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aud ch 4 - vip
| Question | Answer |
|---|---|
| What is the definition of Audit Risk (AR)? | The risk that the auditor expresses an inappropriate opinion when financial statements are materially misstated. |
| What term describes the probability that a material misstatement enters the financial statements in the absence of internal controls? | Inherent Risk (IR) |
| What risk is defined as the likelihood that the client's internal controls fail to prevent or detect a material misstatement? | Control Risk (CR) |
| What is Detection Risk (DR)? | The likelihood that the auditor's substantive procedures will fail to detect an existing material misstatement. |
| According to the Audit Risk Model (ARM), what two components multiply to form the Risk of Material Misstatement (RMM)? | Inherent Risk (IR) and Control Risk (CR) |
| What is the mathematical formula for the complete Audit Risk Model? | "AR = IR imes CR imes DR" |
| In the Audit Risk Model, how is Detection Risk (DR) calculated using the other variables? | "DR = \frac{AR |
| Which specific component of the Audit Risk Model can the auditor determine or influence? | Detection Risk (DR) |
| If the auditor assesses Risk of Material Misstatement (RMM) at 0.50 and sets Audit Risk (AR) at 0.05, what is the planned Detection Risk? | 0.1 |
| Holding Audit Risk constant, what is the relationship between Risk of Material Misstatement (RMM) and Detection Risk (DR)? | An inverse relationship. |
| If an auditor is allowed a lower Detection Risk, how must the nature of audit procedures change? | The auditor must use more effective tests. |
| How does a requirement for lower Detection Risk impact the timing of audit procedures? | Testing should be performed at year-end rather than at an interim date. |
| To achieve a lower Detection Risk, what adjustment should be made to the extent of audit procedures? | The auditor must perform more tests. |
| What is Sampling Risk? | The risk of choosing a sample that is not representative of the population. |
| What is Non-sampling Risk? | The risk that the auditor reaches an inappropriate conclusion based on available evidence for reasons unrelated to sample size. |
| What are the two primary types of fraud defined in auditing standards? | Fraudulent financial reporting and misappropriation of assets. |
| What is the auditor's responsibility regarding the detection of fraud? | The auditor is responsible only for detecting fraud that results in a material misstatement of the financial statements. |
| What three categories of factors should auditors consider during fraud brainstorming? | Management characteristics, industry conditions, and operating characteristics/financial stability. |
| What is a 'Cookie Jar Reserve'? | A fraud technique where a company shifts net income from good years to bad years to consistently meet earnings targets. |
| What are the five steps for performing analytical procedures? | Develop expectation, define significant difference, compare amount to expectation, investigate differences, and document steps. |
| At which two stages of the audit are analytical procedures required by standards? | The planning stage and the final conclusion stage. |
| To whom should an auditor communicate identified fraud involving senior management? | Directly to the audit committee of the board of directors. |
| How does high accounting personnel turnover affect Inherent Risk? | It increases Inherent Risk. |
| What effect do complex transactions have on a firm's Inherent Risk? | They increase Inherent Risk. |
| Why is Inherent Risk generally higher for assets and revenue than for expenses? | Assets and revenue are more likely to be intentionally overstated than understated. |
| If sales were overstated by recording a false credit sale, where would the corresponding 'dangling debit' most likely be found? | Accounts Receivable |
| Why are auditors prohibited from setting Inherent Risk or Control Risk to zero? | Setting them to zero would imply no material misstatement could exist, which would eliminate the need for any audit testing. |
| What is the composition of a company's Audit Committee? | Independent members of the board of directors who are not involved in day-to-day operations. |
| What happens to the current ratio if a company records profitable fictitious credit sales? | The current ratio increases because current assets (A/R) increase more than any related reduction in inventory. |
| What is the auditor's responsibility regarding noncompliance with laws that have a direct effect on financial statements? | The auditor has the same responsibility as for detecting material errors and fraud. |
| Which management assertion is tested when an auditor ensures all shipments made before year-end are recorded as sales? | Completeness |
| Which assertion is primarily addressed by excluding consigned goods from a client's inventory balance? | Rights and Obligations |
| What is 'Professional Skepticism'? | An attitude that includes a questioning mind and a critical assessment of audit evidence. |
| Why do audits provide 'reasonable assurance' rather than 'absolute guarantee'? | Due to the nature of financial reporting, the use of sampling, and time/cost constraints. |
| What defines the 'appropriateness' of audit evidence? | The quality of evidence, encompassing its relevance and reliability. |
| What defines the 'sufficiency' of audit evidence? | The quantity of evidence obtained. |
| What is an 'Unqualified Opinion'? | A 'clean' opinion stating the financial statements are presented fairly in all material respects. |
| What is the purpose of an engagement letter? | To act as a contract that defines the objectives, responsibilities, and limitations of the audit engagement. |
| Under the Audit Risk Model, what is the effect of decreasing Detection Risk on audit scope? | The auditor must expand the scope by conducting more tests and collecting more reliable evidence. |
| If an auditor performs substantive analytical procedures at an interim date rather than year-end, which risk type increases? | Detection Risk |
| What is the 'Basis for Opinion' section of the audit report? | A section identifying management and auditor responsibilities and stating the audit followed PCAOB standards. |
| What is the 'Audit Strategy Memorandum'? | A document that sets the scope, timing, and direction of the audit and guides the development of the audit plan. |
| What term describes intentional misstatements of financial statements? | Fraud |
| What term describes unintentional misstatements of financial statements? | Error |
