Chapter 9

The following questions concern the assessment of the risk of material misstatements. Choose
the best response.
Which of the following circumstances most likely would cause the auditor to suspect that there are
material misstatements in the entity's financial statements?
Significant differences between the physical inventory count and the accounting records are not
investigated.
Which of the following statements describes why a properly designed and executed audit may not detect
a material misstatement in the financial statements resulting from fraud?
Audit procedures that are effective for detecting an unintentional misstatement may be ineffective for an
intentional misstatement that is concealed through collusion.
Prior to, or in conjunction with, the information-gathering procedures for an audit, audit team members
should discuss the potential for material misstatement due to fraud. Which of the following best
characterizes the mindset that the audit team should maintain during this discussion?
Questioning

The following questions concern the audit risk model. Choose the best response.
Some account balances, such as those for pensions and leases, are the result of complex calculations.
The susceptibility to material misstatements in these types of accounts is defined as inherent risk.

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As the acceptable level of detection risk decreases, the auditor may do one or more of the following

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except change the assurances provided by audit procedures to a lower level.
Inherent risk and control risk differ from planned detection risk in that they exist independently of the

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financial statement audit.

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The following questions deal with audit risk and evidence. Choose the best response.
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Which of the following does not increase the need for sufficient appropriate audit evidence?
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A decrease in the assessed inherent risk
As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more
work on individual accounts to find smaller misstatements.
Based on evidence gathered and evaluated, an auditor decides to increase the assessed level of control
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risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the
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planned audit risk level, the auditor could decrease detection risk.
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The following questions concern auditor responsibilities related to the assessment of risks of
material misstatement. Choose the best response.
Which of the following procedures would a CPA most likely perform during the planning stage of
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the audit?
Determine areas where there is a higher risk of material misstatement.
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Dan, CPA, has been engaged to audit Modern Home, a manufacturing company that specializes in
furniture. Which of the following matters related to the year under audit would most likely result in an
increase of inherent risk?
Modern Home recently engaged in a complex derivative transaction.
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After making a preliminary assessment of the risk of material misstatement during planning and beginning
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to apply audit procedures, an auditor determines that this risk is actually higher than anticipated. Which
would be the most likely effect of this finding on the auditor's desired level of detection risk and the overall
level of audit risk, as compared to the levels originally planned?
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Auditor's Desired Level of Detection Risk Overall Level of Audit Risk

Decrease Same

There are eight parts of the planning phase of an audit. Which parts involve the evaluation of risk?
(Select all that apply.)
Identify significant risks due to fraud or error
Assess inherent risk
Understand internal control and assess control risk

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 Chapter 9

Why is it important for the auditor to consider the risk of material misstatement at the overall
financial statement level?
It is important for the auditor to consider risks at the overall financial statement level given those risks may
increase the likelihood of risks of material misstatement across a number of accounts and assertions for
those accounts.

Provide two examples of factors that might increase the risk of material misstatement at the
overall financial statement level.
declining economic conditions
significant changes in the industry

Assume that you are concerned that your client has recorded revenues that did not occur. What
audit objective would you assess as having a high risk of materialmisstatement?
Occurrence

Describe the types of procedures auditors perform as part of their risk assessment procedures.
(Select all that apply.)

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Observation and inspection: Auditors observe the entity's operations and they inspect documents, such

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as the organization's strategic plan, business model, and its organizational structure to increase

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the auditor's understanding of how the business is structured and how it organizes key business

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functions and leaders in the oversight of day-to-day operations.
Discussion among engagement team members: Auditing standards require the engagement partner and

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other key engagement team members to discuss the susceptibility of the client's financial
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statements to material misstatement. This includes explicit discussion about the susceptibility of
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the client's financial statements to fraud, in addition to their susceptibility of material misstatement
due to errors.
Analytical procedures: Auditors are required to perform preliminary analytical procedures as part of audit
planning to better understand the entity and to assess client business risks.
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Inquiries of management and others within the entity: Because management and others, including those
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charged with governance and internal audit, have important information to assist the auditor in
identifying risks of material misstatements, the auditor will make a number of inquiries of these
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individuals to understand the entity and its environment, including internal control, and to ask
them about their assessments of the risks of material misstatements.
Other risk assessment procedures: The auditor may perform other procedures to assist in the auditor's
assessment of the risk of material misstatement.
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In addition to inquiring of individuals among management who are involved in financial

reporting positions, such as the CFO and controller, which additional individuals should you
consider making inquiries of as part of your risk assessment procedures? Be sure to describe
how those individuals might be helpful to you in assessing risks of material misstatement. (Select
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all that apply.)

Because internal auditors typically have exposure to all aspects of the client's business and operations,
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they may have important information about risks at the overall financial statement level or
assertion level.
Inquiries of those charged with governance, such as the board of directors or audit committee, may
provide important insights about the overall competitive environment and strategy of the business
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that may provide important insights about overall client business risks.

