Audit Planning Ii Moroney Ch.4 Test Bank Docx - Auditing Canada 4e | Test Bank with Answers by Robyn Moroney. DOCX document preview.
CHAPTER 4
AUDIT PLANNING ll
CHAPTER LEARNING OBJECTIVES
1. Evaluate audit risk.
Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. The three components of audit risk are inherent risk, control risk, and detection risk.
2. Explain and apply the concept of materiality.
Information is considered to be material if it impacts the decision-making process of users of the financial statements.
3. Describe how an auditor determines the audit strategy.
The audit strategy is a key component of the risk assessment phase of the audit. It sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan. An audit strategy will depend on the auditor’s preliminary inherent and control risk assessment.
4. Outline how clients measure performance.
By understanding how a client measures its own performance, an auditor can plan the audit to take into consideration areas where the client may be under pressure to achieve certain outcomes.
5. Summarize how an auditor uses analytical procedures when planning an audit.
Analytical procedures are conducted at the risk assessment phase of the audit to identify unusual fluctuations, help identify risks, help when gaining an understanding of a client, identify the accounts at risk of material misstatement, and reduce audit risk by concentrating audit effort where the risk of material misstatement is greatest. There are many processes that can be used when conducting analytical procedures. The processes discussed in this chapter include simple comparisons, trend analysis, common-size analysis, and ratio analysis.
TRUE-FALSE STATEMENTS
1. Audit risk is the risk that a client's system of internal controls will not prevent or detect a
material misstatement.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
2. If inherent risk and control risk are low, the auditor can set detection risk as high.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
3. When classifying risks, significant consideration is given to whether the risk involves simple
routine transactions.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
4. Materiality is assessed during the risk assessment phase of every audit.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
5. Information is considered quantitatively material if it exceeds an auditor's preliminary
materiality assessment.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
6. By setting a higher planning materiality level, an auditor increases the quality and quantity of
evidence that needs to be obtained.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
7. There is an inverse relationship between the assessed level of inherent and control risk and detection risk as set by the auditor.
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
8. A walkthrough involves an auditor tracing a transaction through a client's accounting system.
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
9. 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.
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
10. Profitability is the ability of a company to pay its debts as they fall due.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
11. Companies enter into debt covenants with lenders when taking on significant loans.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
12. Key performance indicators used by a client to monitor its performance provide an auditor
insight into which accounts are potentially at risk of misstatement.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
13. Trend analysis involves a comparison of account balances to a single line item.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
14. Analytical procedures are conducted at the risk assessment phase of an audit to enhance the understanding of the auditor's client.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
15. Inventory turnover measures how many times a year a company collects cash from its
debtors.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
MULTIPLE CHOICE QUESTIONS
16. Keith Fiorino, a manager at Cox, Durham, & Elliott, CPA’s was given the mandate to
deal with the following risks: fraud risks, complex transactions, and significant related party
transactions. How would you classify these risks?
a) audit risk
b) inherent risk
c) control risk
d) significant risk
Difficulty: Medium
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
17. Millie Buenavista made the following two statements concerning inherent risk:
(i) Inherent risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
(ii) Inherent risk deals with the susceptibility of the financial statements to material misstatements without considering internal controls.
a) both (i) and (ii) are correct
b) neither (i) or (ii) are correct
c) only (i) is correct
d) only (ii) is correct
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
18. Which of the following statements is correct about audit risk?
a) It is possible to completely eliminate audit risk.
b) Audit risk is the risk that an auditor expresses an inappropriate opinion when the financial statements are materially misstated.
c) Audit risk cannot be reduced at the risk assessment phase of an audit by identifying the key risks faced by the client.
d) The level of audit risk is determined by the client’s management.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
19. When classifying risks, significant consideration is not given to whether the risk
a) is related to significant economic or accounting developments.
b) involves simple transactions.
c) involves significant related party transactions.
d) involves fraud.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
20. If there is a risk that management's assertion that recorded inventory exists is not valid, the
auditor will
a) spend more time testing for the existence of recorded inventory.
b) spend less time testing for the existence of recorded inventory.
c) spend more time testing for the completeness of inventory.
d) not adjust their audit strategy.
