Deck 7: Planning the Audit: Identifying and Responding to the Risks of Material Misstatement

Question 1

Brainstorming sessions should be led by the engagement team.

Answer 1

False

Question 2

News media and web searches can provide useful information related to client management's integrity and the risk of material misstatement in the financial statements.

Answer 2

True

Question 3

Materiality relates to the significance or importance of an item.

Answer 3

True

Question 4

When a successor auditor contacts a company's previous auditor, the successor auditor might obtain information related to client management's integrity.

Question 5

Only public companies have to be concerned with business risk.

Question 6

As detection risk increases, the amount of evidence an auditor needs to obtain decreases.

Question 7

Clearly trivial and not material are terms that can be used interchangeably.

Question 8

The purpose of the auditor's consideration of the effectiveness of internal controls is to determine the nature, extent and timing of substantive testing.

Question 9

Trend analysis deals with the relationship between two or more accounts within the current-year.

Question 10

Touring a company's plant offers much insight into potential audit issues.

Question 11

During the process of a brainstorming session, the focus is more on the quality of ideas generated rather than the quantity of ideas generated.

Question 12

Detection risk is measured on a scale of 0% to 5%.

Question 13

One potential limitation to using industry data in preliminary analytical procedures is that the data from the client may not be directly comparable to the data of the industry.

Question 14

When business risk is low, the auditor does not have a high concern about the ability of the organization to operate efficiently.

Question 15

Auditors and management should agree on what is considered material.

Question 16

LEXIS is a public database where the existence of legal proceedings against a company or key members of the company can be found.

Question 17

If detection risk is low, the auditor is more willing to take a higher risk of the substantive audit procedures not detecting a material misstatement.

Question 18

Auditors need to choose materiality amounts carefully because once a materiality judgment has been made, it cannot be revised.

Question 19

A risk of material misstatement of 100% indicates that material misstatement is highly likely.

Question 20

The usual length of a brainstorming session is about four hours.

Question 21

All audit procedures must be completed before year end.

Question 22

An immaterial misstatement is defined as one that is clearly inconsequential, whether taken individually or in the aggregate and whether judged by any criteria of circumstance.

Question 23

The lower the dollar amount of the performance materiality the more audit evidence is required.

Question 24

Auditors are only concerned with materiality for the financial statements as a whole.

Question 25

Tolerable misstatement is always less than or equal to performance materiality.

Question 26

Internal controls that the auditor expects to rely on to reduce substantive testing must be tested.

Question 27

Audit procedures have to be announced or be completed at predictable times.

Question 28

A significant risk is the same as a material risk.

Question 29

The internal controls of an organization have no impact on the efficiency of an audit.

Question 30

Ineffective internal controls result in higher risk of material misstatement in the financial statements than effective internal controls.

Question 31

The existence of one or more risk factors means that there is a material misstatement present.

Question 32

In most audits, materiality is most commonly expressed as a percentage of net income.

Question 33

Performance materiality is used for assessing the risks of material misstatement and determining the nature, timing, and extent of audit procedures to perform during the audit opinion formulation process.

Question 34

Inherent and control risks are risk controlled by the auditor.

Question 35

A company's history of exactly meeting analyst estimates is a factor which could lead auditors to assess inherent risk at a higher level.

Question 36

Heightened risk of material misstatement causes the auditor to perform audit procedures closer to year end.

Question 37

When the risk of material misstatement is heightened, the auditor increases the extent of audit procedures and requires more evidence.

Question 38

A detection risk of 90% would suggest that an auditor must perform extensive substantive audit testing.

Question 39

Tolerable misstatement is the amount of misstatement in an account balance that the auditor could tolerate and still not judge the underlying account balance to be materially misstated.

Question 40

A risk factor indicating a heightened risk of fraud would be considered a significant risk.

Question 41

Detection risk is controllable by the client.

Question 42

Which of the following factors will result in control risk being assessed at a higher level?

