. When procedures are conducted. c. How procedures are conducted. d. Who conducts the procedures.

When procedures are conducted.

Which of the following statements is false regarding the nature, timing, and extent of risk responses? a. The nature of risk response refers to the types of audit procedures applied given the nature of the account balance and the most relevant assertions regarding that account balance. b. The timing of risk response refers to when audit procedures are conducted. c. When the risk of material misstatement is low, the auditor conducts the audit procedures closer to year-end, on an unannounced basis, and includes more elements of unpredictability in the procedures. d. The extent of risk response refers to the sufficiency of evidence that is necessary given the client's assessed risks, materiality, and the acceptable level of audit risk.

When the risk of material misstatement is low, the auditor conducts the audit procedures closer to year-end, on an unannounced basis, and includes more elements of unpredictability in the procedures.