Audit Test Test #3 Ch. 9 Test Bank

Front 1

Chapter 9

Back 1

Materiality and Risk

Front 2

LO 9-1

Back 2

LO 9-1

Front 3

1) If it is probable that the judgment of a reasonable person will be 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.

Back 3

A) material.

Front 4

2) The scope paragraph of the standard unqualified auditor's 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

Back 4

C) reasonable

Front 5

3) 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) the client shareholders.
D) the client's management.

Back 5

D) the client's management.

Front 6

4) The FASB definition of materiality focuses on potential users of financial statements.
A) True
B) False

Back 6

B) False

Front 7

LO 9-2

Back 7

LO 9-2

Front 8

1) Audit standards require the auditor to consider materiality early in the audit. Which statement(s) regarding preliminary materiality are true?
I. Preliminary materiality may change during the engagement.
II. Preliminary materiality is the maximum amount the auditor by which the auditor believes the financials could be misstated and still not affect the decisions of reasonable users.
A) I only
B) II only
C) both I and II
D) neither are true

Back 8

C) both I and II

Front 9

2) Why do auditors establish a preliminary judgment about materiality?
A) To determine the appropriate level of staff to assign to the audit.
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 control risk assessment.

Back 9

C) To plan the appropriate audit evidence to accumulate and develop an overall audit strategy.

Front 10

3) If an auditor establishes a relatively high level for materiality, then the auditor will:
A) accumulate more evidence than if a lower level had been set.
B) accumulate less evidence than if a lower level had been set.
C) accumulate approximately the same evidence as would be the case were materiality lower.
D) accumulate an undetermined amount of evidence.

Back 10

B) accumulate less evidence than if a lower level had been set.

Front 11

4) The preliminary judgment about materiality and the amount of audit evidence accumulated are ________ related.
A) directly
B) indirectly
C) not
D) inversely

Back 11

D) inversely

Front 12

5) Which of the following is the primary basis used to decide materiality for a for-profit entity?
A) net sales
B) net assets
C) net income before tax
D) all of the above

Back 12

C) net income before tax

Front 13

6) 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

Back 13

C) require

Front 14

7) Amounts involving fraud are usually considered ________ important than unintentional errors of equal dollar amounts.
A) less
B) no less
C) no more
D) more

Back 14

D) more

Front 15

8) Qualitative factors can affect an auditor's assessment of materiality. Which of the following qualitative factors could influence the assessment of materiality?
I. Misstatements that are otherwise immaterial may be material if they affect earnings trends.
II. Minor misstatements resulting from the consequences of contractual obligations.
A) I only
B) II only
C) I and II
D) neither I nor II

Back 15

C) I and II

Front 16

9) 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 first three steps in correct sequence would be:
A) 1, 2, 5
B) 3, 4, 2
C) 2, 1, 5
D) 3, 2, 4

Back 16

B) 3, 4, 2

Front 17

10) 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.

Back 17

B) The most important base used as the criterion for deciding materiality is total assets.

Front 18

11) 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)
Amounts involving frauds are considered more important than
errors of equal amount Misstatements that are otherwise immaterial may be material if they affect a trend in earnings
Yes Yes

B)
Amounts involving frauds are considered more important than
errors of equal amount Misstatements that are otherwise immaterial may be material if they affect a trend in earnings
No No

C)
Amounts involving frauds are considered more important than
errors of equal amount Misstatements that are otherwise immaterial may be material if they affect a trend in earnings
Yes No

D)
Amounts involving frauds are considered more important than
errors of equal amount Misstatements that are otherwise immaterial may be material if they affect a trend in earnings
No Yes

Back 18

A) Yes Yes

Front 19

12) 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.

Back 19

A) more evidence is required for a low dollar amount than for a high dollar amount.

Front 20

12) 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.

Back 20

A) more evidence is required for a low dollar amount than for a high dollar amount.

Front 21

13) Lewis Corporation has a few large accounts receivable that total one million dollars whereas
Clark Corporation has many small accounts receivable that total one million dollars. Misstatement in any one account is more significant for Lewis corporation because of the concept of:
A) Materiality.
B) Audit risk.
C) Reasonable assurance.
D) Comparative analysis.

