Deck7: Materiality and risk

Question 1

Why might an auditor revise the preliminary assessment of materiality?

A) because client circumstances may have changed
B) because of qualitative events
C) because the auditor determined preliminary assessment of materiality before year-end
D) all of the above

Answer 1

D

Question 2

When setting a preliminary judgement about materiality at the planning stage, auditors may have to subsequently change this preliminary assessment.The new assessment is called:

A) allocated materiality.
B) segment materiality.
C) revised assessment of materiality.
D) planned materiality.

Answer 2

C

Question 3

The preliminary judgement about materiality is the ________ amount by which the auditor believes the statements could be misstated and still NOT affect the economic decisions of users.

A) median average
B) minimum
C) maximum
D) mean average

Answer 3

C

Question 4

Applying materiality in practice is:

A) based on experience.
B) fairly simple.
C) straightforward.
D) different for each audit

Question 5

The Auditor's Responsibility paragraph in the auditor's report includes two important phrases that are directly related to materiality and risk.What are these two phrases?
1)'relevant ethical requirements relating to audit engagements'
2)'plan and perform the audit'
3)'free from material misstatement'
4)'reasonable assurance'

A) 1 and 2
B) 3 and 4
C) 2 and 3
D) 1 and 4

Question 6

Allocating the preliminary judgement about materiality to segments of the financial statements is necessary because:

A) it is required by the Code of Ethics for Professional Accountants.
B) evidence is accumulated by segments rather than for the financial statements as a whole.
C) evidence is accumulated for the financial statements as a whole so the materiality doesn't apply to them.
D) it is required by the Corporations Act.

Question 7

Benchmarks are needed for evaluating materiality.If you used operating profit before income tax, what minimum percentage would you use for planning materiality?

A) 5%
B) 10%
C) 1%
D) none of the above

Question 8

Benchmarks are needed for evaluating materiality.What base would you use for the balance sheet?

A) operating profit before income tax
B) current assets
C) total assets
D) current liabilities

Question 9

Benchmarks are needed for evaluating materiality.If you used current liabilities or current assets, what minimum percentage would you use for planning materiality?

A) 5%
B) 10%
C) 1%
D) none of the above

Question 10

If it is probable that the economic decisions of users would have been influenced by the omission or misstatement of information, then that information is:

A) relevant.
B) insignificant.
C) material.
D) significant.

Question 11

According to ASA 320, at what point should materiality be considered?

A) when determining the nature, timing, and extent of audit procedures
B) when evaluating the effect of uncorrected misstatements, if any, on the financial report and in forming the opinion in the auditor's report
C) at all stages of audit planning
D) both A and B

Question 12

Materiality is affected by quantitative and ________ factors.

A) audit risk
B) absolute
C) relevant
D) qualitative

Question 13

Which one of the following statements does NOT apply to the preliminary assessment of materiality?

A) It is the maximum amount by which the auditor believes the statements could be misstated and still NOT affect the decisions of reasonable users.
B) It is a matter of auditor judgement.
C) It is a professional opinion, and it may NOT change during the engagement.
D) Auditors decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit, when they are developing the overall strategy for the audit.

Question 14

Where auditors have knowledge of specific intended users and uses, their judgement of what they consider material:

A) remains unchanged.
B) may be affected.
C) is based on the last audit.
D) none of the above

Question 15

What is the correct sequence of applying the five steps of materiality?
1) Estimate the combined misstatement.
2) Estimate the total misstatement in the segment.
3) Set the preliminary judgement of materiality.
4) Allocate the preliminary judgement of materiality to segments.
5) Compare the combined estimate with the preliminary judgement about materiality.
The correct sequence from start to finish would be:

A) 1 2 5 4 3.
B) 5 1 3 2 4.
C) 3 4 2 1 5.
D) 4 3 1 5 2.

Question 16

Materiality and risk are ________ concepts in planning the audit and designing an audit approach.

A) reasonable
B) typical
C) optional
D) fundamental

Question 17

Which one of the following statements is NOT correct?

A) Normally, the most important base used as the criterion for deciding materiality is total assets.
B) Qualitative factors as well as quantitative factors affect materiality.
C) Materiality is a relative rather than an absolute concept.
D) Given equal dollar amounts, fraud is usually considered more important than errors.

Question 18

Materiality is best described as which type of concept?

A) qualitative
B) quantitative
C) relative
D) relevant

Question 19

Which type of guidelines are suggested by AASB 1031?

A) relative
B) relevant
C) qualitative
D) quantitative

Question 20

Which of the following is NOT a difficulty auditors face when allocating materiality?