Auditing standards require that the engagement team members engage in discussion about the
risk of material misstatement. Describe the nature of this required discussion and who should be
involved.
Auditing standards require the engagement partner and other key engagement team members to discuss
the susceptibility of the client's financial statements to material misstatement. This discussion provides an

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 Chapter 9
opportunity for more experienced team members to share their insights about the entity and its
environment, including their understanding of internal controls, with other members of the team.

Auditing standards require that the engagement team members engage in discussion about the
susceptibility of the financial statements to the risk of fraud. How does this discussion relate to
the required discussion about the risk of material misstatement?
Auditing standards explicitly require that the discussion among engagement team members consider the
susceptibility of the client's financial statements to fraud in addition to their susceptibility of material
misstatement due to errors. A discussion about fraud can be held concurrently with the discussion about
the susceptibility of the financial statements to material misstatement due to error. These discussions
should include an exchange of ideas or brainstorming among the engagement team members about
business risks and how and where the financial statements might be susceptible to
material misstatements, whether due to fraud or error.
Why is it important to distinguish the auditor's assessment of the risk of material misstatement
due to fraud from the assessment of the risk of material misstatement due to error?

Auditing standards require the auditor to explicitly consider fraud risk because the risk of not detecting a
material misstatement due to fraud is higher than the risk of not detecting a misstatement due to error.

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Fraud often involves complex and sophisticated schemes designed by perpetrators to conceal it. And,

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individuals engaged in conducting a fraud often intentionally misrepresent information, and they may try to

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conceal the transaction through collusion with others. As a result, explicitly focusing on the risks of

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material misstatements due to fraud helps the auditor apply professional skepticism as part of theauditor's
planning procedures.

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How should the auditor consider risks related to revenue recognition when assessing the risk of
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material misstatement due to fraud?
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Risks related to audit objectives for revenue transactions and their related account balances and
presentation and disclosure are presumed to be significant risks in most audits. If the auditor determines
that the presumption is not applicable to a particular audit engagement, the auditor must document this
conclusion in the working papers.
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What types of inquiries should the auditor make when considering the risk of material
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misstatement due to fraud?

inquire of management and others within the entity about their knowledge of any actual, suspected, or
alleged fraud affecting the client and whether management has communicated any information
about fraud risks to those charged with governance
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ask management to describe the frequency of management's assessment and the extent of their
consideration of risks due to fraud.
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inquire of management about their assessment of the risk that the financial statements may be materially
misstated due to fraud.

What constitutes a significant risk?

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An identified and assessed risk of material misstatement that, in the auditor's professional judgment,
requires special audit consideration.
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Describe examples of characteristics of transactions and balances that might cause an auditor to
determine that a risk of material misstatement is a significant risk.
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Select the characteristics of transactions and balances that might cause an auditor to determine that a
risk of material misstatement is a significant risk and then select each characteristic's matching
description.

1. This generally involves concealment and so detecting material misstatements

is difficult. As a result, when auditors identify a potential risk of material
misstatement, auditing standards require the auditor to consider that risk a

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 Chapter 9
significant risk, which triggers required responses to those risks.
2. Transactions that are common, either due to size or nature, and that are
frequent in occurrence. These transactions may increase the risk of material
misstatement because they often involve a greater extent of management
intervention, including more reliance on manual versus automated data
collection and processing, and they can involve complex calculations or
unusual accounting principles not subject to effective internal controls due to
the nature of their frequency. Related party transactions often reflect these
characteristics, thereby increasing the likelihood they are considered significant
risks.
3. Classes of transactions or account balances that are based on the
development of accounting estimates that are subjective or based on
assumptions about future events. As a result, these types of transactions or
balances frequently are identified as significant risks.
4. Transactions that are unusual, either due to size or nature, and that are
infrequent in occurrence. These transactions may increase the risk of material
misstatement because they often involve a greater extent of management
intervention, including more reliance on manual versus automated data

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collection and processing, and they can involve complex calculations or

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unusual accounting principles not subject to effective internal controls due to
the nature of their frequency. Related party transactions often reflect these

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characteristics, thereby increasing the likelihood they are considered significant

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risks.

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Characteristic
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Matters requiring significant judgement 3.
Fraud risk 1.
Non-routine transactions 4.
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Describe which two factors of the audit risk model relate to the risk of material misstatement at
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the assertion level.

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1. Measures the auditor's assessment of the susceptibility of an assertion to

material misstatement, before considering the effectiveness of related internal
controls.
2. Measures how willing the auditor is to accept that the financial statements
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may be materially misstated after the audit is completed and an unmodified

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opinion has been issued.

