Deck 4: Audit Planning II

Question 1

Materiality is assessed during the risk assessment phase of every audit.

Answer 1

True

Question 2

Inventory turnover measures how many times a year a company collects cash from its
debtors.

Answer 2

False

Question 3

When classifying risks, significant consideration is given to whether the risk involves simple
routine transactions.

Answer 3

False

Question 4

Trend analysis involves a comparison of account balances to a single line item.

Question 5

If there is a risk that management's assertion that recorded inventory exists is not valid, the auditor will

A) spend more time testing for the existence of recorded inventory.
B) spend less time testing for the existence of recorded inventory.
C) spend more time testing for the completeness of inventory.
D) not adjust their audit strategy.

Question 6

Audit risk is the risk that a client's system of internal controls will not prevent or detect a
material misstatement.

Question 7

Millie Buenavista made the following two statements concerning inherent risk: (i) Inherent risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
(ii) Inherent risk deals with the susceptibility of the financial statements to material misstatements without considering internal controls.

A) both (i) and (ii)
B) neither (i) not (ii)
C) (i) only
D) (ii) only

Question 8

If the client has one or more appropriate controls in place, the audit strategy is to conduct few
or no tests of controls for the identified risk.

Question 9

There is an inverse relationship between audit risk and detection risk as set by the auditor.

Question 10

If inherent risk and control risk are low, the auditor can set detection risk as high.

Question 11

Information is considered quantitatively material if it exceeds an auditor's preliminary
materiality assessment.

Question 12

Analytical procedures are conducted at the risk assessment phase of an audit to enhance the understanding of the auditor's client.

Question 13

Which of the following statements is correct about audit risk?

A) It is impossible to completely eliminate audit risk.
B) Audit risk is the risk that an auditor expresses an inappropriate opinion when the financial statements are materially stated.
C) Audit risk can be reduced at the risk assessment phase of an audit by identifying the key risks faced by the client.
D) all of the above

Question 14

Martin Shawbridge, a manager at Cox, Durham, & Elliott, CPA's was given the mandate to deal with the following risks: fraud risks, complex transactions, significant related party
Transactions. How would you classify these risks?

A) audit risk
B) inherent risk
C) control risk
D) significant risk

Question 15

Profitability is the ability of a company to pay its debts as they fall due.

Question 16

By setting a higher planning materiality level, an auditor increases the quality and quantity of
evidence that needs to be obtained.

Question 17

Key performance indicators used by a client to monitor its performance provide an auditor
insight into which accounts are potentially at risk of misstatement.

Question 18

A walkthrough involves an auditor tracing a transaction through a client's accounting system.

Question 19

Companies enter into debt covenants with lenders when taking on significant loans.

Question 20

When classifying risks, significant consideration is not given to whether the risk

A) is related to significant economic or accounting developments.
B) involves simple transactions.
C) involves significant related party transactions.
D) involves fraud.

Question 21

By setting a lower planning materiality level, an auditor

A) decreases the quality and quantity of evidence that needs to be gathered.
B) does not change the audit strategy they use.
C) increases the quality and quantity of evidence that needs to be gathered.
D) can be certain that they will detect all instances of fraud that have occurred.

Question 22

Which of the following statements regarding materiality is correct?

A) Materiality is a key auditing concept.
B) The preliminary assessment of materiality guides audit planning.
C) Items are material if they impact on the decision making of the users of the financial statements.
D) all of the above

Question 23

Sami Zubair's client does not have in place appropriate controls for a risk he has identified. What should Sami do?

A) conduct few or no tests of controls
B) report the weaknesses to those charged with governance
C) increase his reliance on substantive tests
D) all of the above

Question 24

An audit strategy

A) is determined by the client.
B) involves determining the amount of time to be spent testing the client's internal controls and conducting detailed substantive testing.
C) sets the scope, timing and direction of the audit.
D) both b and c

Question 25

Which of the following is an example of an item considered qualitatively material?

A) a change in an accounting method
B) related party transactions
C) being in danger of breaching a debt covenant
D) all of the above

Question 26

Control risk is

A) the risk that a client's system of internal controls will prevent or detect a material misstatement.
B) the susceptibility of an assertion to a material misstatement assuming there are no related controls.
C) the risk that a client's system of internal controls will not prevent or detect a material misstatement.
D) none of the above

Question 27

The audit strategy for a client with high inherent risk and high control risk will include

A) no or very limited tests of controls.
B) decreased reliance on substantive tests.
C) increased testing of controls.
D) increased reliance on controls.

