Test bank auditing and assurance principles ch05 audit risk and materiality

At a level that equates the joint probability of inherent risk, control risk, and detection risk with overall audit risk.. The auditor should design audit procedures that will provide re

Audit Risk and Materiality MULTIPLE CHOICE:

1 An auditor compares 2002 revenues and expenses with those of

the prior year and investigates all changes exceeding 10% By this procedure the auditor would be most likely to learn that

a An increase in property tax rates has not been

recognized in the client's accrual

b The 2002 provision for uncollectible accounts is

inadequate, because of worsening economic conditions

c Fourth quarter payroll taxes were not paid

d The client changed its capitalization policy for small

tools in 2002 ANSWER: D

2 The element of the audit planning process most likely to be

agreed upon with the client before implementation of the

audit strategy is the determination of the

a Timing of inventory observation procedures to be

performed

b Evidence to be gathered to provide a sufficient basis

for the auditor's opinion

c Procedures to be undertaken to discover litigation,

claims, and assessments

d Pending legal matters to be included in the inquiry of

the client's attorney ANSWER: A

3 When a CPA is approached to perform an audit for the first

time, the CPA should make inquiries of the predecessor auditor This is a necessary procedure because the

predecessor may be able to provide the successor with

information that will assist the successor in determining

a Whether the predecessor's work should be utilized

b Whether the company follows the policy of rotating its

auditors

c Whether, in the predecessor's opinion, internal

control of the company has been satisfactory

d Whether the engagement should be accepted ANSWER: D

4 Having evaluated inherent risk and control risk, the auditor

determines detection risk

a As the complement of overall audit risk

b By performing substantive audit tests

c As a product of further study of the business and

industry and application of analytical procedures

d At a level that equates the joint probability of

inherent risk, control risk, and detection risk with overall audit risk

ANSWER: D

5 Which of the following is not a factor that affects the

auditor's judgment, during audit planning, as to the

quantity, type, and content of working papers?

a The auditor's preliminary assessment of control risk b The auditor's preliminary evaluation of inherent risk based on discussions with the client c The nature of the client’s business d The type of report to be issued by the auditor

ANSWER: D 6 How can the audit program best be described at the beginning of the audit process?

a Tentative

b Conclusive

c Comprehensive

d Optional

ANSWER: A 7 The auditor's analytical procedures will be facilitated if the client a Uses a standard cost system that produces variance

reports

b Segregates obsolete inventory before the physical inventory count c Corrects material weaknesses in internal control

before the beginning of the audit d Reduces inventory balances to the lower of cost or

market ANSWER: A

8 Experience has shown that certain conditions in an

organization are symptoms of possible management fraud

Which of the following conditions would not be considered an indicator of possible fraud?

a Managers regularly assuming subordinates' duties

b Managers dealing in matters outside their profit

center's scope

c Managers not complying with corporate directives and

procedures

d Managers subject to formal performance reviews on a

regular basis ANSWER: D

9 Which of the following underlies the application of

generally accepted auditing standards, particularly the standards of field work and reporting?

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 ANSWER: A

10 Which of the following is not a purpose served by the

application of analytical procedures?

a As part of audit planning to assist in locating

significant changes in revenues and expenses

b To provide a basis for lowering materiality thresholds

where significant earnings inflation is indicated

c To determine the economic substance of related party

transactions

d As part of audit review to determine that all

significant abnormalities have been resolved to the auditor's satisfaction

ANSWER: C

11 The probability of an auditor's procedures leading to the

conclusion that a material error does not exist in an

account balance when, in fact, such error does exist is referred to as

a Prevention risk

b Inherent risk

c Control risk

d Detection risk ANSWER: D

12 Which of the following concepts is most useful in assessing

the scope of an auditor's program relating to various

accounts?

a Attribute sampling

b Materiality

c The reliability of information

d Management fraud ANSWER: B

13 The existence of a related party transaction may be

indicated when another entity

a Sells real estate to the corporation at a price that is

comparable to its appraised value

b Absorbs expenses of the corporation

c Borrows from the corporation at a rate of interest

which equals the current market rate

d Lends to the corporation at a rate of interest, which

equals the current market rate ANSWER: B

14 Which of the following is an indicator of possible

fraudulent financial reporting for the purpose of inflating earnings?

