Deck 4: Risk Assessment

Question 1

The components of the audit risk model include inherent risk, control risk, and detection risk.

Answer 1

True

Question 2

The risk of material misstatement differs from detection risk in that it

A) Arises from the misapplication of auditing procedures.
B) May be assessed in either quantitative or qualitative terms.
C) Exists independently of the actions of the auditor.
D) Can be changed at the auditor's discretion.

Answer 2

C

Question 3

The combination of inherent risk and control risk is referred to as client risk.

Answer 3

True

Question 4

Which of the following is a factual misstatement?

A) A management estimate that is outside the range of reasonable outcomes determined by the auditor.
B) A fixed asset being recorded at the incorrect cost.
C) A projected misstatement resulting from errors found during sampling.
D) Difference in judgment between the auditor and management.

Question 5

All of the following are inherent risk factors that are pervasive to the financial statements except:

A) Highly complex significant transactions.
B) Non-routine transactions.
C) Classes of transactions are not processed systematically.
D) Supplies inventory is difficult to count.

Question 6

Which of the following characteristics most likely would heighten an auditor's 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 slow.

Question 7

The risk of a material misstatement includes inherent risk and sampling risk.

Question 8

The risk that an auditor will conclude, based on substantive procedures, that a material error does not exist in an account balance when, in fact, such an error does exist is referred to as

A) Sampling risk.
B) Detection risk.
C) Nonsampling risk.
D) Inherent risk.

Question 9

Engagement risk is

A) The risk of issuing an incorrect audit opinion.
B) The auditor's risk of loss from events arising in connection with financial statements audited and reported upon.
C) The overall risk of material misstatement.
D) The risk of the entity's financial failure.

Question 10

An auditor knows that an audit client operating in an industry in which common stock is valued based on the price-earnings ratio will soon make an initial public offering. All of the following are true except:

A) Materiality should be reduced.
B) Risk of material misstatement should increase.
C) Detection risk should decrease.
D) Audit risk should increase.

Question 11

Inherent risk is the susceptibility of an assertion to material misstatement, assuming no related controls.

Question 12

Engagement risk can be eliminated by

A) Establishing policies for client acceptance and continuance.
B) Lowering audit risk.
C) Lowering materiality.
D) Engagement risk cannot be eliminated.

Question 13

Inherent risk includes sampling risk and detection risk.

Question 14

Under Statements on Auditing Standards, which of the following would be classified as an error?

A) Misappropriation of assets for the benefit of management.
B) Misinterpretation by management of facts that existed when the financial statements were prepared.
C) Preparation of records by employees to cover a fraudulent scheme.
D) Intentional omission of the recording of a transaction to benefit a third party.

Question 15

Client risk as defined in the text is

A) The auditor's risk of loss from events arising in connection with financial statements audited and reported upon.
B) The overall risk of material misstatement.
C) The risk that audit procedures will fail to detect material misstatements.
D) The risk of the entity's financial failure.

Question 16

When assessing the risk of material misstatement, auditors evaluate the reasonableness of an entity's accounting estimates. An auditor normally would be concerned about assumptions that are

A) Susceptible to bias.
B) Consistent with prior periods.
C) Insensitive to variations.
D) Similar to industry guidelines.

Question 17

Audit risk is the auditor's exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited.

Question 18

Professional judgment must be used when evaluating business risk.

Question 19

Engagement risk is the auditor's exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited.

Question 20

The achieved (actual) level of audit risk

A) Can always be accurately assessed by the auditor.
B) Should be greater than or equal to acceptable audit risk.
C) Can never be known with certainty.
D) Is the same for all audit engagements.

Question 21

Which of the following is not an important consideration in an auditor's evaluation of an entity's business risk?

A) The specific business risks an entity faces that may result in financial statement errors and fraud.
B) Business risk factors that impact the ability of the entity to be profitable and survive.
C) Audit standards include many entity business risk factors that identify circumstances that increase the likelihood of material misstatements.
D) Audit standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability.

Question 22

The risk of material misstatement includes which of the following?

A) Detection risk.
B) Audit risk.
C) Inherent risk.
D) Nonsampling risk.

Question 23

An auditor learns that a client's employee in control of inventory gets divorced and is responsible for paying a large amount of child support. All of the following for the audit of inventory likely are true except:

A) Fraud risk increases.
B) The risk of misappropriation of assets increases.
C) Risk of material misstatement increases.
D) Detection risk increases.

Question 24

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

A) Heavily emphasizing the importance of professional skepticism.
B) Assigning more experienced personnel to the audit.
C) Increasing detection risk.
D) Taking steps to obtain more reliable evidence.

Question 25

When an auditor increases the assessed level of risk of material misstatement because certain control procedures were determined to be ineffective, the auditor would most likely increase the

A) Extent of tests of controls.
B)Level of detection risk.
C)Extent of substantive tests.
D)Level of inherent risk.

Question 26

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

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 statements.

Question 27

As the acceptable level of detection risk decreases, an auditor may change the

A) Timing of tests of controls by performing them at an interim date rather than at year-end.
B) Nature of substantive procedures from less effective to more effective procedures.
C) Timing of tests of controls by performing them at several dates rather than at one time.
D) Assessed level of risk of material misstatement to a higher amount.

Question 28

When an entity moves into a significant new line of business, all of the following increase except:

A) Client risk.
B) Acceptable audit risk.
C) Risk of material misstatement.
D) Entity business risk.

Question 29

Which of the following is a source of detection risk?

A) Unstable business environment.
B) Poor client controls.
C) A nonrepresentative sample.
D) Inherent risk assessed too high.