Question 28

When information exceeds an auditor's preliminary materiality assessment, it is deemed to be

A) performance materiality.
B) specific materiality.
C) quantitatively material.
D) none of the above

Question 29

Qualitative materiality refers to information that

A) impacts a user's decision-making process due to its magnitude.
B) impacts a user's decision-making process for a reason other than its magnitude.
C) is less than an auditor's preliminary materiality assessment.
D) exceeds an auditor's preliminary materiality assessment.

Question 30

Moises Alou has reviewed internal controls at a spring training facility in Florida and has deemed control risk to be high. Which kind of audit strategy may be appropriate for Moises?

A) combined audit strategy
B) substantive audit strategy
C) both a and b
D) none of the above

Question 31

When a control is effective, the next step is to

A) identify what could go wrong.
B) test the control.
C) perform a walkthrough.
D) reduce reliance on detailed substantive procedures.

Question 32

By setting high detection risk, an auditor will

A) eliminate the possibility that fraud will be detected.
B) reduce the level of reliance placed on their detailed substantive procedures.
C) increase the level of reliance placed on their detailed substantive procedures.
D) reduce the level of testing of the client's internal control system.

Question 33

An example of a qualitative material item is

A) an incorrect value reported for an asset.
B) a related party transaction.
C) interest expenses as being 6% of total sales.
D) none of the above

Question 34

When Brenda discovered she had a low risk client with low inherent risk and low control risk, how did she set her detection risk?

A) low
B) high
C) medium
D) detection risk is not related to inherent risk and control risk

Question 35

Setting the level of planning materiality as low would cause an auditor to

A) increase the quality and quantity of evidence to be collected.
B) reduce the quality and quantity of evidence to be collected.
C) revise the acceptable level of audit risk.
D) none of the above

Question 36

An audit strategy will include increased reliance on tests of controls when

A) inherent risk and control are high.
B) inherent risk and control risk are low.
C) the auditor believes there is a high risk that their client's internal controls will not prevent or detect material misstatements.
D) there is a high susceptibility of assertions to material misstatements.

Question 37

Which of the following statements about materiality is incorrect?

A) The preliminary assessment of materiality guides audit planning and testing.
B) Materiality is used to guide the validity of information contained in the financial statements.
C) Materiality is a key auditing concept that is assessed during the risk assessment phase of every audit.
D) Information is considered material if it has no impact on the decision-making process of financial statement users.

Question 38

A transaction walkthrough involves

A) taking a tour of the client's manufacturing facility.
B) vouching recorded transactions back to the source documents.
C) tracing a transaction through a client's accounting system.
D) none of the above

Question 39

An item that is considered material due to its magnitude is referred to as being

A) quantitatively material.
B) of no interest to the auditor.
C) qualitatively material.
D) none of the above

Question 40

An auditor has gained a detailed understanding of the client's system of internal controls and has conducted extensive tests of those controls. She later assesses control risk as low.
What is she planning to perform?

A) a combined audit strategy
B) an audit of financial controls
C) a substantive audit strategy
D) a modified audit strategy

Question 41

Which of the following statements regarding key performance indicators (KPIs) is correct?

A) They reflect the success factors of an organization.
B) They can be quantified.
C) Some KPIs are common to many clients, including return on assets.
D) all of the above

Question 42

Analytical procedures are undertaken to

A) analyze the audit client's profitability.
B) assess the going concern status of the audit client.
C) identify fluctuations in accounts inconsistent with the auditor's expectations.
D) identify non-compliance with internal control procedures.

Question 43

Analytical procedures are used at which of the following stages of an audit?

A) final review
B) planning
C) execution
D) all of the above

Question 44

Ratio analysis is used to

A) assess the relationship between various financial statement balances.
B) evaluate the profitability of the audit client.
C) assess the audit client's return on investment.
D) assess the liquidity of the audit client.

Question 45

Which of the following is not an example of a profitability ratio?

A) current ratio
B) gross profit margin
C) return on assets
D) profit margin

Question 46

By assessing control risk as high, an auditor has determined that their client's system of internal controls

A) is unlikely to be effective in mitigating inherent risks identified.
B) is very effective at preventing or detecting material misstatements.
C) is very strong.
D) will eliminate the possibility of material fraud or error.

Question 47

Which of the following statements relating to debt covenants is incorrect?

A) Covenants are written into loan contracts.
B) If a company breaches a debt covenant it will not need to renegotiate or repay the loan.
C) Covenants restrict a company's activities.
D) Companies enter into debt covenants with banks when they borrow a significant amount.