A) audit costs
B) reliability of audit evidence
C) understatements and/or overstatements
D) expectations of misstatements in accounts

Question 21

Which one of the following might NOT signal a lack of integrity in management?

A) Frequent disagreements with previous auditors
B) Prior criminal conviction of an assembly line foreman
C) Frequent turnover of key internal audit personnel
D) Frequent turnover of key financial personnel

Question 22

Direct projection from the sample to the population:

A) ignores sampling error.
B) is only necessary when the sample error is material.
C) takes into account errors in accounts not audited.
D) none of the above

Question 23

Risk is:

A) measured by tolerable error.
B) to be avoided in the audit.
C) a measure of uncertainty.
D) all of the above

Question 24

When discussing planned detection risk (PDR)and the audit risk model, which of the following statements is NOT true?

A) PDR is a measure of the risk that the auditor will not detect a misstatement in an assertion that could be material.
B) When PDR is changed from low to medium, the required accumulation of evidence would be increased.
C) PDR determines the amount of evidence the auditor plans to accumulate, inversely with the size of planned detection risk.
D) PDR is dependent on the other three factors in the model; i.e., it will change only if another changes.

Question 25

Which one of the following statements is NOT correct?

A) A misclassification in the balance sheet will have no effect on operating income.
B) Either an overstatement of an asset account or an understatement of a liability account would have the same effect on the income statement.
C) Either an understatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.
D) Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

Question 26

Suppose an auditor calculates an estimate of the errors by direct projection from the sample to the population.If the auditor finds $15 000 of net overstatement errors in a sample of $100 000 out of a total population of $500 000, the estimate of errors in the population will be:

A) $75 000.
B) $7 500.
C) $750.
D) $750 000.

Question 27

The estimate for sampling error results because the auditor has sampled only a portion of the population.Sampling error represents the:

A) minimum misstatements in accounts not audited.
B) maximum misstatements in accounts not audited.
C) maximum misstatements in the audited accounts.
D) minimum misstatements in the audited accounts.

Question 28

When discussing acceptable audit risk (AAR)and the audit risk model, which one of the following statements is true?

A) The terms audit assurance, overall assurance. and level of assurance are synonyms for AAR.
B) When the auditor decides on a lower acceptable audit risk, it means the auditor wants to be certain that the financial statements are not materially misstated.
C) AAR is the risk that the auditor is willing to take that the financial statements are fairly stated after the audit is completed and an unqualified opinion has been reached.
D) AAR is objectively determined by the auditor.

Question 29

Which of the following is NOT a good indicator of the degree to which statements are relied on by external users?

A) nature and amount of liabilities
B) client size, as measured by total assets or total revenue
C) distribution of ownership among the public
D) amount of net income or loss after taxes

Question 30

When discussing control risk (CR)and the audit risk model, which one of the following statements is NOT true?

A) The relationship between CR and detection risk is inverse.
B) The relationship between CR and evidence is direct.
C) CR is a measure of the auditor's assessment of the likelihood that errors will not be prevented or detected by the client's internal control.
D) If the auditor concludes that internal control is completely ineffective to prevent or detect errors, he or she would assign a 0% to CR.

Question 31

In situations in which the auditor believes the chance of financial failure or loss is high, and there is a corresponding increase in engagement risk for the auditor, acceptable audit risk should:

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

Question 32

When allocating materiality, most practitioners choose to allocate to:

A) the income statement accounts because they are more important.
B) both balance sheet and income statement accounts because there could be errors on either one.
C) all of the financial statements because there could be errors on other statements besides the income statement and balance sheet.
D) the balance sheet accounts because there are fewer of them.

Question 33

Which factor listed is NOT a good indicator of potential financial failure?

A) The client is constantly short of cash and working capital.
B) The client has had increasing net losses for several years.
C) The client's retained earnings were reduced by half as a result of a large dividend payout.
D) The client relies heavily on debt financing, especially by financing permanent assets with short-term loans.

Question 34

Regardless of how the allocation of the preliminary judgement about materiality was done, when the audit is complete, the auditor must be confident that the combined errors in all accounts are:

A) less than the preliminary judgement.
B) more than the preliminary judgement.
C) less than or equal to the preliminary judgement.
D) equal to the preliminary judgement.

Question 35

How does the amount of evidence change when the auditor reduces planned detection risk?

A) It is indeterminate.
B) It increases.
C) It remains unchanged.
D) It decreases.