A) Controls are well designed.
B) There is a lack of supervision of accounting personnel.
C) Accounting staff are well trained and educated.
D) The control environment is operating effectively.

Question 43

Which of the following would be a reason that industry and client data were not directly comparable?

A) Broad industry.
B) Use of different accounting principles.
C) Neither of the above.
D) Both A & B are correct.

Question 44

The purpose of tests of controls are to provide reasonable assurance that internal controls are operating effectively.

Question 45

Insistence from the CEO that she must be present at all meetings between the audit committee and internal/external auditors would cause auditors to assess inherent risk at a higher level.

Question 46

The quick ratio is useful for analyzing inventory accounts.

Question 47

Which of the following phrases or terms regarding materiality is used by the Supreme Court of the United States and is not found in FASB Concepts Statement No. 2?

A) "amount of a misstatement or omission"
B) "in light of surrounding circumstances"
C) "probable that the judgement of a reasonable person"
D) "significantly altered the total mix of information available"

Question 48

Which of the following best describes the amount of misstatement an auditor is willing to accept and still judge that an account balance is not materially misstated?

A) Tolerable misstatement.
B) Performance materiality.
C) A clearly trivial amount.
D) Significant risk.

Question 49

Which item is correct concerning the risk of material misstatement?

A) Risk of material misstatement arises because audit procedures have been misapplied.
B) Risk of material misstatement can be controlled and changed by the auditor.
C) Risk of material misstatement must be assessed in non-quantitative terms.
D) Risk of material misstatement is controllable by the client.

Question 50

Which of the following are two frequently used preliminary analytical procedures?

A) Reasonableness tests and economic analyses.
B) Trend analyses and reasonableness tests.
C) Ratio analyses and economic analyses.
D) Ratio analyses and trend analyses.

Question 51

Detection risk is affected by which aspects of substantive audit procedures?

A) Nature.
B) Timing.
C) Extent.
D) All of the above.

Question 52

Which of the following ratios provide information about liquidity?

A) Net profit margin.
B) Current ratio.
C) Inventory turnover.
D) Sales to assets.

Question 53

To learn more about a company and its inherent risks, auditors can use which of the following resources?

A) Management inquiries.
B) Economic statistics.
C) Online searches.
D) Any of the above could be used.

Question 54

If tolerable misstatement for accounts payable is $1,000, the auditor would need to obtain more audit evidence for that account than if tolerable misstatement were $100,000.

Question 55

Which of the following is a reason a predecessor auditor can decline to reply to a firm's current auditor?

A) Data is under court order.
B) They must always respond.
C) The client does not approve of confidential information being shared.
D) Both A and C are correct.

Question 56

If $15,000 is considered to be material to the income statement, but $25,000 is material to the balance sheet, the auditor should set overall materiality at which of the following dollar amounts?

A) $20,000
B) $25,000
C) $40,000
D) $15,000

Question 57

If materiality judgments change during the audit opinion formulation process, what happens to previous audit decisions that were based on the evidence obtained using the initial material setting?

A) They need to be reassessed.
B) They need to be noted in the footnotes.
C) No action is required.
D) None of the above.

Question 58

Which of the following factors would lead an auditor to assess inherent risk at a higher level?

A) The account balance is easily determined without estimation.
B) The account balance is composed of a high volume of nonroutine transactions.
C) The account balance is composed of simple transactions.
D) All of the above would lead the auditor to assess a higher level of inherent risk.

Question 59

What is the nature of the relationship between risk of material misstatement and audit risk?

A) Direct.
B) None.
C) Correlational.
D) Inverse.

Question 60

Which of the following best describes year-to-year comparisons of account balances?

A) Time analyses.
B) Reasonableness tests.
C) Ratio analyses.
D) Trend analyses.

Question 61

If the auditor's assessment of audit risk is low (e.g., 1% rather than 5%), what is the effect on the amount of direct testing performed by the auditor?