Question 48

Emmanuela Zhang was explaining the importance of analytical procedures to her staff. She made two statements:
(i) Analytical procedures are conducted throughout an audit.
(ii) Analytical procedures are an efficient method for estimating account balances.

A) both (i) and (ii)
B) neither (i) nor (ii)
C) (i) only
D) (ii) only

Question 49

Gaining an understanding of how an audit client measures and assesses its performance, assists the auditor to

A) assess audit risk.
B) evaluate the profitability of the audit client.
C) gain an understanding of accounts that may be at risk.
D) determine the overall audit strategy.

Question 50

Which of the following is an example of a liquidity ratio?

A) gross profit divided by net sales
B) profit divided by average assets
C) cost of sales divided by average inventory
D) current assets divided by current liabilities

Question 51

Which of the following is not a reason for using profitability measures?

A) to assess performance of key staff
B) to compare performance against competitors
C) to measure the ability to meet its debts as they fall due
D) to track revenue and expenses over time

Question 52

In conducting analytical procedures, which of the following information sources are not generally considered to be reliable?

A) audited information
B) information generated by an accounting system with ineffective internal controls
C) information generated using consistent accounting methods
D) information generated by an accounting system with effective internal controls

Question 53

Common measures of a company's profitability include

A) price-earnings ratio.
B) earnings per share.
C) both a and b
D) quick ratio.

Question 54

Matthias Holewsky was explaining how important it was for his staff to use analytical procedures in order to cut down on substantive testing. He mentioned two factors that he felt
Were important when conducting analytical procedures:
(i) reliability of client data
(ii) the ability to make comparisons over time
Which of these two factors can help him achieve his objective?

A) (i) only
B) (ii) only
C) both (i) and (ii)
D) neither (i) nor (ii)

Question 55

Analytical procedures are

A) based on available financial statement data.
B) expected to be efficient and effective.
C) relevant to achieving audit objectives.
D) conducted throughout the audit.

Question 56

In conducting analytical procedures, which of the following sources of information is considered to be most reliable?

A) information generated using consistent accounting methods
B) information from external sources
C) information generated by an accounting system that has effective internal controls
D) information provided by the client

Question 57

Analytical procedures are conducted at the risk assessment phase of the audit to

A) aid in the identification of risk.
B) identify where fraud has occurred.
C) enhance the understanding of a client.
D) both a and c

Question 58

Explain audit risk and the three components of the audit risk model.

Question 59

Which of the following is not an example of an analytical procedure?

A) comparison of financial data to invoices
B) comparison of financial data to industry averages
C) comparison of financial data to budgets
D) comparison of financial data to non-financial data

Question 60

Liquidity refers to

A) the ability of a company to earn a profit.
B) a comparison of account balances to a single line item.
C) the ability of a company to pay its debts when they fall due.
D) none of the above

Question 61

(Reproduced with permission from CICA UFE Question 1996 - Paper 4 - Question 2)
Allentown Credit Union (ACU) is located in a rural community in Canada. Membership is open to people in the community and the surrounding area. The local economy, which is predominantly agricultural, has been harmed by droughts in recent years and by declines in commodity prices, leading to a decline in ACU's profitability.
ACU has always had an external audit and has always prepared its financial statements in accordance with International Financial Reporting Standards. Ellino & Co. has audited ACU for the last several years. You, CPA, a senior with Ellino & Co., have been appointed to the audit of ACU for the year ended December 31, 2016. It is now early January 2017, and you are at the client's premises reviewing the information gathered to date.
ACU was founded in 1942, and it has always maintained a philosophy of serving the community. This has resulted in liberal lending practices and investment in the local community whenever possible. This stance has distinguished it from other financial institutions, which are primarily branches of national banks, and has given ACU a 75% share of the market.
ACU has been headed by the general manager, Ted Richards, for the past ten years. Ted reports directly to the Board of Directors, which is comprised of local people, some of whom have no formal financial training. Ted has always been accessible to members of the credit union and, on occasion, he has intervened in favour of the customer over the staff. He maintains that this flexibility is crucial to generating revenue, which is an important objective of the Board.
The loan manager, Sheila Meigs, joined ACU in the past year. She is responsible for the entire lending function, which includes authorization of loans, appraisal of collateral, and assessment of the collectability of outstanding loans. The loan portfolio is the largest asset on the balance sheet, representing 75% of total assets.
The accountant, Vivian Larson, and the head teller, Joanne Blake, both have 15 years of experience at ACU. Both are married to farmers and work to supplement their income. Both families are members of ACU, and all their personal and business transactions are conducted through the credit union.
As you read through your notes, Ted Richards interrupts you to tell you about some of the events that have occurred at ACU during the year.
-ACU foreclosed on a large loan and sold the land held as collateral. One effect of this sale was to depress the land prices in the surrounding area. ACU still maintains a high inventory of land received from past foreclosures but has decided to hold onto this land for fear of depressing land prices further.
-As a result of the depressed state of the local economy, provisions have recently been made to allow some customers to repay their loans with grains (i.e., oats and barley) instead of cash. Although such payments are not a common practice, Ted has approved these transactions on an exception basis.
-Even though the economy is depressed, Ted believes this will turn around and loans will be collected over the long term. Therefore, he has instructed to Sheila Meigs, Loan Manager, not to write off any significant loans as loan balances.
Required:
a) Define inherent risk and perform an inherent risk assessment for ACU.
b) Perform a control risk assessment
c) Conclude on the overall risk of material misstatement
d) How will your audit risk conclusion impact the audit strategy?

