Chapter 04 - Risk Assessment

Chapter 04 Risk Assessment

True / False Questions

1. Audit risk is the auditor's exposure to loss or injury of his or her reputation from events arising in onne tion !ith finan ial statements audited. "rue #alse

$. %ngagement risk is the auditor's exposure to loss or injury of his or her reputation from events arising in onne tion !ith finan ial statements audited. "rue #alse

&. "he omponents of the audit risk model in lude inherent risk' ontrol risk' and dete tion risk. "rue #alse

4. (nherent risk is the sus epti)ility of an assertion to material misstatement' assuming no related ontrols. "rue #alse

*. +rofessional judgment must )e used !hen evaluating )usiness risk. "rue #alse

,. "he risk of a material misstatement in ludes inherent risk and sampling risk. "rue #alse

-. "he om)ination of inherent risk and ontrol risk is referred to as lient risk. "rue #alse

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Chapter 04 - Risk Assessment

.. (nherent risk in ludes sampling risk and dete tion risk. "rue #alse

Multiple Choice Questions

/. %ngagement risk is A. "he risk of issuing an in orre t audit opinion. 0. "he auditor's risk of loss from events arising in onne tion !ith finan ial statements audited and reported upon. C. "he overall risk of material misstatement. 1. "he risk of the lient's finan ial failure.

10. Client risk as defined in the text is A. "he auditor's risk of loss from events arising in onne tion !ith finan ial statements audited and reported upon. 0. "he overall risk of material misstatement. C. "he risk that audit pro edures !ill fail to dete t material misstatements. 1. "he risk of the lient's finan ial failure.

11. 2nder 3tatements on Auditing 3tandards' !hi h of the follo!ing !ould )e lassified as an error4 A. 5isappropriation of assets for the )enefit of management. 0. 5isinterpretation )y management of fa ts that existed !hen the finan ial statements !ere prepared. C. +reparation of re ords )y employees to over a fraudulent s heme. 1. (ntentional omission of the re ording of a transa tion to )enefit a third party.

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Chapter 04 - Risk Assessment

1$. 6hen assessing the risk of material misstatement' auditors evaluate the reasona)leness of an entity's a ounting estimates. An auditor normally !ould )e on erned a)out assumptions that are A. 3us epti)le to )ias. 0. Consistent !ith prior periods. C. (nsensitive to variations. 1. 3imilar to industry guidelines.

1&. 6hi h of the follo!ing hara teristi s most likely !ould heighten an auditor's on ern a)out the risk of intentional manipulation of finan ial statements4 A. "urnover of senior a ounting personnel is lo!. 0. (nsiders re ently pur hased additional shares of the entity's sto k. C. 5anagement pla es su)stantial emphasis on meeting earnings proje tions. 1. "he rate of hange in the entity's industry is slo!.

14. 6hi h of the follo!ing is a kno!n misstatement4 A. A management estimate that is outside the range of reasona)le out omes determined )y the auditor. 0. A fixed asset )eing re orded at the in orre t ost. C. A proje ted misstatement resulting from errors found during sampling. 1. 1ifferen e in judgment )et!een the auditor and management.

1*. %ngagement risk an )e eliminated )y A. %sta)lishing poli ies for lient a eptan e and ontinuan e. 0. 7o!ering audit risk. C. 7o!ering materiality. 1. %ngagement risk annot )e eliminated.

1,. "he a hieved 8a tual9 level of audit risk A. Can al!ays )e a urately assessed )y the auditor. 0. 3hould )e greater than or e:ual to a epta)le audit risk. C. Can never )e kno!n !ith ertainty. 1. (s the same for all audit lients.

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Chapter 04 - Risk Assessment

1-. An auditor kno!s that an audit lient operating in an industry in !hi h ommon sto k is valued )ased on the pri e-earnings ratio !ill soon make an initial pu)li offering. All of the follo!ing are true ex ept; A. 5ateriality should )e redu ed. 0. Risk of material misstatement should in rease. C. 1ete tion risk should de rease. 1. Audit risk should in rease.

1.. "he risk that an auditor !ill on lude' )ased on su)stantive pro edures' that a material error does not exist in an a ount )alan e !hen' in fa t' su h an error does exist is referred to as A. 3ampling risk. 0. 1ete tion risk. C. <onsampling risk. 1. (nherent risk.

1/. "he risk of material misstatement differs from dete tion risk in that it A. Arises from the misappli ation of auditing pro edures. 0. 5ay )e assessed in either :uantitative or :ualitative terms. C. %xists independently of the a tions of the auditor. 1. Can )e hanged at the auditor's dis retion.

$0. All of the follo!ing are inherent risk fa tors that are pervasive to the finan ial statements ex ept; A. =ighly omplex signifi ant transa tions. 0. <on-routine transa tions. C. Classes of transa tions are not pro essed systemati ally. 1. 3upplies inventory is diffi ult to ount.

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Chapter 04 - Risk Assessment

$1. 6hen an auditor in reases the assessed level of risk of material misstatement )e ause ertain ontrol pro edures !ere determined to )e ineffe tive' the auditor !ould most likely in rease the A. %xtent of tests of ontrols. 0. 7evel of dete tion risk. C. %xtent of su)stantive tests. 1. 7evel of inherent risk.

$$. >n the )asis of audit eviden e gathered and evaluated' an auditor de ides to in rease the assessed level of risk of material misstatement from that originally planned. "o a hieve an overall audit risk level that is su)stantially the same as the planned audit risk level' the auditor !ould A. 1e rease amount of su)stantive testing. 0. 1e rease dete tion risk. C. (n rease dete tion risk. 1. (n rease materiality levels.

