Ch04 tb moroney 3e - quiz solutions PDF

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Testbank to accompany

Auditing: a practical approach 3e by Moroney et al.

© John Wiley & Sons Australia, Ltd 2017

Chapter 4: Risk Assessment II

Chapter 4: Risk assessment II True/False 1.

When classifying risks as being significant consideration is given to whether the risk involves simple routine transactions. a. *b.

True False

Correct answer: b Learning Objective 4.1 ~ evaluate audit risk

2.

Audit risk is the risk that a client's system of internal controls will not prevent or detect a material misstatement. a. *b.

True False

Correct answer: b Learning Objective 4.1 ~ evaluate audit risk

3.

There is an inverse relationship between audit risk and detection risk as set by the auditor. *a. b.

True False

Correct answer: a Learning Objective 4.1 ~ evaluate audit risk

4.

If inherent risk and control risk are low, the auditor can set detection risk as high. *a. b.

True False

Correct answer: a Learning Objective 4.1 ~ evaluate audit risk

© John Wiley and Sons Australia, Ltd 2017

4.2

Testbank to accompany Auditing: a practical approach 3e

5.

Information is considered quantitatively material if it exceeds an auditor's preliminary materiality assessment. *a. b.

True False

Correct answer: a Learning Objective 4.2 ~ explain the concept of materiality

6.

Materiality is assessed during the risk assessment phase of every audit. *a. b.

True False

Correct answer: a Learning Objective 4.2 ~ explain the concept of materiality

7.

By setting a higher planning materiality level, an auditor increases the quality and quantity of evidence that needs to be obtained. a. *b.

True False

Correct answer: b Learning Objective 4.2 ~ explain the concept of materiality

8.

Information can be considered material if it impacts on the decision making for the users of the financial information. *a. b.

True False

Correct answer: a Learning Objective 4.2 ~ explain the concept of materiality

© John Wiley and Sons Australia, Ltd 2017

4.3

Chapter 4: Risk Assessment II

9.

The audit strategy is the determination of the amount of time spent testing the client’s internal controls and conducting detailed testing of transactions and account balances. *a. b.

True False

Correct answer: a Learning Objective 4.3 ~ determine how an auditor determines their audit strategy

10. A walkthrough involves an auditor tracing a transaction through a client's accounting system. *a. b.

True False

Correct answer: a Learning Objective 4.3 ~ determine how an auditor determines their audit strategy

11.

If the client has one or more appropriate controls in place, the audit strategy is to conduct few or no tests of controls for the identified risk. a. *b.

True False

Correct answer: b Learning Objective 4.3 ~ determine how an auditor determines their audit strategy

12.

Profitability is the ability of a company to pay its debts as they fall due. a. *b.

True False

Correct answer: b Learning Objective 4.4 ~ describe how clients measure performance

© John Wiley and Sons Australia, Ltd 2017

4.4

Testbank to accompany Auditing: a practical approach 3e

13.

Key performance indicators used by a client to monitor its performance provide an auditor an insight into which accounts are potentially at risk of misstatement. *a. b.

True False

Correct answer: a Learning Objective 4.4 ~ describe how clients measure performance

14.

Companies enter into debt covenants with lenders when taking on significant loans. *a. b.

True False

Correct answer: a Learning Objective 4.4 ~ describe how clients measure performance

15.

Trend analysis involves a comparison of account balances to a single line item. a. *b.

True False

Correct answer: b Learning Objective 4.5 ~ describe how an auditor uses analytical procedures when assessing risk

16.

Inventory turnover measures how many times a year a company collects cash from its debtors. a. *b.

True False

Correct answer: b Learning Objective 4.5 ~ describe how an auditor uses analytical procedures when assessing risk

© John Wiley and Sons Australia, Ltd 2017

4.5

Chapter 4: Risk Assessment II

17.

Analytical procedures are conducted at the risk assessment phase of an audit to enhance the understanding of the auditor's client. *a. b.

True False

Correct answer: a Learning Objective 4.5 ~ describe how an auditor uses analytical procedures when assessing risk

© John Wiley and Sons Australia, Ltd 2017

4.6

Testbank to accompany Auditing: a practical approach 3e

Multiple-choice questions 18.

By setting high detection risk, an auditor will: a. b. c. *d.

Reduce the level of testing of the client's internal control system. Eliminate the possibility that fraud will be detected. Increase the level of reliance placed on their detailed substantive procedures. Reduce the level of reliance placed on their detailed substantive procedures.

Correct answer: d Learning Objective 4.1 ~ evaluate audit risk

19.

When classifying risks as being significant consideration is not given to whether the risk: a. b. *c. d.

Involves significant related party transactions. Is related to significant economic or accounting developments. Involves simple transactions. Involves fraud.

Correct answer: c Learning Objective 4.1 ~ evaluate audit risk

20.

If there is a risk that management's assertion that recorded inventory exists is not valid, the auditor will: a. b. c. *d.

Spend less time testing for the existence of recorded inventory. Spend more time testing for the completeness of inventory. Not adjust their audit strategy. Spend more time testing for the existence of recorded inventory.

