Chapter 04
Management Fraud and Audit Risk
True / False Questions
1. Frauds are unintentional misstatements or omissions of accounts or disclosures in financial statements.
True False
2. The nature of extended procedures for fraud detection is limited to those listed in the Professional Standards and Practices for Certified Fraud Examiners.
True False
3. Fraud consists of knowingly making material misrepresentation of fact with the intent of inducing someone to believe the falsehood and suffer a loss.
True False
4. Audit care and attention should be greater where business and inherent risks are judged to be lower.
True False
5. Control risk should not be assessed so low that auditors place complete reliance on controls and do not perform any other audit work.
True False
6. Detection risk occurs when internal control activities fail to detect material misstatements.
7. The auditing profession official standard for an acceptable level of overall audit risk is 0.05 at the current level.
True False
8. Audit risk (AR) is a quality criterion based on professional judgment. True False
9. The audit risk model assumes that elements of audit risk are independent and therefore multiplicative.
True False 10
.
Generally, fraudulent financial statements show financial performance and ratios that are better than current industry experience.
True False 11
.
The demographics of white-collar criminals are similar to those of typical bank robbers.
True False 12
.
Knowledge and understanding of a client's business is absolutely essential in completing an audit.
True False 13
.
Auditing standards require that analytical procedures be applied in the beginning stages of each audit.
True False 14
.
Auditors look for relationships that do not make sense as indicators of problems in the accounts and use such indicators to plan further audit work.
15 .
Analytical procedures are considered to be "soft" evidence and therefore considered ineffective.
True False 16
.
Audits are not designed to detect material errors and fraud in financial statements.
True False 17
.
Knowledge of the client's business from preliminary analytical
procedures can help auditors identify problem areas and make broad risk assessments.
True False
Multiple Choice Questions 18
.
The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU 240) is on:
A. Employee misappropriation of assets. B. Management fraud.
C. Client fraud on customers. D. Employee embezzlement. 19
.
Management fraud generally refers to
A. Unintentional mistakes. B. Noncompliance.
C. Intentional distortions of financial statements. D. Violations of GAAS.
20 .
External auditors are responsible
A. For authenticating documents.
B. For reporting immaterial frauds to a level of management at least one level above the people involved.
C. For finding all intentional misstatements concealed by collusion. D. For reporting all frauds to outside agencies or parties.
21 .
According to auditing standards, external auditors' responsibilities for indirect noncompliance do not include
A. Designing audit procedures to detect noncompliance in the absence of specific information brought to the auditors' attention.
B. Performing audit procedures when specific information indicates that possible noncompliance may have an indirect material effect on financial statements.
C. Considering the qualitative materiality of known and suspected noncompliance.
D. Obtaining written management representations concerning the absence of violations of laws and regulations.
22 .
Certain conditions and circumstances are often present when management fraud occurs. Which of the following is not such a condition or circumstance?
A. Unfavorable industry conditions. B. Lack of working capital.
C. High liquidity.
23 .
Independent auditors who consider fraud in the course of financial statement audits are well-advised to quantify "materiality" in terms of:
A. The maximum amount of asset overstatement that might mislead investors in relation to the latest financial statements under audit. B. A maximum percentage of net income overstatement that might
mislead investors in relation to the latest financial statements under audit.
C. A cumulative amount of misstatement of assets or income over several years past and current that might mislead investors in relation to the latest financial statements under audit.
D. Controversial accounting measurements that might mislead investors in relation to the latest financial statements under audit.
24 .
An auditor assesses the risk of material misstatement because it
A. Is relevant to the auditor's understanding of the control environment. B. Provides assurance that the auditor's overall materiality levels are
appropriate.
C. Indicates to the auditor where inherent risk may be the greatest. D. Affects the level of detection risk that the auditor may accept. 25
.
When fraud risk is significant, and management cooperation is unsatisfactory, the auditors will most likely
A. Perform extended audit procedures. B. Consult with fraud examiners.
C. Report directly to the Securities and Exchange Commission within one day.
26 .
Which of the following statements concerning noncompliance by clients is correct?
A. An auditor's responsibility to detect noncompliance that has a direct and material effect on the financial statements is the same as that for errors and frauds.
B. An audit in accordance with generally accepted auditing standards normally includes audit procedures specifically designed to detect noncompliance that has an indirect but material effect on the financial statements.
C. An auditor considers noncompliance from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions.
D. An auditor has no responsibility for noncompliance that has an indirect effect on the financial statements.
27 .
Which of the following statements best describes auditors' responsibility to detect errors and frauds?
A. Auditors should design an audit to provide reasonable assurance of detecting errors and frauds that are material to the financial
statements.
B. Auditors are responsible to detect material errors but have no responsibility to detect material frauds that are concealed through employee collusion or management override of the internal control structure.
C. Auditors have no responsibility to detect errors and frauds unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial statements were materially misstated.
D. Auditors have no responsibility to detect errors and frauds because auditors are not insurers and an audit does not constitute a
28 .
The probability that an audit team will give an inappropriate opinion on financial statements best describes
A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk. 29 .
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.
30 .
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 statements is correct?
A. Detection risk will decrease. B. Inherent risk will increase. C. Audit risk will decrease. D. Detection risk will increase. 31
.
If fictitious credit sales were recorded and the fictitious accounts receivable were later directly written off as bad debt expense
A. Income would be overstated. B. Income would be understated. C. Income would not be misstated.
32 .
An audit team uses the assessed risk of material misstatement to
A. Evaluate the effectiveness of the entity's internal control policies and activities.
B. Identify transactions and account balances where inherent risk is at the maximum.
C. Indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.
D. Determine the acceptable level of detection risk for financial statement assertions.
33 .
The risk of material misstatement differs from detection risk in that it
A. Arises from the misapplication of audit procedures.
B. May be assessed in either quantitative or nonquantitative terms. C. Exists independently of the financial statement audit.
D. Can be changed at the auditor's discretion. 34
.
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 exists is
A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk. 35 .
Based on 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
36 .
The acceptable level of detection risk is inversely related to the
A. Assurance provided by substantive tests. B. Risk of misapplying audit procedures.
C. Preliminary judgment about materiality levels. D. Risk of failing to discover material misstatements. 37
.
The existence of audit risk is recognized by the statement in the auditor's standard report that the
A. Auditor is responsible for expressing an opinion on the financial statements, which are the responsibility of management.
B. Financial statements are presented fairly, in all material respects, in conformity with applicable financial reporting framework.
C. Audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
D. Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement.
38 .
When determining the inherent risk related to an account balance, an auditor theoretically does not explicitly consider the
A. Liquidity of the account.
B. Degree of management estimation involved in determining the proper account balance.
C. Related internal control policies and procedures. D. Complexity of calculations involved.
39 .
An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if
A. The noncompliance is a violation of generally accepted accounting principles.
B. The client does not take the remedial action that the auditor considers necessary.
C. The illegal act was committed during a prior year that was not audited.
D. The auditor has already assessed control risk at the maximum level. 40
.
When an auditor becomes aware of possible noncompliance by a client, the auditor should obtain an understanding of the nature of the act to
A. Evaluate the effect on the financial statements.
B. Determine the reliability of management's representations. C. Consider whether other similar acts may have occurred. D. Recommend remedial actions to the audit committee. 41
.
Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc. What assurance does Jones provide that direct effect noncompliance that is material to XYZ's financial statements and noncompliance that has a material but indirect effect on the financial statements will be detected?
A. Direct effect noncompliance: Reasonable; indirect effect noncompliance: none.
B. Direct effect noncompliance: Reasonable; indirect effect noncompliance: reasonable.
C. Direct effect noncompliance: Limited; indirect effect noncompliance: none.
D. Direct effect noncompliance: Limited; indirect effect noncompliance: reasonable.
42 .
Generally accepted auditing standards state that analytical procedures
A. Should be applied in the planning and final review stages of the audit and as a substantive test during the audit.
B. Should be applied in the planning and final review stages of the audit and can be used as a substantive test during the audit.
C. Should be applied in the planning stage and can be applied as a substantive test in the final review stage.
D. Should be applied in the final review stage and can be applied as a substantive test in the planning stage.
43 .
In the planning stage, analytical procedures are used to
A. Identify potential problem areas.
B. Provide direct evidence about the balances in accounts.
C. Determine the mathematical correctness of the financial statements. D. All of the above.
44 .
Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the
expectations (estimates) developed by the auditor. If management is unable to provide an acceptable explanation, the auditor should
A. Consider the matter a scope limitation.
B. Perform additional audit procedures to investigate the matter further. C. Intensify the audit with the expectation of detecting management
fraud.
D. Withdraw from the engagement. 45
.
For audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent
A. As a substantive test: yes; in the final review stage: yes B. As a substantive test: yes; in the final review stage: no C. As a substantive test: no; in the final review stage: yes D. As a substantive test: no; in the final review stage: no
46 .
Which of the following would not likely be found in the minutes of the board of directors?
A. Amount of dividends declared.
B. Approval to pledge assets as security for debts. C. Authorization of officers' salaries.
D. Approval of a new desktop computer for the controller. 47
.
An auditor who encounters significant risks at the client should do all of the following except
A. Inform the SEC.
B. Perform extended procedures.
C. Include more experienced auditors on the engagement. D. Perform tests closer to year-end.
48 .
Horizontal analysis refers to
A. The trend of income from year to year of persons suspected of fraud. B. Changes of financial statement numbers and ratios across several
years.
C. Financial statement amounts expressed each year as a proportion of a base amount.
D. The change in a suspect's net worth from the beginning to the end of a period.
49 .
Analytical procedures used in planning an audit should focus on
A. Reducing the scope of tests of controls and substantive tests. B. Providing assurance that potential material misstatements will be
identified.
C. Enhancing the auditor's understanding of the client's business. D. Assessing the adequacy of the available evidential matter.
50 .
Sources of financial and nonfinancial data do not include
A. Financial account information for comparable prior periods. B. Nonfinancial information such as physical production statistics. C. Company budgets and forecasts.
D. Bureau of Labor statistics. 51
.
The type of financial analysis that expresses balance sheet accounts as percentages of total assets is known as:
A. Horizontal analysis. B. Vertical analysis. C. Net worth analysis. D. Expenditure analysis. 52
.
Which of the following accounts tends to be most predictable for purposes of analytical procedures?
A. Accounts receivable.
B. Travel and entertainment expense. C. Interest expense.
D. Income taxes payable. 53
.
Analytical procedures are audit methods of evaluating financial statement accounts by studying and comparing relationships among financial and nonfinancial data. The primary purpose of analytical procedures conducted during the planning stages is to
A. Identify the appropriate schedules to be prepared by the client. B. Identify the types of errors or frauds that can occur in transactions. C. Identify unusual conditions that deserve additional audit effort. D. Determine the existence of unrecorded liabilities or overstated
54 .
Which of the following is not required by AU 240, "Consideration of Fraud in a Financial Statement Audit"?
A. Conduct a continuing assessment of the risks of material misstatement due to fraud throughout the audit.
B. Conduct a discussion by the audit team of the risks of material misstatement due to fraud.
C. Conduct the audit with professional skepticism, which includes an attitude that assumes balances are incorrect until verified by the auditor.
D. Conduct inquiries of shareholders as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud.
55 .
An auditor who increases the planned assessed level of control risk because certain control activities were determined to be ineffective would most likely increase the
A. Extent of substantive tests of details. B. Level of inherent risk.
C. Extent of tests of controls. D. Level of detection risk. 56
.
What assurance does the auditor provide that errors, frauds, and direct effect noncompliance that are material to the financial statements will be detected?
A. Errors: limited; frauds: negative; direct effect noncompliance: limited.
B. Errors: limited; frauds: limited; direct effect noncompliance: reasonable.
C. Errors: reasonable; frauds: limited; direct effect noncompliance: limited.
D. Errors: reasonable; frauds: reasonable; direct effect noncompliance: reasonable.
57 .
Experience has shown that the many large fraudulent transactions can be found in
A. Systematic processing of large volumes of day-to-day ordinary transactions.
B. Payroll fraudsters' mistakes in using unissued Social Security numbers.
C. Petty cash embezzlements.
D. Nonroutine, nonsystematic journal entries. 58
.
Which of the following pieces of information discovered by an auditor when performing substantive tests of account balances would most likely raise red flags about the possible existence of material fraudulent financial reporting?
A. Paper copies of paid invoices and cancelled checks were microfiched and then destroyed.
B. The controller requires that you schedule any audit inquiries daily after lunch, not in the morning.
C. The petty cash fund custodian never takes a vacation.
D. The client's estimate of the allowance for doubtful accounts is lower than the auditor's independent evaluation of the allowance.
59 .
Inherent risk and control risk differ from detection risk in that inherent risk and control risk are
A. Elements of audit risk whereas detection risk is not.
B. Changed at the auditor's discretion whereas detection risk is not. C. Considered at the individual account balance level whereas detection
risk is not.
D. Functions of the client and its environment whereas detection risk is not.
60 .
The auditor uses the assessed level of risk of material misstatement to determine the acceptable level of detection risk for financial statement assertions. As the acceptable level of detection risk decreases, the auditor may do one or more of the following except change the
A. Nature of substantive tests to more effective procedures.
B. Timing of substantive tests, such as performing them at year-end rather than at an interim date.
C. Extent of substantive tests, such as using larger sample sizes. D. Assurances provided by substantive tests to a lower level. 61
.
Which of the following is an acceptable response to fraud risks related to sales that were identified in an audit?
A. Exercise professional skepticism when performing sales testing. B. Increase the assessment of control risk for sales.
C. Increase the assessment of detection risk for sales.
D. Perform additional substantive sales procedures on a surprise basis. 62
.
If tests of controls induce the auditor to change the assessed level of control risk for property plant & equipment from 50 percent to 100 percent and audit risk (6 percent) and inherent risk remain constant, the acceptable level of detection risk
A. Would most likely change from 10 percent to 5 percent. B. Would most likely change from 20 percent to 40 percent. C. Would most likely change from 30 percent to 15 percent.
D. Would be unchanged because the auditor has control over detection risk.
E. Cannot be determined because inherent risk is not given. 63
.
Managing business risk is the responsibility of
A. The auditors. B. Management.
C. The SEC.
64 .
Auditors would use the enterprise risk model
A. To reduce the client's business risk. B. To determine detection risk.
C. To evaluate management's risk assessment. D. To monitor client risk.
65 .
Auditors use brainstorming
A. To heighten the audit team's awareness of fraud potential. B. To heighten management's awareness of fraud potential. C. To determine detection risk.
D. To set materiality. 66
.
The purpose of an audit strategy is
A. To provide a defense against litigation. B. To gain an understanding of the client. C. To comply with securities law.
D. To set the scope, timing, and direction for auditing each relevant assertion.
67 .
Auditors are responsible for the quality of the work related to management and control of
A. Inherent risk. B. Business risk. C. Control risk. D. Detection risk.
68 .
Which of the following engagement planning procedures would most likely assist the auditor in identifying related-party transactions before the balance-sheet date?
A. Interviewing internal auditors about their reporting responsibilities. B. Reviewing accounting records for recurring transactions occurring
near year-end.
C. Inspecting communications with the client's legal counsel regarding recorded contingent liabilities.
D. Scanning the minutes for significant transactions with members of the board of directors.
69 .
The likelihood that material misstatements may have entered the
accounting system and not been detected and corrected by the client's internal control is referred to as
A. Inherent risk. B. Control risk. C. Detection risk.
D. Risk of material misstatement. 70
.
The risk of material misstatements is composed of which audit risk components?
A. Inherent risk and control risk. B. Control risk and detection risk. C. Inherent risk and detection risk.
D. Inherent risk, control risk, and detection risk. 71
.
Auditing standards do not require auditors of financial statements to
A. Understand the nature of errors and frauds.
B. Assess the risk of occurrence of errors and frauds.
C. Design audits to provide reasonable assurance of detecting errors and frauds.
72 .
The risk that the auditors' own procedures will lead to the decision that material misstatements do not exist in the financial statements when in fact such misstatements do exist is
A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk. 73 .
The auditors assessed risk of material misstatement at 0.50 and said they wanted to achieve a 0.05 risk of failing to express a correct opinion on financial statements that were materially misstated. What detection risk do the auditors plan to use for planning the remainder of the audit work?
A. 0.20. B. 0.10. C. 0.75. D. 0.00. 74 .
If tests of controls induce the audit team to change the assessed level of control risk for fixed assets from 0.4 to 1.0 and audit risk (0.05) and inherent risk remain constant, the acceptable level of detection risk is most likely to
A. Change from 0.1 to 0.04. B. Change from 0.2 to 0.3. C. Change from 0.25 to 0.1. D. Be unchanged.
75 .
Which of the following is a specific procedural response to a particular fraud risk in an account balance or class of transactions?
A. Exercising more professional skepticism.
B. Carefully avoiding conducting interviews with people in the fraud-rich areas.
C. Performing procedures such as inventory observation and cash counts on a surprise or unannounced basis.
D. Studying management's selection and application of accounting principles more carefully.
76 .
It is acceptable under generally accepted auditing standards for an audit team to
A. Assess risk of material misstatement at high and achieve an acceptably low audit risk by performing extensive detection work. B. Assess control risk at zero and perform a minimum of detection
work.
C. Assess inherent risk at zero and perform a minimum of detection work.
D. Decide that audit risk can be 40 percent. 77
.
If sales were overstated by recording a false credit sale at the end of the year, where could you find the false "dangling debit"?
A. Inventory. B. Cost of goods sold. C. Bad debt expense. D. Accounts receivable.
78 .
One of the typical characteristics of management fraud is
A. Falsification of documents in order to misappropriate funds from an employer.
B. Victimization of investors through the use of materially misleading financial statements.
C. Illegal acts committed by management to evade laws and regulations.
D. Conversion of stolen inventory to cash deposited in a falsified bank account.
79 .
Under the Private Securities Litigation Reform Act, independent auditors are required to
A. Report in writing all instances of noncompliance to the client's board of directors.
B. Report to the SEC all instances of noncompliance they believe have a material effect on financial statements if the board of directors does not first report to the SEC.
C. Report clearly inconsequential noncompliance to the audit committee of the client's board of directors.
D. Resign from the audit engagement and report the instances of noncompliance to the SEC.
80 .
Which of the following circumstances would most likely cause an audit team to perform extended procedures?
A. Supporting documents are produced when requested.
B. The client made several large adjustments at or near year-end.
C. The company has recently hired a new chief financial officer after the previous one retired.
81 .
When the auditors become aware of noncompliance with a law or regulation committed by client personnel, the primary reason that the auditors should obtain a better understanding of the nature of the act is to
A. Recommend remedial actions to the audit committee. B. Evaluate the effect of the noncompliance on the financial
statements.
C. Determine whether to contact law enforcement officials. D. Determine whether other similar acts could have occurred. 82
.
Which of the following statements best describes auditors'
responsibility for detecting a client's noncompliance with a law or regulation?
A. The responsibility for detecting noncompliance exactly parallels the responsibility for errors and fraud.
B. Auditors must design tests to detect all material noncompliance that indirectly affect the financial statements.
C. Auditors must design tests to obtain reasonable assurance that all noncompliance with direct material statement effects are detected. D. Auditors must design tests to detect all noncompliance that directly
affect the financial statements. 83
.
Analytical procedures are generally used to produce evidence from
A. Confirmations mailed directly to the auditors by client customers. B. Physical observation of inventories.
C. Relationships among current financial balances and prior balances, forecasts, and nonfinancial data.
D. Detailed examination of external, external-internal, and internal documents.
84 .
Auditors perform analytical procedures in the planning stage of an audit for the purpose of
A. Deciding the matters to cover in an engagement letter.
B. Identifying unusual conditions that deserve more auditing effort. C. Determining which of the financial statement assertions are the most
important for the client's financial statements.
D. Determining the nature, timing, and extent of audit procedures for auditing the inventory.
85 .
Which of the following relationships between types of analytical procedures and sources of information are most logical?
A. Option A B. Option B C. Option C D. Option D 86 .
Analytical procedures can be used in which of the following ways?
A. As a means of overall review at the end of an audit.
B. As "attention-directing" methods when planning an audit at the beginning.
C. As substantive audit procedures to obtain evidence during an audit. D. All of the above.
87 .
Analytical procedures used when planning an audit should concentrate on
A. Weaknesses in the company's internal control activities.
B. Predictability of account balances based on individual transactions. C. Management assertions in financial statements.
D. Accounts and relationships that can represent specific potential problems and risks in the financial statements.
88 .
When a company that sells its products for a (gross) profit increases its sales by 15 percent and its cost of goods sold by 7 percent, the cost of goods sold ratio will
A. Increase. B. Decrease. C. Remain unchanged.
D. Not be able to be determined with the information provided. 89
.
Analytical procedures are used
A. To set materiality limits.
B. To assess the reasonableness of financial statement amounts. C. To provide direct evidence about the numbers in the financial
statements.
D. To test internal controls. 90
.
The risk that material misstatements have occurred in transactions entering the accounting system is
A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk.
91 .
In the audit risk model, if an audit team wanted to keep audit risk at a low level but there was a great inherent risk of material misstatement and the internal control was ineffective, then procedures would need to be designed so that
A. Detection risk was at a low level. B. Detection risk was at a high level. C. Control risk was at a low level. D. Inherent risk was at a high level. 92
.
Inherent risk is not a characteristic of the
A. Client's business. B. Substantive procedures. C. Major types of transactions.
D. Effectiveness of the client's accountants. 93
.
Which of the following risks is entirely a quality criterion based on professional judgment? A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk. 94 .
In general, most fraudulent companies will prepare financial statements that are materially misleading by doing all of the following except
A. Understate revenues and assets. B. Understate expenses and liabilities.
C. Show financial performance better than industry average. D. Have performance exactly meet announced targets.
95 .
In the planning stage, analytical procedures are not used to
A. Identify unusual conditions that deserve more audit effort. B. Point out accounts that may contain errors and fraud. C. Review the overall quality of the audit.
D. Reduce the risk of missing something important. 96
.
The analytical procedures completed during the planning stages typically would not include comparison of current-year account balances with
A. Balances for one or more comparable periods. B. Anticipated results found in budgets.
C. Evaluation of relationships to other current-year balances. D. Other accounts as substantive procedures.
Fill in the Blank Questions 97
.
The evaluation of financial statement accounts by studying and comparing relationships among financial and nonfinancial data is known as a(n) _________________________________.
________________________________________ 98
.
By both fraud and aggressive _______________________________, companies have caused financial statements to be misleading. ________________________________________
99 .
Auditing standards (specifically AU 240) require that auditors
specifically assess the risk of _______________________________ due to fraud for each engagement.
100 .
_______________________________________ is the probability that material misstatements have occurred in transactions entering the accounting system.
________________________________________ 101
.
Because auditors have little control over inherent risk and control risk, the two risks are often combined and referred to as the risk of
_____________________________.
________________________________________ 102
.
_____________________________ involving senior management are never ____________________________.
________________________________________ 103
.
The probability that audit procedures will fail to produce evidence of material misstatements is referred to as
_____________________________________. ________________________________________ 104
.
Audit risk can be expressed in the following model: Audit risk = _____________________________ x _________________________________. ________________________________________
105 .
Auditors ___________ choose to rely almost exclusively on evidence produced by substantive procedures, especially when
_____________________________ risk and _____________________________ risk are high.
________________________________________ 106
.
In an overall sense, _________________________________ is the probability that a public accounting firm will give an inappropriate opinion on financial statements.
107 .
_____________________________________ is the term used to refer to violations of laws and regulations that are
_______________________________ from financial statement effects. ________________________________________
108 .
_________________________________ refers to financial statement amounts expressed each year as proportions of a base.
________________________________________ 109
.
In the _____________________________ stage,
_______________________________ are used to identify potential problem areas and to reduce risk.
________________________________________ 110
.
Comparison of financial statement numbers and ratios across two or more years is referred to as _______________________________.
________________________________________ 111
.
__________________________________ are those individuals or
organizations that are closely tied to the auditee, possibly by familial or investment relationships.
________________________________________ 112
.
Reasonableness tests use to gain an understanding of financial statement accounts and relationships are known as
_______________________________________. ________________________________________ 113
.
The preliminary analytical work performed in the planning stage of an audit is sometimes called
________________________________________________. ________________________________________
Short Answer Questions 114
.
For each of the descriptions in Column A, match the correct word or words from Column B.
115 .
For each of the descriptions 1-4, match the correct word or words from A-L.
116 .
A. Audit risks for particular accounts can be expressed in the model: Audit risk (AR) = Inherent risk (IR) x Internal control risk (CR) x
Detection risk (DR). If an audit risk is set at 5 percent, the inherent risk at 80 percent, and the internal control risk at 25 percent, what would be the detection risk?
B. If the audit team wanted to reduce the audit risk to 1 percent, what would be the detection risk?
C. What would the audit team have to do to reduce the audit risk?
Essay Questions 117
.
What are the independent auditor's responsibilities to detect and report errors and frauds?
118 .
Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Explain your answer using the audit risk model.
119 .
Post, CPA, accepted an engagement to audit the financial statements of General Co., a new client. General is a publicly held retailing entity that recently replaced its operating management. In the course of applying audit procedures, Post discovered that General's financial statements might be materially misstated due to the existence of fraud.
Required:
A. Describe post's responsibilities in the circumstances described above.
B. Describe post's responsibilities for reporting on general's financial statements and other communications if post is precluded from applying necessary procedures in searching for frauds.
C. Describe post's responsibilities for reporting on general's financial statements and other communications if post concludes that general's financial statements are materially affected by frauds. (AICPA
120 .
Items 1 through 6 represent an auditor's observed changes in certain financial statement ratios or amounts from the prior-year ratios or amounts. For each observed change, select the most likely explanation or explanations from the list of explanations provided. Answers on the list may be selected once, more than once, or not at all.
Auditor's observed changes (considered independent of each other): 1. Inventory turnover increased substantially from the prior year. (Select 3 explanations.)
2. Accounts receivable turnover decreased substantially from the prior year. (Select 3 explanations.)
3. Allowance for doubtful accounts increased from the prior year, but allowance for doubtful accounts as a percentage of accounts
receivable decreased from the prior year. (Select 3 explanations.) 4. Long-term debt increased from the prior year, but interest expense increased a larger than proportionate amount than long-term debt. (Select 1 explanation.)
5. Operating income increased from the prior year although the entity was less profitable than in the prior year. (Select 2 explanations.) 6. Gross margin percentage was unchanged from the prior year although gross margin increased from the prior year. (Select 1 explanation.)
Explanations
A. Items shipped on consignment during the last month of the year were recorded as sales.
B. A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded.
C. Year-end purchases of inventory were overstated by incorrectly including items received in the first month of the subsequent year. D. Year-end purchases of inventory were understated by incorrectly excluding items received before the year-end.
E. A higher percentage of sales occurred during the last month of the year as compared to the prior year.
F. A smaller percentage of sales occurred during the last month of the year as compared to the prior year.
G. The same percentage of sales occurred during the last month of the year as compared to the prior year.
H. Sales increased at the same percentage as cost of goods sold as compared to the prior year.
I. Sales increased at a higher percentage than cost of goods sold increased as compared to the prior year.
J. Sales increased at a lower percentage than cost of goods sold increased as compared to the prior year.
K. Interest expense decreased as compared to the prior year.
L. The effective income tax rate increased as compared to the prior year.
M. The effective income tax rate decreased as compared to the prior year.
N. Short-term borrowing was refinanced on a long-term basis at the same interest rate.
O. Short-term borrowing was refinanced on a long-term basis at a lower interest rate.
P. Short-term borrowing was refinanced on a long-term basis at a higher interest rate.
121 .
Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. They range from simple comparisons to the use of complex models involving many relationships and elements of data. They involve comparisons of recorded amounts or ratios developed from recorded amounts to expectations developed by auditors. Required:
A. Describe the broad purposes of analytical procedures.
B. Identify the sources of information from which an auditor develops expectations.
122 .
Analytical procedures are one type of evidence-gathering procedure. According to auditing standards, there are five general forms of
analytical procedures. Auditing standards also provide examples of five sources of information for analytical procedures.
Required:
Describe three of the five general forms of analytical procedures. For each form, describe a typical source of the information for the form. For each source, include any questions or concerns an auditor would have about the reliability or relevancy of the source.
123 .
This question tests your ability to perceive the place(s) where various potential problems may exist and the type of problem (overstatement or understatement) that may exist. It asks that you supply the words or descriptions that complete the analyses begun by applying
analytical procedures. Required:
For each of the items below, identify the account or accounts that need to be audited carefully and the reason (i.e., potential
overstatement or understatement of ______).
a. If the current-year accounts receivable are larger than last year but the allowance for doubtful accounts is the same.
b. If the year inventory is larger than last year and the current-year gross margin (profit) is larger.
c. If current-year long-term liabilities are larger than last year and the interest expense is the same.
d. If current-year fixed assets are larger and current depreciation expense is the same as last year.
124 .
Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data. Understanding and evaluating such relationships are essential to the audit process.
The following financial statements were prepared by ABC
Manufacturing Co. for the year ended December 31, 2013. Also
presented are various financial statement ratios for ABC as calculated from the prior-year financial statements. Sales represent net credit sales. The total assets and the receivables and inventory balances at December 31, 2013, were the same as at December 31, 2012.
Items 1 through 9 below represent financial ratios that the auditor calculated during the prior-year audit. For each ratio, calculate the current-year ratio from the financial statements presented above.
125 .
Why is it important for auditors to understand their clients' business risks?
126 .
The audit risk model includes the four risks listed below. Place the correct type of risk with the related definition below.
1. The probability that audit procedures will fail to produce evidence of material
misstatements
Detectio
n risk ____ 2. The probability that an auditor
will give an inappropriate opinion on financial statements
Inherent
risk ____ 3. The probability that material
misstatements have occurred in transactions entering the
accounting system
Audit
risk ____ 4. The probability that the client's
internal control policies and procedures will fail to detect material misstatements if they have entered the accounting system
Control
127 .
For each of the following statements or phrases, indicate the professional standard to which it relates:
1. Investigate large and unusual transactions, particularly those that occur at or near year-end
AU 260: "The Auditor's Communication with Those Charged with
Governance" ____ 2. Evaluate the net
realizable value of inventory AU 240: "Consideration of Fraud in a Financial Statement Audit" ____ 3. Make inquiries about
management's policies and procedures for compliance with laws and regulations AU 250: "Consideration of Laws and Regulations" ____ 4. Address disagreements with management on significant accounting and auditing matters
AU 540: "Auditing Accounting
128 .
For each of the following statements, indicate the term it best describes or typifies.
1. An employee in a supermarket takes home bags of fresh fruit each day
without paying for them Errors ____ 2. The controller changed the
journal entry for estimating bad debt expense to a smaller number to hide the poor results from extending credit to high-risk customers. This made income materially higher than it otherwise
would have been Larceny ____ 3. Misdeeds done by people
who steal with a pencil or computer
White-collar
crime ____ 4. A type of fraud involving
employees or nonemployees wrongfully taking money or property entrusted to their care Embezzleme nt or defalcation ____ 5. A bookkeeper inadvertently recorded depreciation by transposing numbers in a journal entry Management fraud ____
Chapter 04 Management Fraud and Audit Risk
Answer Key
True / False Questions
1. Frauds are unintentional misstatements or omissions of accounts or disclosures in financial statements.
FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Topic: Auditor's Risk Assessment 2. The nature of extended procedures for fraud detection is limited to
those listed in the Professional Standards and Practices for Certified Fraud Examiners.
FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Topic: Auditor's Risk Assessment
3. Fraud consists of knowingly making material misrepresentation of fact with the intent of inducing someone to believe the falsehood and suffer a loss.
TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Topic: Auditor's Risk Assessment 4. Audit care and attention should be greater where business and
inherent risks are judged to be lower. FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-04 Understand sources of inherent risk factors including the client's business and environment. Topic: Assessing Inherent Risk 5. Control risk should not be assessed so low that auditors place
complete reliance on controls and do not perform any other audit work.
TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium
Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Topic: The Audit Risk Model 6. Detection risk occurs when internal control activities fail to detect
material misstatements. FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Topic: The Audit Risk Model 7. The auditing profession official standard for an acceptable level of
overall audit risk is 0.05 at the current level. FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Topic: The Audit Risk Model 8. Audit risk (AR) is a quality criterion based on professional judgment.
TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium
Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Topic: The Audit Risk Model 9. The audit risk model assumes that elements of audit risk are
independent and therefore multiplicative. TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Topic: The Audit Risk Model 10. Generally, fraudulent financial statements show financial
performance and ratios that are better than current industry experience.
TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Topic: Auditor's Risk Assessment 11. The demographics of white-collar criminals are similar to those of
typical bank robbers. FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Topic: Auditor's Risk Assessment 12. Knowledge and understanding of a client's business is absolutely
essential in completing an audit. TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-04 Understand sources of inherent risk factors including the client's business and environment. Topic: Assessing Inherent Risk 13. Auditing standards require that analytical procedures be applied in
the beginning stages of each audit. TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-05 Understand sources of information for assessing risks including analytical procedures; brainstorming; and inquiries. Explain how auditors respond to assessed risks. Topic: Gathering Information, Assessing and Responding to Risks
14. Auditors look for relationships that do not make sense as indicators of problems in the accounts and use such indicators to plan further audit work.
TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Topic: The Audit Risk Model 15. Analytical procedures are considered to be "soft" evidence and
therefore considered ineffective. FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-05 Understand sources of information for assessing risks including analytical procedures; brainstorming; and inquiries. Explain how auditors respond to assessed risks. Topic: Gathering Information, Assessing and Responding to Risks 16. Audits are not designed to detect material errors and fraud in
financial statements. FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the
differences among several types of fraud and errors that might occur in an organization. Topic: Auditor's Risk Assessment 17. Knowledge of the client's business from preliminary analytical
procedures can help auditors identify problem areas and make broad risk assessments.
TRUE
Reference: Question also found in study guide
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-05 Understand sources of information for assessing risks including analytical procedures; brainstorming; and inquiries. Explain how auditors respond to assessed risks. Topic: Gathering Information, Assessing and Responding to Risks
Multiple Choice Questions
18. The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU 240) is on:
A. Employee misappropriation of assets. B. Management fraud.
C. Client fraud on customers. D. Employee embezzlement. AACSB: Analytic AICPA BB: Legal AICPA FN: Research Blooms: Remember Difficulty: 3 Hard Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk
19. Management fraud generally refers to
A. Unintentional mistakes. B. Noncompliance.
C. Intentional distortions of financial statements.
D. Violations of GAAS. AACSB: Analytic AICPA BB: Legal AICPA FN: Research Blooms: Remember Difficulty: 1 Easy Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk 20. External auditors are responsible
A. For authenticating documents.
B. For reporting immaterial frauds to a level of management at least one level above the people involved.
C. For finding all intentional misstatements concealed by collusion. D. For reporting all frauds to outside agencies or parties.
AACSB: Analytic AICPA BB: Legal AICPA FN: Research Blooms: Remember Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk
21. According to auditing standards, external auditors' responsibilities for indirect noncompliance do not include
A. Designing audit procedures to detect noncompliance in the
absence of specific information brought to the auditors' attention. B. Performing audit procedures when specific information indicates
that possible noncompliance may have an indirect material effect on financial statements.
C. Considering the qualitative materiality of known and suspected noncompliance.
D. Obtaining written management representations concerning the absence of violations of laws and regulations.
AACSB: Analytic AICPA BB: Legal AICPA FN: Research Blooms: Remember Difficulty: 2 Medium Learning Objective: 04-06 Explain auditors' responsibilities with respect to a client's failure to comply with laws or regulations. Source: Original Topic: Noncompliance 22. Certain conditions and circumstances are often present when
management fraud occurs. Which of the following is not such a condition or circumstance?
A. Unfavorable industry conditions. B. Lack of working capital.
C. High liquidity.
D. Slow customer collections.
AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk
23. Independent auditors who consider fraud in the course of financial statement audits are well-advised to quantify "materiality" in terms of:
A. The maximum amount of asset overstatement that might mislead investors in relation to the latest financial statements under audit. B. A maximum percentage of net income overstatement that might
mislead investors in relation to the latest financial statements under audit.
C. A cumulative amount of misstatement of assets or income over several years past and current that might mislead investors in relation to the latest financial statements under audit.
D. Controversial accounting measurements that might mislead
investors in relation to the latest financial statements under audit. AACSB: Analytic AICPA BB: Industry AICPA FN: Research Blooms: Understand Difficulty: 3 Hard Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk 24. An auditor assesses the risk of material misstatement because it
A. Is relevant to the auditor's understanding of the control environment.
B. Provides assurance that the auditor's overall materiality levels are appropriate.
C. Indicates to the auditor where inherent risk may be the greatest. D. Affects the level of detection risk that the auditor may accept.
AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: AICPA Topic: Audit Risk Model
25. When fraud risk is significant, and management cooperation is unsatisfactory, the auditors will most likely
A. Perform extended audit procedures. B. Consult with fraud examiners.
C. Report directly to the Securities and Exchange Commission within one day.
D. Withdraw from the engagement.
AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Understand Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk 26. Which of the following statements concerning noncompliance by
clients is correct?
A. An auditor's responsibility to detect noncompliance that has a direct and material effect on the financial statements is the same as that for errors and frauds.
B. An audit in accordance with generally accepted auditing standards normally includes audit procedures specifically designed to detect noncompliance that has an indirect but material effect on the financial statements.
C. An auditor considers noncompliance from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions.
D. An auditor has no responsibility for noncompliance that has an indirect effect on the financial statements.
AACSB: Analytic AICPA BB: Legal AICPA FN: Research Blooms: Remember Difficulty: 3 Hard Learning Objective: 04-06 Explain auditors' responsibilities with respect to a client's failure to comply with laws or regulations. Source: AICPA Topic: Noncompliance
27. Which of the following statements best describes auditors' responsibility to detect errors and frauds?
A. Auditors should design an audit to provide reasonable assurance of detecting errors and frauds that are material to the financial
statements.
B. Auditors are responsible to detect material errors but have no responsibility to detect material frauds that are concealed through employee collusion or management override of the internal control structure.
C. Auditors have no responsibility to detect errors and frauds unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial statements were materially misstated.
D. Auditors have no responsibility to detect errors and frauds because auditors are not insurers and an audit does not constitute a
guarantee. AACSB: Analytic AICPA BB: Legal AICPA FN: Research Blooms: Remember Difficulty: 2 Medium Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Learning Objective: 04-05 Understand sources of information for assessing risks including analytical procedures; brainstorming; and inquiries. Explain how auditors respond to assessed risks. Source: AICPA Topic: Fraud Risk 28. The probability that an audit team will give an inappropriate opinion
on financial statements best describes
A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk. AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: Original
Topic: Audit Risk Model 29. 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.
AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: 1 Easy Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: Original Topic: Inherent Risk 30. 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 statements is correct?
A. Detection risk will decrease. B. Inherent risk will increase. C. Audit risk will decrease. D. Detection risk will increase.
AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Understand Difficulty: 3 Hard Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: Original Topic: Audit Risk Model
31. If fictitious credit sales were recorded and the fictitious accounts receivable were later directly written off as bad debt expense
A. Income would be overstated. B. Income would be understated. C. Income would not be misstated.
D. Accounts receivable would be understated.
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Blooms: Understand Difficulty: 3 Hard Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the differences among several types of fraud and errors that might occur in an organization. Source: Original Topic: Fraud Risk 32. An audit team uses the assessed risk of material misstatement to
A. Evaluate the effectiveness of the entity's internal control policies and activities.
B. Identify transactions and account balances where inherent risk is at the maximum.
C. Indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.
D. Determine the acceptable level of detection risk for financial statement assertions.
AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: AICPA Topic: Fraud Risk
33. The risk of material misstatement differs from detection risk in that it
A. Arises from the misapplication of audit procedures.
B. May be assessed in either quantitative or nonquantitative terms. C. Exists independently of the financial statement audit.
D. Can be changed at the auditor's discretion.
AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Understand Difficulty: 3 Hard Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: AICPA Topic: Detection Risk 34. 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 exists is
A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk. AACSB: Analytic AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: 2 Medium Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its components in terms of professional judgment and audit planning. Source: Original Topic: Detection Risk
