Deck 6: Assessing Risks in an Audit Engagement

Question 1

Quality of earnings refers to ________.

A) the accuracy of the net income calculation
B) a company's ability to continue earning at its current level
C) how closely earnings per share agree to analyst predictions
D) the percentage of net income to total revenue

Answer 1

B

Question 2

Business processes cross boundaries between functional areas of an organization. Business process management systems have been facilitated by _______.

A) management information systems
B) enterprise resource planning systems
C) database management systems
D) Web-based application systems

Answer 2

B

Question 3

Theoretically, when assessing the inherent risk related to an account balance, an auditor does not explicitly consider the ________.

A) liquidity of the account
B) management estimates involved in determining the account balance
C) internal control policies and procedures
D) complexity of calculations involved

Answer 3

C

Question 4

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk 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 substantive testing
B) decrease detection risk
C) increase inherent risk
D) increase materiality levels

Question 5

After obtaining an understanding of the internal control system and assessing control risk, an auditor decided not to perform additional tests of controls. The auditor most likely concluded that ________.

A) the additional evidence to support a further reduction in control risk was not cost-beneficial
B) the assessed level of inherent risk exceeded the assessed level of control risk
C) the internal control system was properly designed and justifiably may be relied on
D) the evidence obtainable through tests of controls would not support an increased level of control risk

Question 6

What is inherent risk?

A) The probability that some accounts are more susceptible to misstatement than others.
B) The probability that the client's internal control policies and procedures will fail to detect material misstatements.
C) The probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements.
D) The probability that the auditor may not detect material misstatements in the financial statements.

Question 7

Three key management assertions about items on the balance sheet are ________.

A) occurrence, completeness, and accuracy
B) classification, existence, and cut-off
C) confirmation, presentation, and disclosure
D) existence, completeness, and presentation

Question 8

The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when, in fact, such misstatement actually does exist is ________.

A) audit risk
B) inherent risk
C) control risk
D) detection risk

Question 9

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

A) extent of tests of details
B) level of inherent risk
C) extent of tests of controls
D) level of detection risk

Question 10

What is the definition of business risk?

A) An event or action that will make it more difficult for an organization to achieve its objectives.
B) An event or action that causes an organization to become bankrupt.
C) An event or action that causes an organization's financial statements to be materially incorrect.
D) Unfortunate events or actions that are common to all businesses in the economy.

Question 11

The business process view also highlights the fact that business organizations ________.

A) differ in terms of the technology they use
B) essentially all perform the same activities
C) should simplify their business to follow clear rules
D) work best when run as a hierarchy

Question 12

The probability that an auditor will give an inappropriate opinion on the financial statements best describes ________.

A) audit risk
B) inherent risk
C) control risk
D) detection risk

Question 13

An auditor begins the identification of business risks by doing what?

A) Preliminary analysis.
B) Financial analysis.
C) Strategic analysis.
D) Horizontal analysis.

Question 14

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the ________.

A) factors that raise doubts about the auditability of the financial statements
B) operating effectiveness of internal control policies and procedures
C) risk that material misstatements exist in the financial statements
D) possibility that the nature and extent of substantive tests may be reduced

Question 15

If control risk increases and all other risks in the audit risk model stay constant (except the one referred to below), which of the following is correct?

A) Detection risk must increase.
B) Inherent risk will increase.
C) Audit risk will decrease.
D) Detection risk must decrease.

Question 16

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 misstatement
B) assesses the accounting principles used and also evaluates the overall financial statement presentation
C) realizes some matters, either individually or in the aggregate, 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

Question 17

Inherent risk and control risk differ from detection risk in that they ________.

A) arise from the misapplication of auditing procedures
B) may be assessed in either quantitative or non-quantitative terms
C) exist independently of the financial statement audit
D) can be changed at the auditor's discretion

Question 18

The valuation assertion includes ________.

A) the measurement assumption used
B) ensuring all inventory is counted
C) making sure that all receivables relate to sales during the year
D) the method of presenting short-term and long-term liabilities

Question 19

The audit objective specifying that "all recorded assets, liabilities, and transactions represent real assets, liabilities, revenues, and expenses" is related most closely to which assertion(s)?

A) Existence or occurrence.
B) Rights and obligations.
C) Completeness.
D) Presentation and disclosure.

Question 20

The acceptable level of detection risk is inversely related to the ________.

A) assurance provided by substantive tests
B) risk of misapplying auditing procedures
C) preliminary judgment about materiality levels
D) risk of failing to discover material misstatements

Question 21

Decisions involving the proper application of GAAP primarily involve which management assertion? Give some examples.

Question 22

The audit objective related to existence is to obtain evidence that the asset, liability or equity exists physically or legally.

Question 23

Control risk is the probability that audit procedures will fail to detect material misstatements in the financial statements.

Question 24

There are two parts to business risk analysis: process analysis and industry analysis.

Question 25

Audit risk is the probability that an auditor will give an inappropriate opinion on financial statements.

Question 26

As control risk gets smaller, audit risk gets larger, assuming all other risks stay constant.

Question 27

Give some examples of cut off errors and explain what management assertions are affected by such errors.

Question 28

Detection risk is the probability that audit procedures will produce evidence of material misstatements.

Question 29

One way to think of an accounting process is as a cycle. The idea of a cycle reflects that ________.

A) transactions have to undergo a series of procedures before being recorded in the accounts
B) transactions are not complete until they are recorded
C) there is a set of accounts that record transaction information from the same business process
D) every business process results in the start of another process

Question 30

An auditor might suspect that the auditee is in financial difficulty if ________.

A) the auditee offers more generous customer credit terms
B) the auditee takes a large bank loan at market rates
C) sales increase and inventory increases
D) purchases increase and payables increase

Question 31

A completeness error occurs when an account balance is overstated.

Question 32

Define control risk.

Question 33

Auditors find it easier to audit related accounts instead of attacking each account on its own.

Question 34

Risk should not be tolerated on a cost-benefit basis.

Question 35

An organization with a very hierarchical structure is typical of companies in complex business environments as this structure reduces the ability of a junior employee to make a wrong decision.

Question 36

Business processes can be thought of as a structured set of activities within an entity.

Question 37

An auditor examines an organization's strategy to determine its objectives. After assessing whether the strategy is guiding the whole operation, what steps will the auditor take next? What key management assertion can be affected by any weakness in the strategy?

Question 38

Auditors do not create or control inherent risk; they can only try to assess its magnitude.

Question 39

Generally accepted auditing standards permit auditors to place complete reliance on internal control (zero control risk assessment) to justify the exclusion of substantive audit procedures for a balance sheet or income statement account.

Question 40

An auditor considers two factors in understanding business risks. What are they?

A) The likelihood of a risk occurring and the materiality of the risk.
B) The magnitude of the risk and the type of risk.
C) The likelihood of the risk occurring and the type of risk.
D) The likelihood of a risk occurring and the magnitude the risk.

Question 41

Discuss four ways of managing risk in an organization.

Question 42

Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Explain your answer using the audit risk model.