Back 21

A) Materiality.

Front 22

16) The auditor's preliminary judgment about materiality is the maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of reasonable users.
A) True
B) False

Back 22

True

Front 23

17) Preliminary judgments about materiality are often changed during the course of the engagement.
A) True
B) False

Back 23

True

Front 24

18) Net assets are the most often used base for deciding materiality.
A) True
B) False

Back 24

False

Front 25

19) The lower the dollar amount of the preliminary judgment the more audit evidence is required.
A) True
B) False

Back 25

True

Front 26

20) Amounts involving fraud are not usually considered qualitative factors affecting the preliminary materiality judgment.
A) True
B) False

Back 26

False

Front 27

21) Auditors have difficulty applying the concept of materiality in practice because they often do not know who the users of the financial statements are or what decisions will be made.
A) True
B) False

Back 27

True

Front 28

22) Statements on Auditing Standards provide detailed, objective guidance on how auditors are to establish a preliminary materiality level, thus eliminating the need for subjective auditor judgment in this task.
A) True
B) False

Back 28

False

Front 29

23) If the preliminary judgment of materiality increases, the amount of audit evidence required will decrease.
A) True
B) False

Back 29

True

Front 30

24) Net income before tax is the normal base used to determine materiality in a non-for-profit company.
A) True
B) False

Back 30

False

Front 31

LO 9-3

Back 31

LO 9-3

Front 32

1) 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.

Back 32

D) tolerable misstatement.

Front 33

2) 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.

Back 33

A) balance sheet only.

Front 34

3) Which of the following is an incorrect 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.

Back 34

B) The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence.

Front 35

4) Which of the following statements is true concerning the allocation of preliminary materiality?
A) It is necessary to allocate preliminary materiality to financial statements as a whole rather than by segments.
B) Preliminary materiality should be allocated to income statement accounts only.
C) It is required by the SEC.
D) When preliminary materiality is allocated to segments it is termed tolerable misstatement.

Back 35

D) When preliminary materiality is allocated to segments it is termed tolerable misstatement.

Front 36

5) Which of the following statements is false?
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.

Back 36

C) Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

Front 37

6) Which of the following are major difficulties auditors face when allocating materiality to balance sheet accounts?
A)
Certain accounts contain
more misstatements
than others Only overstatements
need be considered Audit costs can
affect allocation
Yes No Yes

B)
Certain accounts contain
more misstatements
than others Only overstatements
need be considered Audit costs can
affect allocation
Yes Yes No

C)
Certain accounts contain
more misstatements
than others Only overstatements
need be considered Audit costs can
affect allocation
Yes Yes Yes

D)
Certain accounts contain
more misstatements
than others Only overstatements
need be considered Audit costs can
affect allocation
No Yes No

Back 37

A) Yes No Yes

Front 38

7) When tolerable misstatement is exceeded by ________ the auditor should request the client to adjust their account balance.
I. Known misstatements
II. Projected misstatement
A) I only
B) II only
C) I and II
D) None of the above

Back 38

C) I and II

Front 39

8) 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 it is required by GAAS.

Back 39

B) the balance sheet accounts because there are fewer.

Front 40

9) 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.

Back 40

D) does not affect any of the four risks.

Front 41

12) Most practitioners allocate the preliminary judgment about materiality to balance sheet accounts.
A) True
B) False

Back 41

A) True

Front 42

13) The primary purpose of allocating the preliminary judgment about materiality to financial statement accounts is to help the auditor decide the appropriate evidence to accumulate.
A) True
B) False

Back 42

True

Front 43

14) Both overstatements and understatements must be considered when allocating materiality to balance sheet accounts.
A) True
B) False

Back 43

True

Front 44

15) If an auditor assigns a tolerable misstatement of $1,000 to accounts payable, he or she would need to obtain more audit evidence for that account than if $100,000 had been assigned.
A) True
B) False

Back 44

True

Front 45

16) To maximize audit efficiency, the auditor should allocate less tolerable misstatement to accounts that can be verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit.
A) True
B) False

Back 45

True

Front 46

LO 9-4

Back 46

LO 9-4

Front 47

1) Auditors are ________ to document the known and likely misstatements in the financial statements under audit.
A) permitted
B) required
C) not allowed
D) strongly encouraged

