Chapter 4 Flashcards
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.
A) Auditor obtains reasonable assurance about whether the financial statements are free of material misstatements.
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.
B) The nature of the credit authorization process.
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.B) Detection risk.
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.
A) It will likely increase the risk of material misstatement.
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.
A) Misinterpretation by management of facts that existed when the financial statements were prepared.
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.
D) Operating losses make a hostile takeover imminent.
he auditor obtains an understanding of the entity and its environment by performing all of the following assessment procedures except:
B) Compute the level of detection risk
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.
C) The level of risk must be set quantitatively (i.e., inherent risk is 60%).
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.
C) A Wall Street analyst inquiry regarding future profit projections.
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.
D) Collusion.
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.
D) All of the above.
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.
A) Increasing supervision.
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.
C) Alert the authorities.
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.
B) A misstatement found by the auditor that is due to incorrect pricing on a sales invoice.
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.
C) Low.
2 major risks the auditor faces
- engagement
2. audit risk
Engagement Risk
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
Audit risk
the risk that the auditor may issue an unqualified/unmodified opinion on materially misstated financial statements
How does an auditor set audit risk?
With their professional judgement and along the auditing standard guidelines
Audit risk level affects the:
scope of the audit, nature, timing, and extent of auditing procedures and evidence gathering
Audit risk equation
AR = IR x CR x DR
The susceptibility of an assertion to material misstatement, assuming no related internal controls
Inherent Risk
_____ and ____ are assessed by the auditor when determining audit risk
inherent risk and control risk
Accounts/instances with a high inherent risk
Goodwill, High balance account, accounts with estimations, non-routine transactions, application of new accounting standards, history of misstatement
The risk that material misstatements will not be prevented or detected on a timely basis by the entity’s internal controls
Control Risk
The risk that the auditor will not detect a material misstatement that exists in the financial statements
Detection risk
Detection risk is composed of 2 risks or uncertainties:
1.
2.
- Sampling risk: the sample does not represent the whole
- Non-Sampling Risk: eg. innapropriet audit procedure, dailure to detect a missstatement with an appropriate procedure, misinterpretation of results
Steps to use the audit risk model:
- Set
- Assess
- Solve
- Set a planned level of audit risk
- Assess inherent and control risk
- Solve the audit risk equation for the appropriate level of detection risk
Audit risk model faucet figure order
- inherent risk
- control risk
- detection risk
- audit risk
RMM (risk of material misstatement)
IR x CR
Risk assessment procedures to obtain an understanding of the entity and its environment
1
2
3
- inquires to management and others
- analytical procedures
- observation and inspection
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
D. Materiality and audit risk
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
A. Obtains reasonable assurance about whether the financial statements are free of material misstatement
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
C. Inherent risk and control risk
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
A. Find smaller errors
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
C. Management places substantial emphasis on meeting earnings projections
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%
C. An employee of a consumer electronics store steals 12 CD players
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
B. Whether management has any knowledge of fraud that has been perpetrated on or within the entity
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
A. Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales
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
C. In response to inquiries from a successor auditor
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
A. Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved
