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aud ch 4
| Question | Answer |
|---|---|
| What is the definition of Audit Risk (AR)? | The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. |
| Which component of the Audit Risk Model represents the probability that a material misstatement enters the financial statements in the absence of internal controls? | Inherent Risk (IR) |
| What is Control Risk (CR)? | The likelihood that the client's internal control policies and procedures fail to prevent or detect a material misstatement. |
| Define Detection Risk (DR). | The likelihood that the auditor's substantive procedures will fail to detect an existing material misstatement. |
| Which risk component is the only one that the auditor can actually determine or influence? | Detection Risk (DR) |
| Write the fundamental formula for the Audit Risk Model (ARM). | AR = IR times CR times DR |
| What is the formula for the Risk of Material Misstatement (RMM)? | RMM = IR times CR |
| How is Detection Risk (DR) calculated mathematically using the Audit Risk Model? | DR = AR (IR times CR) |
| Holding Audit Risk constant, what is the relationship between Detection Risk and the Risk of Material Misstatement? | They have an inverse relationship. |
| If an auditor allows for a lower Detection Risk, what change is required in the 'Nature' of audit procedures? | The auditor must use more effective tests. |
| If an auditor allows for a higher Detection Risk, what change can be made to the 'Timing' of audit procedures? | Testing can be performed at interim dates rather than at year-end. |
| How does a 'Lower Detection Risk Allowed' impact the 'Extent' of audit procedures? | It requires the auditor to perform more tests. |
| List the four qualitative categories of Control Risk assessment. | Low, Moderate, Slightly below maximum, and Maximum. |
| What is the quantitative probability assigned to 'Maximum' control risk? | 1.00 |
| According to the matrix approach, what is the level of Detection Risk when both Inherent Risk and Control Risk are high? | Low Detection Risk. |
| What are the two primary types of fraud that result in material misstatements? | Fraudulent financial reporting and Misappropriation of assets. |
| What is the key difference between 'fraud' and 'error' in auditing? | Fraud is an intentional misstatement, whereas error is unintentional. |
| Under auditing standards, what is the auditor's specific responsibility regarding the detection of fraud? | The auditor is only responsible for detecting fraud that results in material misstatements of the financial statements. |
| Identify the three categories of factors auditors should consider when brainstorming potential fraud risk. | Management's characteristicsinfluence, Industry conditions, and Operating characteristicsfinancial stability. |
| What is 'Management Override' of internal controls? | The ability of management to bypass established controls to manipulate accounting records and prepare fraudulent financial statements. |
| Define 'Cookie Jar Reserve' in the context of fraudulent financial reporting. | Shifting net income from good years to bad years by over-accruing expenses in the good years to meet future targets. |
| What are the five steps for performing analytical procedures? | 1. Develop an expectation; 2. Define a significant difference; 3. Compare expectation with recorded amount; 4. Investigate significant differences; 5. Document steps. |
| During which two phases of an audit are analytical procedures required by standards? | The planning stage and the final reviewconclusion stage. |
| Are analytical procedures required for substantive testing during the audit? | No, they are optional for substantive testing. |
| To whom should identified fraud be communicated within the client's organization? | To an appropriate level of management, usually at least one level above those involved. |
| If fraud is committed by top management, to whom must the auditor report it? | The entity's audit committee of its board of directors. |
| What is the auditor's responsibility for a client's noncompliance with laws and regulations that have a direct effect on financial statements? | The same responsibility as that for detecting errors and fraud. |
| What is the primary purpose of an Audit Strategy Memorandum? | To set the overall scope, timing, and direction of the audit for each relevant assertion based on the audit risk model. |
| Inherent risk is generally higher for _____ and _____ because they are more likely to be overstated than understated. | Assets; Revenue |
| Inherent risk is generally higher for _____ and _____ because they are more likely to be understated than overstated. | Expenses; Liabilities |
| Name three factors that increase a firm's inherent risk related to the 'Nature of the Client'. | Operating results sensitive to economic factors, going concern problems, or high turnover of key personnel. |
| What component of Detection Risk involves the risk of choosing an unrepresentative sample? | Sampling risk |
| Define 'Non-sampling risk'. | The risk that the auditor may reach inappropriate conclusions based upon available evidence for reasons unrelated to sample size. |
| Why is it unacceptable under GAAS for an audit team to assess Control Risk at zero? | It would imply the risk of material misstatement is zero and that no audit work is necessary, which violates conservative auditing standards. |
| How does an increase in the complexity of transactions affect Inherent Risk? | It increases Inherent Risk. |