a A trend analysis discloses: (1) sales increases of

50 percent and (2) cost of goods sold increases of

25 percent

b A ratio analysis discloses: (1) sales of $50 million

and (2) cost of goods sold of $25 million

c A cross-sectional analysis of common size statements

discloses: (1) the firm's ratio of cost of goods sold

to sales is 4 and (2) the industry average ratio of cost of goods sold to sales is 5

d A cross-sectional analysis of common size statements

discloses: (1) the firm's ratio of cost of goods sold

to sales is 5 and (2) the industry average ratio of cost of goods sold to sales is 4 ANSWER: A

15 An auditor judged an item to be immaterial when planning an

audit However, the auditor may still include the item if

it is subsequently determined that:

a Sufficient staff is available

b Adverse effects related to the item are likely to

occur

c Related evidence is reliable

d Miscellaneous income is affected ANSWER: B

16 Given that an audit in accordance with generally accepted

auditing standards is influenced by the possibility of

material errors and fraud, the auditor should conduct the audit with an attitude of

a Professional responsiveness

b Conservative advocacy

c Objective judgment

d Professional skepticism ANSWER: D

17 Warning signs that cause the auditor to question management

integrity must be taken seriously and pursued vigorously Which of the following may lead the auditor to suspect

management dishonesty?

a The president and chief executive officer of the client

corporation has held numerous meetings with the controller for the purpose of discussing accounting practices that will maximize reported profits

b The client has been named as a defendant in a product

liability suit

c The client has experienced a decrease in revenue from

increased import competition

d A new federal regulation making customer licenses more

difficult to obtain may adversely affect the client's operations

ANSWER: A

18 Auditors sometimes use comparison of ratios as audit

evidence For example, an unexplained decrease in the ratio

of gross profit to sales may suggest which of the following possibilities?

a Unrecorded purchases

b Unrecorded sales

c Merchandise purchases being charged to selling and

general expense

d Fictitious sales

ANSWER: B

19 In applying analytical procedures, the auditor discovered

that gross profit as a percent of sales declined sharply during the current year A possible cause might be

a The client has significant amounts of obsolete

inventory carried at full cost

b A significant quantity of finished goods located in a

distant warehouse was inadvertently omitted from the ending inventory

c Recorded sales included goods that were shipped the

following year

d Depreciation of office equipment was overstated

ANSWER: B

20 Which of the following is not a component of audit planning?

a Observing the client's annual physical inventory taking

and making test counts of selected items

b Making arrangements with the client concerning the

timing of audit field work and use of the client's staff in completing certain phases of the examination

c Obtaining an understanding of the business

d Developing audit programs

ANSWER: A

21 Audit risk consists of all but the following components:

a Inherent risk

b Detection risk

c Substantive risk

d Control risk

ANSWER: C

22 Significant unexpected fluctuations identified by

analytical procedures will usually necessitate a(an)

a Consistency qualification

b Review of internal control

c Explanation in the representation letter

d Auditor investigation ANSWER: D

23 Which of the following conditions supports an increase in

detection risk?

a Internal control over cash receipts is excellent

b Application of analytical procedures reveals a

significant increase in sales revenue in December, the last month of the fiscal year

c Internal control over shipping, billing, and recording

of sales revenue is weak

d Study of the business reveals that the client recently

acquired a new company in an unrelated industry

ANSWER: A

24 Which of the following statements best describes the

auditor's responsibility regarding the detection of fraud?

a The auditor is responsible for the failure to detect

fraud only when such failure clearly results from nonperformance of audit procedures specifically

described in the engagement letter

b The auditor should design audit procedures that will

provide reasonable assurance that the financial statements are free from material misstatement due to errors and/or fraud

c The auditor must extend auditing procedures to

actively search for evidence of fraud where the examination indicates that fraud may exist

d The auditor is responsible for the failure to detect

fraud only when an unqualified opinion is issued ANSWER: B

25 An independent auditor observed that only one of the

company's ten divisions had a large number of material sales transactions close to the end of the fiscal year

