Multiple-Choice Questions - CPA Diary



Chapter 9

Multiple-Choice Questions

|1. |If it is probable that the judgment of a reasonable person would have been changed or influenced by the omission or |

|easy |misstatement of information, then that information is, by definition of FASB Statement No. 2: |

|a | |

| |a. material. |

| |b. insignificant. |

| |c. significant. |

| |d. relevant. |

| | |

|2. |The preliminary judgment about materiality is the amount by which the auditor believes the |

|easy |statements could be misstated and still not affect the decisions of reasonable users. |

|b |a. minimum |

| |b. maximum |

| |c. mean average |

| |d. median average |

| | |

|3. |Auditors are responsible for determining whether financial statements are materially misstated, so upon discovering a|

|easy |material misstatement they must bring it to the attention of: |

|d |a. regulators. |

| |b. the audit firm’s managing partner. |

| |c. no one in particular. |

| |d. the client’s management. |

| | |

|4. |The FASB definition of materiality emphasizes what class of financial statement users? |

|easy |a. Regulators. |

|c |b. Informed investors. |

| |c. Reasonable persons. |

| |d. Potential investors. |

| | |

|5. |When auditors allocate the preliminary judgment about materiality to account balances, the materiality allocated to |

|easy |any given account balance is referred to as: |

|d |a. the materiality range. |

| |b. the error range. |

| |c. tolerable materiality. |

| |d. tolerable misstatement. |

| | |

|6. |Why do auditors establish a preliminary judgment about materiality? |

|easy |a. To determine the appropriate level of audit experience required for the work. |

|c |b. So that the client can know what records to make available to the auditor. |

| |c. To plan the appropriate audit evidence to accumulate and develop an overall audit strategy. |

| |d. To finalize the assessment of control risk. |

| | |

|7. |Auditors are _____ to decide on the combined amount of misstatements in the financial statements that they would |

|easy |consider material early in the audit. |

|b |a. permitted |

| |b. required |

| |c. not allowed |

| |d. strongly encouraged |

| | |

|8. |If an auditor establishes a relatively high level for materiality, then the auditor will: |

|easy |a. accumulate more evidence than if a lower level had been set. |

|b |b. accumulate less evidence than if a lower level had been set. |

| |c. accumulate approximately the same evidence as would be the case were materiality lower. |

| |d. accumulate an undetermined amount of evidence. |

| | |

|9. |The preliminary judgment about materiality and the amount of audit evidence accumulated are _____ related. |

|easy | |

|d |a. directly |

| |b. indirectly |

| |c. not |

| |d. inversely |

| | |

|10. |After the preliminary judgment about materiality has been established, auditors may: |

|easy |a. not adjust it. |

|d |b. adjust it downward only. |

| |c. adjust it upward only. |

| |d. adjust it either downward or upward. |

| | |

|11. |In an audit area that has a lower inherent risk, it would be prudent to: |

|easy |a. increase the amount of audit evidence gathered. |

|c |b. assign more experienced staff to that area. |

| |c. increase the tolerable misstatement for the area. |

| |d. expand planning procedures. |

| | |

|12. |Which of the following is least likely to be appropriate as the basis for determining the preliminary judgment about |

|easy |materiality in the audit of financial statements? |

|d |a. Net income before taxes. |

| |b. Current assets. |

| |c. Owners’ equity. |

| |d. Inventory. |

| | |

|13. |Auditing standards _____ that the basis used to determine the preliminary judgment about materiality be documented in|

|easy |the audit files. |

|c |a. permit |

| |b. do not allow |

| |c. require |

| |d. strongly encourage |

| | |

|14. |Amounts involving fraud are usually considered _____ important than unintentional errors of equal dollar amounts. |

|easy | |

|d |a. less |

| |b. no less |

| |c. no more |

| |d. more |

| | |

|15. |Which of the following qualitative factors may significantly influence whether an item is deemed to be material? |

|easy | |

|a | |

| |Misstatements that are otherwise minor may be | | |

| |material if there are possible consequences | |Misstatements that are otherwise immaterial may be |

| |arising from contractual obligations. | |material if they affect a trend in earnings |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | | | |

|16. |Auditors generally allocate the preliminary judgment about materiality to the: |

|easy |a. balance sheet only. |

|a |b. income statement only. |

| |c. income statement and balance sheet. |

| |d. statement of cash flows. |

| | |

|17. |Which of the following statements regarding inherent risk is correct? |

|easy |a. The inherent risk assigned in the audit risk model is unaffected by the auditor’s experience with client’s |

|c |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. The inherent risk assigned in the audit risk model is dependent upon the strengths in client’s internal control |

| |system. |

| | |

|18. |Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in |

|easy |assessing inherent risk during the planning phase? |

|a |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. |

| | |

|19. |Auditors commonly allocate materiality to balance sheet accounts rather than income statement accounts because most |

|medium |income statement misstatements have a(n) _____ effect on the balance sheet. |

|b | |

| |a. reduced |

| |b. equal |

| |c. undetermined |

| |d. increased |

| | |

|20. |Which of the following is not a correct statement regarding the allocation of the preliminary judgment about |

|medium |materiality to balance sheet accounts? |

|b |a. Auditors expect certain accounts to have more misstatements than others. |

| |b. The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate |

| |audit evidence. |

| |c. Auditors expect to identify overstatements as well as understatements in the accounts. |

| |d. Relative audit costs affect the allocation. |

| | |

|21. |What is the primary means of dealing with risk in planning decisions related to audit evidence? |

|medium |a. Selection of more effective tests of details of balances. |

|b |b. Application of the audit risk model. |

| |c. Establishing a lower preliminary judgment about materiality. |

| |d. Allocating materiality judgment to segments. |

| | |

|22. |The phrase “in our opinion” in the auditor’s report is intended to inform users that auditors: |

|medium |a. guarantee fair presentation of the financial statements. |

|d |b. act as insurers of the accuracy of the statements. |

| |c. certify the material presented in the statements by management. |

| |d. base their conclusions about the statements on professional judgment. |

| | |

|23. |Inherent risk is _______ related to detection risk and _______ related to the amount of audit evidence. |

|medium | |

|d |a. directly, inversely |

| |b. directly, directly |

| |c. inversely, inversely |

| |d. inversely, directly |

| | |

|24. |The five steps in applying materiality are listed below in random order. |

|medium | 1. Estimate the combined misstatement. |

|b | 2. Estimate the total misstatement in the segment. |

| | 3. Set preliminary judgment about materiality. |

| | 4. Allocate preliminary judgment about materiality to segments. |

| |5. Compare combined estimate with preliminary judgment about materiality. |

| |The correct sequence from start to finish would be: |

| |a. 1 2 5 4 3. |

| |b. 3 4 2 1 5. |

| |c. 4 3 1 5 2. |

| |d. 5 1 3 2 4. |

| | |

|25. |Which of the following statements is not correct? |

|medium |a. Materiality is a relative rather than an absolute concept. |

|b |b. The most important base used as the criterion for deciding materiality is total assets. |

| |c. Qualitative factors as well as quantitative factors affect materiality. |

| |d. Given equal dollar amounts, frauds are usually considered more important than errors. |

| | |

|26. |Since materiality is relative, it is necessary to have bases for establishing whether misstatements are material. |

|medium |Normally, the most common base for deciding materiality is: |

|a |a. net income before taxes. |

| |b. net working capital. |

| |c. net income after taxes. |

| |d. total assets. |

| | |

|27. |Certain types of misstatements are likely to be more important than other types to users, even if the dollar amounts |

|medium |are the same. Which of the following demonstrates this? |

|a | |

| |Amounts involving frauds are considered more | |Misstatements that are otherwise immaterial may be |

| |important than errors of equal amount | |material if they affect a trend in earnings. |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | |

|28. |Allocating the preliminary judgment about materiality to financial statements segments is necessary because: |

|medium | |

|b |a. evidence is accumulated for the financial statements as a whole so materiality does not apply to them. |

| |b. evidence is accumulated by segments rather than for the financial statements as a whole. |

