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Chapter 9 Multiple-Choice Questions 1. easy a

If it is probable that the judgment of a reasonable person would have been changed or influenced by the omission or misstatement of information, then that information is, by definition of FASB Statement No. 2: a. material. b. insignificant. c. significant. d. relevant.

2. easy b

The preliminary judgment about materiality is the amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users. a. minimum b. maximum c. mean average d. median average

3. easy d

Auditors are responsible for determining whether financial statements are materially misstated, so upon discovering a material misstatement they must bring it to the attention of: a. regulators. b. the audit firm’s managing partner. c. no one in particular. d. the client’s management.

4. easy c

The FASB definition of materiality emphasizes what class of financial statement users? a. Regulators. b. Informed investors. c. Reasonable persons. d. Potential investors.

5. easy d

When auditors allocate the preliminary judgment about materiality to account balances, the materiality allocated to any given account balance is referred to as: a. the materiality range. b. the error range. c. tolerable materiality. d. tolerable misstatement.

6. easy c

Why do auditors establish a preliminary judgment about materiality? a. To determine the appropriate level of audit experience required for the work. b. So that the client can know what records to make available to the auditor. c. To plan the appropriate audit evidence to accumulate and develop an overall audit strategy. d. To finalize the assessment of control risk.

7. easy b

Auditors are _____ to decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit. a. permitted b. required c. not allowed d. strongly encouraged

8.

If an auditor establishes a relatively high level for materiality, then the auditor will:

Arens/Elder/Beasley

easy b

a. b. c. d.

9. easy d

The preliminary judgment about materiality and the amount of audit evidence accumulated are _____ related. a. directly b. indirectly c. not d. inversely

10. easy d

After the preliminary judgment about materiality has been established, auditors may: a. not adjust it. b. adjust it downward only. c. adjust it upward only. d. adjust it either downward or upward.

11. easy c

In an audit area that has a lower inherent risk, it would be prudent to: a. increase the amount of audit evidence gathered. b. assign more experienced staff to that area. c. increase the tolerable misstatement for the area. d. expand planning procedures.

12. easy d

Which of the following is least likely to be appropriate as the basis for determining the preliminary judgment about materiality in the audit of financial statements? a. Net income before taxes. b. Current assets. c. Owners’ equity. d. Inventory.

13. easy c

Auditing standards _____ that the basis used to determine the preliminary judgment about materiality be documented in the audit files. a. permit b. do not allow c. require d. strongly encourage

14. easy d

Amounts involving fraud are usually considered _____ important than unintentional errors of equal dollar amounts. a. less b. no less c. no more d. more

15. easy a

Which of the following qualitative factors may significantly influence whether an item is deemed to be material?

a. b. c. d. Arens/Elder/Beasley

accumulate more evidence than if a lower level had been set. accumulate less evidence than if a lower level had been set. accumulate approximately the same evidence as would be the case were materiality lower. accumulate an undetermined amount of evidence.

Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations. Yes No Yes No

Misstatements that are otherwise immaterial may be material if they affect a trend in earnings Yes No No Yes

16. easy a

Auditors generally allocate the preliminary judgment about materiality to the: a. balance sheet only. b. income statement only. c. income statement and balance sheet. d. statement of cash flows.

17. easy c

Which of the following statements regarding inherent risk is correct? a. The inherent risk assigned in the audit risk model 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 experience, even when there is inherent risk. d. The inherent risk assigned in the audit risk model is dependent upon the strengths in client’s internal control system.

18. easy a

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.

19. medium b

Auditors commonly allocate materiality to balance sheet accounts rather than income statement accounts because most income statement misstatements have a(n) _____ effect on the balance sheet. a. reduced b. equal c. undetermined d. increased

20. medium b

Which of the following is not a correct statement regarding the allocation of the preliminary judgment about materiality to balance sheet accounts? a. Auditors expect certain accounts to have more misstatements than others. b. The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence. c. Auditors expect to identify overstatements as well as understatements in the accounts. d. Relative audit costs affect the allocation.

21. medium b

What is the primary means of dealing with risk in planning decisions related to audit evidence? a. Selection of more effective tests of details of balances. b. Application of the audit risk model. c. Establishing a lower preliminary judgment about materiality. d. Allocating materiality judgment to segments.

