Audit Chapter 08

Auditing and Assurance Services, 17e, Global Edition (Arens/Elder/Beasley)
Chapter 8 Assessing the Risk of Material Misstatement
8.1 Learning Objective 8-1
1) Which of the following would not increase the risks of material misstatement at the overall
financial statement level?
A) effective oversight by the board of directors
B) deficiencies in management's integrity
C) inadequate accounting systems
D) all of the above
Answer: A
Terms: Risk of material misstatement at the overall financial statement level
Difficulty: Easy
Objective: LO 8-1
AACSB: Reflective thinking
2) The auditor's responsibility section in an audit report states that "…the standards require that
we plan and perform the audit to obtain ________ assurance about whether the financial
statements are free of material misstatement." What type of assurance is given?
A) immediate
B) limited
C) reasonable
D) absolute
Answer: C
Terms: Type of assurance provided
Difficulty: Easy
Objective: LO 8-1
3) ________ risk represents the auditor's assessment of the susceptibility of an assertion to

material misstatement, before considering the effectiveness of the client's internal controls.
A) Material
B) Account balance
C) Control
D) Inherent
Answer: D
Terms: Inherent risk
Difficulty: Moderate
Objective: LO 8-1
1
Copyright © 2020 Pearson Education Ltd.
4) Risk of material misstatement at the assertion level
A) is only relevant to account balances.
B) determines the nature, timing, and extent of further auditing procedures.
C) refers to risks that are pervasive to the financial statements as a whole.
D) consists of business risk and inherent risk.
Answer: B
Terms: Risk of material misstatement at the assertion level
Objective: LO 8-1
5) Assessing the risk of material misstatement is closely related to each of the following except
A) the auditor's overall audit responsibilities.
B) the auditor's materiality and audit planning.
C) not a critical consideration in most financial statement audits.
D) the auditor's review of the key transaction cycles and associated audit objectives.
Answer: C
Terms: Assessing the risk of material misstatement
Objective: LO 8-1
6) The risk of material misstatement exists only at the overall financial statement level.
Answer: FALSE
Terms: Risk of material misstatements
Difficulty: Easy
Objective: LO 8-1
7) Significant changes in the industry may increase the risk of material misstatement at the
assertion level.
Answer: FALSE
Objective: LO 8-1
8) Inherent risk and control risk exist independent of the audit of the financial statements.
Answer: TRUE
Terms: Control risk and inherent risk
Objective: LO 8-1
2
9) Audit reports issued under the PCAOB and the AICPA standards contain two important
phrases that are directly related to materiality and to risk: obtain absolute assurance and free of
material misstatement.
Answer: FALSE
Terms: Materiality and risk
Objective: LO 8-1
10) Audit reports contain the phrase obtain reasonable assurance, which is intended to inform
users that auditors do not guarantee or ensure the fair presentation of the financial statements
which the audit reports cover.
Answer: TRUE
Terms: The phrase reasonable assurance
Objective: LO 8-1
11) Some risk exists that the financial statements are not fairly stated, even when the auditor's
opinion is unmodified.
Answer: TRUE
Terms: The phrase reasonable assurance
Objective: LO 8-1
12) The phrase free of material misstatement informs users that the auditor's responsibility is not
limited to only material financial information.
Answer: FALSE
Terms: The phrase free of material misstatement
Objective: LO 8-1
13) For well-planned audits, it is practical for auditors to provide assurances on immaterial
amounts included in the financial statements.
Answer: FALSE
Terms: The phrase free of material misstatement
Objective: LO 8-1
3
14) As management is responsible for the financial statements, failure to assess the risk of
material misstatement is not detrimental to the auditor.
Answer: FALSE
Terms: Assessing the risk of material misstatement
Objective: LO 8-1
15) Name some examples where the auditor accepts some level of uncertainty in performing the
audit function.
Answer:
• The inherent uncertainty about the appropriateness of evidence obtained.
• The uncertainty about the effectiveness of a client's internal controls
• The uncertainty about whether the financial statements are fairly stated
when the audit is completed.
• Assessing risks is a matter of professional judgment rather than a precise measurement.
Terms: Risk assessment uncertainty
Objective: LO 8-1
1) Risk assessment procedures include inquiries of management and others by the auditor. As
part of these procedures, the auditor should talk to
A) internal auditors.
B) board of directors.
C) individuals involved with regulatory compliance.
D) all of the above.
Answer: D
Terms: Risk assessment procedures; inquiries
Objective: LO 8-2
2) Risk assessment procedures include

A) a required discussion among the staff members of the audit and the client regarding material
misstatements in the financial statement.
B) determination of the type of audit opinion to issue.
C) observation of the entity's operations.
D) assessing acceptable audit risk.
Answer: C
Terms: Risk assessment procedures
Objective: LO 8-2
4
3) The performance of risk assessment procedures is designed to help the auditor obtain an
understanding of the entity.
Answer: TRUE
Difficulty: Easy
Objective: LO 8-2
4) Auditing standards require the engagement partner to be included in discussions about the
susceptibility of the client's financial statements to material misstatements.
Answer: TRUE
Objective: LO 8-2
5) Auditors are not allowed to make inquires of employees who are not considered management,
such as marketing or sales personnel.
Answer: FALSE
Terms: Risk assessment procedures; inquiries
Difficulty: Easy
Objective: LO 8-2
6) Auditing standards emphasize the benefits and importance of obtaining information or

different perspectives through inquiries of others within the entity and employees with differing
levels of authority within the organization.
Answer: TRUE
Terms: Inquiries of management and others within the entity
Difficulty: Easy
Objective: LO 8-2
7) PCAOB auditing standards require the auditor to make inquiries of the audit committee about
the risks of material misstatement.
Answer: TRUE
Difficulty: Easy
Objective: LO 8-2
5
8) The PCAOB, but not the AICPA, auditing standards require inquiry of internal audit
personnel by the auditor when that function exists within the audit client.
Answer: FALSE
Difficulty: Easy
Objective: LO 8-2
9) Discussions, including exchanges of ideas or brainstorming among the engagement team

members about business risks should include the financial statements, but not necessarily the
related disclosures.
Answer: FALSE
Terms: Discussions among engagement team members
Difficulty: Easy
Objective: LO 8-2
10) Risk assessment procedures are performed to identify and assess the risk of material
misstatement. List three risk assessment procedures.
Answer:
• Inquiries of management and others within the entity
• Analytical procedures
• Observation and inspection
• Discussion among engagement team members
• Other risk assessment procedures, including discussions with predecessor auditor, evidence
obtained during other procedures performed for the client
Objective: LO 8-2
1) When considering the risk of misstatement due to fraud,

A) the risk of not detecting a material misstatement due to fraud is lower than the risk of not
detecting a misstatement due to error.
B) the risk is only made at the financial statement level.
C) auditing standards require the auditor to presume that risk of fraud exists in expense
transactions.
D) auditing standards outline procedures the auditor should perform to obtain information from
management about their consideration of fraud.
Answer: D
Terms: Fraud risk
Objective: LO 8-3
6
2) Individuals engaged in conducting a fraud will generally not misrepresent information to the
auditor.
Answer: FALSE
Terms: Fraud risk
Difficulty: Easy
Objective: LO 8-3
3) The auditor's risk assessment for fraud should be ongoing throughout the audit.
Answer: TRUE
Terms: Fraud risk
Objective: LO 8-3
4) The application of professional skepticism consists of two primary components: a questioning

mind and a critical assessment of the audit evidence obtained during the audit.
Answer: TRUE
Terms: Fraud risk
Difficulty: Easy
Objective: LO 8-3
5) The auditor's consideration of the risk of material misstatement due to fraud is made primarily
at the financial statement level, not at the assertion level.
Answer: FALSE
Terms: Fraud risk
Objective: LO 8-3
6) Revenue transactions and account balances subject to significant risk are not required to be
documented in the working papers if the auditor determines significant risk does not apply in a
particular audit engagement.
Answer: FALSE
Terms: Fraud risk
Objective: LO 8-3
7
1) A ________ risk represents an identified and assessed risk of material misstatement that, in
the auditor's professional judgment, requires special audit consideration.
A) material
B) substantial
C) financial statement
D) significant
Answer: D
Terms: Significant risk
Difficulty: Easy
Objective: LO 8-4
2) Which of the following will generally be considered a significant risk?

A) a sale to a customer
B) the determination of the amount of bad debt expense
C) the purchase of inventory
D) obtaining a loan from the bank
Answer: B
Objective: LO 8-4
3) Significant risks often relate to routine transactions.