Difficulty: Medium
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
21. Control risk is
a) the risk that a client's system of internal controls will prevent or detect a material
misstatement.
b) the susceptibility of an assertion to a material misstatement assuming there are no related controls.
c) the risk that a client's system of internal controls will not prevent or detect a material misstatement.
d) the risk the auditor will not be able to perform tests of controls.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
22. By setting high detection risk, an auditor will
a) eliminate the possibility that fraud will be detected.
b) reduce the level of reliance placed on their detailed substantive procedures.
c) increase the level of reliance placed on their detailed substantive procedures.
d) reduce the level of testing of the client's internal control system.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
23. When information exceeds an auditor's preliminary materiality assessment, it is deemed to
be
a) performance materiality.
b) specific materiality.
c) quantitatively material.
d) a control risk.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
24. Which of the following statements about materiality is incorrect?
a) The preliminary assessment of materiality guides audit planning and testing.
b) Materiality is used to guide the validity of information contained in the financial statements.
c) Materiality is a key auditing concept that is assessed during the risk assessment phase of every audit.
d) Information is considered material if it has no impact on the decision-making process of financial statement users.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
25. An item that is considered material due to its magnitude is referred to as being
a) quantitatively material.
b) of no interest to the auditor.
c) qualitatively material.
d) immaterial.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
26. Qualitative materiality refers to information that
a) impacts a user's decision-making process due to its magnitude.
b) impacts a user's decision-making process for a reason other than its magnitude.
c) is less than an auditor's preliminary materiality assessment.
d) exceeds an auditor's preliminary materiality assessment.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
27. Which of the following is an example of an item considered qualitatively material?
a) a change in an accounting method
b) related party transactions
c) being in danger of breaching a debt covenant
d) all of the answers are correct
Difficulty: Medium
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
28. By setting a lower planning materiality level, an auditor
a) decreases the quality and quantity of evidence that needs to be gathered.
b) does not change the audit strategy they use.
c) increases the quality and quantity of evidence that needs to be gathered.
d) can be certain that they will detect all instances of fraud that have occurred.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
29. Which of the following statements regarding materiality is correct?
a) Materiality is a key auditing concept.
b) The preliminary assessment of materiality does not guide audit planning.
c) All items are considered material if they are reported incorrectly on the financial statements.
d) Once materiality for an audit is determined, it cannot be changed.
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
30. An example of a qualitative material item is
a) an incorrect value reported for an asset.
b) a related party transaction.
c) interest expenses as being 6% of total sales.
d) sales incorrectly recorded twice.
Difficulty: Medium
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
31. Setting the level of planning materiality as low would cause an auditor to
a) increase the quality and quantity of evidence to be collected.
b) reduce the quality and quantity of evidence to be collected.
c) revise the acceptable level of audit risk.
d) none of the above
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
32. An auditor has gained a detailed understanding of the client's system of internal controls
and has conducted extensive tests of those controls. She later assesses control risk as low.
What is she planning to perform?
a) a combined audit strategy
b) an audit of financial controls
c) a substantive audit strategy
d) a modified audit strategy
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
33. When a control is effective, the next step is to
a) identify what could go wrong.
b) test the control.
c) perform a walkthrough.
d) reduce reliance on detailed substantive procedures.
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
34. When Brenda discovered she had a low risk client with low inherent risk and low control risk, how did she set her detection risk?
a) low
b) high
c) medium
d) detection risk is not related to inherent risk and control risk
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
35. Zain Hakim’s client does not have in place appropriate controls for a risk he has identified.
What should Zain do?
a) conduct few or no tests of controls
b) report the weaknesses to those charged with governance
c) increase his reliance on substantive tests
d) all of the answers are correct
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
36. Moises Alou has reviewed internal controls at a spring training facility in Florida and has
deemed control risk to be high. Which kind of audit strategy may be appropriate for Moises?
a) combined audit strategy
b) substantive audit strategy
c) both a and b
d) none of the above
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
37. An audit strategy
a) is determined by the client.
b) involves determining the amount of time to be spent testing the client's internal
controls and conducting detailed substantive testing.
c) sets the scope, timing, and direction of the audit.
d) both b and c
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
38. The audit strategy for a client with high inherent risk and high control risk will include
a) no or very limited tests of controls.
b) decreased reliance on substantive tests.
c) increased testing of controls.
d) increased reliance on controls.
