Chapter 7 [Planning the Audit: Identifying, Assessing, and Responding to the Risk of Material Misstatement]

Question 1

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

Answer 1

Audit risk

Question 2

A conceptual depiction of the relationship between inherent risk, control risk, detection risk, and audit risk.

Answer 2

Audit risk model

Question 3

See engagement risk

Answer 3

Auditor business risk

Question 4

Such a misstatement occurs when,
during the audit, the auditor comes to find that there exists an error in the recording of a particular transaction, regardless of whether it was intentional or unintentional.

Answer 4

Auditor-detected misstatement

Question 5

A group discussion designed to encourage auditors to creatively assess client risks, particularly those relevant to the possible existence of fraud in the organization.

Answer 5

Brainstorming

Question 6

Risks affecting the business operations and potential outcomes of an organization’s activities.

Answer 6

Client business risk

Question 7

The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Answer 7

Control risk

Question 8

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Answer 8

Detection risk

Question 9

This risk reflects the potential for loss to the auditor that the client poses, including being a publicly traded client, not being a profitable engagement, damaging the auditor’s reputation, and/or potential litigation relating to the engagement.

Answer 9

Engagement risk (also known as auditor business risk)

Question 10

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Answer 10

Extent of risk response

Question 11

Locations that are financially significant to the client’s financial statements overall.

Answer 11

Individually important locations

Question 12

The susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Answer 12

Inherent risk

Question 13

The magnitude of an omission or misstatement of accounting information that, in view of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.

Answer 13

Materiality

Question 14

An error, either intentional or unintentional, that exists in a transaction or financial statement account balance.

Answer 14

Misstatement

Question 15

The types of audit procedures applied given the nature of the account balance and the most relevant assertions regarding that account balance.

Answer 15

Nature of risk response

Question 16

A materiality level that the auditor uses in determining whether the financial statements overall are materially correct.

Answer 16

Overall materiality (also known as planning materiality)

Question 17

A materiality level that the auditor uses for determining significant accounts, significant locations, and audit procedures for those accounts and locations

Answer 17

Performance materiality (also known as tolerable error)

Question 18

A materiality level that the auditor uses in determining whether the financial statements overall are materially correct

Answer 18

Planning materiality (also known as overall materiality

Question 19

A materiality level that signifies the misstatements identified throughout the audit that will be considered at the end of the audit in determining whether the financial statements overall are materially correct.

Answer 19

Posting materiality

Question 20

An analytical technique that is useful in identifying significant differences between the client results and a norm (such as industry ratios) or between auditor expectations and actual results; ______________ is also useful in identifying potential audit problems that may be found in ratio changes between years.

Answer 20

Ratio analysis

Question 21

Risk that exists at the overall financial statement level and at the assertion level, and within these levels risk can be categorized as involving inherent risk and control risk.

Answer 21

Risk of material misstatement

Question 22

An identified and assessed risk of material misstatement that, in the auditor’s professional judgment, requires special consideration.

Answer 22

Significant risk

Question 23

Refers to when audit procedures are conducted and whether those procedures are conducted at announced or predictable times.

Answer 23

Timing of risk response

Question 24

A materiality level that the auditor uses for determining significant accounts, significant locations, and audit procedures for those accounts and locations.

Answer 24

Tolerable error (also known as performance materiality)

Question 25

An analytical technique that includes simple year-to-year comparisons of account balances, graphic presentations, analysis of financial data, histograms of ratios, and projections of account balances based on the history of changes in the account.

Answer 25

Trend analysis

Question 26

The auditor bases materiality solely on quantitative factors.

T or F?

Answer 26

FALSE

Question 27

Performance materiality is an amount less than overall materiality and helps the auditor determine the extent of audit evidence needed.

T or F?

Answer 27

TRUE

Question 28

Which of the following statements is true regarding materiality?

a. Materiality is the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
b. Materiality is the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it possible that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
c. A fact is material if there is a substantial likelihood that a reasonable investor would have viewed the fact as having significantly altered the total mix of information made available.
d. Both (a) and (c) are correct.
e. Both (b) and (c) are correct.

Answer 28

D

Question 29

Which of the following statements is true concerning performance materiality?

a. Performance materiality is set less than overall materiality and helps the auditor determine the extent of audit evidence to obtain.
b. If performance materiality is set too low, the auditor might not perform sufficient procedures to detect material misstatements in the financial statements.
c. If performance materiality is set too high, the auditor might perform more substantive procedures than necessary.
d. Performance materiality is essentially the same as overall materiality

Answer 29

A

Question 30

Detection risk is the susceptibility of an assertion to a material misstatement before consideration of related controls.

T or F?

Answer 30

FALSE

Question 31

Some level of control risk is always present in an organization because of the inherent limitations of internal control.

T or F?

Answer 31

TRUE

Question 32

Which of the following statements represents the appropriate directional relationships?

a. As inherent risk increases, audit risk increases.
b. As inherent risk increases, audit risk decreases.
c. As control risk increases, detection risk decreases.
d. As control risk increases, inherent risk decreases.

Answer 32

C

Question 33

Which of the following statements is false regarding planning analytical procedures?

a. The precision of the auditor’s expectation tends to be less precise, and based on more
aggregated data, for planning analytical procedures than for substantive analytical procedures.
b. The objective for planning analytical procedures is to identify accounts with heightened risk of misstatement to provide a basis for designing and implementing responses to the assessed risks.
c. For planning analytical procedures, significant unexpected differences suggest that the auditor will need to increase substantive procedures.
d. A frequently used planning analytical procedure is regression analysis.

Answer 33

D

Question 34

A high level of detection risk means that the audit firm is willing to accept a low risk of not detecting a material misstatement.

T or F?

Answer 34

FALSE

Question 35

The nature of risk response refers to the sufficiency and appropriateness of evidence that is necessary given the risk of material misstatement and the level of acceptable audit risk.

T or F?

Answer 35

FALSE

The extent of risk response refers to the sufficiency of evidence that is necessary given the client’s assessed risks, materiality, and the acceptable level of audit risk.

Question 36

Assume that the auditor sets audit risk at 1%. What is the appropriate interpretation of this level of audit risk?

a. The auditor is willing to take only a 1% chance
that audit procedures will not detect a material
misstatement.
b. The auditor is 99% confident that the audit procedures will detect a material misstatement.
c. The auditor is willing to take only a 1% chance of expressing an audit opinion that the financial statements are fairly presented when they are materially misstated.
d. The auditor is 99% confident that the audit opinion is correct.

Answer 36

C

Question 37

Which of the following statements is false regarding the nature, timing, and extent of risk responses?

a. The nature of risk response refers to the types of audit procedures applied given the nature of the account balance and the most relevant assertions regarding that account balance.
b. The timing of risk response refers to when the auditor performs the audit procedures.
c. When the risk of material misstatement is low, the auditor conducts the audit procedures closer to yearend, on an unannounced basis, and includes more elements of unpredictability in the procedures.
d. The extent of risk response refers to the sufficiency of evidence that is necessary given the client’s assessed risks, materiality, and the acceptable level of audit risk.

Answer 37

C