Answer: FALSE
Difficulty: Easy
Objective: LO 8-4
4) The auditor must perform substantive tests related to assertions deemed to have significant
risks.
Answer: TRUE
Objective: LO 8-4
8
5) Financial statement matters like estimates for the allowance for doubtful accounts and
allowances for slow-moving inventories, are deemed significant matters which should be
addressed by auditor in their assessment of the risk of material misstatement.
Answer: TRUE
Objective: LO 8-4
6) Nonroutine transactions are unusual in nature but not infrequent in occurrence.

Answer: FALSE
Objective: LO 8-4
7) Nonroutine transactions may not necessarily increase the risk of material misstatement.
Answer: TRUE
Objective: LO 8-4
9
1) Which of the following risks are used in the audit risk model?
A)
Planned Detection
Control Risk Inherent Risk Risk
Yes Yes Yes
B)
Planned Detection
Yes Yes No
C)
Planned Detection
No No Yes
D)
Planned Detection
No No No
Answer: A
Terms: Audit risk model components
Difficulty: Easy
Objective: LO 8-5
2) Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed
level of control risk from that originally planned. To achieve an overall audit risk level that is
substantially the same as the planned audit risk level, the auditor would
A) increase materiality levels.
B) decrease detection risk.
C) decrease substantive testing.
D) increase inherent risk.
Answer: B
Terms: Control risk and planned audit risk model
Difficulty: Challenging
Objective: LO 8-5
10
3) When dealing with audit risk,
A) auditors cannot accept any level of risk in performing the audit function.
B) most risks that auditors encounter are relatively easy to measure.
C) the audit risk model is only used for classes of transactions.
D) the audit risk model helps the auditor to decide how much and what types of evidence to
accumulate.
Answer: D
Terms: Audit risk model
Objective: LO 8-5
4) The measurement of the auditor's assessment of the susceptibility of an assertion to material

misstatement, before considering the effectiveness of related internal controls is defined as
A) audit risk.
B) inherent risk.
C) sampling risk.
D) detection risk.
Answer: B
Difficulty: Easy
Objective: LO 8-5
5) The risk that audit evidence for an audit objective will fail to detect misstatements exceeding
performance materiality levels is
A) audit risk.
B) control risk.
C) inherent risk.
D) planned detection risk.
Answer: D
Terms: Risk audit evidence will fail to detect misstatements
Objective: LO 8-5
6) If the auditor decides to reduce acceptable audit risk, planned detection risk
A) increases.
B) decreases.
C) stays the same.
D) cannot be determined.
Answer: B
Terms: Audit risk and detection risk
Objective: LO 8-5
11
7) Inherent risk is ________ related to planned detection risk and ________ related to the
amount of audit evidence.
A) directly; inversely
B) directly; directly
C) inversely; inversely
D) inversely; directly
Answer: D
Terms: Relationship of inherent risk, detection risk, and amount of audit evidence
Objective: LO 8-5
8) Auditors frequently refer to the terms audit assurance, overall assurance, and level of
assurance instead of
A) detection risk.
B) audit report risk.
C) acceptable audit risk.
D) inherent risk.
Answer: C
Terms: Audit assurance, overall assurance and level of assurance
Objective: LO 8-5
9) If planned detection risk is reduced, the amount of evidence the auditor accumulates will
A) increase.
B) decrease.
C) remain unchanged.
D) be indeterminate.
Answer: A
Terms: Assess control risk
Objective: LO 8-5
10) Planned detection risk

I. determines the amount of substantive evidence the auditor plans to accumulate.
II. is dependent on inherent risk and business risk.
A) I only
B) II only
C) both I and II
D) neither I nor II
Answer: A
Terms: Planned detection risk
Objective: LO 8-5
12
11) Inherent risk is often high for an account such as
A) inventory.
B) land.
C) capital stock.
D) notes payable.
Answer: A
Objective: LO 8-5
12) Inherent risk and control risk

A) are inversely related to each other.
B) are inversely related to detection risk.
C) are directly related to detection risk.
D) are directly related to audit risk.
Answer: B
Terms: Inherent risk and control risk
Objective: LO 8-5
13) To what extent do auditors typically rely on internal controls of their public company
clients?
A) extensively
B) only very little
C) infrequently
D) never
Answer: A
Terms: Extent auditors rely on internal controls of public company client
Objective: LO 8-5
14) Auditors typically rely on internal controls of their private company clients
A) only as needed to complete the audit and satisfy Sarbanes-Oxley requirements.
B) only if the controls are determined to be effective.
C) only if the client asks an auditor to test controls.
D) only if the controls are sufficient to increase control risk to an acceptable level.
Answer: B
Terms: Extent auditors rely on internal controls of private company client
Objective: LO 8-5
13
15) Which is a true statement about audit risk?
A) Audit risk measures the risk that a material misstatement could occur and not be detected by
internal control.
B) When auditors decide on a higher acceptable audit risk, they want to be more certain that the
financial statements are not materially misstated.
C) Audit assurance is the complement of acceptable audit risk.
D) There is an inverse relationship between acceptable audit risk and planned detection risk.
Answer: C
Terms: Acceptable audit risk
Objective: LO 8-5
16) The risk of material misstatement refers to