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
39. A transaction walkthrough involves
a) taking a tour of the client's manufacturing facility.
b) vouching recorded transactions back to the source documents.
c) tracing a transaction through a client's accounting system.
d) observing an inventory count
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
40. An audit strategy will include increased reliance on tests of controls when
a) inherent risk and control are high.
b) inherent risk and control risk are low.
c) the auditor believes there is a high risk that their client's internal controls will not prevent or detect material misstatements.
d) there is a high susceptibility of assertions to material misstatements.
Difficulty: Easy
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
41. By assessing control risk as high, an auditor has determined that their client's system of
internal controls
a) is unlikely to be effective in mitigating inherent risks identified.
b) is very effective at preventing or detecting material misstatements.
c) is very strong.
d) will eliminate the possibility of material fraud or error.
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
42. Which of the following statements regarding key performance indicators (KPIs) is incorrect?
a) They reflect the success factors of an organization.
b) They can be quantified.
c) Some KPIs are common to many clients, including return on assets.
d) The auditors determine the KPIs for a company.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
43. Common measures of a company's profitability include
a) price-earnings ratio.
b) earnings per share.
c) both a and b
d) quick ratio.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
44. Which of the following statements relating to debt covenants is incorrect?
a) Covenants are written into loan contracts.
b) If a company breaches a debt covenant it will not need to renegotiate or repay the loan.
c) Covenants restrict a company's activities.
d) Companies typically enter into debt covenants with banks when they borrow a significant amount.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
45. Liquidity refers to
a) the ability of a company to earn a profit.
b) a comparison of account balances to a single line item.
c) the ability of a company to pay its debts when they fall due.
d) the ability of a company to use its assets efficiently.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
46. Gaining an understanding of how an audit client measures and assesses its performance, assists the auditor to
a) assess audit risk.
b) evaluate the profitability of the audit client.
c) gain an understanding of accounts that may be at risk.
d) determine the overall audit strategy.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
47. Which of the following is not a reason for using profitability measures?
a) to assess performance of key staff
b) to compare performance against competitors
c) to measure the ability to meet its debts as they fall due
d) to track revenue and expenses over time
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
48. Francesca Prez was explaining the importance of analytical procedures to her staff. She
made two statements:
(i) Analytical procedures are conducted throughout an audit.
(ii) Analytical procedures are an efficient method for estimating account balances.
a) both (i) and (ii) are correct
b) neither (i) nor (ii) are correct
c) only (i) is correct
d) only (ii) is correct
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
49. Matthias Holewsky was explaining how important it was for his staff to use analytical
procedures in order to cut down on substantive testing. He mentioned two factors that he felt
were important when conducting analytical procedures:
(i) reliability of client data
(ii) the ability to make comparisons over time
Which of these two factors can help him achieve his objective?
a) (i) only
b) (ii) only
c) both (i) and (ii)
d) neither (i) nor (ii)
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
50. Analytical procedures are
a) always based only on available financial statement data.
b) expected to be efficient and effective.
c) relevant to achieving audit objectives.
d) conducted throughout the audit.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
51. Analytical procedures are undertaken to
a) prove the client is profitable.
b) determine the correct cash balance.
c) identify fluctuations in accounts inconsistent with the auditor’s expectations.
d) identify non-compliance with internal control procedures.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
52. Which of the following is not an example of an analytical procedure?
a) comparison of financial data to invoices
b) comparison of financial data to industry averages
c) comparison of financial data to budgets
d) comparison of financial data to non-financial data
Difficulty: Medium
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
53. Ratio analysis is used to
a) assess the relationship between various financial statement balances.
b) compare account balances over time.
c) compare account balances with a single line item.
d) assess the effectiveness of internal controls.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
54. In conducting analytical procedures, which of the following sources of information is considered to be most reliable?
a) information generated using consistent accounting methods
b) information from external sources
c) information generated by an accounting system that has effective internal controls
d) information provided by the client
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
55. Analytical procedures are conducted at the risk assessment phase of the audit to
a) aid in the identification of risk.
b) identify where fraud has occurred.
c) determine if account balances are accurate.
d) evaluate the work performed by the auditors.