| |c. it is required by the AICPA’s Code of Professional Conduct. |

| |d. it is required by the SEC. |

| | |

|29. |Which of the following statements is not correct? |

|medium |a. Either an overstatement of an asset account or an understatement of a liability account would have the same |

|c |effect on the income statement. |

| |b. A misclassification in the balance sheet will have no effect on operating income. |

| |c. Either an overstatement of an asset account or an overstatement of a liability account would have the same effect|

| |on the income statement. |

| |d. Either an understatement of an asset account or an overstatement of a liability account would have the same |

| |effect on the income statement. |

| | |

|30. |Regardless of how the preliminary judgment about materiality is allocated, the auditor must be confident that total |

|medium |combined misstatements in all accounts are: |

|d |a. less than the preliminary judgment. |

| |b. equal to the preliminary judgment. |

| |c. more than the preliminary judgment. |

| |d. less than or equal to the preliminary judgment. |

| | |

|31. |Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance to refer to |

|medium |________. |

|c |a. detection risk |

| |b. audit report risk |

| |c. acceptable audit risk |

| |d. inherent risk |

| | |

|32. |_____ misstatements are those where the auditor can determine the amount of the misstatement in the account. |

|medium | |

|c |a. Potential |

| |b. Likely |

| |c. Known |

| |d. Projected |

|33. |When a different extent of evidence is needed for the various cycles, the difference is caused by: |

|medium |a. errors in the client’s accounting system. |

|d |b. a client’s need to achieve an unqualified opinion. |

| |c. an auditor’s need to follow auditing standards. |

| |d. an auditor’s expectations of errors and assessment of internal control. |

| | |

|34. |If planned detection risk is reduced, the amount of evidence the auditor accumulates will: |

|medium |a. increase. |

|a |b. decrease. |

| |c. remain unchanged. |

| |d. be indeterminate. |

| | |

|35. |Likely misstatements can result from: |

|Medium | |

|a | | | | |Projections of misstatements |

| | | |Differences between management’s and | |based on an auditor’s tests of a|

| |Computation of the sampling | |an auditor’s judgment about account | |sample from a population |

| |error for the cash account | |balances | | |

| |a. |No | |Yes | |Yes |

| |b. |Yes | |Yes | |No |

| |c. |No | |No | |Yes |

| |d. |Yes | |No | |No |

| | | | | | | |

| | |

|36. |When discussing control risk (CR) and the audit risk model, which of the following is false? |

|medium |a. CR is a measure of the auditor’s assessment of the likelihood that misstatements will not be prevented or detected|

|b |by internal control. |

| |b. If the auditor concludes that internal control is completely ineffective to prevent or detect errors, he/she would|

| |assign a low value (e.g., 0%) to CR. |

| |c. The relationship between control risk and detection risk is inverse. |

| |d. The relationship between control risk and evidence needed to support account balances is direct. |

| | |

|37. |Which of the following is not a good indicator of the degree to which statements are relied on by external users? |

|medium | |

|d |a. Client’s size, as measured by total assets or total revenue. |

| |b. Distribution of ownership among the public. |

| |c. Nature and amount of liabilities. |

| |d. Amount of net income or loss after taxes. |

| | |

|38. |If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk|

|medium |for the auditor, acceptable audit risk would likely: |

|a |a. be reduced. |

| |b. be increased. |

| |c. remain the same. |

| |d. be calculated using a computerized statistical package. |

| | |

|39. |When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as|

|medium |completely honest in all dealings, auditors normally: |

|a |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. |

| | |

|40. |One accounting issue that does not require management to use significant judgments is: |

|medium |a. the allowance for doubtful accounts. |

|b |b. the useful life of equipment for tax purposes. |

| |c. obsolete inventory. |

| |d. the liability for warranty payments. |

| | |

|41. |Inherent risk is often low for an account such as: |

|medium |a. inventory. |

|d |b. marketable securities. |

| |c. cash. |

| |d. accounts receivable. |

| | |

|42. |The auditor typically does not assess control risk and inherent risk for: |

|medium |a. each audit objective. |

|d |b. each cycle. |

| |c. each account. |

| |d. the overall audit. |

| | |

|43. (Public) |To what extent do auditors typically rely on internal controls of their public company clients? |