| If a warehouse employee steals inventory and records a journal entry debiting inventory obsolescence, what is the impact on the financial statement's inventory balance? | There is no impact on the inventory balance on the books because the credit to inventory was recorded. |
| What is the 'dangling debit' when a fraudster records a fictitious credit sale? | Accounts Receivable |
| How does a fictitious profitable credit sale affect the client's current ratio? | It increases (makes higher) the current ratio. |
| When auditing interest expense, why would an auditor be concerned if the ratio of interest expense to debt is unusually high? | It may indicate an overstatement of interest expense or an understatement of interest-bearing debt. |
| What three factors must the auditor evaluate for significant unusual transactions as part of management override procedures? | Examine journal entries, review accounting estimates for biases, and evaluate the business rationale. |
| What is an 'Audit Committee'? | A subset of the board of directors composed of independent members who oversee the financial reporting process. |
| Auditors must document their risk assessment in the _____. | Work papers |
| True or False: Auditors are required to always consider improper revenue recognition as a fraud risk. | TRUE |
| How does high accounting personnel turnover affect Inherent Risk? | It increases Inherent Risk due to potentially inadequate accounting skills or lack of continuity. |
| If an auditor increases the assessed Control Risk from 0.4 to 1.0, and keeps AR and IR constant, what must happen to the acceptable DR? | The acceptable level of Detection Risk must decrease. |
| What is 'Inquiry' in the context of risk assessment procedures? | The required procedure of asking management, internal auditors, and others about the risk of fraud and error. |
| Which management assertion is violated when fictitious sales are recorded to nonexistent customers? | Occurrence |
| Which management assertion is violated when shipments are made to a friend and intentionally never recorded? | Completeness |
| Which management assertion is violated when a loan to the CEO is classified as a standard account receivable to conceal it? | Classification |
| Which management assertion is violated when shipments made in January are backdated to December? | Cutoff |
| Which management assertion is violated when an employee calculates depreciation incorrectly? | Accuracy |
| What are the three components of the 'Fraud Triangle' mentioned as brainstorming factors? | Motivation (IncentivePressure), Opportunity, and Attitude (Rationalization). |
| Why is 'Liquidity' of an account considered a factor in its susceptibility to misstatement? | Highly liquid assets (like cash) are more easily misappropriated, increasing inherent risk. |
| What is the auditor's responsibility for 'Other laws and regulations' (indirect effect), such as workplace safety? | The audit does not provide assurance they will be detected, but the auditor must perform specified procedures if noncompliance is suspected. |
| Define 'Significant Risk' in an audit. | A risk that requires special audit consideration due to the nature of the risk or the likelihoodmagnitude of misstatement. |
| What is the 'Nature' of the financial statement element influence on risk? | Certain accounts (like estimates) are inherently more susceptible to misstatement or bias. |
| If the bank has a loan officer who meets regularly with the CEO to monitor performance, does this increase or decrease audit risk? | Decrease (due to external monitoring acting as a check on management). |
| A warehouse employee steals 50,000 in inventory and does NOT make an entry. What is the impact on the financial report? | Inventory is overstated by 50,000 on the books. |
| In the analytical procedures process, what does it mean to 'Develop an expectation'? | The auditor uses independent data to predict what the account balance should be. |
| Holding Inherent Risk and Control Risk constant, a decrease in Detection Risk implies the auditor must expand the _____ of the audit. | Scope |
| If an auditor performs substantive analytical procedures at an interim date, which risk type increases? | Detection Risk (DR) |
| What are 'Operating Characteristics' as a fraud risk factor? | Internal factors like weak control environments, pressure to obtain capital, or difficult accounting measurements. |
| Who is responsible for the overall audit strategy memorandum? | The auditor. |
| What is the impact on net income if fictitious credit sales are recorded and then written off as bad debt expense in the same period? | Net income would not be misstated (as revenue and expense wash each other out). |
| What qualitative assessment of Control Risk is equivalent to a quantitative probability of 0.10-0.45? | Low control risk. |
| List two factors that affect Control Risk. | The control environment, the effectiveness of control activities, or monitoring activities. |
| What happens to the Acceptable Detection Risk if Inherent Risk is 'High' and Control Risk is 'Low'? | It is assessed at a 'Moderate' level. |
| Explain the concept of 'Going concern problems' in relation to inherent risk. | If there is doubt about a company's ability to continue, there is high pressure to misstate results, thus increasing inherent risk. |
| Which type of misstatement is harder to detect: Fraud or Error? | Fraud, because it is often accompanied by sophisticated schemes of concealment. |
Created by:
444ali