$&. "he risk of material misstatement in ludes !hi h of the follo!ing4 A. 1ete tion risk. 0. Audit risk. C. (nherent risk. 1. <onsampling risk.

$4. An auditor learns that a lient employee in ontrol of inventory gets divor ed and is responsi)le for paying a large amount of hild support. All of the follo!ing for the audit of inventory likely are true ex ept; A. #raud risk in reases. 0. "he risk of misappropriation of assets in reases. C. Risk of material misstatement in reases. 1. 1ete tion risk in reases.

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Chapter 04 - Risk Assessment

$*. 6hi h of the follo!ing audit risk omponents may )e assessed in :ualitative terms4 A. Risk of material misstatement. 0. 1ete tion risk. C. <either risk of material misstatement nor dete tion risk. 1. 0oth risk of material misstatement and dete tion risk.

$,. 6hen an entity moves into a signifi ant ne! line of )usiness' all of the follo!ing in rease ex ept; A. Client risk. 0. A epta)le audit risk. C. Risk of material misstatement. 1. %ntity )usiness risk.

$-. 6hi h of the follo!ing pro edures !ould not )e used to o)tain an understanding of the entity and its environment4 A. >)serve entity operations. 0. Reperform entity pro esses. C. ?erify proper valuation of inventory su)je t to te hnologi al o)soles en e. 1. Revie! prior year's audit do umentation.

$.. 6hi h of the follo!ing is not an important onsideration in an auditor's evaluation of an entity's )usiness risk4 A. "he spe ifi )usiness risks an entity fa es that may result in finan ial statement errors and fraud. 0. 0usiness risk fa tors that impa t the a)ility of the entity to )e profita)le and survive. C. Audit standards in lude many entity )usiness risk fa tors that identify ir umstan es that in rease the likelihood of material misstatements. 1. Audit standards re:uire the auditor to evaluate the entity's )usiness risk in order to provide suggestions to improve the entity's profita)ility.

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Chapter 04 - Risk Assessment

$/. 6hi h of the follo!ing is a sour e of dete tion risk4 A. 2nsta)le )usiness environment. 0. +oor lient ontrols. C. A non-representative sample. 1. (nherent risk assessed too high.

&0. (n general' material frauds perpetrated )y !hi h of the follo!ing are most diffi ult to dete t4 A. (nternal auditor. 0. @eypun h operator. C. Cashier. 1. Controller.

&1. 6hi h of the follo!ing ir umstan es most likely !ould ause an auditor to )elieve that material misstatements may exist in an entity's finan ial statements4 A. A ounts re eiva)le onfirmation re:uests yield signifi antly fe!er responses than expe ted. 0. Audit trails of omputer-generated transa tions exist only for a short time. C. "he hief finan ial offi er does not sign the management representation letter until the last day of the auditor's field !ork. 1. 5anagement onsults !ith other a ountants a)out signifi ant a ounting matters.

&$. "he primary responsi)ility for preventing fraud in an organiAation lies !ith A. "he audit ommittee of the )oard of dire tors. 0. "he internal audit staff. C. "he external auditor. 1. "he organiAation's management.

&&. 6hi h of the follo!ing is not a misstatement of the finan ial statements4 A. "he lient uses different inventory a ounting methods for internal and external reporting. 0. A departure from BAA+. C. "he footnote for pensions is omitted. 1. A lerk in orre tly )ased the allo!an e for dou)tful a ounts on &1C of sales as opposed to 1&C of sales as determined )y the ontroller.

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Chapter 04 - Risk Assessment

&4. All of the follo!ing represent an in reased opportunity for management to ommit fraud ex ept; A. 3ignifi ant related party transa tions. 0. "he auditor's relationship !ith management is strained. C. 5anagement is dominated )y a single person. 1. "he finan ial statements in luded highly su)je tive estimates.

&*. "he auditor an respond to an in reased risk of fraud )y doing all of the follo!ing ex ept; A. =eavily emphasiAing the importan e of professional skepti ism. 0. Assigning more experien ed personnel to the audit. C. (n reasing dete tion risk. 1. "aking steps to o)tain more relia)le eviden e.

&,. An auditor dis overs a likely fraud during an audit )ut on ludes that the overall effe t of the fraud is not suffi iently material to affe t the audit opinion. "he auditor should pro)a)ly A. 1is lose the fraud to the appropriate level of the lient's management. 0. 1is lose the fraud to appropriate authorities external to the lient. C. 1is uss !ith the lient the additional audit pro edures that !ill )e needed to identify the exa t amount of the fraud. 1. 5odify the audit program to in lude tests spe ifi ally designed to identify the fraud and its impa t on the finan ial statements.

&-. "he a epta)le level of dete tion risk is inversely related to the A. %xtent of the su)stantive pro edures. 0. Risk of misapplying auditing pro edures. C. +lanning materiality. 1. Risk of failing to dis over material misstatements.

&.. As the a epta)le level of dete tion risk de reases' an auditor may hange the A. "iming of tests of ontrols )y performing them at an interim date rather than at year-end. 0. <ature of su)stantive pro edures from less effe tive to more effe tive pro edures. C. "iming of tests of ontrols )y performing them at several dates rather than at one time. 1. Assessed level of risk of material misstatement to a higher amount.

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Chapter 04 - Risk Assessment

&/. As the a epta)le level of dete tion risk de reases' the assuran e dire tly provided from A. 3u)stantive pro edures should in rease. 0. 3u)stantive pro edures should de rease. C. "ests of ontrols should in rease. 1. "ests of ontrols should de rease.