|medium |a. Extensively |

|a |b. Only very little |

| |c. Infrequently |

| |d. Never |

| | |

|44. |Auditors typically rely on internal controls of their private company clients: |

|medium |a. Only as needed to complete the audit and satisfy Sarbanes-Oxley requirements. |

|b |b. Only if the controls are determined to be effective. |

| |c. Only if the client asks an auditor to test controls. |

| |d. Only if the controls are sufficient to increase Control Risk to an acceptable level. |

| | |

|45. |Acceptable audit risk is ordinarily set by the auditor during planning and: |

|medium |a. held constant for each major cycle and account. |

|a |b. held constant for each major cycle but varies by account. |

| |c. varies by each major cycle and by each account. |

| |d. varies by each major cycle but is constant by account. |

| | |

|46. |When the auditor is attempting to determine the extent to which external users rely on a client’s financial |

|medium |statements, they may consider several factors except for: |

|d |a. client size. |

| |b. concentration of ownership. |

| |c. types and amounts of liabilities. |

| |d. assessment of detection risk. |

| | |

|47. |A major difficulty in the application of the audit risk model is: |

|medium |a. defining the terms of the model. |

|b |b. measuring the components of the model. |

| |c. understanding the effect on other factors in the model when one factor is changed. |

| |d. the failure of the Audit Standards Board to accept it and incorporate it into standards. |

| | |

|48. |When setting a preliminary judgment about materiality: |

|medium |a. more evidence is required for a low dollar amount than for a high dollar amount. |

|a |b. less evidence is required for a low dollar amount than for a high dollar amount. |

| |c. the same amount of evidence is required for either low or high dollar amounts. |

| |d. there is no relationship between it and the dollar amount of evidence needed. |

| | |

|49. |When allocating materiality, most practitioners choose to allocate to: |

|challenging |a. the income statement accounts because they are more important. |

|b |b. the balance sheet accounts because there are fewer. |

| |c. both balance sheet and income statement accounts because there could be errors on either. |

| |d. all of the financial statements because there could be errors on other statements besides the income statement |

| |and balance sheet. |

| | |

|50. |The risk of material misstatement refers to: |

|challenging |a. control risk and acceptable audit risk. |

|c |b. inherent risk. |

| |c. the combination of inherent risk and control risk. |

| |d. inherent risk and audit risk. |

| | |

|51. |Auditors may assess inherent risk and control risk: |

| | | | |

|medium |Jointly to determine the risk of material | |Separately and combine their effects in the audit risk model|

|a |misstatement | | |

| |a. |Yes |Yes |

| |b. |No |No |

| |c. |Yes |No |

| |d. |No |Yes |

| | |

|52. |Which one of the following statements about the cycle approach to auditing is not correct? |

|challenging |a. There are differences among cycles in the frequency and size of expected errors. |

|c |b. There are differences among cycles in the effectiveness of internal controls. |

| |c. There are differences among cycles on the auditor’s willingness to accept risk that material errors exist after |

| |the auditing is complete. |

| |d. It is common for auditors to want an equally low likelihood of errors for each cycle after the auditor is |

| |finished. |

| | |

|53. |When the auditor has the same level of willingness to risk that material misstatements will exist after the audit is |

|challenging |finished for all financial statement cycles: |

|a |a. a different extent of evidence will likely be needed for various cycles. |

| |b. the same amount of evidence will be gathered for each cycle. |

| |c. the auditor has not followed generally accepted auditing standards. |

| |d. the level for each cycle must be no more than 2% so that the entire audit does not exceed 10%. |

| | |

|54. |Which of the following statements is not true? |

|challenging |a. Inherent risk is inversely related to detection risk. |

|b |b. Inherent risk is inversely related to evidence. |

| |c. Inherent risk is the susceptibility of the financial statements to material error, assuming no internal controls. |

| |d. Inherent risk is the auditor’s assessment of the likelihood that errors exceeding a tolerable amount exist in a |

| |segment before considering the effectiveness of internal controls. |

| | |

|55. |Which of the following is not a primary consideration when assessing inherent risk? |