3. Measures the auditor's assessment of the risk that a material misstatement
could occur in an assertion and not be prevented or detected on a timely
basis by the client's internal controls.
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4. A measure of the risk that audit evidence for a segment will fail to detect
misstatements that could be material, should such misstatements exist.
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Factor Description
Inherent risk 1.
Control risk 3.
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Explain the causes of an increased or decreased planned detection risk.

Begin by explaining the causes of an increased planned detection risk.

An increase in planned detection risk may be caused by an increase in acceptable audit risk or a
decrease in either control risk or inherent risk.

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 Chapter 9
Next explain the causes of a decreased planned detection risk.
A decrease in planned detection risk is caused by a decrease in acceptable audit risk or an increase in
control risk or inherent risk.

Define what is meant by inherent risk. Identify four factors that are associated with higher inherent
risk in audits.
Define what is meant by inherent risk.
Inherent risk is a measure of the auditor's assessment of the likelihood that there are material
misstatements in a segment before considering the effectiveness of internal control.

Identify four factors that are associated with higher inherent risk in audits. (Identify all four answers from
the list below.)
Nature of the client's business
Related parties
Initial versus repeat engagement
Results of previous audits

Explain why inherent risk is set for audit objectives for segments (classes of transactions,

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balances, and presentation and disclosure) rather than for the overall audit. What is the effect on

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the amount of evidence the auditor must accumulate when inherent risk is increased from
medium too high for an audit objective?

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Inherent risk is set for audit objectives for segments rather than for the overall audit because

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misstatements occur at the objective level within a segment. By identifying expectations of misstatements

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in segments, the auditor is thereby able to modify audit evidence by searching for misstatements in those
segments.
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What is the effect on the amount of evidence the auditor must accumulate when inherent risk is increased
from medium too high for a segment?
When inherent risk is increased from medium to high, the auditor should increase the audit evidence
accumulated to determine whether the expected misstatement actually occurred.
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Explain the effect of extensive misstatements found in the prior year's audit on inherent risk,
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planned detection risk, and planned audit evidence.

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Extensive misstatements in the prior year's audit would cause inherent risk to be set at a high level. An
increase in inherent risk would lead to a decrease in planned detection risk, which would require that the
auditor increase the level of planned audit evidence.
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Explain what is meant by the term acceptable audit risk. What is its relevance to
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evidence accumulation?
Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may
be materially misstated after the audit is completed and an unqualified opinion has been issued.
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What is its relevance to evidence accumulation?

Acceptable audit risk has an inverse relationship to evidence. If acceptable audit risk is reduced, planned
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evidence should increase.

Explain the relationship between acceptable audit risk and the legal liability of auditors.
When the auditor is in a situation where he or she believes that there is a high exposure to legal liability,
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the acceptable audit risk would be set lower than when there is little exposure to liability. Even when the
auditor believes that there is little exposure to legal liability, there is still a minimum acceptable audit risk
that should be met.

Explain why there is an inverse relationship between planned detection risk and the amount of
evidence an auditor collects for a specific audit objective.

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 Chapter 9
Planned detection risk is the risk that audit evidence for a segment will fail to detect misstatements that
could be material, should such misstatements exist. In order to reduce this risk, the auditor would
increase the amount of evidence they collect for a specific audit objective. For example, if the auditor
wanted a low level of risk that audit procedures designed to test the existence of inventory fail to detect a
material misstatement, they would increase the amount of inventory tested and/or the number of audit
procedures performed.

Auditors have not been successful in measuring the components of the audit risk model. How is it
possible to use the model in a meaningful way without a precise way of measuring the risk?
Exact quantification of all components of the audit risk model is not required to use the model in a
meaningful way. An understanding of the relationships among model components and the effect that
changes in the components have on the amount of evidence needed will allow practitioners to use the
audit risk model in a meaningful way.

Explain the circumstances when the auditor should revise the components of the audit risk model
and the effect of the revisions on planned detection risk and planned evidence.
The auditor should revise the components of the audit risk model when the evidence accumulated during
the audit indicates that the auditor's original assessments of inherent risk or control risk are too low or too

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high or the original assessment of acceptable audit risk is too low or too high.

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Explain the effect of the revisions on planned detection risk and planned evidence.

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To determine the additional amount of evidence that will be required, it should be done without the use of
the audit risk model. When the audit risk model is used to determine a revised planned detection risk,

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there is a chance of not increasing the evidence sufficiently.
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Explain how audit risk and materiality are related and why they need to be considered together in
planning an audit.
Audit risk is a measure of how willing the auditor is to accept that the financial statements may be
materially misstated after the audit is completed and an unqualified opinion has been issued. An auditor
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cannot assess the risk of material misstatement without first deciding the size of misstatements that will
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be considered material. Materiality and audit risk are considered together in planning the nature and
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extent of risk assessment procedures to be performed, identifying and assessing the risks of
material misstatement, determining the nature, timing and extent of audit procedures, and evaluating
audit findings.
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sh

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