Deck 9: Assessing the Risk of Material Misstatement

Question 1

Some risk exists that the financial statements are not fairly stated, even when the auditor's opinion is unmodified.

Answer 1

True

Question 2

Inherent risk and control risk exist independent of the audit of the financial statements.

Answer 2

True

Question 3

Risk of material misstatement at the assertion level

A) is only relevant to account balances.
B) determines the nature, timing, and extent of further auditing procedures.
C) refers to risks that are pervasive to the financial statements as a whole.
D) consists of business risk and inherent risk.

Answer 3

B

Question 4

________ risk represents the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of the client's internal controls.

A) Material
B) Account balance
C) Control
D) Inherent

Question 5

Which of the following would not increase the risks of material misstatement at the overall financial statement level?

A) effective oversight by the board of directors
B) deficiencies in management's integrity
C) inadequate accounting systems
D) all of the above

Question 6

Assessing the risk of material misstatement is closely related to each of the following except

A) the auditor's overall audit responsibilities.
B) the auditor's materiality and audit planning.
C) not a critical consideration in most financial statement audits.
D) the auditor's review of the key transaction cycles and associated audit objectives.

Question 7

Risk assessment procedures include inquiries of management and others by the auditor. As part of these procedures, the auditor should talk to

A) internal auditors.
B) board of directors.
C) individuals involved with regulatory compliance.
D) all of the above.

Question 8

The performance of risk assessment procedures is designed to help the auditor obtain an understanding of the entity.

Question 9

Risk assessment procedures include

A) a required discussion among the staff members of the audit and the client regarding material misstatements in the financial statement.
B) determination of the type of audit opinion to issue.
C) observation of the entity's operations.
D) assessing acceptable audit risk.

Question 10

Audit reports issued under the PCAOB and the AICPA standards contain two important phrases that are directly related to materiality and to risk: obtain absolute assurance and free of material misstatement.

Question 11

As management is responsible for the financial statements, failure to assess the risk of material misstatement is not detrimental to the auditor.

Question 12

Name some examples where the auditor accepts some level of uncertainty in performing the audit function.

Question 13

For well-planned audits, it is practical for auditors to provide assurances on immaterial amounts included in the financial statements.

Question 14

Auditing standards require the engagement partner to be included in discussions about the susceptibility of the client's financial statements to material misstatements.

Question 15

The auditor's responsibility section in an audit report states that "…the standards require that we plan and perform the audit to obtain ________ assurance about whether the financial statements are free of material misstatement." What type of assurance is given?

A) immediate
B) limited
C) reasonable
D) absolute

Question 16

The phrase free of material misstatement informs users that the auditor's responsibility is not limited to only material financial information.

Question 17

Significant changes in the industry may increase the risk of material misstatement at the assertion level.

Question 18

Audit reports contain the phrase obtain reasonable assurance, which is intended to inform users that auditors do not guarantee or ensure the fair presentation of the financial statements which the audit reports cover.

Question 19

The risk of material misstatement exists only at the overall financial statement level.

Question 20

Auditors are not allowed to make inquires of employees who are not considered management, such as marketing or sales personnel.

Question 21

Nonroutine transactions are unusual in nature but not infrequent in occurrence.

Question 22

Risk assessment procedures are performed to identify and assess the risk of material misstatement. List three risk assessment procedures.

Question 23

Revenue transactions and account balances subject to significant risk are not required to be documented in the working papers if the auditor determines significant risk does not apply in a particular audit engagement.

Question 24

The application of professional skepticism consists of two primary components: a questioning mind and a critical assessment of the audit evidence obtained during the audit.

Question 25

Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would

A) increase materiality levels.
B) decrease detection risk.
C) decrease substantive testing.
D) increase inherent risk.

Question 26

Which of the following risks are used in the audit risk model?

A)
B)
C)
D)

Question 27

PCAOB auditing standards require the auditor to make inquiries of the audit committee about the risks of material misstatement.

Question 28

Discussions, including exchanges of ideas or brainstorming among the engagement team members about business risks should include the financial statements, but not necessarily the related disclosures.

Question 29

The auditor's risk assessment for fraud should be ongoing throughout the audit.