|challenging |a. Nature of client’s business. |

|c |b. Existence of related parties. |

| |c. Frequency and intensity of management’s review of accounting transactions and records. |

| |d. Susceptibility to defalcation. |

| | |

|56. |Which of the following is an example of the concept of inherent risk? |

|challenging |a. Humans make more errors than computers; therefore, a manual accounting system is riskier than a computerized |

|c |system. |

| |b. Accounting systems with vouchers have many more controls built in, so the risk that there will be errors on the |

| |financial statements is reduced. |

| |c. Loans receivable for a finance company are less likely to be collectible than those of a bank. |

| |d. Audits with larger sample sizes are less risky than those with smaller sample sizes. |

| | |

|57. |Tolerable misstatement as set by the auditor: |

|challenging |a. decreases acceptable audit risk. |

|d |b. increases inherent risk and control risk. |

| |c. affects planned detection risk. |

| |d. does not affect any of the four risks. |

| | |

|58. |Which of the following underlies the application of generally accepted auditing standards, particularly the standards|

|challenging |of fieldwork and reporting? |

|a |a. The elements of materiality and relative risk. |

| |b. The element of internal control. |

| |c. The element of corroborating evidence. |

| |d. The element of reasonable assurance. |

| | |

Essay Questions

|59. |Discuss the three main factors that affect an auditor’s preliminary judgment about materiality. |

|medium | |

| |Answer: |

| |The three main factors that affect an auditor’s judgment about materiality are: |

| |Materiality is a relative rather than an absolute concept. A misstatement of a given size might be material for a |

| |small company, whereas the same dollar misstatement could be immaterial for a larger one. |

| |Bases are needed for evaluating materiality. Since materiality is relative, it is necessary to have bases for |

| |establishing whether misstatements are material. Net income before taxes is normally the most commonly used base, but|

| |other possible bases include current assets, total assets, current liabilities, and owners’ equity. |

| |Qualitative factors also affect materiality. Certain types of misstatements are likely to be more important to users |

| |than others, even if the dollar amounts are the same, such as misstatements involving frauds. |

| | |

|60. |Due to qualitative factors, certain types of misstatements are likely to be more important to users than others, even|

|medium |if the dollar amounts are the same. Identify two qualitative factors that might significantly affect an auditor’s |

| |materiality judgment, and give an example of each. |

| |Answer: |

| |Qualitative factors that affect an auditor’s materiality judgment include: |

| |Amounts involving fraud. Amounts involving fraud are usually considered more important than unintentional errors of |

| |equal dollar amounts because fraud reflects on the honesty and reliability of the management or other personnel |

| |involved. For example, an intentional misstatement of inventory would be more important to users than a clerical |

| |error in inventory of the same amount. |

| |Misstatements affecting contractual obligations. Misstatements that are otherwise minor may be material if there are |

| |possible consequences arising from contractual obligations. For example, if a misstatement causes a required minimum |

| |account balance to exceed the minimum, when the correct balance is less than the minimum, this misstatement likely |

| |would be important to users. |

| |Profit vs. loss. Misstatements that cause a loss to be reported as a profit or misstatements that affect trends in |

| |earnings are likely to be important to users. |

| | |

|61. |Explain why it is necessary to allocate the preliminary judgment about materiality to individual accounts (segments) |

|medium |in the financial statements. Also explain why allocating to balance sheet accounts is more common than allocating to |

| |income statement accounts. |

| |Answer: |

| |Allocating the preliminary judgment about materiality to individual accounts is necessary because evidence is |

| |accumulated for accounts rather than for the financial statements as a whole. Allocating to accounts establishes a |

| |tolerable misstatement amount for each account, which helps the auditor decide the appropriate audit evidence to |

| |accumulate for each account. Most practitioners allocate materiality to balance sheet accounts rather than income |

| |statement accounts because there are fewer balance sheet than income statement accounts. |

| | |

|62. |Why do most practitioners allocate the preliminary judgment about materiality to balance sheet accounts? |

|medium | |

| |Answer: |

| |Most income statement misstatements have an equal effect on the balance sheet because of the double-entry bookkeeping|

