Deck 6: Assessing Inherent Risk, and Other Specific Business Risks

Question 1

Which of the following actions cannot be taken by auditors to reduce audit risk?

A)Increase the amount of substantive testing of account balances at year-end.
B)Reduce the level of inherent risk.
C)Increase the use of analytical procedures.
D)Reduce the level of detection risk.

Answer 1

B

Question 2

If the auditor considers an illegal act to be sufficiently serious to warrant withdrawing from the engagement, the auditor should:

A)notify all parties who may rely upon the company's illegal act.
B)consult with legal counsel as to what other action, if any, should be taken.
C)return all incriminating evidence and working papers to the client's audit committee for follow-up.
D)contact the successor auditor to make the successor aware of the possible consequences of relying on management's representations.

Answer 2

B

Question 3

In general, material frauds perpetrated by which of the following people are most difficult to detect?

A)Internal auditor.
B)Keypunch operator.
C)Cashier.
D)Financial controller.

Answer 3

D

Question 4

With respect to illegal acts, the auditor's responsibility is to:

A)uncover all illegal acts.
B)design the audit to provide reasonable assurance of detecting illegal acts that are material to the financial report.
C)plan the audit to search for illegal acts that could be material to the financial report.
D)rely on the client's solicitor to identify illegal acts that should be disclosed.

Question 5

An auditor discovers a likely fraud during an audit, but concludes that the effect of the fraud is not sufficiently material to affect the auditor's opinion.The auditor should:

A)disclose the fraud to the appropriate level of the client's management.
B)disclose the fraud to appropriate authorities external to the client.
C)discuss with the client the additional audit procedures that will be needed to identify the exact amount of the fraud.
D)modify the audit program to include tests specifically designed to identify the fraud and its impact on the financial report.

Question 6

Which of the following situations does not represent an opportunity to commit fraud?

A)Significant related-party transactions exist.
B)The auditor's relationship with management is strained.
C)Management is dominated by a single person.
D)The financial report includes highly subjective estimates.

Question 7

Some account balances, such as those for foreign currency transactions, are the results of complex calculations.The susceptibility to material misstatements in these types of accounts is defined as:

A)detection risk.
B)audit risk.
C)sampling risk.
D)inherent risk.

Question 8

Which of the following inventory items is likely to have high inherent risk?

A)Internet computer software.
B)Steel.
C)Refrigerators.
D)Office furniture.

Question 9

If, as a result of auditing procedures, an auditor believes that a client may have committed illegal acts, which of the following actions should be taken immediately by the auditor?

A)Consult with the client's legal counsel and with the auditor's legal counsel to determine how the suspected illegal acts will be communicated to the shareholders.
B)Extend normal auditing procedures to ascertain whether the suspected illegal acts may have a material effect on the financial report.
C)Inquire of the client's management and consult with the client's legal counsel and/or other specialists, as necessary, to obtain an understanding of the nature of the acts and their possible effects on the financial report.
D)Notify the audit committee about the nature of the acts and request that they give guidance with respect to the approach to be taken by the auditor.

Question 10

Which of the following statements best describes the auditor's responsibility regarding the detection of fraud?

A)The auditor must extend auditing procedures to actively search for fraud.
B)The auditor is responsible for the failure to detect fraud only when an unmodified auditor's opinion is issued.
C)The auditor is responsible for fraud when such failure results from non-performance of procedures described in the engagement letter.
D)The auditor must plan the audit so as to have a reasonable expectation of discovering material fraud.

Question 11

When the auditor concludes, based on information obtained and, if necessary, consultation with legal advisers, that an illegal act has or is likely to have occurred, the auditor should:

A)express a qualified or adverse opinion, depending on materiality.
B)notify appropriate law enforcement agencies.
C)withdraw from the engagement.
D)consider the effect on the financial report as well as the implications for other aspects of the audit.

Question 12

ASA 240 (ISA 240) provides that the primary day-to-day responsibility for prevention of fraud rests with:

A)the internal auditor.
B)management.
C)the external auditor.
D)the audit committee.

Question 13

Which of the following statements is true?

A)The risk that material misstatement will not be prevented or detected on a timely basis by internal controls can be reduced to zero by effective control activities.
B)Cash is more susceptible to theft than an inventory of coal because it has a greater inherent risk.
C)Detection risk is a function of the efficiency of an auditing procedure.
D)The existing levels of inherent risk, control risk and detection risk can be changed at the discretion of the auditor.

Question 14

Which of the following factors would most likely increase an auditor's concern about the risk of fraudulent financial reporting?

A)Inability to generate cash flows from operations while reporting substantial earnings growth.
B)Management's lack of interest in increasing the entity's earnings trend.
C)Large amounts of liquid assets that are easily converted into cash.
D)Inability to borrow necessary capital without granting debt covenants.

Question 15

Your audit client, Red Roses Ltd, has a new management incentive scheme in place, with bonuses calculated on the basis of the increase in net profit over the previous year.The basis of the bonus will remain the same for the next three years.Your client has had a very poor year and there is no way this year that it will be able to meet its budget or last year's net profit.Which of the following represents a high inherent risk for this year?

A)Insufficient provisions.
B)Next year's expenses taken up this year.
C)Next year's sales incorrectly taken up this year.
D)Overstatement of debtors.

Question 16

Which of the following approaches should be part of an auditor's planning of the audit engagement?

A)Plan to search for fraud or errors that would have a material or immaterial effect on the financial report.
B)Plan to search for fraud or errors that would have a material effect on the financial report.
C)Plan to discover fraud or errors that are material.
D)Plan to discover fraud or errors that are either material or immaterial.