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
56. Analytical procedures are used at which of the following stages of an audit?
a) final review
b) planning
c) execution
d) all of the answers are correct
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
57. Which of the following is not an example of a profitability ratio?
a) current ratio
b) gross profit margin
c) return on assets
d) profit margin
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
58. Which of the following is an example of a liquidity ratio?
a) gross profit divided by net sales
b) profit divided by average assets
c) total liabilities divided by total assets
d) current assets divided by current liabilities
Difficulty: Medium
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
59. In conducting analytical procedures, which of the following information sources are not
generally considered to be reliable?
a) audited information
b) information generated by an accounting system with ineffective internal controls
c) information generated using consistent accounting methods
d) information generated by an accounting system with effective internal controls
Difficulty: Easy
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
SHORT ANSWER QUESTIONS
60. Explain audit risk and the three components of the audit risk model.
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
61. Indicate whether you agree or disagree with the following statements and explain your reasoning.
a) Monica Callahan, the in-charge auditor, was explaining to her junior auditors why she was setting inherent risk high. “It is appropriate to set higher inherent risk for this company as our client is in an industry that is very competitive.”
b) In selecting an appropriate materiality base, an auditor can choose an item from the balance sheet or income statement.
c) Randy Roberts has mentioned to his staff auditors that audit risk is based on factors that relate to the entity, while materiality is based on the user needs. As a result, materiality and audit risk are two concepts that need to be considered separately when considering material misstatements.
d) Shareep Kaur has determined control risk at a biochem company to be high. She plans to use a combined audit strategy.
Difficulty: Medium
Learning Objective: Evaluate audit risk.
Learning Objective: Explain and apply the concept of materiality.
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.1 Audit risk
Section Reference: 4.2 Materiality
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
62. What is the relationship between materiality and audit risk?
Difficulty: Easy
Learning Objective: Explain and apply the concept of materiality.
Section Reference: 4.2 Materiality
CPA Competency: Audit and Assurance
AACSB: Analytic
63. Explain the audit approach used by an auditor when they assess control risk as high.
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
64. Direct Home Builders was incorporated in December of 2019 and started operating in January of 2020. The company operates a retail web site that sells home building products to contractors in Canada. The business is owned and managed by two brothers, Buster and Dave Jameson. Despite a slowdown in the very competitive construction sector, the brothers have developed several unique interactive on-line shopping features that have led to significant revenue growth. As a result of this revenue growth, the owners have had to hire more sales, customer service, IT, and accounting staff. This has increased the payroll costs to the extent the company is now experiencing cash flow difficulties. The local bank has provided interim financing, but a new cash injection is required. Buster and Dave are considering making a public share offering to raise further capital.
The brothers have approached a CPA firm to determine what may be involved with an initial public offering. They have been advised that one requirement is annual audited financial statements. They have discussed this requirement with their Controller, who believes they may have some challenges obtaining an unqualified audit opinion. She has expressed this concern due to the issues she has had with the new accounting hires and the turnover within the accounting area. She has had to let a couple of the staff go as they made several material accounting errors. She has since implemented stronger controls over the accounting processes, but she is still uncertain whether material errors remain.
Required:
Discuss the factors that will increase the inherent risk of Direct Home Builders.
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.3 Audit Strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
65. Describe the profitability and liquidity approaches to measuring a client's performance.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
66. Discuss the purpose and some common examples of profitability ratios.
Difficulty: Easy
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
ESSAY QUESTIONS
67. Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially stated. Why is the concept of audit risk so important to auditors and what can they do to reduce it to an acceptably low level?
Difficulty: Easy
Learning Objective: Evaluate audit risk.
Section Reference: 4.1 Audit risk
CPA Competency: Audit and Assurance
AACSB: Analytic
68. Gaining an understanding of a client includes auditors learning how their clients measure their performance. How is this information used by auditors in audit planning and what are examples of non-financial performance measures commonly used by auditors?
Difficulty: Medium
Learning Objective: Outline how clients measure performance.
Section Reference: 4.4 Client approaches to measuring performance
CPA Competency: Audit and Assurance
AACSB: Analytic
69. Analytical procedures are used by auditors to evaluate their clients' financial information by studying plausible relationships among both financial and non-financial data. Explain how analytical procedures are used at different stages of an audit.
