Chapter 4

Question 1

The existence of audit risk is recognized by the statement in the auditor’s standard report that the:
A) Auditor obtains reasonable assurance about whether the financial statements are free of material misstatements.
B) Auditor is responsible for expressing an opinion on the financial statements, which are the responsibility of management.
C) Financial statements are presented fairly, in all material respects, in conformity with GAAP.
D) Audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.

Answer 1

A) Auditor obtains reasonable assurance about whether the financial statements are free of material misstatements.

Question 2

Which of the following factors would an auditor least likely consider when assessing the inherent risk associated with sales transactions?
A) Billings are made using the percentage-of-completion method of revenue recognition.
B) The nature of the credit authorization process.
C) Some invoices are normally billed prior to shipments [which occur at a later date].
D) The conditions of the sale allow for a right of return or the right to modify the purchase agreement.

Answer 2

B) The nature of the credit authorization process.

Question 3

The risk that an auditor's procedures will lead to a conclusion that a material misstatement in an account balance does not exist when, in fact, a misstatement does exist, is known as:
        A)	Audit risk.
	B)	Detection risk.
	C)	Inherent risk.
	D)	Business risk.

Answer 3

B) Detection risk.

Question 4

One of your clients recently upgraded its accounting system from a medium-scale general ledger package to a complex state-of-the-art enterprise resource planning system. This installation took place over the last nine months of the entity’s fiscal year and is nearly 100% complete by the balance sheet date. Which of the following best describes the main affect of this event on the audit risk model for the current year?
A) It will likely increase the risk of material misstatement.
B) It will likely decrease the risk of material misstatement.
C) It will likely decrease the audit risk.
D) It will likely increase the detection risk.

Answer 4

A) It will likely increase the risk of material misstatement.

Question 5

Which of the following would be classified as an error?
A) Misinterpretation by management of facts that existed when the financial statements were prepared.
B) Misappropriation of assets for the benefit of management.
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.

Answer 5

A) Misinterpretation by management of facts that existed when the financial statements were prepared.

Question 6

Which of the following factors is least likely to represent an opportunity to commit fraud?
A) The audit committee is ineffective.
B) Poor internal controls over cash transactions.
C) The existence of highly complex transactions.
D) Operating losses make a hostile takeover imminent.

Answer 6

D) Operating losses make a hostile takeover imminent.

Question 7

he auditor obtains an understanding of the entity and its environment by performing all of the following assessment procedures except:

Answer 7

B) Compute the level of detection risk

Question 8

Which of the following statements is false as it relates to the auditor’s responsibility to document the risk assessment?
A) The documentation may include the use of questionnaires.
B) Management’s response to high-risk areas identified by the auditor should be included in the documentation.
C) The level of risk must be set quantitatively (i.e., inherent risk is 60%).
D) All of the above are false.

Answer 8

C) The level of risk must be set quantitatively (i.e., inherent risk is 60%).

Question 9

The disclosure of fraud to parties other than the entity’s senior management and its audit committee ordinarily would be precluded by the auditor’s ethical or legal obligations of confidentiality. However, the auditor has a duty to disclose the information to parties outside the entity in all of the following circumstances except:
A) A court subpoena in conjunction with a fraud investigation.
B) A successor auditor makes inquiries in determining whether to accept the engagement.
C) A Wall Street analyst inquiry regarding future profit projections.
D) To comply with legal or regulatory requirements.

Answer 9

C) A Wall Street analyst inquiry regarding future profit projections.

Question 10

Which of the following is not one of the three conditions that are generally present when fraud occurs?
	A)	Incentive or pressure.
	B)	Opportunity.
	C)	Rationalization or attitude.
	D)	Collusion.

Answer 10

D) Collusion.

Question 11

Audit risk is typically considered and assessed:
A) At the assertion level.
B) At the account balance level.
C) For the financial statements as a whole.
D) All of the above.

Answer 11

D) All of the above.

Question 12

If risk of material misstatement is higher than originally anticipated, the auditor may respond by:
	A)	Increasing supervision.
	B)	Reducing control risk.
	C)	Reducing inherent risk.
	D)	None of the above.

Answer 12

A) Increasing supervision.

Question 13

f the auditor determines that a material misstatement may be due to fraud, the auditor should do all of the following except:
A) Attempt to obtain evidence to determine whether the misstatement was, in fact, due to fraud.
B) Discuss the findings with an appropriate level of management.
C) Alert the authorities.
D) Suggest that management consult with legal counsel.

Answer 13

C) Alert the authorities.

Question 14

Which of the following represents a factual misstatement?
A) A misstatement that management knows about, but the auditor does not.
B) A misstatement found by the auditor that is due to incorrect pricing on a sales invoice.
C) A misstatement arising from the differences between the auditor’s estimate and management’s estimate of the allowance for doubtful accounts.
D) A misstatement based on an auditor’s projection of an error found in a sample.

Answer 14

B) A misstatement found by the auditor that is due to incorrect pricing on a sales invoice.