A) Increase in direct testing.
B) Decrease in direct testing
C) No change in direct testing.
D) Direct testing is not needed.

Question 62

Which of the following approaches can be used to introduce unpredictability into the audit?

A) Assessing high risk accounts.
B) Performing procedures on an unannounced basis.
C) Performing the audit in the same location each year.
D) Selecting items that would normally be tested.

Question 63

Which of the following are common brainstorming session guidelines?

A) Freedom of expression.
B) Respectful communication.
C) Suspension of criticism.
D) All of the above.

Question 64

Which of the following statements best describes what is meant by setting control risk at100%?

A) Controls are effective.
B) Controls are relevant.
C) Controls are ineffective.
D) Cannot be determined from the information given.

Question 65

Which of the following best describes what is meant by the timing of risk response?

A) Where procedures are conducted.
B) When procedures are conducted.
C) How procedures are conducted.
D) Who conducts the procedures.

Question 66

Which of the following would be the likely risk results from using a 1% level of detection risk?

A) High detection risk and low audit risk.
B) High detection risk and high audit risk.
C) Low detection risk and high audit risk.
D) Low detection risk and low audit risk.

Question 67

Which of the following terms best describes the types and appropriateness of audit procedures used?

A) Nature of detection risk.
B) Material misstatement risk.
C) Nature of auditing procedures.
D) Nature of risk response.

Question 68

What is the typical range for the setting of audit risk?

A) 1% - 10%
B) 1% - 5%
C) 0% - 5%
D) 0% - 10%

Question 69

What is the auditor trying to accomplish by varying the timing of audit procedures from the prior year?

A) Introduce unpredictability.
B) Confuse the client.
C) Gather information during different times of the year.
D) Finish the audit sooner.

Question 70

Which of the following risk factors suggests a heightened level of risk of material misstatement?

A) Having a stable product.
B) The departure of key personnel of a company.
C) Few immaterial related-party transactions.
D) Declining a merger with another company.

Question 71

Which of the following terms best describes the numerical depiction of the relationship between control risk, inherent risk, detection risk, and audit risk?

A) Audit risk model.
B) Risk of misstatement model.
C) Significance model.
D) Materiality equation.

Question 72

What type of relationship exists between audit risk and detection risk?

A) Direct.
B) Inverse.
C) Indirect.
D) No relationship.

Question 73

What is the main reason to establish guidelines for brainstorming sessions?

A) To not hurt feelings.
B) It is required by the SEC.
C) To encourage interactive and constructive group dialogue and idea exchange.
D) To pass information up to top-level management efficiently.

Question 74

An increase in the risk of material misstatement would lead to which of the following responses?

A) Increase in the extent of auditing procedures.
B) Decrease in the extent of auditing procedures.
C) No change in the extent of auditing procedures.
D) No change in the extent of audit procedures.

Question 75

As inherent risk increases, and other risk factors remain constant, what happens to the extent of audit work?

A) Increases.
B) Decreases.
C) Stays the same.
D) Becomes less reliable.

Question 76

What procedure has to be completed at or after the end of the period?

A) Assessment of control risk.
B) Engagement letter.
C) Evaluation of adjusting journal entries.
D) All procedures must be completed prior to period end.

Question 77

Appropriateness addresses which aspect of audit procedures?

A) Relevance.
B) Reasoning.
C) Reliability.
D) Both A & C.

Question 78

When an auditor chooses not to rely on a client's internal controls because the control design is ineffective, which of the following tests are eliminated?

A) Substantive testing.
B) Tests of controls.
C) Tests of details of balances.
D) Substantive analytical procedures.

Question 79

Which of the following terms best describes the risk that audit procedures will fail to detect misstatements exceeding tolerable misstatement?

A) Audit risk.
B) Control risk.
C) Detection risk.
D) Inherent risk.

Question 80

What is the typical range for the assessment of the risk of material misstatement?

A) 0% - 100%
B) 0% - 10%
C) 0% - 5%
D) 1% - 100%