Unit 8 - Risk Response

Question 1

The Risk Response phase of an audit is often referred to as ________.

Answer 1

performing substantive procedures.

Question 2

What are the three approaches to an audit strategy?

Answer 2

• take a reliance on controls approach
• a substantive approach
• a combo of both

Question 3

Define substantive procedures.

Answer 3

Audit procedures designed to detect material misstatements at the assertion level and to gather evidence to support management assertions.

Question 4

When combined assessed levels of inherent risk and control risk (RMM) is high:

Detection Risk is _________.

Substantive tests are _________.

Collect evidence __________.

How much evidence ________.

Answer 4

Detection Risk is LOW.

Substantive tests are MORE EFFECTIVE.

Collect evidence AT YEAR-END.

How much evidence LARGER SAMPLE SIZES.

Question 5

When combined assessed levels of inherent risk and control risk (RMM) is low:

Detection Risk is _________.

Substantive tests are _________.

Collect evidence __________.

How much evidence ________.

Answer 5

Detection Risk is HIGH.

Substantive tests are LESS EFFECTIVE.

Collect evidence IN THE INTERIM.

How much evidence SMALLER SAMPLE SIZES.

Question 6

Explain the relationship between inherent risk, control risk, and detection risk.

Answer 6

Inherent risk and control risk make up Risk of Material Misstatement (RMM)

RMM and detection risk have an inverse relationship. When RMM is high, then detection risk will be low.

Question 7

Describe why management assertions are important in the determination of detection risk.

Answer 7

Auditing standards require that auditors assess the risk of material misstatement at the assertion level. Therefore, assertions are important because they impact the assessment of inherent and control risks which is the driving force in determining detection risk.

Question 8

If significant fraud risk exists, auditors should respond by including elements of _____________________ in their audit plan.

Answer 8

Unpredictability

Question 9

What factors affect the auditor’s risk response at the financial statement level?

Answer 9

Risk response at the financial statement level is affected by the auditor’s understanding of the entity’s control environment and the assessed risk of material misstatement due to fraud.

Question 10

AU-C 330 and AS 2301 state that auditors are required to perform substantive procedures for all __________ that have been identified during the risk assessment phase.

Answer 10

Relevant assertions

Question 11

Define dual-purpose test.

Answer 11

A substantive test of a transaction and a test of control relevant to that transaction that are performed concurrently.

Auditors may design a test of controls and a substantive test of details to be performed at the same time on the same transaction.

Question 12

Define Analytical Procedures.

Answer 12

Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data; analytical procedures also encompass such investigation, as is necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a signification amount.

Question 13

Give examples of analytical procedures. (4)

Answer 13

Ratio analysis, trend analysis, simple comparisons of data, and complex statistical analysis techniques

Question 14

When is using analytical procedures required in an audit?

Answer 14

At the end of the audit to assist the auditor when forming an overall conclusion on the financial statements (risk assessment)

Question 15

What are the four factors that impact the effectiveness and efficiency of using a substantive analytical procedure to respond to risk?

Answer 15

1) the nature of the assertion

2) the plausibility and predictability of the relationship

3) the availability and reliability of the data used to develop the expectation

4) the precision of the expectation

Question 16

Define Tests of Details.

Answer 16

The substantive procedures auditors use to test the details of account balances, transactions, and disclosures.

Question 17

What are the eight types of Tests of Details?

Answer 17

1) Inspection

2) Observation

3) Inquiry

4) Confirmation

5) Recalculation

6) Reperformance

7) Scanning

8) ADA

Question 18

Define confirmation bias.

Answer 18

The tendency to seek or interpret evidence in ways that support pre-existing beliefs or expectations.

Question 19

What are some advantages of using audit data analytics in the audit process? (4)

Answer 19

• can be used during risk assessment or risk response
• analyze entire populations of data
• compare two sets of data, such as vendor and employee addresses

-quickly identify outlier, or unusual, items

Question 20

Define roll-forward procedures.

Answer 20

When substantive procedures are performed during an interim period, auditors perform roll-forward procedures to update their audit findings from the time of the interim procedures through to year-end.

Procedures performed at year-end on transactions occurring between an interim date and year-end (the roll-forward period) to provide sufficient appropriate audit evidence on which to base conclusions at year-end when substantive procedures are performed at an interim date.

Question 21

What are two situations in which auditors may decide to test 100% of a population?

Answer 21

1) when the population is very small

2) when the population is large, the data is reliable and in electronic form and the auditor can use ADA software

Question 22

Auditors are required to perform substantive procedures for all _________ ___________ that have been identified during the risk assessment phase.

Answer 22

Relevant Assertions

Question 23

Define Audit Sampling

Answer 23

application of an audit procedure to LESS THAN 100% of the items within an account balance or class of transaction for the purpose of evaluating some characteristic of the balance or class

When data is available in electronic form, ADA software can analyze an entire population regardless of size. If it is not in electronic form and the population size makes it cost or time prohibited to analyze the entire population, a sampling of the population can be used.

Question 24

Define estimation uncertainty.

Answer 24

The susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement

Question 25

Define management bias

Answer 25

A lack of neutrality by management in the preparation and fair presentation of information.

Question 26

What are the three categories of misstatements?

Answer 26

1) Factual misstatements

2) Judgmental misstatements

3) Projected misstatements

Question 27

What are the 3 purposes of analytical procedures?

Answer 27

1) Required in planning

2) May be useful as substantive audit evidence

3) Required in final review

Question 28

Which assertion is typically related to income statement accounts rather than balance sheet accounts or presentation and disclosure?

a) Rights and obligations

b) Cutoff

c) Completeness

d) Accuracy

Answer 28

b) Cutoff

Question 29

How should a misstatement be classified if an auditor feels that the allowance for doubtful accounts is understated?

a) As a quantitative misstatement

b) As a judgmental misstatement

c) As a projected misstatement

d) As a factual misstatement

Answer 29

b) As a judgmental misstatement

Judgmental misstatements are caused by management judgment regarding accounting estimates the auditors feel are unreasonable.

This would not be considered a projected misstatement because it is only one transaction.

Question 30

Which level of detail is required in the substantive testing working papers?

a) A summary of the selections without specific selections

b) Documentation of specific items selected for testing

c) As determined by professional judgment

d) A discussion of sampling techniques

Answer 30

c) As determined by professional judgment

The level of detail to include in the working papers is a matter of professional judgment. Another auditor must be able to review the working papers, re-perform the steps, and reach the same conclusion as the auditor who prepared the working papers.

Question 31

An auditor verified that a sales transaction represented in the income statement occurred and was recorded in the correct accounting period.

Which assertions are tested in this procedure?

a) Classification in the presentation and disclosure

b) Accuracy in the presentation and disclosure

c) Valuation in the balance sheet accounts

d) Existence in the balance sheet accounts

Answer 31

d) Existence in the balance sheet accounts

Showing that these sales transactions occurred provides evidence that the balance of the accounts receivable at year-end exists, and that the client holds those rights.

Question 32

Which extent of substantive audit procedures is warranted when an auditing sales discount program that was created in the current does not have a material balance and the detection risk is very low?

a) Substantive procedures should decrease due to the low detection risk

b) Substantive procedures should begin in the second year

c) The sample size would increase due to the implementation of the new process.

d) The sample size should not be affected by the new process.

Answer 32

c) The sample size should increase due to the implementation of the new process.

Due to the new system implemented in the current year and the low detection risk, the sample size should be higher.