| In an audit of stockholders' equity, checking for dividend restrictions in loan agreements tests which assertion? | Presentation and Disclosure |
| What is the relationship between the effectiveness of internal controls and the required sufficiency of evidence? | More effective internal controls allow for a decrease in the quantity (sufficiency) of substantive evidence needed. |
| What type of engagement evaluates whether a division uses resources economically and efficiently? | Operational Audit |
| What is 'Information Risk'? | The probability that information circulated by a company will be false or misleading. |
| According to SOX Section 302, what must the CEO and CFO certify regarding financial reports? | That they have read the reports, they are not aware of any false statements, and the reports accurately reflect the company's condition. |
| What is 'Independence in Fact'? | The auditor's actual unbiased mental attitude during the audit. |
| What is 'Independence in Appearance'? | The public's perception of the auditor's objectivity and unbiased nature. |
| What is the difference between 'Vouching' and 'Tracing'? | Vouching checks recorded amounts against source documents (existence), while tracing follows source documents to the ledger (completeness). |
| How does the size of a sample affect sampling risk? | Increasing the sample size directly reduces sampling risk. |
| What is the auditor's responsibility for communicating illegal acts involving bribery of government employees? | The auditor must report such acts as they reflect a lack of management integrity and violate laws. |
| Under the Audit Risk Model, if IR = 0.8, CR = 0.9, and AR = 0.05, what is the calculated Detection Risk? | 0.069 |
| What qualitative factor makes a small dollar-amount misstatement 'material'? | If the misstatement allows a firm to meet an earnings target or change a loss into a profit. |
| What risk increases if an auditor accepts a client with management that lacks integrity? | Fraud Risk (making the engagement potentially unacceptable). |
| What does 'Due Care' require of an auditor? | The level of diligence and performance expected of a prudent auditor in similar circumstances. |
| How does a 'Cookie Jar Reserve' affect net income in a 'bad' year when earnings fall short? | The company reverses a previously recorded liability to artificially increase reported revenue or decrease expenses. |
| What is the primary purpose of obtaining an understanding of a client's internal control? | To determine the nature, timing, and extent of subsequent substantive audit procedures. |
| What is 'Performance Materiality'? | An amount set lower than overall materiality to reduce the probability that aggregated uncorrected misstatements exceed overall materiality. |
| Why is evidence obtained from an independent third party considered more reliable than client-generated evidence? | Third parties have no incentive to misstate the client's financial information. |
| Which risk component is assessed as 1.0 (Maximum) if the auditor decides not to rely on internal controls? | Control Risk (CR) |
| What is the 'Inverse Relationship' in the Audit Risk Model? | The rule that as Risk of Material Misstatement increases, the acceptable level of Detection Risk must decrease. |
| What assertion is violated if a company records January sales in the previous December? | Cutoff |
| What does the 'Reporting Principle' of GAAS require of an auditor's opinion? | The opinion must state whether financial statements are presented in accordance with the applicable financial reporting framework (e.g., GAAP). |
| What is the primary difference between a 'Financial Statement Audit' and an 'Attestation Engagement'? | Auditing focuses specifically on financial statements, while attestation can cover a broader range of subject matter or assertions. |
| What is 'Business Risk'? | The risk that a company will fail to meet its objectives, such as failing to pay debt or remain a going concern. |
| Which entity is responsible for setting auditing standards for public companies in the U.S.? | The Public Company Accounting Oversight Board (PCAOB) |
| Which management assertion is tested by 'recomputing' a client's depreciation expense? | Valuation or Allocation |
| What does 'Scanning' as an audit procedure involve? | Reviewing accounting data to identify significant or unusual items, such as large or credit entries in expense accounts. |
| How does 'High Bankruptcy Risk' impact the Audit Risk Model? | It increases Inherent Risk (IR). |
| If an auditor's analytical procedures show interest expense is much higher than expected given the debt level and rates, what is the primary concern? | Understatement of interest-bearing debt. |
| What is 'Embezzlement'? | A type of fraud where employees wrongfully misappropriate funds or property entrusted to their care. |
| In the Audit Risk Model, what does 0.05 typically represent for Audit Risk? | A standard 'acceptably low' level of risk (5%) that the auditor may give a wrong opinion. |
| If an auditor assesses IR=0.4, CR=0.5, and DR=0.25, what is the total Audit Risk? | 0.05 |
| What assertion is being tested when an auditor physically locates fixed assets listed on the books? | Existence |
| What is the 'Responsibilities Principle' in GAAS? | The principle that auditors must be competent, ethical, independent, and exercise professional skepticism. |
| What is 'Sampling Risk' a direct function of? | Sample size. |
| What is the auditor's responsibility for 'Larceny' (simple theft) that does not impact the financial statements? | The auditor is not responsible for detecting it as it does not lead to a material misstatement of the books. |
| If an auditor's tests of controls lead to a higher assessment of Control Risk, how must Detection Risk change to keep Audit Risk constant? | The acceptable level of Detection Risk must decrease. |
| What are 'Substantive Procedures'? | Audit steps designed to create evidence about management assertions related to the dollar amounts and disclosures in financial statements. |
| According to exercise 4.61, what is the impact of withholding payment checks past year-end on the current ratio if the ratio is currently > 1? | The current ratio increases. |
| What assertion is tested when an auditor inspects shipping documents to ensure the date matches the recorded sale date? | Cutoff |
| What is the 'Performance Principle' in GAAS? | The principle that auditors must plan the audit, set materiality, assess risks, and obtain sufficient appropriate evidence. |
Created by:
444ali