A) control risk and acceptable audit risk.
B) inherent risk.
C) the combination of inherent risk and control risk.
D) inherent risk and audit risk.
Answer: C
Objective: LO 8-5
17) When assessing risk, it is important to remember that

A) for acceptable audit risk, the SEC decides the risk the CPA firm should take for public clients.
B) inherent risk can be changed by the auditor.
C) detection risk can only be determined after audit risk, inherent risk, and control risk are
determined.
D) control risk is determined by company management since they are responsible for internal
control.
Answer: C
Terms: Difference between material misstatement and detection risk
Objective: LO 8-5
14
18) Which of the following is a correct relationship?
A) Acceptable audit risk and planned detection risk have an inverse relationship.
B) Control risk and planned detection risk have a direct relationship.
C) Planned detection risk and inherent risk have an inverse relationship.
D) All of the above are correct relationships.
Answer: C
Terms: Relationship of acceptable audit risk, inherent risk, control risk, and planned detection
risk.
Objective: LO 8-5
19) In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the
following?
A) the internal audit department's objectivity in reporting a material misstatement of a financial
statement assertion it detects to the audit committee
B) the risk that the internal control system will not detect a material misstatement of a financial
statement assertion
C) the risk that the audit procedures implemented will not detect a material misstatement of a
financial statement assertion
D) the susceptibility of a financial statement assertion to a material misstatement, assuming there
are no related controls
Answer: D
Terms: Inherent risk assessment
Objective: LO 8-5
20) Which of the following statements is not true?

A) Inherent risk is inversely related to the amount of audit evidence whereas detection risk is
directly related to the amount of audit evidence required.
B) Inherent risk is directly related to evidence whereas detection risk is inversely related to the
amount of audit evidence required.
C) Inherent risk is the susceptibility of the financial statements to material error, assuming no
internal controls.
D) Inherent risk and control risk are assessed by the auditor and function independently of the
financial statement audit.
Answer: A
Objective: LO 8-5
15
21) An auditor who audits a business cycle that has low inherent risk should
A) increase the amount of audit evidence gathered.
B) assign more experienced staff to that area.
C) expand planning procedures.
D) do none of the above.
Answer: D
Terms: Low inherent risk
Difficulty: Easy
Objective: LO 8-5
22) The most important element of the audit risk model is control risk.
Answer: FALSE
Terms: Audit risk model and control risk
Difficulty: Easy
Objective: LO 8-5
23) The audit risk model that must be used for planning audit procedures and evaluating audit
results is:
= AAR.
Answer: FALSE
Objective: LO 8-5
24) If acceptable audit risk is low, and inherent risk and control risk are both low, then planned
detection risk should be high.
Answer: TRUE
Terms: Relationship of acceptable audit risk, inherent risk, control risk, and planned detection
risk.
Difficulty: Easy
Objective: LO 8-5
25) If the audit assurance rate is 95%, then the level of acceptable audit risk is 5%.
Answer: TRUE
Terms: Audit risk
Objective: LO 8-5
16
26) A high detection risk equates to a low amount of audit evidence needed.
Answer: FALSE
Terms: Detection risk and amount of evidence needed
Difficulty: Easy
Objective: LO 8-5
27) For a private company client, auditors are required to test any internal controls they believe
have not been operating effectively during the period under audit.
Answer: FALSE
Terms: Auditors required to test internal controls for private companies
Difficulty: Easy
Objective: LO 8-5
28) There is a direct relationship between acceptable audit risk and planned detection risk.
Answer: TRUE
Objective: LO 8-5
29) Acceptable audit risk and the amount of substantive evidence required are inversely related.
Answer: TRUE
Terms: Acceptable audit risk and substantive evidence
Objective: LO 8-5
30) As control risk increases, the amount of substantive evidence the auditor plans to accumulate
should increase.
Answer: TRUE
Terms: Control risk and substantive evidence
Objective: LO 8-5
31) Inherent risk and control risk are directly related.

