Chapter 4 audit review

The confidence level desired considers _______________ ______________ which is an auditor's exposure to financial loss and/or damage to his reputation from taking on a client

engagement risk

auditor obtains an understanding of the entity and its environment by performing risk assessment procedures such as

inquires of management, other entity personnel, others outside the entity, observation and inspection

the risk of material misstatement( client risk) is the combination of what?

inherent risk and control risk

how we address quality of audit evidence to be gathered?

careful planning and scheduling of tests tests performed by experienced personnel rather than inexperienced careful supervision during testing strictly adhering to the audit firms quality control measures

when is a duty to disclose fraud to parties other than the entity's senior management and its audit committee most likely to exist?

- in response to inquiries from a successor auditor -to comply with certain legal and regulatory requirements -response to subpoena -funding agency or other specified agency in accordance with requirements for the audits of entities that receive governmental financial assistance

1. client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly 2. cash is more susceptible to theft than an inventory of coal 3. confirmation of receivables by an auditor fails to detect a material misstatements 4. disbursements have occurred without proper approval 5. there is an inadequate segregation of duties 6. a necessary substantive audit procedure is omitted 7. notes rec are susceptible to material misstatement assuming there are no related controls 8. technological developments make major product obsolete 9. client is very close to violating debt covenants 10. xxx company a client lacks sufficient working capital to continue operations

1. CR 2. IR 3. DR 4. CR 5. CR 6. DR 7. IR 8. IR 9. IR 10. IR

match the following terms: 1. audit risk 2.inherent risk 3. control risk 4.detection risk 5.risk of material misstatement 6.engagement risk 7.business risk a. the susceptibility of an assertion to material misstatement, assuming no related internal controls b. the risk that the auditor may unknowingly fail to appropriately modify his opinion on financial statements that are materially misstated c. the risk that material misstatements that could occur will not be prevented or detected by the internal controls d. is the risk that the auditor will not detect a material misstatement that exists in the financial statements. e.a combination of IR x CR. The risk that the F/S are materially misstated prior to the audit. f. threats to the entity's ability to achieve its objectives and execute its strategies. g. an auditor's exposure to financial loss and/or damage to his reputation from taking on a client

1. b 2. a 3. c 4. d 5. e 6. g 7. f

1. AR : very low RMM: high DR: ??? 2. AR: low RMM: moderate DR:?? 3. AR:low RMM: low DR:??

1. low 2. moderate 3. high

bob inc is a fast growing company operating in the SE part of US. the company is publicly held but bob and his sons control 55% of the stock. bob is chariman of the board and CEO. he personally makes all major decisions with little consultation with the board of directors. most of the directors are either family members of the bob family or friends. the board basically rubber stamps bobs decisions explain how risk of material misstatement should be assessed and what effect that assessment will have on detection risk.

1. you have one person making with majority of the stock making most of the decisions. this will cause RMM to be high because there is no review of important decisions and the actions bob could take will not be in the best interest of the stockholders or the company. 2. the rapid expansion may result to material misstatements since decision making may become decentralized without solid internal control 3. the high RMM will result in a lower detection risk will result in an increase of the scope of the auditors work

The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor a. obtains reasonable assurance about whether the financial statements are free of material missatement b. assesses the accounting principles used and evaluates the overall financial statement presentation c. realizes that some matters are important while other matters are not important d. is responsible for expressing an opinion on the financial statements which are the responsibility of management

A

auditor sets AR at .05 and sets RMM for accounts receivable at .60. what should the detection risk be for testing the accounts receivable balance?

AR= RMM x DR .05= .6DR solve for DR so DR is .08

As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to a. find smaller errors b. find larger errors c. increase the tolerable misstatements in the accounts d. decrease the risk of over reliance

a

which is correct concerning required 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 involved b. fraud with a material effect on the financial statements should be reported directly by the auditor to the SEC c. any requirements to disclose fraud outside the entity is the responsibility of management and not that of the auditor d. the professional standards provide no requirements related to the communication of fraud, but the auditor should use professional judgement in determining communication reprehensibility

a. b would be correct if it didn't say sec. the auditor would report it the audit committee

auditing standards require auditors to make certain inquiries of management regarding fraud. which of the following inquiries is required? a. whether management has ever intentionally violated the securities law b. whether management has any knowledge of fraud that has been perpetrated on or within the entity c. managements attitudes toward regulatory authorities d. managements attitude about hiring ethical employees

b

which of the following characteristics most likely would heighten an auditors concern about the risk of intentional manipulation of financial statements? a. turnover of senior accounting personnel is low b. insiders recently purchased additional shares of the entity's stock c. management places substantial emphasis on meeting earnings projections d. the rate of change in the entity's industry is low

c

Which of the following is NOT one of the 3 conditions that are generally present when fraud occurs A.Incentive or pressure B.Opportunity C.Business Risk D.Rationalization or attitude

c.