Question 36

Risk in auditing means that the auditor accepts some level of uncertainty in performing the audit function.An effective auditor will:

A) set the risk level between 5% and 10%.
B) take any means available to reduce the risk to the lowest possible level.
C) recognise that risks exist and deal with those risks in an appropriate manner.
D) perform the audit procedures first and quantitatively set the risk level before forming an opinion and writing the report.

Question 37

Likely misstatements arise from:

A) the auditor's estimate of misstatements.
B) projections of misstatements based on the auditor's tests.
C) projections of misstatements based on the auditor's preliminary assessment of materiality.
D) differences between management's and the auditor's judgement about estimates of account balances.

Question 38

What is the term used to describe the preliminary judgement about materiality allocated to any given account balance?

A) tolerable materiality
B) the materiality range
C) the error range
D) tolerable misstatement

Question 39

The audit risk model is used primarily:

A) while doing tests of controls.
B) for planning purposes in determining how much evidence to accumulate.
C) to evaluate the evidence that has been gathered.
D) to determine the type of opinion to express.

Question 40

An aim of allocating a preliminary judgement about materiality to balance sheet accounts is to:

A) minimise audit costs and maintain audit quality.
B) determine the level of audit to accumulate.
C) increase audit quality.
D) reduce audit risk.

Question 41

Most auditors would use a higher inherent risk for inventory when:

A) inventory turnover slowed during the year.
B) obsolete inventory has been identified.
C) there is a large number of errors in the previous year.
D) both A and C

Question 42

Many account balances require estimates and/or a great deal of management judgement.One area that does NOT require such judgement would be:

A) obsolete inventory.
B) liability for warranty payments.
C) interest expense.
D) allowance for uncollectible accounts.

Question 43

Which one of the following is an example of the concept of inherent risk?

A) Accounting systems with vouchers have many more controls built in, so the risk that there will be errors on the financial statements is reduced.
B) Loans receivable for a finance company are less likely to be collectible than those of a bank.
C) Humans make more errors than computers; therefore, a manual accounting system is riskier than a computerised system.
D) Audits with larger sample sizes are less risky than those with smaller sample sizes.

Question 44

A major limitation in the application of the audit risk model is the:

A) difficulty in understanding the effect on other factors in the model when one factor is changed.
B) difficulty in measuring the components of the model.
C) difficulty in defining the terms of the model.
D) failure of the Auditing and Assurance Standards Board to accept it and incorporate it into the standards.

Question 45

When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as completely honest in all dealings, auditors normally:

A) increase inherent risk and control risk.
B) reduce inherent risk and control risk.
C) reduce acceptable audit risk and increase inherent risk.
D) increase acceptable audit risk and reduce inherent risk.

Question 46

Inherent risk is reduced where the likelihood of misstatement is low.This would be true for accounts receivable if most balances in accounts receivable were:

A) from related parties.
B) overdue.
C) from overseas customers.
D) current.

Question 47

Auditors respond to risk by:

A) changing the extent of testing and type of audit procedures.
B) modifying the assessment of materiality.
C) increasing the amount of evidence collected.
D) all of the above

Question 48

Acceptable audit risk is ordinarily set by the auditor during planning and:

A) varies by each major cycle and by each account.
B) holds constant for each major cycle and account.
C) varies by each major cycle but is constant by account.
D) holds constant for each major cycle but varies by account.

Question 49

Which of the following is NOT a consideration when the auditor is attempting to assess the inherent risk?

A) results of previous audits
B) existence of related parties
C) nature of client's business
D) frequency and intensity of top management's review of the accounting transactions and records

Question 50

The auditor assesses control risk and inherent risk.On a typical engagement, the auditor would be LEAST likely to assess these for:

A) each audit objective.
B) each cycle.
C) the overall audit.
D) each account.

Question 51

Which statement regarding inherent risk is correct?

A) Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain experience, even when there is inherent risk.
B) The inherent risk assigned in the audit risk model is unaffected by the auditor's experience with client's organisation.
C) The inherent risk assigned in the audit risk model is dependent upon the strengths in client's internal control system.
D) Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect.

Question 52

Which one of the following discoveries by the auditor would NOT raise the red flag of increased inherent risk?

A) This is the fourth consecutive year that the firm has audited this client.
B) Client is a parent company with a subsidiary.
C) The client is an electronics manufacturer that is holding extensive inventory.
D) Review of the results of the previous year's audit shows there were significant misstatements in accounts payable.

Question 53

What is a potential risk of under-auditing?