Question 15

If acceptable audit risk is set at low and the assessed risk of material misstatement is high, then detection risk must be:
A) High.
B) Moderate.
C) Low.
D) Cannot determine detection risk from the information given.

Answer 15

C) Low.

Question 16

2 major risks the auditor faces

Answer 16

1. engagement

2. audit risk

Question 17

Engagement Risk

Answer 17

the auditor’s exposure to loss or injury to professional practice from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on

Question 18

Audit risk

Answer 18

the risk that the auditor may issue an unqualified/unmodified opinion on materially misstated financial statements

Question 19

How does an auditor set audit risk?

Answer 19

With their professional judgement and along the auditing standard guidelines

Question 20

Audit risk level affects the:

Answer 20

scope of the audit, nature, timing, and extent of auditing procedures and evidence gathering

Question 21

Audit risk equation

Answer 21

AR = IR x CR x DR

Question 22

The susceptibility of an assertion to material misstatement, assuming no related internal controls

Answer 22

Inherent Risk

Question 23

_____ and ____ are assessed by the auditor when determining audit risk

Answer 23

inherent risk and control risk

Question 24

Accounts/instances with a high inherent risk

Answer 24

Goodwill, High balance account, accounts with estimations, non-routine transactions, application of new accounting standards, history of misstatement

Question 25

The risk that material misstatements will not be prevented or detected on a timely basis by the entity’s internal controls

Answer 25

Control Risk

Question 26

The risk that the auditor will not detect a material misstatement that exists in the financial statements

Answer 26

Detection risk

Question 27

Detection risk is composed of 2 risks or uncertainties:
1.
2.

Answer 27

1. Sampling risk: the sample does not represent the whole
2. Non-Sampling Risk: eg. innapropriet audit procedure, dailure to detect a missstatement with an appropriate procedure, misinterpretation of results

Question 28

Steps to use the audit risk model:

1. Set
2. Assess
3. Solve

Answer 28

1. Set a planned level of audit risk
2. Assess inherent and control risk
3. Solve the audit risk equation for the appropriate level of detection risk

Question 29

Audit risk model faucet figure order

Answer 29

1. inherent risk
2. control risk
3. detection risk
4. audit risk

Question 30

RMM (risk of material misstatement)

Answer 30

IR x CR

Question 31

Risk assessment procedures to obtain an understanding of the entity and its environment
1
2
3

Answer 31

1. inquires to management and others
2. analytical procedures
3. observation and inspection

Question 32

Which of the following concepts are pervasive in the application of GAAS particularly the standards of field work and reporting?
A. Internal control
B. Expected misstatement
C. Control risk
D. Materiality and audit risk

Answer 32

D. Materiality and audit risk

Question 33

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. Assess the accounting principles used and evaluates the overall financial statement presentation
C. Realizes that 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

Answer 33

A. Obtains reasonable assurance about whether the financial statements are free of material misstatement

Question 34

Risk of material misstatement refers to a combination of which two components of the audit risk model?
A. Audit risk and inherent risk
B. Audit risk and Control risk
C. Inherent risk and control risk
D. Control risk and detection risk

Answer 34

C. Inherent risk and control risk

Question 35

As lower acceptance 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 overreliance

Answer 35

A. Find smaller errors

Question 36

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

Answer 36

C. Management places substantial emphasis on meeting earnings projections

Question 37

Which of the following is a misappropriation of assets?
A. Classifying inventory held for resale as supplies
B. Investing cash and earning at a 3% rate of return as opposed to paying off a loan with an interest rate of 7%
C. An employee of a consumer electronics store steals 12 CD players
D. Management estimates bad debt expense as 2% of sales when it actually expects bad debts equal to 10%

Answer 37

C. An employee of a consumer electronics store steals 12 CD players

Question 38

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. Management’s attitudes toward regulatory authorities
D. Management’s attitude about hiring ethical employees

Answer 38

B. Whether management has any knowledge of fraud that has been perpetrated on or within the entity

Question 39

Which of the following is an example of fraudulent financial reporting?
A. Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales
B. An employee diverts customer payments to his personal use, concealing his actions by debiting an expense account thus overstating expenses
C. An employee steals inventory, and the shrinkage is recorded as a cost of goods sold
D. An employee borrows small tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense

Answer 39

A. Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales

Question 40

When is a duty to disclose fraud to parties other than the entity’s senior management and its audit committeee most likely to exist?
A. When the amount is material
B. When the fraud results from misappropriation of assets rather than fraudulent financial reporting
C. In reposnse to inquiries from a successor auditor
D. When a line manager rather than a lower-level employee commits the fraudulent act

Answer 40

C. In response to inquiries from a successor auditor

Question 41

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. Fruad with a material effect of the financial statements should be reported directly by the auditor to the SEC
C. Any requirement to disclose fraud outside the entity is the reposnsibility of management and not the auditor
D. The professional standards provide no requirements related to the communication fo fraud, but the auditor should use professional judegement

Answer 41

A. Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved