Question 1

Discuss three factors that affect client business risk and therefore audit risk.

Accepted Answer

The answer of Discuss three factors that affect client business...

Question 2

PA is auditing a client where the accounts receivable are in worse shape than last year: many accounts are significantly overdue. How would this fact be dealt with in the audit risk model?

Accepted Answer

The fact that the accounts receivable are in worse shape than last year indicates a higher risk of misstatement, which means that inherent risk should be increased.

Question 3

Assessing design effectiveness and conducting tests of controls are required when the auditor

Accepted Answer

Assessing design effectiveness and conducting tests of controls are required when the auditor chooses to set control risk below 100 percent and relies on the controls. This is done to obtain sufficient assurance that the controls are designed effectively and are operating effectively. This helps the auditor to reduce the extent of substantive testing required.

Question 4

With respect to clients, business risk increases when conditions, events, circumstances or inactions

Accepted Answer

Business risk increases when factors adversely affect the entity's ability to achieve its objectives, such as economic downturns, changes in regulations, or shifts in consumer preferences. This can lead to reduced revenue, decreased market share, or even failure of the company. The other choices (B, C, and D) do not necessarily increase business risk on their own.

Question 5

As the effectiveness of internal control increases, what happens to control risk?

Accepted Answer

As the effectiveness of internal control increases, the likelihood of material misstatements due to errors or fraud decreases. Therefore, the control risk decreases as well.

Question 6

The inherent risks of programming errors with resulting data loss increases when

Accepted Answer

Complex configurations such as ERP at multiple locations are more prone to programming errors and resulting data loss due to the higher level of complexity and interdependencies involved.

Question 7

If inherent risk is considered at the assertion level, why does the nature of the client's business affect inherent risk?

Accepted Answer

Inherent risk at the assertion level is influenced by factors specific to the account balance or transaction class being audited. The nature of the client's business can affect inherent risk if certain accounts, such as inventory, are more susceptible to misstatement due to the nature of the client's operations. For example, a manufacturing company's inventory may be more complex and subject to greater inherent risk than a service-oriented company's inventory.

Question 8

Big Box Distribution Company has an in-house information systems department of 50 people. The company generally does its own programming, although some software was acquired as a software package. A software package was purchased for customer relationship management, which will be modified by the programming staff.
Procedures for implementing programs vary by department. All major changes are approved by the Management Information Systems steering committee. The committee is also given a list of the maintenance changes that are planned in the coming year. Some departments request that the data processing department handle testing, while other users are rather picky and want to do their own testing. Requirements are generally prepared in writing, although small maintenance changes may be handled verbally.
Required:
Assess inherent risk associated with program changes at Big Box.

Accepted Answer

The answer of Big Box Distribution Company has an in-house...

Question 9

What is the role of internal controls during the assessment of inherent risk?

Accepted Answer

Inherent risk is assessed independently of internal controls. It represents the susceptibility of an assertion to a material misstatement assuming there were no related controls. Therefore, the quality or existence of internal controls is not considered when assessing inherent risk.

Question 10

In addition to representing an assessment of whether a client's internal control is effective for preventing or detecting misstatements, control risk also represents the

Accepted Answer

Control risk, in the context of an audit, refers to the risk that a misstatement that could occur in an account balance or class of transactions and that could be material, either individually or when aggregated with misstatements in other balances or classes, will not be prevented or detected (and corrected) on a timely basis by the entity's internal control. The auditor's intention to rely on internal controls directly influences the assessment of control risk; if the auditor plans to rely more on the internal controls, they might assess control risk as lower, assuming the controls are effective.

Question 11

When inherent risk is assessed as higher (i.e. more material errors are likely to exist) and control risk is assessed the same from one year to the next, what is the likely effect on detection risk?

Accepted Answer

When inherent risk is assessed as higher and control risk remains the same, auditors will typically reduce detection risk to achieve an acceptable level of overall audit risk. This means they will perform more or more effective audit procedures to catch material misstatements.

Question 12

The inherent risks of data compromise (such as privacy violations) or data loss increase when

Accepted Answer

Using websites to process sales transactions involves transmitting sensitive data over the internet, which can be vulnerable to cyber attacks and data breaches.

Question 13

Your firm has been appointed as the auditor of Bush Mining Inc. (BMI), a company that runs small mining operations in remote areas of northern Canada, primarily in surface mines. You have been assigned the job of senior auditor for BMI.
BMI's operations are subject to provincial and federal laws and regulations. These laws and regulations have become stricter in recent years and some of BMI's older mines may be in violation of environmental laws. Surface mining produces tailings (toxic wastes that are dangerous to animal and plant life). These tailings are either further processed and buried or retained in tailings ponds. BMI is required to restore the mining property to a safe condition after a mine is exhausted. BMI has programs in place to monitor and control pollutants that are released to the air and to local waterways.
Required:
A) What factors would affect the client business risk of BMI? Based upon your assessment of BMI's client business risk, would you adjust audit risk? Why or why not?
B) What is your preliminary assessment of audit risk? Justify your answer.

Accepted Answer

The answer of Your firm has been appointed as the...

Question 14

Using the audit risk model, audit risk describes targeted assurance, while control risk and inherent risk are assessed based upon a variety of factors. Of the components of the audit risk model, which is most likely to be set to 100%?

Accepted Answer

Control risk is often set to 100% when auditors decide not to rely on the client's internal controls and instead perform substantive testing to gather audit evidence.

Question 15

If from last year to the current year's audit, inherent risk has stayed constant but control risk is higher (it is more likely that controls do not detect material errors), what is the likely effect on detection risk?

Accepted Answer

When control risk increases (meaning it's more likely that the entity's controls will fail to detect or prevent material misstatements), the auditor will typically decrease detection risk to compensate. This is done by performing more or different audit procedures to ensure that the overall audit risk remains at an acceptable level. Detection risk is inversely related to control risk; as control risk goes up, auditors aim to reduce detection risk to maintain the desired level of overall audit risk.

Question 16

The inherent risk of programming errors (and thus processing errors for the affected application systems) increases when

Accepted Answer

When an information system group is understaffed, programming errors are more likely to occur due to lack of resources to properly test and review the code. This increases the risk of processing errors for the affected application systems. Customization by an external software house or the use of standard software packages does not necessarily increase the risk of programming errors, while the use of an Internet-based applications service provider may actually decrease the risk since they are likely to have more experience and expertise in ensuring reliability and security of their systems.

Question 17

Use of electronic funds transfers (such as electronic data interchange and online banking) has which of the following effects on the audit risk model?

Accepted Answer

Electronic funds transfers can increase inherent risks associated with cash due to the potential for unauthorized access, fraud, and errors in electronic transactions.

Question 18

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

Accepted Answer

Planned detection risk refers to the risk that the auditor's procedures will not detect a material misstatement in a financial statement assertion. Thus, the risk that the auditor's procedures will lead to the conclusion that an error does not exist when, in fact, such error does exist is a planned detection risk.

Question 19

Senior management of Mega Corp. is entitled to receive large bonuses if they achieve earnings targets. What is the effect of this on the risks associated with recording of revenue?

Accepted Answer

The incentive to achieve earnings targets can lead to manipulation or misstatement of revenue, increasing inherent risks related to the cutoff (timing of revenue recognition) and existence (validity of recorded revenue) assertions.

Question 20

GreenGrow Limited is a local landscaping company that does household and commercial landscaping. Primarily, it helps businesses select plants and manage the plants. It also has regular maintenance contracts such as watering, weeding, and mowing. In the winter, it has some contracts for managing the indoor plants in shopping malls and does snow clearing to help boost this low-income season.
Joey, the majority shareholder of GreenGrow is ecstatic. He has managed to come in as the low bidder for a new type of contract. He bid on the construction of a track for the track and field area of a local university. A piece of land on the north end of the university is being cleared and GreenGrow will be leveling the land and placing a bed of crushed stone for the track. Joey has just the right person to be in charge. Jack has previous experience working as an assistant on a road crew and knows how to use the surveying equipment needed to keep the track level. This is a big contract, and will increase revenues by one third!
Required:
Assess inherent risk for revenue for GreenGrow Limited.

Accepted Answer

The answer of GreenGrow Limited is a local landscaping company...

Quiz 7: Materiality and Risk