Question 62

Don Pablo, the senior auditor at Delahanty, Forbes, CPAs was planning for the audit of Winnipeg Lighting Showcase (WLS) and decided to use benchmarking as an analytical procedure. His manager agreed with Don's approach and suggested information sources that would ensure the reliability of the data for his benchmarking exercise.
As Don walked out of the office he ran into Helena Bodson, a newly hired auditor. He congratulated her on her decision to use a substantive approach to her accounts receivable section of the audit program.
Helena was also going to be reviewing certain internal controls in the WLS audit program. She asked him to whom she should report weaknesses in the client's internal controls.
Required:
a) Which information sources are generally considered to be reliable when conducting benchmarking exercises?
b) What circumstances would have made Helena use a substantive approach?
c) To whom will Helena report weaknesses in a client's system of internal controls?

Question 63

Analytical procedures are used by auditors to evaluate their clients' financial information by studying plausible relationships among both financial and non-financial data. Explain how analytical procedures are used at the different stages of an audit.

Question 64

Describe the profitability and liquidity approaches to measuring a client's performance.

Question 65

Gaining an understanding of a client includes auditors learning how their clients measure their performance. How is this information used by auditors in audit planning and what are examples of non-financial performance measures commonly used by auditors?

Question 66

Direct Home Builders was incorporated in December of 2019 and started operating in January of 2020. The company operates a retail web site that sells home building products to contractors in Canada. The business is owned and managed by two brothers, Buster and Dave Jameson. Despite a slowdown in the very competitive construction sector, the brothers have developed several unique interactive on-line shopping features that have led to significant revenue growth. As a result of this revenue growth, the owners have had to hire more sales, customer service, IT and accounting staff. This has increased the payroll costs to the extent the company is now experiencing cash flow difficulties. The local bank has provided interim financing, but a new cash injection is required. Buster and Dave are considering making a public share offering to raise further capital.
The brothers have approached a CPA firm to determine what may be involved with an initial public offering. They have been advised that one requirement is annual audited financial statements. They have discussed this requirement with their Controller, who believes they may have some challenges obtaining an unqualified audit opinion. She has expressed this concern due to the issues she has had with the new accounting hires and the turnover within the accounting area. She has had to let a couple of the staff go as they made several material accounting errors. She has since implemented stronger controls over the accounting processes, but she is still uncertain whether material errors remain.
Required:
Discuss the factors that will increase the inherent risk of Direct Home Builders.

Question 67

Discuss the purpose and some common examples of profitability ratios.

Question 68

What is the relationship between materiality and audit risk?

Question 69

Explain the audit approach used by an auditor when they assess control risk as high.

Question 70

Indicate whether you agree or disagree with the following statements and explain your reasoning.
a) Monica Callahan, the in-charge auditor, was explaining to her junior auditors why she was setting inherent risk high. "It is appropriate to set higher inherent risk for this company as our client is in an industry that is very competitive."
b) In selecting an appropriate materiality base, an auditor can choose an item from the balance sheet or income statement.
c) Randy Roberts has mentioned to his staff auditors that audit risk is based on factors that relate to the entity, while materiality is based on the user needs. As a result, materiality and audit risk are two concepts that need to be considered separately when considering material misstatements.
d) Shareep Kaur has determined control risk at a biochem company to be high. She plans to use a combined audit strategy.

Question 71

Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially stated. Why is the concept of audit risk so important to auditors and what can they do to reduce it to an acceptably low level?