Deck 4: Audit Planning II

Question 1

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

Answer 1

True

Question 2

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.

Answer 2

C

Question 3

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

Answer 3

False

Question 4

Martin Shawbridge, a manager at Cox, Durham, & Elliott, CA'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 5

Companienter into debt covenants with lenders when taking on significant loans.

Question 6

Materiality is assessed during the planning stage of every audit.

Question 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

Inventory turnover measurhow many tima year a company collects cash from its debtors.

Question 12

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 13

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 14

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 assesscontrol 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 15

Trend analysis involva comparison of account balancto a single line item.

Question 16

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 17

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

Question 18

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

Question 19

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 20

Analytical procedurare conducted at the planning stage of an audit to enhance the understanding of the auditor's client.

Question 21

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 22

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 planning stage of every audit.
D) Information is considered material if it has no impact on the decision-making process of financial statement users.

Question 23

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 24

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

A) Both statements are correct.
B) Neither statement is correct.
C) Only statement (i) is correct.
D) Only statement (ii) is correct.

Question 25

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 26

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 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

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 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

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 31

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 32

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 33

Millie Buenavista made the following two statements concerning inherent risk:
(i) Inherent risk is the risk that an auditor expressan 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 statements are correct.
B) Neither statement is correct.
C) Only statement (i) is correct.
D) Only statement (ii) is correct.

Question 34

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 notprevent or detect material misstatements.
D) there is a high susceptibility of assertions to material misstatements.

Question 35

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 36

MoisAlou 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) a and b
D) none of the above

Question 37

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 38

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 thefinancial statements are materially stated.
C) Audit risk can be reduced at the planning stage of an audit by identifying the key risks faced by the client.
D) All 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

Sami Zubair's client donot 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 41

Builders Direct was incorporated in December of 2013 and started operating in January of 2014. The company operata retail web site that sells home building products to contractors in Canada. The business is owned and managed by two brothers, Jamand Jackie Collingham. Despite a slowdown in the very competitive construction sector, the brothers have developed several unique interactive on line shopping featurthat 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. Jamand Jackie 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 believthey may have some challengobtaining an unqualified audit opinion. She has expressed this concern due to the issushe has had with the new accounting hirand 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 Builders Direct.

Question 42

Indicate whether you agree or disagree with the following statements and explain your reasoning.
a) Roxanne Deboer, 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) Tyler Rappaport 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) Paloma Schenker has determined control risk at a biochem company to be high. She plans to use a combined audit strategy.

Question 43

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

Question 44

What is the relationship between materiality and audit risk?

Question 45

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 46

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

Question 47

Analytical procedurare conducted at the planning stage 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 48

Audit risk is the risk that an auditor expressan 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?

Question 49

Analytical procedurare used at which of the following stagof an audit?

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

Question 50

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

Question 51

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 declinin 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 premisreviewing 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 practicand investment in the local community whenever possible. This stance has distinguished it from other financial institutions, which are primarily branchof 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 includauthorization 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 familiare 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 pricin the surrounding area. ACU still maintains a high inventory of land received from past foreclosurbut has decided to hold onto this land for fear of depressing land pricfurther. 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 believthis 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 52

Discuss the purpose and some common examplof profitability ratios.

Question 53

Common measurof a company's profitability include:

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

Question 54

John Primo, the senior auditor at Delahanty, Forbes, CA's was planning for the audit of Canadian Light Source (CLS) and decided to use benchmarking as an analytical procedure. His manager agreed with John's approach and suggested information sourcthat would ensure the reliability of the data for his benchmarking exercise. As John walked out of the office he ran into Gina Stevenson, a newly hired auditor. He congratulated her on her decision to use a substantive approach to her accounts receivable section of the audit program. Gina was also going to be reviewing certain internal controls in the CLS audit program. She asked him to whom she should report weaknessin 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 Gina use a substantive approach?
c) To whom will Gina report weaknesses in a client's system of internal controls?

Question 55

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

Question 56

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 57

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

Question 58

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 59

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 60

In conducting analytical procedures, which of the following information sourcare 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