4-23 question cont explain how IR CR and DR are interrelated?

detection risk has an inverse relationship to IR and CR IR and CR differ from detection risk in that they exist independently of the audit of financial statements whereas DR relates to the auditors procedures and can be changed when the auditor wants to change it

The risk of material misstatement includes inherent risk and sampling risk. true or false

false it is CR and IR

example of misappropriation of assets would be classifying inventory held for resale as supplies. true or false

false it would be an employee steals 12 CD players

nature refers to when the evidence timing refers to the type of evidence extent refers to how much of the type of evidence will be gathered true or false

false: nature is the type and timing is when

fraud triangle consists of

incentive opportunity rationalization

4-23 question define audit risk:

is the risk that the auditory will provide an incorrect audit opinion when the financial statements are materially misstated

consideration of audit risk at the assertion level means that the auditor must consider the risk that he or she will conclude that an assertion for a particular account balance or a particular disclosure is fairly stated when in fact is it what?

it could be materially misstated. meaning that there could be an error within the assertion made by management.

how do we address quantity of audit evidence to be gathered?

larger samples which reduces sampling risk including multiple tests of an assertion

inherent risk and control risk are high the auditor will set a _______ level of detection in order to achieve the planned level of audit risk

lower level because DR and RMM are inverse of each other. so if RMM ( IR x CR) are low then the audit will set a higher level of detection risk because there is a low likelihood that a material misstatement exists

which of the following concepts are pervasive in the application of auditing standards? internal controls expected misstatements control risk maertiality and audit risk

materiality and audit risk

financial statement level risk are pervasive risks that is they apply to

multiple components of the financial statements

auditors understanding of the entity and its environment includes knowledge about industry and other external factors objectives strategies and related business risks what else?

nature of the entity and internal control. in obtaining knowledge about each of these categories the auditor should be particularly alert for the conditions and events that my indicate the existence of business risks

audit risk at the assertion level contains what potential risks related to the financial statements?

risk of material misstatement: risk that the assertions contain misstatements that could be material to the statements detection risk: the risk that the auditor will not detect such misstatements

the steps that are involved in the auditors use of the audit risk model at assertion level are :

setting a planned level of audit risk assessing the risk of material misstatement determine the level of detection risk

detection risk is the risk that the auditor will not detect what in the financial statements?

that he wont detect a material misstatement

DR : 25% DR:10% DR:67% DR: 25% Which client will require the most substantive testing? which client will require the least substantive testing?

the DR of 10% will require the most substantive testing the DR of 67% will require the least substantive testing inverse relationship

inherent risk and control risk are assessed by who?

the auditor. they are also referred to as auditee or client risk because the auditor cannot change or control these risks

an 8% detection risk for accounts rec means what?

there is only an 8% chance that a material misstatement if present is not detected.

Auditor's Risk Assessment Process starts with performing risk assessment procedures such as inquires of management, observation or inspection. performing this risk assessment helps the auditor obtain an understanding of the entity and its environment. obtaining undestanding of the entity gives the auditor insight to the nature of the entity, the industry and external factos, the companies objectives, strategies, and also their business risks, and understanding of their internal controls. after this they identify the business risks that may result in material misstatements in the financial statements. the auditor then evaluates the entitys risk assessment process to those business risks and obtains evidence of its implementation. at the end they assess the risk of material misstatement at the financial statement and assertion levels. which then this formula comes into play AR= RMM x DR

true

RMM x DR= audit risk true or false

true

audit risk is the combination of these components: the entity's financial statements contain material misstatements and that the auditor fails to detect those material misstatements. true or false

true

engagement risk cannot be directly controlled by the auditor but there is some control that can be exercised if you are careful with the acceptance and continuance of clients true or false

true

example of fraudulent reporting would be company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales

true

misappropriation of assets involve the theft of asserts where the theft causes the financial statements to be misstated.

true

low DR implies that the auditor will conduct a more careful investigation of the account high DR implies that the auditor will gather less evidence true or false

true: the RMM is high if DR is low because this means that there is a high risk of material misstatement that was not prevented or detected by the internal control system so that means the auditor must spend more time being thorough in his investigation.

chase bank has been your client for the past 2 years. during that period you have had numerous arguments with the president and the controller over a number of accounting issues. the major issue has related to the banks reserve for a loan losses and the value of collateral. your prior audits have indicated that a significant adj is required each year to the loan loss reserves explain how risk of material misstatement should be assessed and what effect that assessment will have on detection risk.

•the audit firm has been the bank's auditors for only two years. •there have been contentious accounting issues related to loan loss reserves and the value of collateral. •prior audits have indicated the presence of misstatements in the loan loss reserve. •Based on these risk factors which increase RMM, detection risk will be lower and increased substantive tests performed.

maxiwrite corp is one of several companies engaged in the manufacture of high speed high capacity data storage devices. the industry is very competitive and subject to quick change in technology. maxiwrite operating results would place the company in the 2nd quartile in terms of profitability and financial position. the company has never been the leader in the industry with its product typically slightly behind the industry leaders in terms of performance. explain how risk of material misstatement should be assessed and what effect that assessment will have on detection risk.

•the industry is very competitive, which can lead to price-cutting and its related effects on revenues. •the industry is affected by changes in technology, and MaxiWrite is not one of the industry leaders in technology. Its products usually are not competitive with the industry leaders in terms of performance. •the company is not as profitable or financially strong as the major companies in the industry. •These industry factors result in an increased assessment of the risk of material misstatement for MaxiWrite Corporation, leading to a lower detection risk and more substantive tests.