Difficulty: Medium
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
CASE QUESTIONS
70. (Reproduced with permission from CICA UFE Question 1996 — Paper 4 — Question 2)
Allentown Credit Union (ACU) is located in a rural community in Canada. Membership is open to people in the community and the surrounding area. The local economy, which is predominantly agricultural, has been harmed by droughts in recent years and by declines in commodity prices, leading to a decline in ACU’s profitability.
ACU has always had an external audit and has always prepared its financial statements in accordance with International Financial Reporting Standards. Ellino & Co. has audited ACU for the last several years. You, CPA, a senior with Ellino & Co., have been appointed to the audit of ACU for the year ended December 31, 2022. It is now early January 2023, and you are at the client’s premises reviewing the information gathered to date.
ACU was founded in 1942, and it has always maintained a philosophy of serving the community. This has resulted in liberal lending practices and investment in the local community whenever possible. This stance has distinguished it from other financial institutions, which are primarily branches of national banks, and has given ACU a 75% share of the market.
ACU has been headed by the general manager, Ted Richards, for the past ten years. Ted reports directly to the Board of Directors, which is comprised of local people, some of whom have no formal financial training. Ted has always been accessible to members of the credit union and, on occasion, he has intervened in favour of the customer over the staff. He maintains that this flexibility is crucial to generating revenue, which is an important objective of the Board.
The loan manager, Sheila Meigs, joined ACU in the past year. She is responsible for the entire lending function, which includes authorization of loans, appraisal of collateral, and assessment of the collectibility of outstanding loans. The loan portfolio is the largest asset on the balance sheet, representing 75% of total assets.
The accountant, Vivian Larson, and the head teller, Joanne Blake, both have 15 years of experience at ACU. Both are married to farmers and work to supplement their income. Both families are members of ACU, and all their personal and business transactions are conducted through the credit union.
As you read through your notes, Ted Richards interrupts you to tell you about some of the events that have occurred at ACU during the year.
- ACU foreclosed on a large loan and sold the land held as collateral. One effect of this sale was to depress the land prices in the surrounding area. ACU still maintains a high inventory of land received from past foreclosures but has decided to hold onto this land for fear of depressing land prices further.
- As a result of the depressed state of the local economy, provisions have recently been made to allow some customers to repay their loans with grains (i.e., oats and barley) instead of cash. Although such payments are not a common practice, Ted has approved these transactions on an exception basis.
- Even though the economy is depressed, Ted believes this will turn around and loans will be collected over the long term. Therefore, he has instructed to Sheila Meigs, Loan Manager, not to write off any significant loans as loan balances.
Required:
a) Define inherent risk and perform an inherent risk assessment for ACU.
b) Perform a control risk assessment.
c) Conclude on the overall risk of material misstatement.
d) How will your audit risk conclusion impact the audit strategy?
Difficulty: Medium
Learning Objective: Evaluate audit risk.
Learning Objective: Describe how an auditor determines the audit strategy.
Section Reference: 4.1 Audit risk
Section Reference: 4.3 Audit strategy
CPA Competency: Audit and Assurance
AACSB: Analytic
71. Ron Yates, the senior auditor at Delahanty, Forbes, CPAs was planning for the audit of Winnipeg Lighting Showcase (WLS) and decided to use benchmarking as an analytical procedure. His manager agreed with Ron’s approach and suggested information sources that would ensure the reliability of the data for his benchmarking exercise.
As Ron walked out of the office he ran into Irene Balla, a newly hired auditor. He congratulated her on her decision to use a substantive approach to her accounts receivable section of the audit program.
Irene was also going to be reviewing certain internal controls in the WLS audit program. She asked him to whom she should report weaknesses in the client’s internal controls.
Required:
a) Which information sources are generally considered to be reliable when conducting benchmarking exercises?
b) What circumstances would have made Irene use a substantive approach?
c) To whom will Irene report weaknesses in a client's system of internal controls?
Difficulty: Medium
Learning Objective: Describe how an auditor determines the audit strategy.
Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.
Section Reference: 4.3 Audit strategy
Section Reference: 4.5 Analytical procedures
CPA Competency: Audit and Assurance
AACSB: Analytic
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