22. medium d

The phrase “in our opinion” in the auditor’s report is intended to inform users that auditors: a. guarantee fair presentation of the financial statements. b. act as insurers of the accuracy of the statements. c. certify the material presented in the statements by management. d. base their conclusions about the statements on professional judgment.

23. medium d

Inherent risk is _______ related to detection risk and _______ related to the amount of audit evidence. a. directly, inversely b. directly, directly

Arens/Elder/Beasley

c. d.

inversely, inversely inversely, directly

24. medium b

The five steps in applying materiality are listed below in random order. 1. Estimate the combined misstatement. 2. Estimate the total misstatement in the segment. 3. Set preliminary judgment about materiality. 4. Allocate preliminary judgment about materiality to segments. 5. Compare combined estimate with preliminary judgment about materiality. The correct sequence from start to finish would be: a. 1 2 5 4 3. b. 3 4 2 1 5. c. 4 3 1 5 2. d. 5 1 3 2 4.

25. medium b

Which of the following statements is not correct? a. Materiality is a relative rather than an absolute concept. b. The most important base used as the criterion for deciding materiality is total assets. c. Qualitative factors as well as quantitative factors affect materiality. d. Given equal dollar amounts, frauds are usually considered more important than errors.

26. medium a

Since materiality is relative, it is necessary to have bases for establishing whether misstatements are material. Normally, the most common base for deciding materiality is: a. net income before taxes. b. net working capital. c. net income after taxes. d. total assets.

27. medium a

Certain types of misstatements are likely to be more important than other types to users, even if the dollar amounts are the same. Which of the following demonstrates this?

a. b. c. d.

Amounts involving frauds are considered more important than errors of equal amount Yes No Yes No

Misstatements that are otherwise immaterial may be material if they affect a trend in earnings. Yes No No Yes

28. medium b

Allocating the preliminary judgment about materiality to financial statements segments is necessary because: a. evidence is accumulated for the financial statements as a whole so materiality does not apply to them. b. evidence is accumulated by segments rather than for the financial statements as a whole. c. it is required by the AICPA’s Code of Professional Conduct. d. it is required by the SEC.

29. medium c

Which of the following statements is not correct? a. Either an overstatement of an asset account or an understatement of a liability account would have the same effect on the income statement. b. A misclassification in the balance sheet will have no effect on operating income. c. Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement. d. Either an understatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

Arens/Elder/Beasley

30. medium d

Regardless of how the preliminary judgment about materiality is allocated, the auditor must be confident that total combined misstatements in all accounts are: a. less than the preliminary judgment. b. equal to the preliminary judgment. c. more than the preliminary judgment. d. less than or equal to the preliminary judgment.

31. medium c

Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance to refer to ________. a. detection risk b. audit report risk c. acceptable audit risk d. inherent risk

32. medium c

_____ misstatements are those where the auditor can determine the amount of the misstatement in the account. a. Potential b. Likely c. Known d. Projected When a different extent of evidence is needed for the various cycles, the difference is caused by: a. errors in the client’s accounting system. b. a client’s need to achieve an unqualified opinion. c. an auditor’s need to follow auditing standards. d. an auditor’s expectations of errors and assessment of internal control.

33. medium d

34. medium a

If planned detection risk is reduced, the amount of evidence the auditor accumulates will: a. increase. b. decrease. c. remain unchanged. d. be indeterminate.

35. Medium a

Likely misstatements can result from:

a. b. c. d.

Computation of the sampling error for the cash account No Yes No Yes

Differences between management’s and an auditor’s judgment about account balances Yes Yes No No

Projections of misstatements based on an auditor’s tests of a sample from a population Yes No Yes No

36. medium b

When discussing control risk (CR) and the audit risk model, which of the following is false? a. CR is a measure of the auditor’s assessment of the likelihood that misstatements will not be prevented or detected by internal control. b. If the auditor concludes that internal control is completely ineffective to prevent or detect errors, he/she would assign a low value (e.g., 0%) to CR. c. The relationship between control risk and detection risk is inverse. d. The relationship between control risk and evidence needed to support account balances is direct.

37. medium

Which of the following is not a good indicator of the degree to which statements are relied on by external users?

Arens/Elder/Beasley

d

a. b. c. d.