Question 17

Which of the following situations would be defined as fraud under the auditing standards?

A)Errors in the application of accounting principles.
B)Errors in the accounting data underlying the financial report.
C)Misinterpretation of facts that existed when the financial report was prepared.
D)Misappropriation of assets.

Question 18

The auditor is most likely to presume that a high risk of a fraud exists if:

A)the client is a multinational company that does business in numerous foreign countries.
B)the client does business with several related parties.
C)inadequate segregation of duties places an employee in a position to perpetrate and conceal thefts.
D)inadequate employee training results in lengthy IT exception reports each month.

Question 19

The primary factor that distinguishes error from fraud is:

A)whether the underlying cause of misstatement relates to the misapplication of accounting principles or to clerical processing.
B)whether the misstatement is perpetrated by an employee or by a member of management.
C)whether the underlying cause of a misstatement is intentional or unintentional.
D)whether the misstatement is concealed.

Question 20

The auditor can respond to an increased risk of fraud by taking all of the following actions except:

A)increasing professional scepticism.
B)assigning more experienced personnel to the audit.
C)increasing acceptable audit risk.
D)taking steps to obtain more reliable evidence.

Question 21

If an illegal act is discovered during the audit of a publicly-held company, the auditor should:

A)notify the regulatory authorities.
B)determine who was responsible for the illegal act.
C)intensify the audit.
D)report the act to high-level personnel within the client's organisation.

Question 22

The auditor's report covers the solvency statement in the:

A)directors' declaration.
B)chairperson's review.
C)directors' report.
D)None of the given answers are correct.

Question 23

Which of the following is not a characteristic of whistleblowing?

A)The disclosure is made in good faith.
B)The disclosure is made in the public interest.
C)The disclosure is made to earn a reward.
D)The whistleblower holds a reasonable belief that disclosure will allow stakeholders to determine that there has been misconduct.

Question 24

For a reporting entity that has participated in related-party transactions that are material, disclosure in the financial report should include:

A)the nature of the relationship and the terms and manner of settlement.
B)a summary of the transactions within major classifications.
C)a statement to the effect that a transaction was consummated on terms no less favourable than those that would have been obtained if the transaction had been with an unrelated party.
D)a reference to deficiencies in the entity's internal control.

Question 25

An example of a transaction that may be indicative of the existence of related parties is:

A)borrowing or lending at a rate of interest that equals the current market rate.
B)selling real estate at a price that is comparable to its appraised value.
C)making large loans with specified terms as to when or how the funds will be repaid.
D)exchanging property for similar property in a non-monetary transaction.

Question 26

Why is the auditor concerned about the appropriateness of the going concern assumption?

A)It may motivate management to misstate the financial report.
B)The auditor needs to audit the solvency statement in the directors' declaration
C)It may affect the appropriateness of the financial report.
D)All of the given answers are correct.

Question 27

The auditor should assess the risk that errors and fraud may cause the financial report to be materially misstated and, based on that assessment:

A)design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial report.
B)plan the audit to search for errors or fraud that could be material to the financial report.
C)perform the audit on the basis that errors or fraud are likely to cause a material misstatement of the financial report.
D)apply substantive tests to detect material misstatements except those perpetrated by means of forgery or collusion.

Question 28

An auditor finds evidence that warehouse staff are fraudulently claiming overtime.The auditor should:

A)further investigate the matter and report it to management when concrete evidence has been obtained.
B)report the matter to management in the year-end management letter.
C)report the matter to management immediately if the expected financial effect of the fraud is material.
D)report the matter to management immediately.

Question 29

The relevant period that the auditor needs to consider when assessing the appropriateness of the going concern assumption is:

A)up to the next balance date.
B)up to the expected date of the annual general meeting
C)up to the expected date of the date of the auditor's report on the following financial year.
D)None of the given answers are correct.

Question 30

An independent auditor finds that Baron Pty Ltd occupies office space, at no charge, in an office building owned by a shareholder of Baron Pty Ltd.This finding indicates the existence of:

A)management fraud.
B)related-party transactions.
C)window dressing.
D)weak internal controls.

Question 31

Which of the following conditions or events would be considered a mitigating factor in a going concern assessment?

A)Disposal of land held for redevelopment that was no longer required.
B)Obtaining a loan from a new financial institution.
C)Reducing the current year's dividend from the previous year's amount.
D)All of the given answers are correct.

Question 32

Earnings management includes:

A)intentional violations of accounting standards that are individually immaterial, but have the effect of increasing profit materially in aggregate.
B)inappropriate revenue recognition.
C)'big bath' charges that make poor results look even worse.
D)All of the given answers are correct.

Question 33

Which of the following audit procedures is most likely to identify doubts about the appropriateness of the going concern assumption?

A)Evaluating management's plans to restructure debt.
B)Reviewing compliance with the terms of loan agreements.
C)Considering management's plans to delay expenditure.
D)Reviewing management's plans to dispose of assets.

Question 34

Which of the audit procedures listed below would be least likely to disclose the existence of related-party transactions of a client during the period under audit?

A)Reading 'conflict-of-interest' statements obtained by the client from its management.
B)Scanning accounting records for large transactions at or just prior to the end of the period under audit.
C)Inspecting invoices from law firms.
D)Confirming large purchases and sales transactions with the major suppliers and/or customers involved.

Question 35

Which of the following conditions or events would most likely cause an auditor to have substantial doubt about an entity's ability to continue as a going concern?

A)Cash flows from operating activities are negative.
B)Research and development projects are postponed.
C)Significant related-party transactions are pervasive.
D)Share dividends have replaced annual cash dividends.