Chapter 4: Audit Planning ll

Question 1

Audit Risk

Answer 1

the auditor gives an opinion that the financial statements are fairly presented when they contain a significant error or fraud.

Question 2

What are the three stages in audit risk minimization?

Answer 2

1) identify accounts and related assertions most at risk of material misstatement. (inherent risk).
2) assessment of client’s system of internal controls (control risk).
3) auditor plans to undertake detailed testing of each identified account to the extent deemed necessary.

Question 3

Assertion

Answer 3

statements made by management about recognition, measurement, presentation, and disclosure of items in the financials statements.

Question 4

Risks are more significant when they involve:

Answer 4

• Fraud
• Transactions where subjectivity is involved
• Accounting estimates with high estimation uncertainty or complexity
• Complexity in data collection and/or processing
• Account balances or disclosures that involve complex interpretations
• Entity changes such as mergers and acquisitions

Question 5

Audit Risk Equation

Answer 5

AR = Inherent Risk x Control Risk x Detection Risk

Question 6

Inherent Risk

Answer 6

risk that a material misstatement could occur.

Question 7

Control Risk

Answer 7

risk that client’s system of internal controls will not prevent or detect such a material misstatement.

Question 8

Detection Risk

Answer 8

risk that the auditor’s testing procedures will not be effective in detecting a material misstatement, should there be one.

Question 9

Materiality

Answer 9

guides audit planning, testing, and assessment of information in the financial statements.

• Information is material if it impacts the decision-making process of users of the financial statements.
• Information could be considered material because of its qualitative or quantitative characteristics.

Question 10

What are the two quantitative materiality factors?

Answer 10

• magnitude of the item.
• express as percentage of relevant base figure.

Question 11

Five Qualitative Materiality Factors

Answer 11

• Fraud
• Non-compliance wit laws
• Related party transactions
• Change in accounting method
  -Change in operations

Question 12

Performance Materiality

Answer 12

an amount less than planning materiality, to reduce the likelihood that a misstatement in a particular account balance, class of transactions, or disclosures does not in total exceed overall materiality.

Question 13

Four Types of Common Analytical Procedures

Answer 13

1) Simple Comparisons
2) Trend Analysis (horizontal analysis)
3) Common-sized Analysis (vertical analysis)
4) Ratio Analysis

Question 14

Simple Comparisons

Answer 14

account balance with previous year, budget.

Question 15

Trend Analysis (horizontal analysis)

Answer 15

comparison of account balances over time. Select base year, restate all accounts in subsequent years as a % of that base.

Question 16

Common-sized Analysis (vertical analysis)

Answer 16

comparison of account balances to single line item. On balance sheet express each item as % of total assets and on Income Statement express each item as % of sales.

Question 17

Ratio Analysis

Answer 17

assesses relationship between various financial statement balances.

Question 18

Materiality Percentages

Answer 18

• 3-7% of normalized pre-tax profit.
• 1-3% of total assets.
• 3-5% of equity.
• 1-3% of revenues or expenditures.