40. (n reased fraud risk ould also result in all of the follo!ing ex ept; A. 7o!er dete tion risk. 0. =igher inherent risk. C. 7o!er ontrol risk. 1. =igher lient risk.

41. "he o)je tives of the engagement partner's ommuni ation !ith the audit team in lude A. 5aintaining an adversarial atmosphere )et!een the auditor and management. 0. Complying !ith 3%C rules. C. Complying !ith #A30 rules. 1. %mphasiAing the importan e of professional skepti ism.

4$. "he auditor is most likely to presume that a high risk of a fraud exists if A. "he entity is a multinational ompany that does )usiness in numerous foreign ountries. 0. "he entity does )usiness !ith several related parties. C. (nade:uate segregation of duties pla es an employee in a position to perpetrate and on eal theft. 1. (nade:uate employee training results in lengthy %1+ ex eption reports ea h month.

4&. 6hi h of the follo!ing fa tors most likely !ould heighten an auditor's on ern a)out the risk of fraudulent finan ial reporting4 A. (na)ility to generate ash flo!s from operations !hile reporting su)stantial earnings gro!th. 0. 5anagement's la k of interest in in reasing the entity's earnings trend. C. 7arge amounts of li:uid assets that are easily onverted into ash. 1. (na)ility to )orro! ne essary apital !ithout granting de)t ovenants.

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Chapter 04 - Risk Assessment

44. A properly planned and performed audit may fail to dete t a material misstatement resulting from fraud )e ause A. Audit pro edures that are other!ise effe tive may )e ineffe tive for fraud that is on ealed through ollusion. 0. An audit is planned and performed to provide reasona)le assuran e of dete ting material misstatements aused )y errors )ut not )y fraud. C. "he fa tors onsidered in assessing ontrol risk indi ated an in reased risk of error )ut only a lo! risk of fraud in the finan ial statements. 1. "he auditor did not onsider fa tors influen ing audit risk for a ount )alan es that have effe ts pervasive to the finan ial statements taken as a !hole.

4*. 6hi h of the follo!ing is orre t on erning re:uired auditor ommuni ations a)out fraud4 A. #raud that involves senior management should )e reported dire tly )y the auditor to the audit ommittee regardless of the amount involved. 0. #raud !ith a material effe t on the finan ial statements should )e reported dire tly )y the auditor to the 3e urities and %x hange Commission. C. Any re:uirement to dis lose fraud outside the entity is the responsi)ility of management and not that of the auditor. 1. "he professional standards provide no re:uirements related to the ommuni ation of fraud' )ut the auditor should use professional judgment in determining ommuni ation responsi)ilities.

Short Answer Questions

4,. 2sing the audit risk model' identify the relationship )et!een the follo!ing elements. #or ea h of the items )elo!' highlight !hether the t!o elements have an inverse relationship' a dire t relationship' or no relationship. 6hen onsidering ea h item' assume that the other omponents of the risk model remain onstant.

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Chapter 04 - Risk Assessment

4-. 6hat is the differen e )et!een audit risk and engagement risk4

4.. Dou are tea hing a lass of ne! hires at your international a ounting firm. %xplain the audit risk model using a mathemati al formula.

4/. 3ta ey' the partner in harge of the audit of R(# %nterprises' sets the planned level of audit risk for the audit of a ounts paya)le at .0,. "he risk of material misstatement is assessed at . ,*. 6hat is the dete tion risk for this audit4

*0. Dour lassmate asserts' EA ountants shouldn't need to take )usiness ourses )esides a ounting' )e ause they are only interested in the finan ial statements of a ompany.E 1efend or refute this statement.

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Chapter 04 - Risk Assessment

*1. Dou are the senior on an audit of "!o 0e Bone' a large pu)li ompany. "he ompany re ently ompleted an a :uisition of its fifth largest ompetitor. 6hat risks might this present4 =o! !ill you' the auditor' respond to these risks 8i.e. !hat a tions should you take94

*$. 1efine misstatements arising from fraudulent finan ial reporting and misstatements arising from misappropriation of assets in one senten e ea h.

*&. 1A"R(F' (n .' a #ortune *00 ompany' has )een experien ing poor performan e. (ndustry analysts have )een issuing negative reports and the ompany's sto k pri e has )een steadily de lining. As an auditor' !hat !ould on ern you a)out the audit engagement of 1A"R(F' (n .

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Chapter 04 - Risk Assessment

*4. 1uring the ourse of the audit of ## #inan ial' you find that some a ounting entries have )een altered. Dou )elieve this may )e the result of management fraud and you have determined that the effe t of this ould )e material to the finan ial statements. 6hat steps should you take in response to the a ounting entries and your on ern a)out management fraud4

**. Assume that you are the ne! audit senior on the 7? 1rug Corporation 87?19 engagement. 7?1 is a pharma euti al ompany that has three su essful drugs and a num)er of drugs in progress in its resear h and development pipeline. Dou are onsidering your audit plan and it is important to identify the inherent risks that 7?1 has and ho! they relate to the planning pro ess. Required; #or ea h of the follo!ing fa tors' indi ate !hether it !ill tend to in rease' de rease' or have no effe t on inherent risk' and the reasoning for your ans!er. a. 1r. Gones is the major shareholder of 7?1 and its C%>. ). Dour firm has audited 7?1 for the last four years. . "here has )een high turnover of key a ounting personnel during the last t!o years. d. "he internal audit fun tion reports to the audit ommittee. e. 7?1 has )een the su)je t of la!suits )y users of #ramadon !ho laim that the drug affe ts their liver fun tions. 7?1 is onfident that there are no su h side effe ts from the use of #ramadon.

