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Auditing and Assurance Chapter 4

Enterprise Risk Management is the responsibility of:
Company Management
Failure to meet company objectives is a result of
Business Risk
Auditing Standards do not require auditors of financial statements to
Repot all errors and frauds found to police authorities
If sales were overstated by recording a false credit sale at the end of the year, where could you find the false “dangling debit”?
Accounts Receivable…….In (fictitious) credit sales and (fictitious) receivables.
One of the typical characteristics of management fraud is…
Victimization of investors through the use of materially misleading financial statements.
Which of the following circumstances would most likely cause and audit team to perform extended procedures?
If the client made several large adjustments at year-end (a red flag), extended procedures would be considered necessary to ensure that fraud was not taking place.
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:
Risk of Material Misstatement
The risk of material misstatements is composed of which audit risk components?
The Risk of Material Misstatements (RMM) is composed of:
Inherent Risk and Control Risk
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:
Detection Risk
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?
DR = AR/ (IR x CR) = 0.05 / 0.50 = 0.10
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:
Change from 0.25 to 0.1
Which of the following is a specific procedural response to a particular fraud risk in an account balance or class of transactions?
Performing procedures such as inventory observation and cash counts on a surprise or unannounced basis
Analytical procedures are generally used to produce evidence from:
Relationships among current financial balances and prior balances, forecasts, and nonfinancial data…..Analytical procedures incorporate information from a variety of sources.
Which of the following relationships between types of analytical procedures and sources of information are most logical?
Type of Analytical Procedure – Comparison of current account balances with expected balances….
Source of Information – Company’s Budgets and Forecasts
Analytical procedures can be used in which of the following ways?
1. As a means of overall review at the end of an audit.
2. As “attention-directing” methods when planning an audit at the beginning
3. As substantive audit procedures to obtain evidence during an audit.
Analytical procedures used when planning an audit should concentrate on:
With Preliminary Analytical Procedures–> the auditors are looking for signs of accounts and relationships that may represent specific potential problems and risks in the financial statements.
When a company that sells its products for a (gross) profit increases its sales by 15% and its COGS by 7%, the COGS ratio will:
Decrease…..the numerator (COGS) increases relatively less than the denominator (Sales) increases.
Auditors are not responsible for accounting estimates with respect to:
Management is responsible for making the estimates in the first place, just as management is primarily responsible for all the financial statement elements.
An Audit Strategy contains:
Specifications of procedures the auditors believe appropriate for the financial statements under audit.
It is acceptable under GAAS for an audit team to:
Assess Risk of Material Misstatement at high and achieve an acceptably low audit risk by performing extensive detection work.
Under the Private Securities Litigation Reform Act, independent auditors are required to first:
Once informed, the Board of Directors has the first responsibility to report to the SEC. If the board does not report these items to the SEC, the law then requires the auditors to do so.
When evaluating whether accounting estimates made by management are reasonable, auditors would be most interested in which of the following?
Evidence of a Systematic Bias….whether Agressive or Conservative, would be of most concern to the audit team.
An Audit Committee is:
Composed of members of a company’s Board of Directors who are not involved in the Day-to-Day operations of the company.
When 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:
Evaluate the effect of noncompliance on the financial statements
Which of the following statements best describes auditors’responsibility for detecting client’s noncompliance with a law or regulation?
Auditors must design tests to obtain reasonable assurance that all noncompliance with direct material statement effects is detected.
Auditors perform analytical procedures in the planning stage of an audit for the purpose of:
Identifying unusual conditions that deserve more auditing effort.
Which of the following may cause management to intentionally UNDERSTATE profits:
1. Management wants to creat “cookie jar” reserves for a rainy day
2. The company believes its income tax expense is too high
3. Company is suffering a large loss and wants to take a “big bath”
Auditors specifically consider fraud risk from management override of controls…..

True or False

Auditors would perform the following steps in which order?
1. Set Audit Risk
2. Risk of Material Misstatement
3. Calculate Detection Risk
Which of the following is NOT required by AU 420, “Consideration of Fraud in a Financial Statement Audit?”
Conduct inquiries of shareholders as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud.
AU 420, “Consideration of Fraud in a Financial Statement Audit” Requirements….
1. Conduct a continuing assessment of the risks of material misstatement due to fraud throughout the audit.
2. Conduct a discussion by the audit team of the risks of material misstatement due to fraud.
3. Conduct the audit with professional skepticism, which includes an attitude that assumes balances are incorrect until verified by the auditor.
Analytical procedures are performed in the following order:
1. Develope an Expectation
2. Define a significant difference
3. Calculate predictions and compare them to the Recorded Amount
4. Investigate Significant Difference
The risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated is referred to as:
Audit Risk
What is Detection Risk?
The probability that the auditor’s procedures would not catch a material error or fraud that has ocurred and not been previously detected byt the client’s internal controls. It is an element of Audit Risk.
If results from the auditor’s tests of controls induce the auditor to change the assessed level of control risk for inventory from 0.2 to 0.4 and audit risk and inherent risk remain constant, what is the effect on the acceptable level of detection risk?
Detection Risk would decrease from 0.4 to 0.2
The auditor has assessed the Risk of Material Misstatement (RMM) to determine the acceptable level of detection risk for financial statement assertions for inventory account balances. As the acceptable level of detection risk decreases, which of the following adjustsments to the A/R audit program would the audit team normally make?
Increase the sample size of the confirmations

(If detection risk decreases, the audit team must be more EFFECTIVE in its audit procedures.)

Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?
Interest Expense
Which of the following would NOT cause auditors to increase their assessment of inherent risk?
The client’s controller is an expert in application of accounting standards.
With respect to management’s accounting estimates, auditors are responsible for:
1. Determining the reasonableness of Estimates
2. Determining that estimates are presented in comformity with GAAP.
3. Determining that estimates are adequately disclosed in the financial statements.
Auditors would be responsible for designing audit procedures to detect non-compliance with which of the following laws and regulations?
Federal Income Tax Laws
What should the Audit Strategy take into account?
1. Reporting objectives of the Engagement
2. Factors significant in directing the activities of the engagement team.
3. Results of preliminary engagement activities and the initial risk assessment.

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