Answer: FALSE
Objective: LO 8-5
17
32) Audit assurance is the complement of planned detection risk, that is, one minus planned
detection risk.
Answer: FALSE
Terms: Audit assurance and planned detection risk
Objective: LO 8-5
33) The auditor assesses risks at the overall financial statement level but not at the audit
objective level for the acquisition and payment cycle.
Answer: FALSE
Terms: Audit risk and evidence
Objective: LO 8-5
34) After assessing internal controls are being effective in the sales and collection cycle, the
auditor can assume that internal controls will be effective at each of the client's other transaction
cycles.
Answer: FALSE
Terms: Audit risk and evidence
Objective: LO 8-5
35) A planned detection risk (PDR) of .05 means the auditor plans to accumulate audit evidence
until the risk of misstatement exceeding performance materiality is reduced to 5 percent.
Answer: TRUE
Terms: Planned detection risk
Objective: LO 8-5
36) The audit committee should determine the risk the CPA firm is willing to take that the
financial statements are misstated after the audit is completed.
Answer: FALSE
Objective: LO 8-5
18
37) An example of where the auditor will accept very low risk (low acceptable audit risk) is for
an audit client having an initial public offering.
Answer: TRUE
Difficulty: Easy
Objective: LO 8-5
38) Why do auditors use the audit risk model when planning an audit?
Answer: The audit risk model is used primarily for planning purposes in deciding how much
evidence to accumulate in each cycle. The auditor sets an acceptable level of audit risk, (AAR)
assesses inherent risk (IR) and control risk (CR), and then uses the following audit risk model to
determine an appropriate level of planned detection risk (PDR):
PDR =

Difficulty: Easy
Objective: LO 8-5
19
39) Match the terms below (a-h) with the definitions provided below (1-8).
a. preliminary judgment about materiality

b. inherent risk
c. planned detection risk
d. audit assurance
e. acceptable audit risk
f. performance materiality level
g. control risk
h. materiality
________ 1. a measure of the risk that audit evidence for a segment will fail to detect
misstatements exceeding the performance materiality amount, should such misstatements exist
________ 2. a measure of the auditor's assessment of the likelihood that misstatements

exceeding a performance materiality in a segment will not be prevented or detected by the
client's internal controls
________ 3. a measure of how much risk the auditor is willing to take that the financial
statements may be materially misstated after the audit is completed and an unqualified audit
opinion has been issued
________ 4. the materiality allocated to any given account balance
________ 5. the maximum amount by which the auditor believes that the statements could be
misstated and still not affect the decisions of reasonable users
________ 6. This term is synonymous with acceptable audit risk.
________ 7. the magnitude of an omission or misstatement of accounting information that makes

it probable that the judgment of a reasonable person would have been changed
________ 8. a measure of the auditor's assessment of the likelihood that there are material
misstatements before considering the effectiveness of internal control
Answer:
1. c, 2. g, 3. e, 4. f, 5. a, 6. d, 7.h, 8. b
Terms: Business risk; Control risk; Acceptable audit risk; Materiality; Audit assurance;
Preliminary judgment about materiality; Tolerable misstatement;
Objective: LO 8-5
20
40) Using your knowledge of the relationships among acceptable audit risk, inherent risk, control
risk, planned detection risk, performance materiality, and planned evidence, state the effect on
planned evidence (increase or decrease) of changing each of the following factors, while the
other factors remain unchanged.
1. an increase in acceptable audit risk ________

2. an increase in inherent risk ________
3. a decrease in control risk ________
4. an increase in planned detection risk ________
5. an increase in performance materiality ________
Answer:
1. decrease
2. increase
3. decrease
4. decrease
5. decrease
Terms: Relationships among acceptable audit risk, inherent risk, control risk, planned detection
risk, and tolerable misstatement with planned evidence
Objective: LO 8-5
AACSB: Analytic thinking
21
41) Describe the audit risk model and each of its components.
Answer: The planning form of the audit risk model is stated as follows:
PDR =
where: PDR = planned detection risk

