Question 1

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

Accepted Answer

Engagement risk refers to the risk of an auditor's association with a specific client or audit engagement. It includes the risk of reputation damage, litigation, or financial loss associated with the audit. As such, it is a component of the audit firm's overall business risk.

Question 2

Harker, CPA is in the audit planning phase of Dracule Industries. An understanding needs to be established regarding the responsibilities of Harker and Dracule's Management. For each of the task items listed below indicate the responsible party from the list of choices given. Each choice may be used once, more than once or not at all.

Accepted Answer

The answer of Harker, CPA is in the audit planning...

Question 3

Describe the audit risk model and each of its components.

Accepted Answer

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

Question 4

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

Accepted Answer

According to the audit risk model, an increase in acceptable audit risk would result in a decrease in the amount of substantive evidence required. This is because higher acceptable audit risk means the auditor is willing to accept a higher level of risk that the financial statements may contain material misstatements, and therefore less evidence needs to be gathered to reduce that risk to an acceptable level.

Question 5

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

Accepted Answer

If the auditor believes the chance of financial failure is high and there is an increase in business risk, they would want to reduce acceptable audit risk to mitigate their own risk. This would require more extensive and thorough auditing procedures to provide a higher level of assurance.

Question 6

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 7

Which of the following statements regarding inherent risk is correct?
A) Inherent risk is unaffected by the auditor's experience with client's organization.
B) Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect.
C) 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.
D) Inherent risk is dependent upon the strengths in client's internal control system.

Accepted Answer

Auditors often set a high inherent risk in the first year of an audit due to lack of familiarity with the client, and may reduce it in subsequent years as they gain more understanding and experience with the client's operations and controls.

Question 8

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 9

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 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 the client will have financial difficulties and external users will rely heavily on the financial statements, the auditor will need to ensure that the financial statements are as accurate as possible. They will set acceptable audit risk as low to increase the likelihood of detecting any material misstatements in the financial statements.

Question 11

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?
A) Obtaining client's agreement on the engagement letter.
B) Obtaining knowledge about the client's business and industry.
C) Touring the client's plant and offices.
D) Identifying related parties.

Accepted Answer

Obtaining client's agreement on the engagement letter is a part of audit acceptance and continuance procedures but it would not help in assessing inherent risk during the planning phase. The other options (B, C, D) would help auditors in understanding the client's business, environment, and relationships with related parties, which may impact inherent risk.

Question 12

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 13

As the acceptable level of detection risk increases, an auditor may change the:
A) timing of substantive tests by performing them at an interim date rather than year end.
B) timing of the tests on controls by performing them throughout the year rather than at one time.
C) assess the level of inherent risk to a lower amount.
D) increase the sample size to achieve a more effective test.

Accepted Answer

If the acceptable level of detection risk increases, the auditor may choose to perform substantive tests at an interim date rather than waiting until year-end. This is because performing tests at an interim date can reduce the risk of undetected material misstatements. Changing the timing of tests on controls or lowering the level of inherent risk would not directly address the increased detection risk, and increasing the sample size may not be necessary if the level of detection risk is perceived to be acceptable.

Question 14

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

Accepted Answer

A high detection risk means that there is a high risk that material misstatements may exist in the financial statements, so the auditor needs to gather a sufficient amount of appropriate audit evidence to reduce this risk to an acceptable level. Therefore, a high detection risk equates to a greater amount of audit evidence needed, not a lower amount.

Question 15

Insert risk and control risk are normally assessed for the each segment but sets audit risk at the financial statement level.

Accepted Answer

The answer of Insert risk and control risk are normally...

Question 16

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 17

Which of the following is not a primary consideration when assessing inherent risk?
A) nature of client's business
B) existence of related parties
C) degree of separation of duties
D) susceptibility to defalcation

Accepted Answer

The degree of separation of duties is actually a factor that should be considered when assessing control risk, not inherent risk. The nature of client's business, existence of related parties, and susceptibility to defalcation are all primary considerations when assessing inherent risk.

Question 18

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

Accepted Answer

If management cannot be regarded as completely honest in all dealings, it implies a higher risk of misstatement in the financial statements. Therefore, to maintain a lower overall audit risk, auditors need to reduce acceptable audit risk and increase inherent risk. This would enable the audit team to use more substantive procedures to gather evidence and reduce the risk of not detecting material misstatements.

Question 19

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:
A) client size.
B) concentration of ownership.
C) types and amounts of liabilities.
D) assessment of detection risk.

Accepted Answer

The extent to which external users rely on a client's financial statements is not determined by the assessment of detection risk. Factors that may be considered include client size, concentration of ownership, and types and amounts of liabilities.

Question 20

As control risk increases, the amount of substantive evidence the auditor plans to accumulate should increase.

Accepted Answer

As control risk increases, the auditor cannot rely on the effectiveness of the client's internal controls to prevent and detect material misstatements. Therefore, the auditor must increase the amount of substantive evidence they plan to accumulate in order to obtain more assurance about the accuracy and completeness of the financial statements.

Quiz 9: Materiality and Risk

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

Describe the audit risk model and each of its components.

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

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:

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

Which of the following statements regarding inherent risk is correct?

Inherent risk and control risk are directly related.

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

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.

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?

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.

As the acceptable level of detection risk increases, an auditor may change the:

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

Insert risk and control risk are normally assessed for the each segment but sets audit risk at the financial statement level.

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.

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

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:

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:

As control risk increases, the amount of substantive evidence the auditor plans to accumulate should increase.