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Chapter 04 - Risk Assessment

Chapter 04 Risk Assessment Ans!er @ey

True / False Questions

1. Audit risk is the auditor's exposure to loss or injury of his or her reputation from events arising in onne tion !ith finan ial statements audited. FALS

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'% (nderstand t)e conce*t of audit risk+ ,o*ic: Audit Risk -odel

$. %ngagement risk is the auditor's exposure to loss or injury of his or her reputation from events arising in onne tion !ith finan ial statements audited. TR!

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

&. "he omponents of the audit risk model in lude inherent risk' ontrol risk' and dete tion risk. TR!

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

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Chapter 04 - Risk Assessment

4. (nherent risk is the sus epti)ility of an assertion to material misstatement' assuming no related ontrols. TR!

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

*. +rofessional judgment must )e used !hen evaluating )usiness risk. TR!

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

,. "he risk of a material misstatement in ludes inherent risk and sampling risk. FALS

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

-. "he om)ination of inherent risk and ontrol risk is referred to as lient risk. TR!

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

4-1*

Chapter 04 - Risk Assessment

.. (nherent risk in ludes sampling risk and dete tion risk. FALS

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

Multiple Choice Questions

/. %ngagement risk is A. "he risk of issuing an in orre t audit opinion. "# "he auditor's risk of loss from events arising in onne tion !ith finan ial statements audited and reported upon. C. "he overall risk of material misstatement. 1. "he risk of the lient's finan ial failure.

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

10. Client risk as defined in the text is A. "he auditor's risk of loss from events arising in onne tion !ith finan ial statements audited and reported upon. "# "he overall risk of material misstatement. C. "he risk that audit pro edures !ill fail to dete t material misstatements. 1. "he risk of the lient's finan ial failure.

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

4-1,

Chapter 04 - Risk Assessment

11. 2nder 3tatements on Auditing 3tandards' !hi h of the follo!ing !ould )e lassified as an error4 A. 5isappropriation of assets for the )enefit of management. "# 5isinterpretation )y management of fa ts that existed !hen the finan ial statements !ere prepared. C. +reparation of re ords )y employees to over a fraudulent s heme. 1. (ntentional omission of the re ording of a transa tion to )enefit a third party.

AACSB: !t)ics AICPA BB: Legal AICPA FN: Decision -aking Blooms: A**ly Difficulty: !asy Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Fraud Risk Assessment Process

1$. 6hen assessing the risk of material misstatement' auditors evaluate the reasona)leness of an entity's a ounting estimates. An auditor normally !ould )e on erned a)out assumptions that are A# 3us epti)le to )ias. 0. Consistent !ith prior periods. C. (nsensitive to variations. 1. 3imilar to industry guidelines.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: A**ly Difficulty: !asy Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ ,o*ic: ,)e Auditor0s Risk Assessment Process

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Chapter 04 - Risk Assessment

1&. 6hi h of the follo!ing hara teristi s most likely !ould heighten an auditor's on ern a)out the risk of intentional manipulation of finan ial statements4 A. "urnover of senior a ounting personnel is lo!. 0. (nsiders re ently pur hased additional shares of the entity's sto k. C# 5anagement pla es su)stantial emphasis on meeting earnings proje tions. 1. "he rate of hange in the entity's industry is slo!.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: A**ly Difficulty: !asy Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Fraud Risk Assessment Process

14. 6hi h of the follo!ing is a kno!n misstatement4 A. A management estimate that is outside the range of reasona)le out omes determined )y the auditor. "# A fixed asset )eing re orded at the in orre t ost. C. A proje ted misstatement resulting from errors found during sampling. 1. 1ifferen e in judgment )et!een the auditor and management.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: -easurement Blooms: Remember Difficulty: . -edium Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud

1*. %ngagement risk an )e eliminated )y A. %sta)lishing poli ies for lient a eptan e and ontinuan e. 0. 7o!ering audit risk. C. 7o!ering materiality. $# %ngagement risk annot )e eliminated.

AACSB: Communication AICPA BB: Legal AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

4-1.

Chapter 04 - Risk Assessment

1,. "he a hieved 8a tual9 level of audit risk A. Can al!ays )e a urately assessed )y the auditor. 0. 3hould )e greater than or e:ual to a epta)le audit risk. C# Can never )e kno!n !ith ertainty. 1. (s the same for all audit lients.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

1-. An auditor kno!s that an audit lient operating in an industry in !hi h ommon sto k is valued )ased on the pri e-earnings ratio !ill soon make an initial pu)li offering. All of the follo!ing are true ex ept; A. 5ateriality should )e redu ed. 0. Risk of material misstatement should in rease. C. 1ete tion risk should de rease. $# Audit risk should in rease.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-1/

Chapter 04 - Risk Assessment

1.. "he risk that an auditor !ill on lude' )ased on su)stantive pro edures' that a material error does not exist in an a ount )alan e !hen' in fa t' su h an error does exist is referred to as A. 3ampling risk. "# 1ete tion risk. C. <onsampling risk. 1. (nherent risk.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

1/. "he risk of material misstatement differs from dete tion risk in that it A. Arises from the misappli ation of auditing pro edures. 0. 5ay )e assessed in either :uantitative or :ualitative terms. C# %xists independently of the a tions of the auditor. 1. Can )e hanged at the auditor's dis retion.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-$0

