Question 1

Describe the audit risk model and each of its components.

Accepted Answer

The answer of Describe the audit risk model and each...

Question 2

When the auditor is attempting to determine the extent to which external users rely on a client's financial statements, they may consider several factors except for:

Accepted Answer

The assessment of detection risk is a factor that the auditor considers when developing the overall audit strategy and is not directly related to the extent of reliance on the client's financial statements by external users. The factors that the auditor considers in determining the extent of reliance on the client's financial statements include client size, concentration of ownership, nature and amounts of assets and liabilities, industry conditions, and regulatory environment.

Question 3

Inherent risk and control risk are directly related.

Accepted Answer

Inherent risk is the susceptibility of an assertion about a transaction or balance to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. Control risk, on the other hand, is the risk that a misstatement that could occur in an assertion about a transaction or balance and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control. These risks are components of audit risk but are not directly related; they are independent factors that auditors assess separately.

Question 4

There are several factors that affect an audit firm's business risk and, therefore, acceptable audit risk.Discuss three of these factors.

Accepted Answer

The answer of There are several factors that affect an...

Question 5

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

Accepted Answer

A high detection risk means the auditor perceives a higher risk of not detecting material misstatements, which requires a higher amount of audit evidence to reduce this risk.

Question 6

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

Accepted Answer

When acceptable audit risk is set lower, the amount of substantive evidence required is higher. Conversely, when acceptable audit risk is set higher, the amount of substantive evidence required is lower. This is because a lower acceptable audit risk means that the auditor wants to reduce the risk of material misstatement in the financial statements, which can be achieved through obtaining more substantive evidence.

Question 7

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

Accepted Answer

According to the audit risk model, the acceptable audit risk and planned detection risk are inversely related, meaning when one is low, the other should be high. Therefore, if the acceptable audit risk is low and inherent risk and control risk are both low, planned detection risk should be high to ensure an acceptable level of audit risk.

Question 8

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

Accepted Answer

This is because the audit assurance rate refers to the level of assurance that the auditor is able to provide based on their procedures and findings. The acceptable audit risk refers to the level of risk that the auditor is willing to accept that the financial statements may contain material misstatements despite their procedures. Therefore, if the audit assurance rate is 95%, it means that the auditor is providing a high level of assurance and can accept a lower level of acceptable audit risk (which would be 5%).

Question 9

Which of the following is not a primary consideration when assessing inherent risk?

Accepted Answer

Degree of separation of duties is a factor to consider when assessing control risk, not inherent risk. The other choices are appropriate factors to consider when assessing inherent risk.

Question 10

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 low.

Accepted Answer

If the auditor believes that the client will have financial difficulties and external users will be relying heavily on the financial statements, there is an increased risk of financial misstatements or fraud. Therefore, the auditor will set acceptable audit risk as low to ensure a higher level of assurance for external users.

Question 11

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:

Accepted Answer

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, the auditor may choose to reduce acceptable audit risk to ensure that the likelihood of material misstatement is decreased. However, since management's integrity cannot be completely trusted, the auditor must also increase inherent risk to incorporate the possibility of undetected misstatements. Control risk may or may not be affected by management's integrity, depending on the nature of the control environment. Therefore, the only suitable option is reducing acceptable audit risk and increasing inherent risk.

Question 12

An acceptable audit risk assessment of low indicates a risky client requiring more extensive evidence, assignment of more experienced personnel, and/or a more extensive review of audit files.

Accepted Answer

The answer of An acceptable audit risk assessment of low...

Question 13

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.

Accepted Answer

Auditors may assess the operating effectiveness of a private company's internal controls if they choose to or if it's necessary for their audit approach, but they are not required to test all internal controls they believe have not been operating effectively. Their primary objective is to express an opinion on the financial statements, and testing of internal controls, while it may be part of the audit, is not a requirement unless the audit is being conducted under standards that specifically require such testing (e.g., an audit in accordance with PCAOB standards for public companies). For private companies, the focus is typically on substantive procedures to gather evidence about the amounts and disclosures in the financial statements.

Question 14

Which of the following statements regarding inherent risk is correct?

Accepted Answer

Inherent risk is the risk associated with the financial statement assertions, without considering the client's internal controls. Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain more knowledge about the company. Therefore, statement C is correct, whereas statements A, B, and D are incorrect.

Question 15

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

Accepted Answer

There is a direct relationship between acceptable audit risk and planned detection risk. As acceptable audit risk decreases, planned detection risk should also decrease, as the auditor should be willing to increase the level of testing to achieve a lower risk of material misstatement not being detected. Conversely, if acceptable audit risk is higher, a higher level of planned detection risk may be acceptable.

Question 16

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

Accepted Answer

The answer of Audit assurance is the complement of planned...

Question 17

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?

Accepted Answer

Obtaining client's agreement on the engagement letter is not directly related to assessing inherent risk. It is important for setting the scope and terms of the engagement, but does not provide information about the client's business or industry, related parties, or physical operations.

Question 18

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:

Accepted Answer

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 be reduced. This is because the auditor would need to increase their assurance level to compensate for the increased risk, which would require a lower acceptable audit risk.

Question 19

Engagement risk is effectively the audit firm's business risk.

Accepted Answer

Engagement risk refers to the risk of the audit firm being sued due to an erroneous audit or financial statement. Therefore, it is considered a type of business risk for the audit firm.

Question 20

The risk of fraud should be assessed for the entire audit as well as by cycle, account, and objective.

Accepted Answer

The answer of The risk of fraud should be assessed...

Quiz 9: Materiality and Risk