Correct answer: d Learning Objective 4.1 ~ evaluate audit risk

© John Wiley and Sons Australia, Ltd 2017

4.7

Chapter 4: Risk Assessment II

21.

Which of the following statements is correct about audit risk? d. b. c. *d.

Audit risk can be reduced at the planning stage of an audit by identifying the key risks faced by the client. Audit risk is the risk that an auditor expresses an inappropriate opinion when a financial report is materially stated. It is impossible to completely eliminate audit risk. All of the above.

Correct answer: d Learning Objective 4.1 ~ evaluate audit risk

22.

Control risk is: a. *b. c. d.

The risk that a client's system of internal controls will prevent or detect a material misstatement. The risk that a client's system of internal controls will not prevent or detect a material misstatement. The susceptibility of an assertion to a material assertion assuming there are no related controls. None of the above.

Correct answer: b Learning Objective 4.1 ~ evaluate audit risk

23.

An item that is considered material due to its magnitude is referred to as being: a. *b. c. d.

Of no interest to the auditor. Quantitatively material. Qualitatively material. None of the above.

Correct answer: b Learning Objective 4.2 ~ outline the concept of materiality

© John Wiley and Sons Australia, Ltd 2017

4.8

Testbank to accompany Auditing: a practical approach 3e

24.

Which of the following statements about materiality is incorrect? a. *b. c. d.

Materiality is a key auditing concept that is assessed during the risk assessment phase of every audit. Information is considered material if it has no impact on the decision-making process of financial report users. Materiality is used to guide audit testing and assess the validity of information contained in the financial report. The preliminary assessment of materiality guides audit planning and testing.

Correct answer: b Learning Objective 4.2 ~ outline the concept of materiality

25.

Qualitative materiality refers to information that: a. *b. c. d.

Impacts a user's decision-making process due to its magnitude. Impacts a user's decision-making process for a reason other than its magnitude. Exceeds an auditor's preliminary materiality assessment. Is less than an auditor's preliminary materiality assessment.

Correct answer: b Learning Objective 4.2 ~ outline the concept of materiality

26.

An item that is considered material due to its nature is referred to as being; a. b. *c. d.

Monumentally material. Quantitatively material. Qualitatively material. Significantly material.

Correct answer: c Learning Objective 4.2 ~ outline the concept of materiality

27.

As a rule of thumb which of the following items would be considered immaterial? a. b. c. *d.

An item greater than 10 per cent of profit before tax. An item greater than 1 per cent of total assets. An item greater than 2 per cent of equity. None of the above.

Correct answer: d Learning Objective 4.2 ~ explain the concept of materiality

© John Wiley and Sons Australia, Ltd 2017

4.9

Chapter 4: Risk Assessment II

28.

By setting a lower planning materiality level an auditor: a. b. c. *d.

Decreases their sensitivity to a potential misstatement. Decreases the quality and quantity of evidence that needs to be gathered. Can be certain that they will detect all instances of fraud that have occurred. Increases the quality and quantity of evidence that needs to be gathered.

Correct answer: d Learning Objective 4.2 ~ outline the concept of materiality

29.

A transaction walkthrough involves: a. *b. c. d.

Taking a tour of the client's manufacturing facility. Tracing a transaction through a client's accounting system. Vouching recorded transactions back to the source documents. None of the above.

Correct answer: b Learning Objective 4.3 ~ discuss how an auditor determines their audit strategy

30.

An audit strategy will include increased reliance on tests of controls when: *a. b. c. d.

Inherent risk and control risk are low. The auditor believes there is a high risk that their client's internal controls will not prevent or detect material misstatements. There is a high susceptibility of assertions to material misstatements. Inherent risk and control are high.

Correct answer: a Learning Objective 4.3 ~ discuss how an auditor determines their audit strategy

31.

An audit strategy: a. b. c. *d.

Is determined by the client. Involves determining the amount of time to be spent testing the client's internal controls and conducting detailed substantive testing. Sets the scope, timing and direction of the audit. Both b and c.

Correct answer: d Learning Objective 4.3 ~ discuss how an auditor determines their audit strategy

© John Wiley and Sons Australia, Ltd 2017

4.10

Testbank to accompany Auditing: a practical approach 3e

32.

The audit strategy for a client with high inherent risk and high control risk will include: a. *b. c. d.

Decreased reliance on substantive tests. No or very limited tests of controls. Increased testing of controls. Increased reliance on controls.

Correct answer: b Learning Objective 4.3 ~ discuss how an auditor determines their audit strategy

33.

By assessing control risk as high, an auditor has determined that their client's system of internal controls: a. b. c. *d.

Is very effective at preventing or detecting material misstatements. Is very strong. Will eliminate the possibility of material fraud or error. Is unlikely to be effective in mitigating inherent risks identified.

Correct answer: d Learning Objective 4.3 ~ discuss how an auditor determines their audit strategy

34.

Liquidity refers to: *a. b. c. d.

The ability of a company to pay its debts when they fall due. The ability of a company to earn a profit. A comparison of account balances to a single line item. None of the above.

Correct answer: a Learning Objective 4.4 ~ interpret how clients measure performance

35.