In terms of risk analysis, this would most likely lead the

auditor to conclude that:

a There is a relatively higher risk of overstatement of

revenues for this division than for other divisions

b Risks associated with auditing this division are not

affected by this information

c There is a high risk that liabilities of this division

are understated

d There is a high risk that the other nine divisions

have understated revenues ANSWER: A

26 An abnormal fluctuation in gross profit that might suggest

the need for extended audit procedures for sales and

inventories would most likely be identified in the planning phase of the audit by the use of

a Tests of transactions and balances

b A preliminary review of internal control

c Specialized audit programs

d Analytical procedures

ANSWER: D

27 Inherent risk is defined as the susceptibility of an account

balance or class of transactions to error that could be material assuming that there were no related internal

controls Of the following conditions, which one does not increase inherent risk?

a The client has entered into numerous related party

transactions during the year under audit

b Internal control over shipping, billing, and recording

of sales revenue is weak

c The client has lost a major customer accounting for

approximately 30% of annual revenue

d The board of directors approved a substantial bonus for

the president and chief executive officer, and also approved an attractive stock option plan for

themselves

ANSWER: B

28 The understanding between the client and the auditor as to

the degree of responsibilities to be assumed by each are normally set forth in a(an)

a Representation letter

b Engagement letter

c Management letter

d Comfort letter ANSWER: B

29 The element of the audit planning process most likely to be

agreed upon with the client before implementation of the

audit strategy is the determination of the

a Methods of statistical sampling to be used in

confirming accounts receivable

b Pending legal matters to be included in the inquiry of

the client's attorney

c Evidence to be gathered to provide a sufficient basis

for the auditor's opinion

d Schedules and analyses to be prepared by the client's

staff ANSWER: D

30 Which of the following statements concerning materiality

thresholds is incorrect?

a Aggregate materiality thresholds are a function of the

auditor's preliminary judgments concerning audit risk

b In general, the more misstatements the auditor

expects, the higher should be the aggregate materiality threshold

c The smallest aggregate level of errors or

fraud that could be considered material to any one of the financial statements is referred to as a

"materiality threshold."

d Materiality thresholds may change between the planning

and review stages of the audit These changes may be due to quantitative and/or qualitative factors

ANSWER: B

31 With respect to errors and fraud, the auditor should plan to

a Search for errors or fraud that would have a

material effect on the financial statements

b Discover errors or fraud that would have a material

effect on the financial statements

c Search for errors that would have a material effect and

for fraud that would have either material or immaterial effects on the financial statements

d Search for fraud that would have a material

effect and for errors that would have either material or immaterial effects on the financial

statements

ANSWER: B

32 Why should the auditor plan more work on individual accounts

as lower acceptable levels of both audit risk and materiality are established?

a To find smaller errors

b To find larger errors

c To increase the tolerable error in the accounts

d To decrease the risk of overreliance ANSWER: A

33 The auditor notices significant fluctuations in key elements

of the company's financial statements 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 examination with the expectation of

detecting management fraud

d Withdraw from the engagement ANSWER: B

34 Which of the following audit risk components may be assessed

in non-quantitative terms?

Inherent Control Detection risk risk risk

a Yes Yes No

b Yes No Yes

c No Yes Yes

d Yes Yes Yes ANSWER: D

35 Which of the following statements is true with regard to the

relationship among audit risk, audit evidence, and

materiality?

a The lower the inherent risk and control risk, the lower

the aggregate materiality threshold

b Under conditions of high inherent and control risk, the

auditor should place more emphasis on obtaining external evidence and should reduce reliance on internal evidence

c Where inherent risk is high and control risk is low,

the auditor may safely ignore inherent risk

d Aggregate materiality thresholds should not change

under conditions of changing risk levels

ANSWER: B

36 In evaluating the effectiveness of a company's credit and

collection policies, the ratio most likely to be used by an auditor is

a Quick ratio

b Accounts receivable turnover

c Working capital turnover