| |system. Because there are fewer balance sheet accounts than income statement accounts in most audits and most audit |

| |procedures focus on balance sheet accounts, allocating materiality to balance sheet accounts is the most appropriate |

| |alternative. |

| | |

|63. |Discuss how auditors use the audit risk model when planning an audit. |

|medium | |

| |Answer: |

| |The audit risk model is used primarily for planning purposes in deciding how much evidence to accumulate in each |

| |cycle. The auditor decides an acceptable level of audit risk, assesses inherent risk and control risk, and then uses |

| |the relationship depicted in the following model to determine an appropriate level for planned detection risk: |

| |PDR = AAR |

| |IR x CR |

|64. |Describe the audit risk model and each of its components. |

|medium | |

| |Answer: |

| |The planning form of the audit risk model is stated as follows: |

| | |

| |PDR = AAR |

| |IR x CR |

| | |

| |where: PDR = planned detection risk |

| |AAR = acceptable audit risk |

| |IR = inherent risk |

| |CR = control risk |

| |Planned detection risk is a measure of the risk that audit evidence for an account will fail to detect misstatements |

| |exceeding a tolerable amount, should such misstatements exist. Planned detection risk determines the amount of |

| |substantive evidence that the auditor plans to accumulate. |

| |Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be |

| |materially misstated after the audit is completed and an unqualified opinion has been issued. It is influenced |

| |primarily by the degree to which external users will rely on the statements, the likelihood that a client will have |

| |financial difficulties after the audit report is issued, and the auditor’s evaluation of management’s integrity. |

| |Inherent risk is a measure of the auditor’s assessment of the likelihood that there are material misstatements in an |

| |account before considering the effectiveness of internal control. |

| |Control risk is a measure of the auditor’s assessment of the likelihood that misstatements exceeding a tolerable |

| |amount in an account will not be prevented or detected by the client’s internal controls. |

| | |

|65. |There are several factors that affect an audit firm’s business risk and, therefore, acceptable audit risk. Discuss |

|medium |three of these factors. |

| |Answer: |

| |Business risk and acceptable audit risk are affected by: |

| |The degree to which external users will rely on the statements. For large, publicly held clients, business risk is |

| |greater, and acceptable audit risk will be less, than for small, privately held clients, all things being equal. |

| |The likelihood that a client will have financial difficulties after the audit report is issued. Business risk is |

| |greater, and acceptable audit risk will be lower, when the client is experiencing financial difficulties. |

| |The auditor’s evaluation of management’s integrity. Business risk is greater and acceptable audit risk will be lower |

| |when the client’s management has questionable integrity. |

| | |

|66. |Discuss each of the five steps in applying materiality in an audit, and identify the audit phase(s) in which each |

|challenging |step is performed. List these steps in the order in which they occur. |

| |Answer: |

| |Step 1. Set preliminary judgment about materiality. This is the combined amount of misstatements in the financial |

| |statements that would be considered material. This decision is made in the planning stage of the audit. |

| |Step 2. Allocate preliminary judgment about materiality to segments. In this step, the auditor normally allocates the|

| |preliminary judgment about materiality to the balance sheet accounts. The amount of materiality allocated to an |

| |account is referred to as that account’s tolerable misstatement. This allocation is performed in the audit planning |

| |stage. |

| |Step 3. Estimate total misstatement in segment. In this step, the auditor projects the sample results to the |

| |population. An allowance for sampling risk is also calculated. This would be performed after the substantive tests |

| |for each account are completed. |

| |Step 4. Estimate the combined misstatement. In this step, the projected errors for each account are added, along with|

| |total sampling error, to calculate the combined misstatement. This would be performed after all substantive tests |

| |have been completed. |

| |Step 5. Compare combined estimated misstatement with preliminary or revised judgment about materiality. If the |

| |combined estimated misstatement is less than or equal to the judgment about materiality, then the auditor concludes |

| |the financial statements are fairly presented. This would be performed after all substantive tests have been |

| |completed, in the final review stage of the audit. |

| | |

Other Objective Answer Format Questions

|67. |Below are four situations that involve the audit risk model as it is used for planning audit evidence requirements in|