Which of the following statements relating to debt covenants is incorrect? a. b. *c. d.

covenants are written into loan contracts. covenants restrict a company's activities. if a company breaches a debt covenant it will not need to renegotiate or repay the loan. companies enter into debt covenants with banks when they borrow a significant amount.

Correct answer: c Learning Objective 4.4 ~ interpret how clients measure performance

© John Wiley and Sons Australia, Ltd 2017

4.11

Chapter 4: Risk Assessment II

36. Which of the following statements regarding key performance indicators (KPIs) is correct? a. b. c. *d.

Some KPIs are common to many clients, including return on assets. They reflect the success factors of an organisation. They can be quantified. All of the above.

Correct answer: d Learning Objective 4.4 ~ interpret how clients measure performance

37.

Common measures of a company's profitability include: a. b. *c. d.

Price-earnings ratio. Earnings per share. Both a and b. Quick ratio.

Correct answer: c Learning Objective 4.4 ~ interpret how clients measure performance

38.

Which of the following is not an example of a profitability ratio? a. *b. c. d.

Return on assets. Current ratio. Gross profit margin. Profit margin.

Correct answer: b Learning Objective 4.5 ~ specify how an auditor uses analytical procedures when assessing risk

39.

Analytical procedures are conducted at the risk assessment phase of the audit to: a. b. c. *d.

Aid in the identification of risk. Identify where fraud has occurred. Enhance the understanding of a client. Both a and c.

Correct answer: d Learning Objective 4.5 ~ specify how an auditor uses analytical procedures when assessing risk

© John Wiley and Sons Australia, Ltd 2017

4.12

Testbank to accompany Auditing: a practical approach 3e

40.

Analytical procedures are used at which of the following phases of an audit? a. b. c. *d.

Risk assessment Risk response. Final review. All of the above.

Correct answer: d Learning Objective 4.5 ~ specify how an auditor uses analytical procedures when assessing risk

41.

In conducting analytical procedures, which of the following information sources are not generally considered to be reliable? a. b. *c. d.

Information generated using consistent accounting methods. Information generated by an accounting system with effective internal controls. Information generated by an accounting system with ineffective internal controls. Audited information.

Correct answer: c Learning Objective 4.5 ~ specify how an auditor uses analytical procedures when assessing risk

42.

Which of the following is an example of a liquidity ratio? *a. b. c. d.

Cost of sales divided by average inventory. Gross profit divided by net sales. Profit divided by average assets. Non-current assets divided by total assets.

Correct answer: a Learning Objective 4.5 ~ specify how an auditor uses analytical procedures when assessing risk

© John Wiley and Sons Australia, Ltd 2017

4.13

Chapter 4: Risk Assessment II

Short answer questions 43. What is the relationship between materiality and audit risk? Answer: There is an inverse relation between risk and materiality. For example, if an auditor decides to use profit before tax as the base, materiality is generally set closer to 5 per cent for a client that is considered to be risky and closer to 10 per cent for a client that is not considered risky. By setting a lower planning materiality level, an auditor increases the quality and quantity of evidence that needs to be gathered. When gathering evidence, one of the criteria may be to test material items. The lower the materiality level set, the more items will fall into this definition. Also, by setting a lower materiality level, an auditor increases their sensitivity to a potential misstatement. When analysing test results, an auditor will assess potential misstatements in aggregate with reference to their planning materiality. The lower the materiality, the more likely the auditor will conclude that misstatements are material and further testing is required. Learning Objective 4.1 ~ evaluate audit risk.

44. Explain the audit approach used by an auditor when they assess control risk as high. Answer: By assessing control risk as high, an auditor will adopt a predominantly substantive approach. When this audit strategy is adopted, an auditor will gain the minimum necessary knowledge of the client's system of internal controls as required by the auditing standards, but generally conduct no tests of those controls. If a client's system of internal controls is non-existent, very poor or unlikely to be effective in mitigating an identified inherent risk, there is generally no point testing the internal controls as the auditor will not be planning on relying on them. Instead, an auditor will increase their level of reliance on detailed substantive procedures, which involves intensive testing of year-end account balances and transactions from throughout the year. An exception is where an auditor has identified a significant risk. In this case, an auditor will gain an understanding of their client's controls relevant to that risk. For example, if a client has significant transactions that involve estimation, an auditor will review the processes used by management to make those estimations. If a client does not have adequate controls to address significant risks, this is considered a noteworthy deficiency in a client's system of internal controls. Learning Objective 4.1 ~ evaluate audit risk.

© John Wiley and Sons Australia, Ltd 2017

4.14

Testbank to accompany Auditing: a practical approach 3e

45. Explain audit risk and the three components of the audit risk model. Answer: Audit risk is the risk that an auditor expresses an inappropriate audit opinion when a financial report is materially misstated. This means that an auditor reports that in their opinion the financial report is true and fair when it contains a significant error or fraud. While it is impossible to eliminate audit risk, an auditor will aim to reduce it to an acceptably low level. Inherent risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls. Control risk is the risk that a client's system of internal controls will not prevent or detect a material ...