Question 30

When considering the risk of misstatement due to fraud,

A) the risk of not detecting a material misstatement due to fraud is lower than the risk of not detecting a misstatement due to error.
B) the risk is only made at the financial statement level.
C) auditing standards require the auditor to presume that risk of fraud exists in expense transactions.
D) auditing standards outline procedures the auditor should perform to obtain information from management about their consideration of fraud.

Question 31

Nonroutine transactions may not necessarily increase the risk of material misstatement.

Question 32

The auditor's consideration of the risk of material misstatement due to fraud is made primarily at the financial statement level, not at the assertion level.

Question 33

The PCAOB, but not the AICPA, auditing standards require inquiry of internal audit personnel by the auditor when that function exists within the audit client.

Question 34

Which of the following will generally be considered a significant risk?

A) a sale to a customer
B) the determination of the amount of bad debt expense
C) the purchase of inventory
D) obtaining a loan from the bank

Question 35

The auditor must perform substantive tests related to assertions deemed to have significant risks.

Question 36

Financial statement matters like estimates for the allowance for doubtful accounts and allowances for slow-moving inventories, are deemed significant matters which should be addressed by auditor in their assessment of the risk of material misstatement.

Question 37

A ________ risk represents an identified and assessed risk of material misstatement that, in the auditor's professional judgment, requires special audit consideration.

A) material
B) substantial
C) financial statement
D) significant

Question 38

Auditing standards emphasize the benefits and importance of obtaining information or different perspectives through inquiries of others within the entity and employees with differing levels of authority within the organization.

Question 39

Significant risks often relate to routine transactions.

Question 40

Individuals engaged in conducting a fraud will generally not misrepresent information to the auditor.

Question 41

If the auditor decides to reduce acceptable audit risk, planned detection risk

A) increases.
B) decreases.
C) stays the same.
D) cannot be determined.

Question 42

If planned detection risk is reduced, the amount of evidence the auditor accumulates will

A) increase.
B) decrease.
C) remain unchanged.
D) be indeterminate.

Question 43

Planned detection risk I. determines the amount of substantive evidence the auditor plans to accumulate.
II) is dependent on inherent risk and business risk.

A) I only
B) II only
C) both I and II
D) neither I nor II

Question 44

When dealing with audit risk,

A) auditors cannot accept any level of risk in performing the audit function.
B) most risks that auditors encounter are relatively easy to measure.
C) the audit risk model is only used for classes of transactions.
D) the audit risk model helps the auditor to decide how much and what types of evidence to accumulate.

Question 45

Inherent risk is often high for an account such as

A) inventory.
B) land.
C) capital stock.
D) notes payable.

Question 46

The most important element of the audit risk model is control risk.

Question 47

When assessing risk, it is important to remember that

A) for acceptable audit risk, the SEC decides the risk the CPA firm should take for public clients.
B) inherent risk can be changed by the auditor.
C) detection risk can only be determined after audit risk, inherent risk, and control risk are determined.
D) control risk is determined by company management since they are responsible for internal control.

Question 48

The measurement of the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of related internal controls is defined as

A) audit risk.
B) inherent risk.
C) sampling risk.
D) detection risk.

Question 49

Inherent risk and control risk

A) are inversely related to each other.
B) are inversely related to detection risk.
C) are directly related to detection risk.
D) are directly related to audit risk.

Question 50

Inherent risk is ________ related to planned detection risk and ________ related to the amount of audit evidence.

A) directly; inversely
B) directly; directly
C) inversely; inversely
D) inversely; directly

Question 51

To what extent do auditors typically rely on internal controls of their public company clients?

A) extensively
B) only very little
C) infrequently
D) never

Question 52

Which of the following statements is not true?

A) Inherent risk is inversely related to the amount of audit evidence whereas detection risk is directly related to the amount of audit evidence required.
B) Inherent risk is directly related to evidence whereas detection risk is inversely related to the amount of audit evidence required.
C) Inherent risk is the susceptibility of the financial statements to material error, assuming no internal controls.
D) Inherent risk and control risk are assessed by the auditor and function independently of the financial statement audit.

Question 53

Which of the following is a correct relationship?

A) Acceptable audit risk and planned detection risk have an inverse relationship.
B) Control risk and planned detection risk have a direct relationship.
C) Planned detection risk and inherent risk have an inverse relationship.
D) All of the above are correct relationships.