Chapter 04 - Risk Assessment

$0. All of the follo!ing are inherent risk fa tors that are pervasive to the finan ial statements ex ept; A. =ighly omplex signifi ant transa tions. 0. <on-routine transa tions. C. Classes of transa tions are not pro essed systemati ally. $# 3upplies inventory is diffi ult to ount.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

$1. 6hen an auditor in reases the assessed level of risk of material misstatement )e ause ertain ontrol pro edures !ere determined to )e ineffe tive' the auditor !ould most likely in rease the A. %xtent of tests of ontrols. 0. 7evel of dete tion risk. C# %xtent of su)stantive tests. 1. 7evel of inherent risk.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-$1

Chapter 04 - Risk Assessment

$$. >n the )asis of audit eviden e gathered and evaluated' an auditor de ides to in rease the assessed level of risk of material misstatement from that originally planned. "o a hieve an overall audit risk level that is su)stantially the same as the planned audit risk level' the auditor !ould A. 1e rease amount of su)stantive testing. "# 1e rease dete tion risk. C. (n rease dete tion risk. 1. (n rease materiality levels.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

$&. "he risk of material misstatement in ludes !hi h of the follo!ing4 A. 1ete tion risk. 0. Audit risk. C# (nherent risk. 1. <onsampling risk.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

4-$$

Chapter 04 - Risk Assessment

$4. An auditor learns that a lient employee in ontrol of inventory gets divor ed and is responsi)le for paying a large amount of hild support. All of the follo!ing for the audit of inventory likely are true ex ept; A. #raud risk in reases. 0. "he risk of misappropriation of assets in reases. C. Risk of material misstatement in reases. $# 1ete tion risk in reases.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: Audit Risk -odel ,o*ic: ,)e Fraud Risk Assessment Process ,o*ic: (se of t)e Audit Risk -odel

$*. 6hi h of the follo!ing audit risk omponents may )e assessed in :ualitative terms4 A. Risk of material misstatement. 0. 1ete tion risk. C. <either risk of material misstatement nor dete tion risk. $# 0oth risk of material misstatement and dete tion risk.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Remember Difficulty: . -edium Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: (se of t)e Audit Risk -odel

4-$&

Chapter 04 - Risk Assessment

$,. 6hen an entity moves into a signifi ant ne! line of )usiness' all of the follo!ing in rease ex ept; A. Client risk. "# A epta)le audit risk. C. Risk of material misstatement. 1. %ntity )usiness risk.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ ,o*ic: Audit Risk -odel ,o*ic: ,)e Auditor0s Risk Assessment Process

$-. 6hi h of the follo!ing pro edures !ould not )e used to o)tain an understanding of the entity and its environment4 A. >)serve entity operations. 0. Reperform entity pro esses. C# ?erify proper valuation of inventory su)je t to te hnologi al o)soles en e. 1. Revie! prior year's audit do umentation.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision -aking Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ ,o*ic: ,)e Auditor0s Risk Assessment Process

4-$4

Chapter 04 - Risk Assessment

$.. 6hi h of the follo!ing is not an important onsideration in an auditor's evaluation of an entity's )usiness risk4 A. "he spe ifi )usiness risks an entity fa es that may result in finan ial statement errors and fraud. 0. 0usiness risk fa tors that impa t the a)ility of the entity to )e profita)le and survive. C. Audit standards in lude many entity )usiness risk fa tors that identify ir umstan es that in rease the likelihood of material misstatements. $# Audit standards re:uire the auditor to evaluate the entity's )usiness risk in order to provide suggestions to improve the entity's profita)ility.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ ,o*ic: ,)e Auditor0s Risk Assessment Process

$/. 6hi h of the follo!ing is a sour e of dete tion risk4 A. 2nsta)le )usiness environment. 0. +oor lient ontrols. C# A non-representative sample. 1. (nherent risk assessed too high.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

4-$*

Chapter 04 - Risk Assessment

&0. (n general' material frauds perpetrated )y !hi h of the follo!ing are most diffi ult to dete t4 A. (nternal auditor. 0. @eypun h operator. C. Cashier. $# Controller.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Fraud Risk Assessment Process

&1. 6hi h of the follo!ing ir umstan es most likely !ould ause an auditor to )elieve that material misstatements may exist in an entity's finan ial statements4 A# A ounts re eiva)le onfirmation re:uests yield signifi antly fe!er responses than expe ted. 0. Audit trails of omputer-generated transa tions exist only for a short time. C. "he hief finan ial offi er does not sign the management representation letter until the last day of the auditor's field !ork. 1. 5anagement onsults !ith other a ountants a)out signifi ant a ounting matters.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ Learning "b#ecti$e: %&'%6 Learn )o2 to res*ond to t)e results of t)e risk assessments+ Learning "b#ecti$e: %&'%7 Learn )o2 to e$aluate t)e results of t)e audit tests+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: !$aluation of Audit ,est Results ,o*ic: ,)e Auditor0s Res*onse to t)e Results of t)e Risk Assessments

4-$,

Chapter 04 - Risk Assessment

&$. "he primary responsi)ility for preventing fraud in an organiAation lies !ith A. "he audit ommittee of the )oard of dire tors. 0. "he internal audit staff. C. "he external auditor. $# "he organiAation's management.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision -aking Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Auditor0s Risk Assessment Process ,o*ic: ,)e Fraud Risk Assessment Process