AAR = acceptable audit risk
IR = inherent risk
CR = control risk
Planned detection risk is a measure of the risk that audit evidence for an account (segment) will
fail to detect misstatements exceeding a tolerable amount, should such misstatements exist.
Planned detection risk determines the amount of substantive evidence that the auditor plans to
accumulate.
Acceptable audit risk is a measure of how willing the auditor is to accept that the financial
statements may be materially misstated after the audit is completed and an unqualified opinion
has been issued. It is influenced primarily by the degree to which external users will rely on the
statements, the likelihood that a client will have financial difficulties after the audit report is
issued, and the auditor's evaluation of management's integrity.
Inherent risk is a measure of the auditor's assessment of the likelihood that there are material
misstatements in an account due to error or fraud before considering the effectiveness of internal
control.
Control risk is a measure of the auditor's assessment of the likelihood that misstatements
exceeding a tolerable amount in an account (segment) will be prevented or detected on a timely
basis by the client's internal controls.
Objective: LO 8-5
1) If an auditor believes the chance of financial failure is high and there is a corresponding
increase in business risk for the auditor, acceptable audit risk would likely
A) be reduced.
B) be increased.
C) remain the same.
D) be calculated using a computerized statistical package.
Answer: A
Terms: Increase in business risk, acceptable audit risk
Objective: LO 8-6
22
2) When management has an adequate level of integrity for the auditor to accept the engagement
but cannot be regarded as completely honest in all dealings, auditors normally
A) reduce acceptable audit risk and increase inherent risk.
B) reduce inherent risk and control risk.
C) increase inherent risk and control risk.
D) increase acceptable audit risk and reduce inherent risk.
Answer: A
Terms: Management integrity
Objective: LO 8-6
3) When the auditor is attempting to determine the extent to which external users rely on a
client's financial statements, they may consider several factors except for
A) client size.
B) concentration of ownership.
C) nature and amounts of liabilities.
D) assessment of detection risk.
Answer: D
Terms: Extent to which external users rely on client's financial statements
Objective: LO 8-6
4) ________ is the risk that the auditor or audit firm will suffer harm after the audit is finished,
even though the audit report was correct.
A) Inherent risk
B) Audit risk
C) Engagement risk
D) Control risk
Answer: C
Terms: Engagement risk
Objective: LO 8-6
5) If an auditor believes the client will have financial difficulties after the audit report is issued,
and external users will be relying heavily on the financial statements, the auditor will probably
set acceptable audit risk as low.
Answer: TRUE
Terms: Auditor believes client will have financial difficulties after audit report is issued;
External users rely heavily on financial statements
Objective: LO 8-6
23
6) Overall assessment of acceptable audit risk is highly subjective.
Answer: TRUE
Objective: LO 8-6
7) An acceptable audit risk assessment of low indicates a risky client requiring more extensive
evidence, assignment of more experienced personnel, and/or a more extensive review of audit
files.
Answer: TRUE
Objective: LO 8-6
8) In assessing management integrity for potential new audit clients, the auditor should examine
the prospective client's standing in the business community, financial stability, and relations with
its previous CPA firm, among other procedures.
Answer: TRUE
Terms: Methods practitioners use to assess acceptable audit risk
Objective: LO 8-6
9) There are several factors that affect engagement risk and, therefore, acceptable audit risk.
Discuss three of these factors.
Answer: Engagement risk is affected by:
• The degree to which external users will rely on the statements. For large, publicly held
clients, business risk is greater, and acceptable audit risk will be less, than for small, privately
held clients, all things being equal.
• The likelihood that a client will have financial difficulties after the audit report is issued.
Business risk is greater, and acceptable audit risk will be lower, when the client is experiencing
financial difficulties.
• The auditor's evaluation of management's integrity. Business risk is greater and acceptable
audit risk will be lower when the client's management has questionable integrity.
Terms: Factors that affect business risk and acceptable audit risk
Objective: LO 8-6
24
1) Which of the following statements regarding inherent risk is correct?