Question 54

Which is a true statement about audit risk?

A) Audit risk measures the risk that a material misstatement could occur and not be detected by internal control.
B) When auditors decide on a higher acceptable audit risk, they want to be more certain that the financial statements are not materially misstated.
C) Audit assurance is the complement of acceptable audit risk.
D) There is an inverse relationship between acceptable audit risk and planned detection risk.

Question 55

In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?

A) the internal audit department's objectivity in reporting a material misstatement of a financial statement assertion it detects to the audit committee
B) the risk that the internal control system will not detect a material misstatement of a financial statement assertion
C) the risk that the audit procedures implemented will not detect a material misstatement of a financial statement assertion
D) the susceptibility of a financial statement assertion to a material misstatement, assuming there are no related controls

Question 56

The risk that audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality levels is

A) audit risk.
B) control risk.
C) inherent risk.
D) planned detection risk.

Question 57

The risk of material misstatement refers to

A) control risk and acceptable audit risk.
B) inherent risk.
C) the combination of inherent risk and control risk.
D) inherent risk and audit risk.

Question 58

Auditors typically rely on internal controls of their private company clients

A) only as needed to complete the audit and satisfy Sarbanes-Oxley requirements.
B) only if the controls are determined to be effective.
C) only if the client asks an auditor to test controls.
D) only if the controls are sufficient to increase control risk to an acceptable level.

Question 59

Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance instead of

A) detection risk.
B) audit report risk.
C) acceptable audit risk.
D) inherent risk.

Question 60

An auditor who audits a business cycle that has low inherent risk should

A) increase the amount of audit evidence gathered.
B) assign more experienced staff to that area.
C) expand planning procedures.
D) do none of the above.

Question 61

An example of where the auditor will accept very low risk (low acceptable audit risk) is for an audit client having an initial public offering.

Question 62

The audit committee should determine the risk the CPA firm is willing to take that the financial statements are misstated after the audit is completed.

Question 63

Using your knowledge of the relationships among acceptable audit risk, inherent risk, control risk, planned detection risk, performance materiality, and planned evidence, state the effect on planned evidence (increase or decrease) of changing each of the following factors, while the other factors remain unchanged.
1. an increase in acceptable audit risk ________
2. an increase in inherent risk ________
3. a decrease in control risk ________
4. an increase in planned detection risk ________
5. an increase in performance materiality ________

Question 64

After assessing internal controls are being effective in the sales and collection cycle, the auditor can assume that internal controls will be effective at each of the client's other transaction cycles.

Question 65

Audit assurance is the complement of planned detection risk, that is, one minus planned detection risk.

Question 66

Inherent risk and control risk are directly related.

Question 67

If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk for the auditor, acceptable audit risk would likely

A) be reduced.
B) be increased.
C) remain the same.
D) be calculated using a computerized statistical package.

Question 68

As control risk increases, the amount of substantive evidence the auditor plans to accumulate should increase.

Question 69

For a private company client, auditors are required to test any internal controls they believe have not been operating effectively during the period under audit.

Question 70

A planned detection risk (PDR) of .05 means the auditor plans to accumulate audit evidence until the risk of misstatement exceeding performance materiality is reduced to 5 percent.

Question 71

The auditor assesses risks at the overall financial statement level but not at the audit objective level for the acquisition and payment cycle.

Question 72

If acceptable audit risk is low, and inherent risk and control risk are both low, then planned detection risk should be high.

Question 73

Describe the audit risk model and each of its components.

Question 74

Why do auditors use the audit risk model when planning an audit?

Question 75

A high detection risk equates to a low amount of audit evidence needed.

Question 76

The audit risk model that must be used for planning audit procedures and evaluating audit results is:
= AAR.

Question 77

There is a direct relationship between acceptable audit risk and planned detection risk.

Question 78

If the audit assurance rate is 95%, then the level of acceptable audit risk is 5%.

Question 79

Acceptable audit risk and the amount of substantive evidence required are inversely related.

Question 80

Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in assessing inherent risk during the planning phase?

A) obtaining client's agreement on the engagement letter
B) obtaining knowledge about the client's business and industry
C) touring the client's plant and offices
D) identifying related parties