Back 47

B) required

Front 48

2) ________ misstatements are those where the auditor can determine the amount of the misstatement in the account.
A) Potential
B) Likely
C) Known
D) Projected

Back 48

C) Known

Front 49

3) Likely misstatements can result from:
A)
Computation of the
sampling error for the
cash account Differences between management's and an auditor's judgment about account balances Projections of
misstatements based on
an auditor's tests of a
sample from a
population
No Yes Yes

B)
Computation of the
sampling error for the
cash account Differences between management's and an auditor's judgment about account balances Projections of
misstatements based on
an auditor's tests of a
sample from a
population
Yes Yes No

C)
Computation of the
sampling error for the
cash account Differences between management's and an auditor's judgment about account balances Projections of
misstatements based on
an auditor's tests of a
sample from a
population
No No Yes

Back 49

A) No Yes Yes

Front 50

4) When expressing an unqualified opinion, the auditor who evaluates the audit findings should be satisfied that the:
A) amount of known misstatement is documented in the management representation letter.
B) estimate of the total known and likely misstatements is less than a material amount.
C) estimate of the total likely misstatement includes sample error.
D) amount of known misstatement is acknowledged and recorded by the client.

Back 50

B) estimate of the total known and likely misstatements is less than a material amount.

Front 51

7) The preliminary judgment on materiality is compared to an estimated total misstatements to determine if an account balance is materially misstated.
A) True
B) False

Back 51

True

Front 52

8) Total estimated misstatements include known misstatements and projected misstatements plus a sampling error.
A) True
B) False

Back 52

True

Front 53

LO 9-5

Back 53

LO 9-5

Front 54

1) 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) increase the tolerable misstatement for the area.
D) expand planning procedures.

Back 54

C) increase the tolerable misstatement for the area.

Front 55

2) Which of the following audit risk components may be assessesed in non-quantitative terms?
A)
Control Risk Inherent Risk Detection Risk
Yes Yes Yes

B)
Control Risk Inherent Risk Detection Risk
Yes Yes No

C)
Control Risk Inherent Risk Detection Risk
No No Yes

D)
Control Risk Inherent Risk Detection Risk
No No No

Back 55

A) Yes Yes Yes

Front 56

3) 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.

Back 56

B) decrease detection risk.

Front 57

4) Which of the following underlies the application of generally accepted auditing standards?
A) the elements of materiality and relative risk
B) the element of internal control
C) the element of corroborating evidence
D) the element of reasonable assurance

Back 57

A) the elements of materiality and relative risk

Front 58

7) The most important element of the audit risk model is control risk.
A) True
B) False

Back 58

False

Front 59

8) The audit risk model that must be used for planning audit procedures and evaluating audit results is:
DR /
IR × CR = AAR.
A) True
B) False

Back 59

False

Front 60

LO 9-6

Back 60

LO 9-6

Front 61

1) The measurement of the auditor's assessment of the likelihood that there are material misstatements due to error or fraud in a segment before considering the effectiveness of internal controls is defined as:
A) Audit risk.
B) Inherent risk.
C) Sampling risk.
D) Detection risk.

Back 61

B) Inherent risk.

Front 62

2) The risk that audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement is:
A) Audit risk.
B) Control risk.
C) Inherent risk.
D) Planned detection risk.

Back 62

D) Planned detection risk.

Front 63

3) As the risk of material misstatement increases, detection risk should:
A) medium increase.
B) decrease.
C) stay the same.
D) Is indeterminate.

Back 63

B) decrease.

Front 64

4) Inherent risk is ________ related to detection risk and ________ related to the amount of audit evidence.
A) directly, inversely
B) directly, directly
C) inversely, inversely
D) inversely, directly

Back 64

D) inversely, directly

Front 65

5) 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

Back 65

C) acceptable audit risk

Front 66

6) If planned detection risk is reduced, the amount of evidence the auditor accumulates will:
A) increase.
B) decrease.
C) remain unchanged.
D) be indeterminate.

Back 66

A) increase.

