Deck 7: Assessing Risks and Internal Control

Question 1

Risk should not be tolerated on a cost/benefit basis.

Answer 1

False

Question 2

There are two parts to business analysis: process analysis and industry analysis.

Answer 2

False

Question 3

Theoretically, when assessing the inherent risk related to an account balance, an auditor does not explicitly consider the

A)Liquidity of the account.
B)Management estimates involved in determining the account balance.
C)Internal control policies and procedures.
D)Complexity of calculations involved.

Answer 3

C

Question 4

As control risk gets smaller, audit risk gets larger, assuming all other risks stay constant.

Question 5

Control risk is the probability that audit procedures will fail to detect material misstatements in the financial statements.

Question 6

Business processes can be thought of as a structured set of activities within an entity.

Question 7

Generally accepted auditing standards permit auditors to place complete reliance on internal control (zero control risk assessment) to justify the exclusion of substantive audit procedures for a balance sheet or income statement account.

Question 8

Auditors find it easier to audit related accounts instead of attacking each account on its own.

Question 9

The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when, in fact, such misstatement actually does exist is

A)Audit risk
B)Inherent risk.
C)Control risk.
D)Detection risk.

Question 10

In an overall audit risk is the probability that an auditor will give an inappropriate opinion on financial statements.

Question 11

To assess the risk of material misstatement at the financial statement level, the auditor needs a detailed knowledge of internal control components relevant to financial reporting.

Question 12

Management's philosophy and operating style has to do with how the business is operated and is not part of the internal control environment.

Question 13

An organization with a very hierarchical structure is typical of companies in complex business environments as this structure reduces the ability of a junior employee to make a wrong decision.

Question 14

Auditors do not create or control inherent risk; they can only try to assess its magnitude.

Question 15

Detection risk is the probability that audit procedures will produce evidence of material misstatements.

Question 16

Since management is most familiar with an organization, they should sit on the Board of
Directors and advise those charged with governance of the organization.

Question 17

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the

A)Factors that raise doubts about the auditability of the financial statements.
B)Operating effectiveness of internal control policies and procedures.
C)Risk that material misstatements exist in the financial statements.
D)Possibility that the nature and extent of substantive tests may be reduced.

Question 18

Company-level controls can have a big impact on a company's financial reporting.

Question 19

Inherent risk is the

A)Probability that some accounts are more susceptible to misstatement than others.
B)Probability that the client's internal control policies and procedures will fail to detect material misstatements.
C)Probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements.
D)Probability that the auditor may not detect material misstatements in the financial statements.

Question 20

The probability that an auditor will give an inappropriate opinion on the financial statements best describes

A)Audit risk.
B)Inherent risk.
C)Control risk.
D)Detection risk.

Question 21

An auditor considers two factors in understanding business risks.They are:

A)The likelihood of a risk occurring and the materiality of the risk.
B)The magnitude of the risk and the type of risk.
C)The likelihood of the risk occurring and the type of risk.
D)The likelihood of a risk occurring and the magnitude the risk.

Question 22

The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor

A)Obtains reasonable assurance about whether the financial statements are free of material misstatement.
B)Assesses the accounting principles used and also evaluates the overall financial statement presentation.
C)Realizes some matters, either individually or in the aggregate, are important while other matters are not important.
D)Is responsible for expressing an opinion on the financial statements, which are the responsibility of management.

Question 23

When an auditor increases the planned assessed level of control risk because certain control procedures were determined to be ineffective, the auditor would most likely increase the

A)Extent of tests of details.
B)Level of inherent risk.
C)Extent of tests of controls.
D)Level of detection risk.

Question 24

After obtaining an understanding of the internal control system and assessing control risk, an auditor decided not to perform additional tests of controls.The auditor most likely concluded that the

A)Additional evidence to support a further reduction in control risk was not cost-beneficial.
B)Assessed level of inherent risk exceeded the assessed level of control risk.
C)Internal control system was properly designed and justifiably may be relied on.
D)Evidence obtainable through tests of controls would not support an increased level of control risk.