&&. 6hi h of the follo!ing is not a misstatement of the finan ial statements4 A# "he lient uses different inventory a ounting methods for internal and external reporting. 0. A departure from BAA+. C. "he footnote for pensions is omitted. 1. A lerk in orre tly )ased the allo!an e for dou)tful a ounts on &1C of sales as opposed to 1&C of sales as determined )y the ontroller.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Decision -aking Blooms: Analy3e Difficulty: . -edium Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ Learning "b#ecti$e: %&'%6 Learn )o2 to res*ond to t)e results of t)e risk assessments+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: ,)e Auditor0s Res*onse to t)e Results of t)e Risk Assessments

4-$-

Chapter 04 - Risk Assessment

&4. All of the follo!ing represent an in reased opportunity for management to ommit fraud ex ept; A. 3ignifi ant related party transa tions. "# "he auditor's relationship !ith management is strained. C. 5anagement is dominated )y a single person. 1. "he finan ial statements in luded highly su)je tive estimates.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: ,)e Fraud Risk Assessment Process

&*. "he auditor an respond to an in reased risk of fraud )y doing all of the follo!ing ex ept; A. =eavily emphasiAing the importan e of professional skepti ism. 0. Assigning more experien ed personnel to the audit. C# (n reasing dete tion risk. 1. "aking steps to o)tain more relia)le eviden e.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%6 Learn )o2 to res*ond to t)e results of t)e risk assessments+ ,o*ic: Audit Risk -odel ,o*ic: ,)e Auditor0s Res*onse to t)e Results of t)e Risk Assessments

4-$.

Chapter 04 - Risk Assessment

&,. An auditor dis overs a likely fraud during an audit )ut on ludes that the overall effe t of the fraud is not suffi iently material to affe t the audit opinion. "he auditor should pro)a)ly A# 1is lose the fraud to the appropriate level of the lient's management. 0. 1is lose the fraud to appropriate authorities external to the lient. C. 1is uss !ith the lient the additional audit pro edures that !ill )e needed to identify the exa t amount of the fraud. 1. 5odify the audit program to in lude tests spe ifi ally designed to identify the fraud and its impa t on the finan ial statements.

AACSB: Communication AICPA BB: Critical ,)inking AICPA FN: Decision -aking Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%7 Learn )o2 to e$aluate t)e results of t)e audit tests+ ,o*ic: !$aluation of Audit ,est Results

&-. "he a epta)le level of dete tion risk is inversely related to the A# %xtent of the su)stantive pro edures. 0. Risk of misapplying auditing pro edures. C. +lanning materiality. 1. Risk of failing to dis over material misstatements.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-$/

Chapter 04 - Risk Assessment

&.. As the a epta)le level of dete tion risk de reases' an auditor may hange the A. "iming of tests of ontrols )y performing them at an interim date rather than at year-end. "# <ature of su)stantive pro edures from less effe tive to more effe tive pro edures. C. "iming of tests of ontrols )y performing them at several dates rather than at one time. 1. Assessed level of risk of material misstatement to a higher amount.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

&/. As the a epta)le level of dete tion risk de reases' the assuran e dire tly provided from A# 3u)stantive pro edures should in rease. 0. 3u)stantive pro edures should de rease. C. "ests of ontrols should in rease. 1. "ests of ontrols should de rease.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-&0

Chapter 04 - Risk Assessment

40. (n reased fraud risk ould also result in all of the follo!ing ex ept; A. 7o!er dete tion risk. 0. =igher inherent risk. C# 7o!er ontrol risk. 1. =igher lient risk.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: !$aluate Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: Audit Risk -odel ,o*ic: ,)e Fraud Risk Assessment Process

41. "he o)je tives of the engagement partner's ommuni ation !ith the audit team in lude A. 5aintaining an adversarial atmosphere )et!een the auditor and management. 0. Complying !ith 3%C rules. C. Complying !ith #A30 rules. $# %mphasiAing the importan e of professional skepti ism.

AACSB: Communication AICPA BB: Resource -anagement AICPA FN: Decision -aking Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud

4$. "he auditor is most likely to presume that a high risk of a fraud exists if A. "he entity is a multinational ompany that does )usiness in numerous foreign ountries. 0. "he entity does )usiness !ith several related parties. C# (nade:uate segregation of duties pla es an employee in a position to perpetrate and on eal theft. 1. (nade:uate employee training results in lengthy %1+ ex eption reports ea h month.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: . -edium Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Fraud Risk Assessment Process

4-&1

Chapter 04 - Risk Assessment

4&. 6hi h of the follo!ing fa tors most likely !ould heighten an auditor's on ern a)out the risk of fraudulent finan ial reporting4 A# (na)ility to generate ash flo!s from operations !hile reporting su)stantial earnings gro!th. 0. 5anagement's la k of interest in in reasing the entity's earnings trend. C. 7arge amounts of li:uid assets that are easily onverted into ash. 1. (na)ility to )orro! ne essary apital !ithout granting de)t ovenants.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: !$aluate Difficulty: 4 5ard Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ Learning "b#ecti$e: %&'%6 Learn )o2 to res*ond to t)e results of t)e risk assessments+ Learning "b#ecti$e: %&'%7 Learn )o2 to e$aluate t)e results of t)e audit tests+ ,o*ic: !$aluation of Audit ,est Results ,o*ic: ,)e Auditor0s Res*onse to t)e Results of t)e Risk Assessments ,o*ic: ,)e Fraud Risk Assessment Process