|easy |the audit of inventory. For each situation, calculate planned detection risk. |

| | SITUATION |

| | 1 2 3 4 |

| | |

| |Acceptable audit risk 1% 10% 10% 5% |

| | |

| |Inherent risk 100% 100% 50% 20% |

| | |

| |Control risk 100% 100% 40% 30% |

| | |

| |Planned detection risk ______ ______ ______ ______ |

| | |

| |Answer: 1. 1%; 2. 10%; 3. 50%; 4. 83.3% |

| | |

|68. |Using your knowledge of the relationships among acceptable audit risk, inherent risk, control risk, planned detection|

|easy |risk, tolerable misstatement, and planned evidence, state the effect on planned evidence (increase or decrease) of |

| |changing each of the following factors, while the other factors remain unchanged. |

|decrease |1. An increase in acceptable audit risk. . |

|increase |2. An increase in inherent risk. . |

|decrease |3. A decrease in control risk. . |

|decrease |4. An increase in planned detection risk. . |

|decrease |5. An increase in tolerable misstatement. . |

| | |

|69. |Match nine of the terms (a-i) with the definitions provided below (1-9): |

|medium | |

| |a. Business risk |

| |b. Preliminary judgment about materiality |

| |c. Inherent risk |

| |d. Planned detection risk |

| |e. Audit assurance |

| |f. Acceptable audit risk |

| |g. Tolerable misstatement |

| |h. Control risk |

| |i. Materiality |

| | |

|d | 1. A measure of the risk that audit evidence for a segment will fail to detect misstatements exceeding a tolerable|

| |amount, should such misstatements exist. |

|a | 2. The risk that the auditor or audit firm will suffer harm because of a client relationship, even though the |

| |audit report rendered for the client was correct. |

|h | 3. A measure of the auditor’s assessment of the likelihood that misstatements exceeding a tolerable amount in a |

| |segment will not be prevented or detected by the client’s internal controls. |

|f | 4. A measure of how much risk the auditor is willing to take that the financial statements may be materially |

| |misstated after the audit is completed and an unqualified audit opinion has been issued. |

|g | 5. The materiality allocated to any given account balance. |

|b | 6. The maximum amount by which the auditor believes that the statements could be misstated and still not affect |

| |the decisions of reasonable users. |

|e | 7. This term is synonymous with acceptable audit risk. |

|i | 8. The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment|

| |of a reasonable person would have been changed. |

|c | 9. A measure of the auditor’s assessment of the likelihood that there are material misstatements before |

| |considering the effectiveness of internal control. |

|70. |In practice, auditors rarely assign numerical probabilities to inherent risk, control risk, or acceptable audit risk.|

|medium |It is more common to assess these risks as high, medium, or low. For each of the four situations below, fill in the |

| |blanks for planned detection risk and the amount of evidence you would plan to gather (“planned evidence”) using the |

| |terms high, medium, or low. |

| | |

| | SITUATION |

| | 1 2 3 4 |

| | |

| |Acceptable audit risk Low Low High High |

| | |

| |Inherent risk High Low Low Low |

| | |

| |Control risk High Low Medium Low |

| | |

| |Planned detection risk ______ ______ ______ ______ |

| | |

| |Planned evidence ______ ______ ______ ______ |

| | |

| |Answer: 1. low, high |

| |2. medium, medium |

| |3. medium, medium |

| |4. high, low |

| | |

|71. |The auditor’s preliminary judgment about materiality is the maximum amount by which the auditor believes the |

|easy |financial statements could be misstated and still not affect the decisions of reasonable users. |

|a |a. True |

| |b. False |

|72. |There is no precise definition of materiality in the professional literature. |

|easy |a. True |

|a |b. False |

|73. |The FASB definition of materiality focuses on potential users of financial statements. |

|easy |a. True |

|b |b. False |

|74. |Net income before taxes is normally the most important base for deciding materiality. |

|easy |a. True |

|a |b. False |

|75. |Most practitioners allocate the preliminary judgment about materiality to income statement accounts. |