38. medium a

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.

39. medium a

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.

40. medium b

One accounting issue that does not require management to use significant judgments is: a. the allowance for doubtful accounts. b. the useful life of equipment for tax purposes. c. obsolete inventory. d. the liability for warranty payments.

41. medium d

Inherent risk is often low for an account such as: a. inventory. b. marketable securities. c. cash. d. accounts receivable.

42. medium d

The auditor typically does not assess control risk and inherent risk for: a. each audit objective. b. each cycle. c. each account. d. the overall audit.

43. (Public) medium a

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

44. medium b

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.

45. medium a

Acceptable audit risk is ordinarily set by the auditor during planning and: a. held constant for each major cycle and account. b. held constant for each major cycle but varies by account. c. varies by each major cycle and by each account. d. varies by each major cycle but is constant by account.

46.

When the auditor is attempting to determine the extent to which external users rely on a client’s

Arens/Elder/Beasley

Client’s size, as measured by total assets or total revenue. Distribution of ownership among the public. Nature and amount of liabilities. Amount of net income or loss after taxes.

medium d

financial statements, they may consider several factors except for: a. client size. b. concentration of ownership. c. types and amounts of liabilities. d. assessment of detection risk.

47. medium b

A major difficulty in the application of the audit risk model is: a. defining the terms of the model. b. measuring the components of the model. c. understanding the effect on other factors in the model when one factor is changed. d. the failure of the Audit Standards Board to accept it and incorporate it into standards.

48. medium a

When setting a preliminary judgment about materiality: a. more evidence is required for a low dollar amount than for a high dollar amount. b. less evidence is required for a low dollar amount than for a high dollar amount. c. the same amount of evidence is required for either low or high dollar amounts. d. there is no relationship between it and the dollar amount of evidence needed.

49. challenging b

When allocating materiality, most practitioners choose to allocate to: a. the income statement accounts because they are more important. b. the balance sheet accounts because there are fewer. c. both balance sheet and income statement accounts because there could be errors on either. d. all of the financial statements because there could be errors on other statements besides the income statement and balance sheet.

50. challenging c

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.

51.

Auditors may assess inherent risk and control risk:

medium a a. b. c. d.

Jointly to determine the risk of material misstatement Yes No Yes No

Separately and combine their effects in the audit risk model Yes No No Yes

52. challenging c

Which one of the following statements about the cycle approach to auditing is not correct? a. There are differences among cycles in the frequency and size of expected errors. b. There are differences among cycles in the effectiveness of internal controls. c. There are differences among cycles on the auditor’s willingness to accept risk that material errors exist after the auditing is complete. d. It is common for auditors to want an equally low likelihood of errors for each cycle after the auditor is finished.

53. challenging a

When the auditor has the same level of willingness to risk that material misstatements will exist after the audit is finished for all financial statement cycles: a. a different extent of evidence will likely be needed for various cycles. b. the same amount of evidence will be gathered for each cycle. c. the auditor has not followed generally accepted auditing standards. d. the level for each cycle must be no more than 2% so that the entire audit does not exceed 10%.

Arens/Elder/Beasley

54. challenging b

Which of the following statements is not true? a. Inherent risk is inversely related to detection risk. b. Inherent risk is inversely related to evidence. c. Inherent risk is the susceptibility of the financial statements to material error, assuming no internal controls. d. Inherent risk is the auditor’s assessment of the likelihood that errors exceeding a tolerable amount exist in a segment before considering the effectiveness of internal controls.

55. challenging c

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. Frequency and intensity of management’s review of accounting transactions and records. d. Susceptibility to defalcation.

56. challenging c

Which of the following is an example of the concept of inherent risk? a. Humans make more errors than computers; therefore, a manual accounting system is riskier than a computerized system. b. Accounting systems with vouchers have many more controls built in, so the risk that there will be errors on the financial statements is reduced. c. Loans receivable for a finance company are less likely to be collectible than those of a bank. d. Audits with larger sample sizes are less risky than those with smaller sample sizes.

57. challenging d

Tolerable misstatement as set by the auditor: a. decreases acceptable audit risk. b. increases inherent risk and control risk. c. affects planned detection risk. d. does not affect any of the four risks.

58. challenging a

Which of the following underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? ...