44. A properly planned and performed audit may fail to dete t a material misstatement resulting from fraud )e ause A# Audit pro edures that are other!ise effe tive may )e ineffe tive for fraud that is on ealed through ollusion. 0. An audit is planned and performed to provide reasona)le assuran e of dete ting material misstatements aused )y errors )ut not )y fraud. C. "he fa tors onsidered in assessing ontrol risk indi ated an in reased risk of error )ut only a lo! risk of fraud in the finan ial statements. 1. "he auditor did not onsider fa tors influen ing audit risk for a ount )alan es that have effe ts pervasive to the finan ial statements taken as a !hole.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Auditor0s Risk Assessment Process ,o*ic: ,)e Fraud Risk Assessment Process

4-&$

Chapter 04 - Risk Assessment

4*. 6hi h of the follo!ing is orre t on erning re:uired auditor ommuni ations a)out fraud4 A# #raud that involves senior management should )e reported dire tly )y the auditor to the audit ommittee regardless of the amount involved. 0. #raud !ith a material effe t on the finan ial statements should )e reported dire tly )y the auditor to the 3e urities and %x hange Commission. C. Any re:uirement to dis lose fraud outside the entity is the responsi)ility of management and not that of the auditor. 1. "he professional standards provide no re:uirements related to the ommuni ation of fraud' )ut the auditor should use professional judgment in determining ommuni ation responsi)ilities.

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: . -edium Learning "b#ecti$e: %&' % Learn t)e auditor0s communication re8uirements about fraud to management9 t)e audit committee9 and ot)ers+ ,o*ic: Communications about Fraud to -anagement: t)e Audit Committee: and "t)ers

4-&&

Chapter 04 - Risk Assessment

Short Answer Questions

4,. 2sing the audit risk model' identify the relationship )et!een the follo!ing elements. #or ea h of the items )elo!' highlight !hether the t!o elements have an inverse relationship' a dire t relationship' or no relationship. 6hen onsidering ea h item' assume that the other omponents of the risk model remain onstant.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-&4

Chapter 04 - Risk Assessment

4-. 6hat is the differen e )et!een audit risk and engagement risk4 Audit risk is the risk that the auditor may unkno!ingly fail to appropriately modify the opinion on finan ial statements that are materially misstated. (t an )e dire tly ontrolled )y the s ope of the auditor's test pro edures. %ngagement risk' on the other hand' is the auditor's exposure to loss or injury to professional pra ti e from litigation' adverse pu)li ity' or other events arising in onne tion !ith finan ial statements audited and reported on. (t annot )e dire tly ontrolled )y the auditor' )ut some ontrol an )e exer ised through the areful a eptan e and ontinuan e of lients.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'% (nderstand t)e conce*t of audit risk+ Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ ,o*ic: Audit Risk -odel

4.. Dou are tea hing a lass of ne! hires at your international a ounting firm. %xplain the audit risk model using a mathemati al formula. AR H R55 x 1R AR H Audit risk R55 H Risk of material misstatement 1R H 1ete tion risk Audit risk onsists of; 1. "he risk that the )alan e or lass and related assertions ontain misstatements that ould )e material to the finan ial statements !hen aggregated !ith misstatements in other )alan es or lasses. "hese risks exist independently of the audit. $. "he risk that the auditor !ill not dete t su h misstatements 8dete tion risk9. "his risk an )e ontrolled )y the auditor through the s ope of the audit pro edures performed.

AACSB: Communication AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: (nderstand Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

4-&*

Chapter 04 - Risk Assessment

4/. 3ta ey' the partner in harge of the audit of R(# %nterprises' sets the planned level of audit risk for the audit of a ounts paya)le at .0,. "he risk of material misstatement is assessed at . ,*. 6hat is the dete tion risk for this audit4 3u)stituting the values into the audit risk model' the dete tion risk is around /C. 1R H ARI8R559 1R H .0,I.,* 1R H /.$C

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: A**ly Difficulty: !asy Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

*0. Dour lassmate asserts' EA ountants shouldn't need to take )usiness ourses )esides a ounting' )e ause they are only interested in the finan ial statements of a ompany.E 1efend or refute this statement. "he lassmate is misguided. Auditors need to develop a omprehensive understanding of )usiness. 5ost )usiness on epts and risks have the potential to affe t the finan ial statements either immediately or in the long run. (n addition' a thorough understanding of )usiness risks in reases the likelihood of identifying material misstatements in the finan ial statements. "herefore' an auditor should )e familiar !ith a lient's )usiness environment for numerous reasons' in luding evaluating the going on ern assertion.

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%& (nderstand t)e auditor0s risk assessment *rocess+ Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: ,)e Auditor0s Risk Assessment Process

4-&,

Chapter 04 - Risk Assessment

*1. Dou are the senior on an audit of "!o 0e Bone' a large pu)li ompany. "he ompany re ently ompleted an a :uisition of its fifth largest ompetitor. 6hat risks might this present4 =o! !ill you' the auditor' respond to these risks 8i.e. !hat a tions should you take94 3tudent ans!ers for the first :uestion !ill vary. After identifying possi)le risks' the auditor should determine !hi h ones may result in material misstatements in the finan ial statements. >n e those are identified' the auditor should evaluate ho! those risks may impa t finan ial reporting and then design the audit to o)tain eviden e that addresses !hether those risks have adversely impa ted finan ial reporting. (f the entity does not respond ade:uately to )usiness risks that may affe t finan ial reporting' the auditor !ill have to expand audit tests to determine if any misstatements are present in the related a ount )alan es or lass of transa tions.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: !$aluate Difficulty: 4 5ard Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ Learning "b#ecti$e: %&'%6 Learn )o2 to res*ond to t)e results of t)e risk assessments+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: ,)e Auditor0s Res*onse to t)e Results of t)e Risk Assessments

*$. 1efine misstatements arising from fraudulent finan ial reporting and misstatements arising from misappropriation of assets in one senten e ea h. 5isstatements arising from fraudulent finan ial reporting are intentional misstatements or omissions of amounts or dis losures in finan ial statements intended to de eive finan ial statement users. 5isstatements arising from misappropriation of assets involve the theft of an entity's assets !here the theft auses the finan ial statements to )e misstated.

