II. Planning Activities - Audit Risk

Question 1

As a result of control testing, a CPA has decided to reduce control risk. What is the impact on substantive testing sample size if all other factors remain constant?

Answer 1

The sample size would be lower.

Note: Lowering the assessment of control risk would permit a somewhat higher level of detection risk. Taking a smaller sample size would be associated with a higher level of detection risk, which would be appropriate in view of the reduced control risk.​

Question 2

Which of the following is an example of an inherent risk that an auditor should consider?

Answer 2

Technological developments that may render inventory obsolete.

Note: Inherent risks are defined as risks of material misstatement before consideration of any related controls. External circumstances that influence business risks may also affect inherent risks. Technological developments causing inventory to be obsolete (and therefore susceptible to overstatement) are specifically identified as inherent risks in AICPA Professional Standards (AU-C 200.A42).

Question 3

Inherent risk and control risk differ from detection risk in which of the following ways?

Answer 3

Inherent risk and control risk exists independently of the audit.

Note: Inherent risk and control risk comprise the risk of material misstatement, which the auditor is obligated to assess. The auditor is responsible for designing the audit procedures to be responsive to the assessed risk of material misstatement, which exists independently of the audit itself.

Question 4

The acceptable level of detection risk is inversely (opposite) related to the

Answer 4

Detection risk is inversely related to the assurance provided by substantive tests. The lower the detection risk, the more assurance needed from substantive testing.

Note: < detection risk = > Substantive testings, vice versa

Question 5

The risk that an auditor will conclude, based on substantive tests, that a material error does not exist in an account balance when, in fact, such error does exist is referred to as

Answer 5

Detection risk.

Question 6

Inherent risk and control risk differ from detection risk in that inherent risk and control risk are

Answer 6

Inherent risk and control risk (also called environmental risks) are functions of the client and its environment,

Detection risk is not. As a result, inherent risk and control risk can only be assessed by the auditor, while detection risk is controlled by the auditor.

Question 7

As the acceptable level of detection risk increases, an auditor may change the

Answer 7

Timing of substantive tests from year end to an interim date.

Note: Increasing detection risk means that the auditor can obtain less or weaker evidence. As a result, the auditor may be able to push the timing of substantive tests from year-end to an interim date.

Question 8

When an auditor increases the assessed level of control risk because certain control procedures were determined to be ineffective, the auditor would most likely increase the

Answer 8

Extent of tests of details.

We understand that if CR or IR increase we must decrease Detection Risk, remember that DR = TD x AP, In order to decrease DR we must increase TD or AP.

Note: An increase in the assessed level of control risk means that the risk of a material misstatement occurring and not being detected has increased. To offset that increased risk, the auditor should make decisions that decrease the level of detection risk. Increasing the emphasis on tests of details would decrease detection risk.

Question 9

Holding other planning considerations equal, a decrease in the number of misstatements in a class of transactions that an auditor could tolerate most likely would cause the auditor to

Answer 9

Perform the planned auditing procedures closer to the balance sheet date.

Note: When the level of tolerable misstatements decreases, the auditor will have to increase substantive testing to ensure that all material misstatements are detected. Performing the planned auditing procedures closer to the balance sheet date increases the effectiveness of substantive procedures and therefore increases substantive testing.​

Question 10

The risk that an auditor will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as

Answer 10

Detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion.

Note: detection risk relates to the auditor’s procedures and can be changed at his or her discretion.

May be viewed in terms of two components:

(1) the risk that analytical procedures and other relevant substantive tests would fail to detect misstatements equal to tolerable misstatement, and

(2) the allowable risk of incorrect acceptance for the substantive tests of details.

Question 11

Inherent risk and control risk differ from detection risk in that they

Answer 11

Exist independently of the financial statement audit.

Question 12

Which of the following audit risk components may be assessed in nonquantitative terms?

Control risk

Detection risk

Inherent risk

Answer 12

All of these risks may be assessed in either quantitative terms such as percentages, or nonquantitative terms such as a range from a minimum to a maximum.

Question 13

As the acceptable level of detection risk decreases, the assurance directly provided from

Answer 13

The acceptable level of detection risk decreases, the assurance provided from substantive tests should increase. To gain this increased assurance the auditors may:

(1) change the nature of substantive tests to more effective procedures (e.g., use independent parties outside the entity rather than those within the entity),

(2) change the timing of substantive tests (e.g., perform them at year-end rather than at an interim date), and

(3) change the extent of substantive tests

Question 14

In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?

Answer 14

The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls.

Detection risk -

• audit procedures implemented will not detect a material misstatement of a financial statement assertion.

Control risk -

• internal audit department objectivity is more directly related to control risk
• the risk that the internal control system will not prevent or detect a material misstatement of a financial statement assertion.

Question 15

On the basis of audit evidence related to internal control, an auditor decides to increase the assessed level of the risk of material misstatement 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

Answer 15

Decrease detection risk.

Note: suggests a decrease in detection to accompany the increase in the risk of material misstatement.

Question 16

An auditor would be most likely to assess control risk at the maximum level in an electronic environment with automated system-generated information when

Answer 16

Fixed asset transactions are few in number, but large in dollar amount.

Note:

When such transactions are few in number and involve large dollar amounts, it is likely that an audit trail would exist, which would support the auditor’s substantive tests.

Question 17

On the basis of the 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

Answer 17

Decrease detection risk.

remember: Audit Risk = CR x IR x DR

Note: Best way for an auditor to achieve an overall audit risk level when the audit evidence relating to control risk indicates the need to increase its assessed level.

Question 18

While assessing the risks of material misstatement auditors identify risks, relate risk to what could go wrong, consider the magnitude of risks and

Answer 18

The professional standards suggest that auditors should then consider the likelihood that risks involved could result in material misstatements.

Question 19

Relationship between control risk and detection risk is ordinarily

Answer 19

Inverse

Note: Inverse is correct because as control risk increases (decreases) detection risk must decrease (increase).

Question 20

As the acceptable level of detection risk decreases, an auditor may

Answer 20

Postpone the planned timing of substantive tests from interim dates to the year-end.

Note: Postponement of interim substantive tests to year-end decreases detection risk by reducing the risk for the period subsequent to the performance of those tests; other approaches to decreasing detection risk include changing to more effective substantive tests and increasing their extent.

Question 21

Which of the following is a function of the risks of material misstatement and detection risk?

Answer 21

Audit risk.

Note: Audit risk is the risk that auditor expresses an inappropriate audit opinion when the financial statements are misstated, and it is a function of the risks of material misstatement and detection risk.

Question 22

Detection risk differs from both control risk and inherent risk in that detection risk

Answer 22

Can be changed at the auditor’s discretion.

Note: auditors determine an appropriate level of detection risk based on their assessment of the risk of material misstatement composed of inherent risk and control risk.

Question 23

When an auditor increases the risk of material misstatement because certain control procedures were determined to be ineffective, the auditor would most likely increase the

Answer 23

Extent of tests of details.

Note: increases in the assessed level of risk of material misstatement lead to decreases in the acceptable level of detection risk. Accordingly, the auditor will need to increase the extent of substantive tests such as tests of details.