Front 67

7) Planned detection risk
I. determines the amount of substantive evidence the auditor plans to accumulate.
II. is dependent on inherent risk and control risk.
A) I only
B) II only
C) I and II
D) None of the above

Back 67

A) I only

Front 68

8) Inherent risk is often high for an account such as:
A) inventory.
B) land.
C) cash.
D) notes payable.

Back 68

A) inventory.

Front 69

9) 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.

Back 69

B) are inversely related to detection risk.

Front 70

10) 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

Back 70

A) extensively

Front 71

11) 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.

Back 71

B) only if the controls are determined to be effective.

Front 72

12) 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.

Back 72

A) held constant for each major cycle and account.

Front 73

13) 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.

Back 73

C) the combination of inherent risk and control risk.

Front 74

14) The risk of material misstatement differs from detection risk in that it:
A) arises because audit procedures have been misapplied.
B) can be controlled and changed by the auditor.
C) can be assessed in quantitative and non-quantitative terms.
D) is controllable by the client.

Back 74

D) is controllable by the client.

Front 75

15) Auditors may assess inherent risk and control risk:
A)
Jointly to determine the risk of
material misstatement Separately and combine their effects in the audit risk model
Yes Yes

B)
Jointly to determine the risk of
material misstatement Separately and combine their effects in the audit risk model
No No

C)
Jointly to determine the risk of
material misstatement Separately and combine their effects in the audit risk model
Yes No

D)
Jointly to determine the risk of
material misstatement Separately and combine their effects in the audit risk model
No Yes

Back 75

A) Yes Yes

Front 76

16) In a financial statement audit, inherent risk is evaluated to help an auditor asses 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 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.

Back 76

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

Front 77

17) 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.

Back 77

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.

Front 78

19) If acceptable audit risk is low, and inherent risk and control risk are both low, then planned detection risk should be high.
A) True
B) False

Back 78

True

Front 79

20) Tolerable misstatement does not affect audit risk, inherent risk, control risk, or planned detection risk yet the combination of the tolerable misstatement and the four risks will determine the amount of planned audit evidence.
A) True
B) False

Back 79

True

Front 80

21) A high detection risk equates to a low amount of audit evidence needed.
A) True
B) False

Back 80

True

Front 81

22) 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.
A) True
B) False

Back 81

False

Front 82

23) Inherent risk and control risk are normally assessed for the each segment but sets audit risk at the financial statement level.
A) True
B) False

Back 82

False

Front 83

24) Acceptable audit risk and the amount of substantive evidence required are inversely related.
A) True
B) False

Back 83

True

Front 84

25) As control risk increases, the amount of substantive evidence the auditor plans to accumulate should increase.
A) True
B) False

Back 84

True

Front 85

26) Inherent risk and control risk are directly related.
A) True
B) False

Back 85

False

Front 86

27) 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.
A) True
B) False

Back 86

True

Front 87

LO 9-7

Back 87

LO 9-7

Front 88

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.

Back 88

A) be reduced.

Front 89

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.

Back 89

A) reduce acceptable audit risk and increase inherent risk.

Front 90

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) types and amounts of liabilities.
D) assessment of detection risk.

Back 90

D) assessment of detection risk.

Front 91

6) Audit assurance is the complement of planned detection risk, that is, one minus planned detection risk.
A) True
B) False

Back 91

False

Front 92

7) 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.
A) True
B) False

Back 92

True

Front 93

8) Engagement risk is effectively the audit firm's business risk.
A) True
B) False

Back 93

True

Front 94

LO 9-8

Back 94

LO 9-8

Front 95

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 experience, even when there is inherent risk.
D) Inherent risk is dependent upon the strengths in client's internal control system.

Back 95

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.

Front 96

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.

Back 96

A) Obtaining client's agreement on the engagement letter.

Front 97

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) degree of separation of duties
D) susceptibility to defalcation

Back 97

C) degree of separation of duties

Front 98

LO 9-9

Back 98

LO 9-9

Front 99

1) As the acceptable level of detection risk increases, an auditor may change the:
A) timing of substantive tests by performing them at an interim date rather than year end.
B) timing of the tests on controls by performing them throughout the year rather than at one time.
C) assess the level of inherent risk to a lower amount.
D) increase the sample size to achieve a more effective test.

Back 99

A) timing of substantive tests by performing them at an interim date rather than year end.