AACSB: Communication AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: Remember Difficulty: !asy Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: ,)e Fraud Risk Assessment Process

4-&-

Chapter 04 - Risk Assessment

*&. 1A"R(F' (n .' a #ortune *00 ompany' has )een experien ing poor performan e. (ndustry analysts have )een issuing negative reports and the ompany's sto k pri e has )een steadily de lining. As an auditor' !hat !ould on ern you a)out the audit engagement of 1A"R(F' (n . An auditor should )e on erned )e ause of the apparent in entive the management of 1A"R(F may have to ommit finan ial statement fraud. #or instan e' the ompany's management may )e tempted to hange a ounting estimates or use other means to falsely in rease the ompany's )ook profits. "he auditor should exer ise professional skepti ism in this engagement and addresses arefully the risk of finan ial statement fraud.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Analy3e Difficulty: . -edium Learning "b#ecti$e: %&'%1 Learn )o2 t)e auditor assesses t)e risk of material misstatement+ Learning "b#ecti$e: %&'%/ (nderstand t)e fraud risk assessment *rocess+ ,o*ic: Assessing t)e Risk of -aterial -isstatement Due to !rror or Fraud ,o*ic: ,)e Fraud Risk Assessment Process

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Chapter 04 - Risk Assessment

*4. 1uring the ourse of the audit of ## #inan ial' you find that some a ounting entries have )een altered. Dou )elieve this may )e the result of management fraud and you have determined that the effe t of this ould )e material to the finan ial statements. 6hat steps should you take in response to the a ounting entries and your on ern a)out management fraud4 (n this situation' the auditor should attempt to o)tain audit eviden e to determine !hether material fraud has o urred and' if so' its effe t. "he auditor should onsider the impli ations for other aspe ts of the audit. (f fraud is found in one a ount' there are han es the auditor !ill find fraud in other a ounts' as !ell. "he auditor needs to dis uss the matter and the approa h to further investigation !ith an appropriate level of management that is at least one level a)ove those involved in ommitting the fraud and !ith senior managements. (f appropriate' the auditor ould suggest that the lient onsult !ith legal ounsel. (f the results of the audit tests indi ate a signifi ant risk of fraud' the auditor should onsider !ithdra!ing from the engagement and ommuni ating the reasons for !ithdra!al to the audit ommittee or others !ith e:uivalent authority and responsi)ility.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision -aking Blooms: A**ly Difficulty: . -edium Learning "b#ecti$e: %&'%7 Learn )o2 to e$aluate t)e results of t)e audit tests+ Learning "b#ecti$e: %&'%; (nderstand t)e documentation re8uirements for risk assessments and res*onses+ ,o*ic: Documentation of t)e Auditor0s Risk Assessment and Res*onse ,o*ic: !$aluation of Audit ,est Results

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Chapter 04 - Risk Assessment

**. Assume that you are the ne! audit senior on the 7? 1rug Corporation 87?19 engagement. 7?1 is a pharma euti al ompany that has three su essful drugs and a num)er of drugs in progress in its resear h and development pipeline. Dou are onsidering your audit plan and it is important to identify the inherent risks that 7?1 has and ho! they relate to the planning pro ess. Required; #or ea h of the follo!ing fa tors' indi ate !hether it !ill tend to in rease' de rease' or have no effe t on inherent risk' and the reasoning for your ans!er. a. 1r. Gones is the major shareholder of 7?1 and its C%>. ). Dour firm has audited 7?1 for the last four years. . "here has )een high turnover of key a ounting personnel during the last t!o years. d. "he internal audit fun tion reports to the audit ommittee. e. 7?1 has )een the su)je t of la!suits )y users of #ramadon !ho laim that the drug affe ts their liver fun tions. 7?1 is onfident that there are no su h side effe ts from the use of #ramadon. a. (n rease; "he C%>' as the major shareholder' has additional in entive to EmanageE earnings. ). <o effe t; "he history that the auditor has !ith the lient has no effe t on the inherent risks of the )usiness. =o!ever' the auditor !ill )e a)le to use his past experien e in designing tests that are effi ient and effe tive. . (n rease; "he turnover in personnel may indi ate issues in the management of the ompany. At a minimum' the fa t that many key personnel are ne! and do not kno! the ompany !ell !ill in rease risk. d. <o effe t; "he reporting stru ture of the internal audit group is a ontrol system issue' not an inherent risk fa tor. e. (n rease; "he mere presen e of an ongoing la!suit presents in reased )usinessIinherent risk' even if the ompany is onfident that it !ill prevail.

AACSB: Analytic AICPA BB: Critical ,)inking AICPA FN: Risk Analysis Blooms: !$aluate Difficulty: 4 5ard Learning "b#ecti$e: %&'%. Learn t)e form and com*onents of t)e audit risk model+ Learning "b#ecti$e: %&'%4 (nderstand )o2 to use t)e audit risk model+ ,o*ic: Audit Risk -odel ,o*ic: (se of t)e Audit Risk -odel

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