A) It exposes the audit firm to loss of professional reputation.
B) An audit may be assessed incorrectly.
C) Control risk may be assessed inappropriately.
D) Insufficient evidence may have been allocated to the audit.

Question 54

The amount of evidence required will be lower where:

A) IR and CR are both medium and planned DR is medium.
B) IR and CR are both low and DR is low.
C) IR and CR are both low and planned DR is high.
D) IR and CR are both high and planned DR is low.

Question 55

What is an appropriate strategy when an audit area has a low acceptable risk?

A) Review the completed working papers more thoroughly.
B) Increase the amount of audit evidence gathered.
C) Assign more experienced staff to that area.
D) all of the above

Question 56

Auditors begin their assessments of inherent risk during the planning phase.Which of the following would NOT be a topic of the planning phase that would also help to assess inherent risk?

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

Question 57

If acceptable audit risk is low and inherent and control risks are high, the amount of evidence required is:

A) low.
B) indeterminate.
C) medium.
D) high.

Question 58

Because control risk and inherent risk vary from cycle to cycle, account to account, or objective to objective:

A) detection risk will vary, but audit evidence will remain constant.
B) detection risk and required audit evidence will also vary.
C) acceptable audit risk must remain a constant.
D) detection risk will remain constant, but audit evidence will vary.

Question 59

Which one of the following statements is true? Misstatements found in the previous year's audit:

A) that occur again in the current year's audit indicate management fraud.
B) have little likelihood of occurring again in the current year's audit.
C) have a high likelihood of occurring again in the current year's audit.
D) that occur again in the current year's audit indicate employee fraud.

Question 60

When there is a high degree of engagement risk, auditors can factor this into the audit risk model by:

A) reducing the acceptable audit risk.
B) reducing the planned detection risk.
C) increasing the assessment of inherent risk.
D) all of the above

Question 61

Auditors will vary the acceptable audit risk for each segment of the audit.

Question 62

If an auditor assigns a tolerable misstatement of $1 000 to accounts payable, he or she would need to obtain more audit evidence for that account than if $100 000 had been assigned.

Question 63

The definition of materiality indicates that both the users and the auditors of financial statements are
assumed to have knowledge of the likely preparers of the statements.

Question 64

Auditors have difficulty applying the concept of materiality in practice because they often do not know who the users of the financial statements are or what economic decisions will be made.

Question 65

The primary purpose of allocating the preliminary judgement about materiality to financial statement accounts is to help the auditor decide the appropriate evidence to accumulate for each account.

Question 66

Once the auditor determines the preliminary judgement about materiality for a particular engagement, that amount cannot be changed during the engagement.

Question 67

The definition of materiality in the auditing standards is consistent with that contained in accounting
standards.

Question 68

Preliminary assessment of materiality is the combined amount of misstatements in the financial
statements that auditors would consider material early in the audit.

Question 69

Performance materiality as set by the auditor:

A) does not affect inherent or control risks.
B) increases inherent risk only.
C) increases control risk only.
D) increases inherent risk and control risk.

Question 70

The audit risk model is:

A) useful when performing the tests of balances, but of little value in either the planning or evaluation stages.
B) useful in evaluating results but of limited use in planning.
C) useful in planning but of limited use in evaluating results.
D) a planning, testing, and evaluation model.

Question 71

The lower the dollar amount of the preliminary judgement of materiality, the less audit evidence is
required.

Question 72

To maximise audit efficiency, the auditor should allocate less tolerable error to accounts that can be verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit.

Question 73

If an auditor believes the client will have financial difficulties after the audit report is issued, and external users will be relying heavily on the financial statements, the auditor will probably set acceptable audit risk as high.

Question 74

The primary purpose of the audit risk model is to aid auditors in planning the extent of tests of controls and determining which particular controls should be tested.

Question 75

Most practitioners allocate the preliminary judgement about materiality to balance sheet accounts rather than income statement accounts.

Question 76

Australian auditing standards provide detailed, objective guidance on how auditors are to establish a preliminary materiality level, thus eliminating the need for subjective auditor judgement in this task.

Question 77

A materiality level of $1 000 would require more audit evidence than would a materiality level of $100 000.

Question 78

The auditor's preliminary judgement about materiality is the maximum amount by which the auditor believes the financial statements could be misstated and still not affect the economic decisions of users.

Question 79

Inherent risk and planned detection risk are inversely related; i.e., as inherent risk increases, planned detection risk should decrease, ceteris paribus.

Question 80

If an auditor believes internal controls are completely ineffective to prevent or detect misstatements, the auditor should assess control risk as high, perhaps 100%.