A) Inherent risk is unaffected by the auditor's experience with client's organization.
B) Most auditors set a low inherent risk in the first year of an audit and increase it if experience
shows that it was incorrect.
C) Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent
years as they gain more knowledge about the company.
D) Inherent risk is dependent upon the strengths in client's internal control system.
Answer: C
Difficulty: Easy
Objective: LO 8-7
2) Auditors begin their assessments of inherent risk during audit planning. Which of the
following would not help in assessing inherent risk during the planning phase?
A) obtaining client's agreement on the engagement letter
B) obtaining knowledge about the client's business and industry
C) touring the client's plant and offices
D) identifying related parties
Answer: A
Terms: Assessment of inherent risk during audit planning
Difficulty: Easy
Objective: LO 8-7
3) Which of the following is not a primary consideration when assessing inherent risk?
A) nature of client's business
B) existence of related parties
C) effectiveness of internal controls
D) susceptibility to misappropriation of assets
Answer: C
Terms: Assessing inherent risk
Objective: LO 8-7
25
4) Which of the following is an accurate statement regarding inherent risk?
A) The profession has established guidelines for setting inherent risk.
B) Auditors are generally conservative in setting inherent risk.
C) Factors impacting inherent risk will affect all cycles, balances, and disclosures.
D) Inherent risk has no impact on the amount of evidence gathered.
Answer: B
Objective: LO 8-7
5) The risk of fraud should be assessed for the entire audit as well as by cycle, account, and
objective.
Answer: TRUE
Terms: Fraud
Objective: LO 8-7
6) The auditing profession has established guidelines for setting inherent risk.
Answer: FALSE
Objective: LO 8-7
7) Accounts that require considerable judgment have a higher inherent risk.

Answer: TRUE
Objective: LO 8-7
26
8) The risk of material misstatement is a combination of two client-controlled factors: inherent
risk and control risk. What is inherent risk and why is it important? Give examples of inherent
risk factors.
Answer: Inherent risk is the auditor's assessment of the likelihood that there are material
misstatements in the audit segment before the consideration of internal controls. Inherent risk is
important because it attempts to predict where misstatements are most and least likely to occur.
Factors that the auditor considers when assessing inherent risk include but are not limited to:
• The nature of the client's business
• Results of previous audits
• Initial versus repeat engagements
• Related parties
• Complex or nonroutine transactions
• Judgment required to correctly record account balances and transactions
• Makeup of the population
• Factors related to fraudulent financial reporting
• Factors related to misappropriation of assets
Terms: Factors affecting inherent risk
Difficulty: Easy
Objective: LO 8-7
1) Which of the following is true regarding audit risk for segments?

A) Control risk must be assessed at the same level for all accounts.
B) Factors affecting inherent risk do not differ from account to account.
C) Acceptable audit risk is ordinarily assessed by the auditor during the substantive test of
balances phase and is held constant for each major cycle and account.
D) In some cases, a lower acceptable audit risk may be more appropriate for one account than for
others.
Answer: D
Terms: Audit risk for segments
Objective: LO 8-8
27
2) Auditors respond to risk primarily by
I. changing the extent of testing.
II. changing the types of audit procedures.
A) I only
B) II only
C) both I and II
D) neither I nor II
Answer: C
Objective: LO 8-8
3) When using the audit risk model,

A) auditors find it relatively easy to measure the components of the model.
B) many auditors use broad and subjective measurement terms.
C) auditors find it easy to measure the amount of evidence implied by a given planned detection
risk.
D) auditors are only concerned with understating accounts.
Answer: B
Objective: LO 8-8
4) In applying the audit risk model, auditors are concerned about overstatements, not
understatements.
Answer: FALSE
Difficulty: Easy
Objective: LO 8-8
5) One major limitation in the application of the audit risk model is the difficulty of measuring
the components of the model.
Answer: TRUE
Terms: Audit risk
Difficulty: Easy
Objective: LO 8-8
6) Since the audit risk model is a planning model, it assists the auditor in evaluating results.
Answer: FALSE
Difficulty: Easy
Objective: LO 8-8
28
7) In practice, auditors rarely assign numerical probabilities to inherent risk, control risk, or
acceptable audit risk. It is more common to assess these risks as high, medium, or low. For each
of the four situations below, fill in the blanks for planned detection risk and the amount of
evidence you would plan to gather ("planned evidence") using the terms high, medium, or low.
SITUATION SITUATION SITUATION SITUATION

1 2 3 4
Acceptable audit risk Low Low High High
Inherent risk High Low Low Low
Control risk High Low Medium Low
Planned detection risk ________ ________ ________ ________
Planned evidence ________ ________ ________ ________
Answer:
1. low, high
2. medium, medium
3. medium, medium
4. high, low
Terms: Planned detection risk and planned evidence in relation to acceptable audit risk, inherent
risk, and control risk
Objective: LO 8-8
29
8) Dracule Industries is a privately-owned business that sells medical product and devices to
hospitals, clinics and the public. Certain changes have occurred in Dracule Industries during the
year undergoing the audit. Harker needs to evaluate the effect these changes have on audit risk.
Audit risk at the financial statement level is influenced by the risk of material misstatement;
which include factors related to management, the industry and the entity or a combination
thereof. For each of the following changes that have occurred during the year under audit
identify the appropriate audit response for the list of responses. Each response can be used once,
more than once or not at all.
Client changes: Possible effect on the audit:

1. An internal audit department has been a. increases the acceptable level of detection
established. risk
2. A new inventory control system has b. decreases the acceptable level of
been installed that reduces the access of detection risk
unauthorized parties. c. change has no effect on the acceptable
3. Inexperienced accounting personnel level of detection risk
were hired in the accounting department.
4. Excess cash was used to purchase
complex derivatives.
5. Controls over the sales credit approval
process have laxed.
6. New government regulations now apply
to Dracule Industries.
7. Management has become overly
aggressive in reaching target goals.
8. An expert was hired to help determine
the value of the ore content in ending
materials inventory.
Answer:
1. a
2. a
3. b
4. b
5. b
6. b
7. b
8. a
Terms: Audit risk
Objective: LO 8-8
30
1) When taken together, the concepts of risk and materiality in auditing

A) measure the uncertainty of amounts of a given magnitude.
B) measure uncertainty only.
C) measure magnitude only.
D) measure inherent risk.
Answer: A
Terms: Materiality and risk
Objective: LO 8-9
2) Which of the following is a correct statement?

A) There is no relationship between materiality and risk in auditing.
B) Risk is a measure of magnitude or size.
C) The combination of performance materiality and the audit risk model factors determines
planned audit evidence.
D) Performance materiality is part of the audit risk model.
Answer: C
Terms: Relationship of inherent risk, detection risk, and amount of audit evidence
Objective: LO 8-9
3) Performance materiality impacts inherent risk and control risk.

Answer: FALSE
Terms: Performance materiality
Objective: LO 8-9
4) Performance materiality does not affect any of the four risks to planned audit evidence.
Answer: TRUE
Objective: LO 8-9
5) The combination of performance materiality and the audit risk model factors does not affect
the auditor's planned audit evidence.
Answer: FALSE
Objective: LO 8-9
31
6) The statement that the auditor plans to accumulate evidence that there is only a 5 percent
acceptable audit risk of failing to uncover misstatements exceeding performance materiality of
$250,000 is a precise and meaningful statement.
Answer: TRUE
Objective: LO 8-9
32

Audit Chapter 08

Uploaded by

Copyright:

Available Formats

Audit Chapter 08

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Audit Chapter 08

Uploaded by

Copyright:

Available Formats

Auditing and Assurance Services, 17e, Global Edition (Arens/Elder/Beasley)

Chapter 8 Assessing the Risk of Material Misstatement

8.1 Learning Objective 8-1

3) ________ risk represents the auditor's assessment of the susceptibility of an assertion to

8.2 Learning Objective 8-2

2) Risk assessment procedures include

6) Auditing standards emphasize the benefits and importance of obtaining information or

9) Discussions, including exchanges of ideas or brainstorming among the engagement team

8.3 Learning Objective 8-3

1) When considering the risk of misstatement due to fraud,

4) The application of professional skepticism consists of two primary components: a questioning

2) Which of the following will generally be considered a significant risk?

3) Significant risks often relate to routine transactions.

6) Nonroutine transactions are unusual in nature but not infrequent in occurrence.

4) The measurement of the auditor's assessment of the susceptibility of an assertion to material

10) Planned detection risk

12) Inherent risk and control risk

16) The risk of material misstatement refers to

17) When assessing risk, it is important to remember that

20) Which of the following statements is not true?

31) Inherent risk and control risk are directly related.

Terms: Audit risk model

a. preliminary judgment about materiality

________ 2. a measure of the auditor's assessment of the likelihood that misstatements

________ 4. the materiality allocated to any given account balance

________ 6. This term is synonymous with acceptable audit risk.

________ 7. the magnitude of an omission or misstatement of accounting information that makes

1. an increase in acceptable audit risk ________

where: PDR = planned detection risk

8.6 Learning Objective 8-6

1) Which of the following statements regarding inherent risk is correct?

7) Accounts that require considerable judgment have a higher inherent risk.

8.8 Learning Objective 8-8

1) Which of the following is true regarding audit risk for segments?

3) When using the audit risk model,

SITUATION SITUATION SITUATION SITUATION

Client changes: Possible effect on the audit:

1) When taken together, the concepts of risk and materiality in auditing

2) Which of the following is a correct statement?

3) Performance materiality impacts inherent risk and control risk.

You might also like