Question 25

An auditor might suspect that the auditee is in financial difficulty if:

A)The auditee offers more generous customer credit terms.
B)The auditee takes a large bank loan at market rates.
C)Sales increase and inventory increases.
D)Purchases increase and payables increase.

Question 26

On the basis of 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)Decrease substantive testing.
B)Decrease detection risk.
C)Increase inherent risk.
D)Increase materiality levels.

Question 27

If control risk increases and all other risks in the audit risk model stay constant (except the one referred to below) which of the following is correct?

A)Detection risk must increase.
B)Inherent risk will increase.
C)Audit risk will decrease.
D)Detection risk must decrease.

Question 28

What is the definition of business risk?

A)An event or action which will make it more difficult for an organization to achieve its objectives.
B)An event or action which causes an organization to become bankrupt.
C)An event or action which causes an organization's financial statements to be materially incorrect.
D)Unfortunate events or actions which are common to all businesses in the economy.

Question 29

Two broad groupings of controls are:

A)Internal controls and segregation of duties.
B)Physical access controls and password controls.
C)Validity checks and completeness checks.
D)General controls and application controls

Question 30

One way to think of an accounting process is as a cycle.The idea of a cycle reflects:

A)That transactions have to undergo a series of procedures before being recorded in the accounts.
B)That transactions are not complete until they are recorded.
C)That there is a set of accounts that record transaction information from the same business process.
D)That every business process results in the start of another process.

Question 31

A critical element of control is monitoring.What is likely to happen if management fails to monitor an internal control?

A)Necessary improvements will not be identified.
B)Personnel are likely to stop observing the control.
C)The inherent risk of an error will increase.
D)The auditor is likely to assume the control is working when it might not be.

Question 32

The business process view also highlights the fact that business organizations:

A)Differ in terms of the technology they use.
B)Essentially all perform the same activities.
C)Should simplify their business to follow clear rules.
D)Work best when run as a hierarchy.

Question 33

Inherent risk and control risk differ from detection risk in that they

A)Arise from the misapplication of auditing procedures.
B)May be assessed in either quantitative or non-quantitative terms.
C)Exist independently of the financial statement audit.
D)Can be changed at the auditor's discretion.

Question 34

An auditor's begins the identification of business risks by doing what?

A)Preliminary analysis
B)Financial analysis
C)Strategic analysis
D)Horizontal analysis

Question 35

Business processes cross boundaries between functional areas of an organization.Business process management systems have been facilitated by:

A)Management information systems
B)Enterprise resource planning systems
C)Database management systems
D)Web based application systems

Question 36

Define control risk.

Question 37

Quality of earnings refers to:

A)The accuracy of the net income calculation.
B)A company's ability to continue earning at its current level.
C)How closely earnings per share agree to analyst predictions.
D)The percentage of net income to total revenue.

Question 38

The acceptable level of detection risk is inversely related to the

A)Assurance provided by substantive tests.
B)Risk of misapplying auditing procedures.
C)Preliminary judgment about materiality levels.
D)Risk of failing to discover material misstatements.

Question 39

An auditor can broadly define controls as:

A)Those elements of an organization that taken together support people in achieving an organization's objectives.
B)Those systems, processes and procedures which prevent fraud.
C)Key performance indicators employed by management to measure an organization's success.
D)The structure and culture of an organization which helps to eliminate risk.

Question 40

Internal control includes the following components:

A)Control activities and inherent risks.
B)Information systems and external influences.
C)The control environment and risk assessment processes.
D)Financial reporting and control activities.

Question 41

Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Explain your answer using the audit risk model.

Question 42

What are four of the elements of the internal control environment?

Question 43

What is the connection between communication and internal control?

Question 44

According to the Criteria of Control Guidance on Control, identify four values and preferences of senior management which can greatly influence an organization.

Question 45

Discuss four ways of managing risk in an organization.