|easy |a. True |

|b |b. False |

|76. |The primary purpose of allocating the preliminary judgment about materiality to financial statement accounts is to |

|easy |help the auditor decide the appropriate evidence to accumulate. |

|a |a. True |

| |b. False |

|77. |Auditors cannot use prior year financial statement balances to establish their preliminary judgment about materiality|

|easy |in planning the current year’s audit. |

|b |a. True |

| |b. False |

|78. |If acceptable audit risk is low, and inherent risk and control risk are both high, then planned detection risk should|

|easy |be high. |

|b |a. True |

| |b. False |

|79. |Inherent risk and planned detection risk are inversely related; i.e., as inherent risk increases, planned detection |

|easy |risk should decrease, ceteris paribus. |

|a |a. True |

| |b. False |

| | |

|80. |Acceptable audit risk and planned detection risk are inversely related; i.e., as acceptable audit risk increases, |

|easy |planned detection risk should decrease, ceteris paribus. |

|b |a. True |

| |b. False |

|81. |The most important element of the audit risk model is control risk. |

|easy |a. True |

|b |b. False |

|82. |For a private company client, auditors are required to test any internal controls they believe have not been |

|easy |operating effectively during the period under audit. |

|b |a. True |

| |b. False |

|83. |If an auditor believes the client will have financial difficulties after the audit report is issued, and external |

|easy |users will be relying heavily on the financial statements, the auditor will probably set acceptable audit risk as |

|a |low. |

| |a. True |

| |b. False |

|84. |Achieved detection risk can be reduced only by accumulating more audit evidence. |

|medium |a. True |

|b |b. False |

|85. |Auditors have difficulty applying the concept of materiality in practice because they often do not know who the users|

|medium |of the financial statements are or what decisions will be made. |

|a |a. True |

| |b. False |

|86. |The audit risk model that must be used for planning audit procedures and evaluating audit results is: AcAR = IR x CR |

|medium |x AcDR. |

|b |a. True |

| |b. False |

|87. |Statements on Auditing Standards provide detailed, objective guidance on how auditors are to establish a preliminary |

|medium |materiality level, thus eliminating the need for subjective auditor judgment in this task. |

|b |a. True |

| |b. False |

|88. |If the preliminary judgment of materiality increases, the amount of audit evidence required will also increase. |

|medium |a. True |

|b |b. False |

|89. |Insert risk and control risk are normally assessed for the overall audit. |

|medium |a. True |

|b |b. False |

|90. |Tolerable misstatement is the maximum combined total of all misstatements in the financial statements that the |

|medium |auditor is willing to allow, or tolerate, when issuing a standard unqualified opinion. |

|b |a. True |

| |b. False |

|91. |If an auditor assigns a tolerable misstatement of $1,000 to accounts payable, he or she would need to obtain more |

|medium |audit evidence for that account than if $100,000 had been assigned. |

|a |a. True |

| |b. False |

|92. |To maximize audit efficiency, the auditor should allocate less tolerable misstatement to accounts that can be |

|medium |verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to |

|a |audit. |

| |a. True |

| |b. False |

|93. |To maximize audit effectiveness, the auditor should establish a high preliminary judgment about materiality and |

|medium |allocate most of the amount to balance sheet accounts. |

|b |a. True |

| |b. False |

|94. |Acceptable audit risk and the amount of substantive evidence required are inversely related. |

|medium |a. True |

|a |b. False |

|95. |As control risk increases, the amount of substantive evidence the auditor plans to accumulate should increase. |

|medium |a. True |

|a |b. False |

|96. |Inherent risk and control risk are directly related. |

|medium |a. True |

|b |b. False |

|97. |An acceptable audit risk assessment of low indicates a risky client requiring more extensive evidence, assignment of |

|medium |more experienced personnel, and/or a more extensive review of audit files. |

|a |a. True |

| |b. False |

|98. |Engagement risk is effectively the audit firm’s business risk. |

|medium |a. True |

|a |b. False |

|99. |Audit assurance is the complement of planned detection risk, that is, one minus planned detection risk. |

|medium |a. True |

|b |b. False |

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