Question 30

Increased fraud risk could result in all of the following except:

A) Lower detection risk.
B) Higher inherent risk.
C) Lower control risk.
D) Higher client risk.

Question 31

As the acceptable level of detection risk decreases, the assurance directly provided from

A) Substantive procedures should increase.
B) Substantive procedures should decrease.
C) Tests of controls should increase.
D) Tests of controls should decrease.

Question 32

Which of the following audit risk components may be assessed in qualitative terms?

A) Risk of material misstatement.
B) Detection risk.
C) Neither risk of material misstatement nor detection risk.
D) Both risk of material misstatement and detection risk.

Question 33

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

A) Internal audit function.
B) Keypunch operator.
C) Cashier.
D) Controller.

Question 34

All of the following represent an increased opportunity for management to commit fraud except:

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

Question 35

Which of the following is not a misstatement of the financial statements?

A) The entity uses different inventory accounting methods for internal and external reporting.
B) A departure from GAAP.
C) The footnote for pensions is omitted.
D) A clerk incorrectly based the allowance for doubtful accounts on 31% of sales as opposed to 13% of sales as determined by the controller.

Question 36

The acceptable level of detection risk is inversely related to the

A) Extent of the substantive procedures.
B) Risk of misapplying auditing procedures.
C) Overall materiality.
D) Risk of failing to discover material misstatements.

Question 37

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of risk of material misstatement from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would

A) Decrease amount of substantive testing.
B) Decrease detection risk.
C) Increase detection risk.
D) Increase materiality levels.

Question 38

Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity's financial statements?

A) Accounts receivable confirmation requests yield significantly fewer responses than expected.
B) Audit trails of computer-generated transactions exist only for a short time.
C) The chief financial officer does not sign the management representation letter until the last day of the auditor's fieldwork.
D) Management consults with other accountants about significant accounting matters.

Question 39

Which of the following procedures would not be used to obtain an understanding of the entity and its environment?

A) Observe entity operations.
B) Reperform entity processes.
C) Verify proper valuation of inventory subject to technological obsolescence.
D) Review prior year's audit documentation.

Question 40

The primary responsibility for preventing fraud in an organization lies with

A) The audit committee of the board of directors.
B) The internal audit function.
C) The external auditor.
D) The organization's management.

Question 41

You are teaching a class of new hires at your international accounting firm. Explain the audit risk model using a mathematical formula.

Question 42

Which of the following 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 Securities and Exchange Commission.
C) Any requirement 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 judgment in determining communication responsibilities.

Question 43

In one sentence each, define misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets.

Question 44

Your classmate asserts, "Accountants shouldn't need to take business courses besides accounting, because they are only interested in the financial statements of a company." Defend or refute this statement.

Question 45

The objectives of the engagement partner's communication with the audit team include

A) Maintaining an adversarial atmosphere between the auditor and management.
B) Complying with SEC rules.
C) Complying with FASB rules.
D) Emphasizing the importance of professional skepticism.

Question 46

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

A) The entity is a multinational company that does business in numerous foreign countries.
B) The entity does business with several related parties.
C) Inadequate segregation of duties places an employee in a position to perpetrate and conceal theft.
D) Inadequate employee training results in lengthy EDP exception reports each month.

Question 47

Assume that you are the new audit senior on the LV Drug Corporation (LVD) engagement. LVD is a pharmaceutical company that has three successful drugs and a number of drugs in progress in its research and development pipeline. You are considering your audit plan and it is important to identify the inherent risks that LVD has and how they relate to the planning process.
Required:
For each of the following factors, indicate whether it will tend to increase, decrease, or have no effect on inherent risk, and the reasoning for your answer.
a. Dr. Jones is the major shareholder of LVD and its CEO.
b. Your firm has audited LVD for the last four years.
c. There has been high turnover of key accounting personnel during the last two years.
d. The internal audit function reports to the audit committee.
e. LVD has been the subject of lawsuits by users of Framadon who claim that the drug affects their liver functions. LVD is confident that there are no such side effects from the use of Framadon.

Question 48

Stacey, the partner in charge of the audit of RIF Enterprises, sets the planned level of audit risk for the audit of accounts payable at .06. The risk of material misstatement is assessed at .65. What is the detection risk for this audit?

Question 49

A properly planned and performed audit may fail to detect a material misstatement resulting from fraud because

A) Audit procedures that are otherwise effective may be ineffective for fraud that is concealed through collusion.
B) An audit is planned and performed to provide reasonable assurance of detecting material misstatements caused by errors but not by fraud.
C) The factors considered in assessing control risk indicated an increased risk of error but only a low risk of fraud in the financial statements.
D) The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole.

Question 50

During the course of the audit of FF Financial, you find that some accounting entries have been altered. You believe this may be the result of management fraud and you have determined that the effect of this could be material to the financial statements. What steps should you take in response to the accounting entries and your concern about management fraud?

Question 51

You are the senior on an audit of Two Be Gone, a large public company. The company recently completed an acquisition of its fifth largest competitor. What risks might this present? How will you, the auditor, respond to these risks (i.e. what actions should you take)?

Question 52

What is the difference between audit risk and engagement risk?

Question 53

Which of the following factors most likely would heighten 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 54

Using the audit risk model, identify the relationship between the following elements. For each of the items below, highlight whether the two elements have an inverse relationship, a direct relationship, or no relationship. When considering each item, assume that the other components of the risk model remain constant.

Question 55

DATRIX, Inc., a Fortune 500 company, has been experiencing poor performance. Industry analysts have been issuing negative reports and the company's stock price has been steadily declining. As an auditor, what would concern you about the audit engagement of DATRIX, Inc.