Q 1 Match the terms below (a-h) with the definitions provided below (1-8):

a. Preliminary judgment about materiality

b. Inherent risk
c. Planned detection risk
d. Audit assurance
e. Acceptable audit risk
f. Control risk
g. Materiality

___C_____ 1. A measure of the risk that audit evidence for a segment will fail to detect
misstatements exceeding the performance materiality amount, should such misstatements
exist.

_____F___ 2. A measure of the auditor's assessment of the likelihood that misstatements

exceeding a performance materiality in a segment will not be prevented or detected by
the client's internal controls.

_____E___ 3. A measure of how much risk the auditor is willing to take that the financial
statements may be materially misstated after the audit is completed and an unqualified
audit opinion has been issued.

_____A___ 4. The maximum amount by which the auditor believes that the statements
could be misstated and still not affect the decisions of reasonable users.

______D__ 5. This term is synonymous with acceptable audit risk.

_G_______ 6. The magnitude of an omission or misstatement of accounting information

that makes it probable that the judgment of a reasonable person would have been
changed.

____B____ 7. A measure of the auditor's assessment of the likelihood that there are
material misstatements before considering the effectiveness of internal control.

Q 2 Define the audit risk model components

 Control risk. This risk is caused by the failure of existing controls or the absence
of controls, leading to incorrect financial statements.
 Detection risk. This risk is caused by the failure of the auditor to discover a
material misstatement in the financial statements.
 Inherent risk. This risk is caused by an error or omission arising from factors
other than control failures. This risk is most common when accounting transactions are
quite complex, there is a high degree of judgment involved in accounting for
transactions, or the training level of the accounting staff is low.

Q 3 what are the five steps in applying materiality in an audit. Identify the audit phase(s)
in which each step is performed. List these steps in the order in which they occur.

Answer
Step 1. Set preliminary judgment about materiality. This is the combined amount of
misstatements in the financial statements that would be considered material. This
decision is made in the planning stage of the audit.
Step 2. Allocate preliminary judgment about materiality to segments. In this step, the
auditor normally allocates the preliminary judgment about materiality to the balance
sheet accounts. The amount of materiality allocated to an account is referred to as that
account's performance materiality. This allocation is performed in the audit planning
stage.
Step 3. Estimate total misstatement in segment. In this step, the auditor projects the
sample results to the population. An allowance for sampling risk is also calculated. This
would be performed after the substantive tests for each account are completed.

Step 4. Estimate the combined misstatement. In this step, the projected errors for each
account are added, along with total sampling error, to calculate the combined
misstatement. This would be performed after all substantive tests have been completed.
Step 5. Compare combined estimated misstatement with preliminary or revised judgment
about materiality. If the combined estimated misstatement is less than or equal to the
judgment about materiality, then the auditor concludes the financial statements are fairly
presented. This would be performed after all substantive tests have been completed, in
the final review stage of the audit.

Q 4 Explain the internal control framework (COSO)

The control environment consists of the actions, policies, and procedures that reflect the overall
attitudes of top management, directors, and owners of an entity about internal control and its
importance to the entity.

Integrity and ethical values are the product of the entity’s ethical and behavioral standards as
well as how they are communicated and reinforced in practice.

Competence is the knowledge and skills necessary to accomplish tasks that define an
individual’s job.

The board of directors is essential for effective corporate governance because it has ultimate
responsibility to make sure management implements proper internal control and financial
reporting processes.

1. Risk Assessment

 Identify factors that may increase risk

 Estimate the significance of the risk

 Assess the likelihood of the risk occurring

 Determine actions necessary to manage the risk

2. Control Activities:Control activities are the policies and procedures that help ensure
that necessary actions are taken to address risks to the achievement of the entity’s
objectives.
- Adequate separation of duties
- Adequate documents and records
- Physical control over assets and records
 3. Information and Communication: The purpose of an accounting information and
communication system
4. Monitoring activities deal with management’s ongoing and periodic assessment of the
quality of internal control performance to determine whether controls are operating as
intended and modified when needed

Q 5 Choose the correct answer

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

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

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

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

2) When evaluating the audit findings, the auditor 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.

3) 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.
4) When dealing with audit risk:
A) auditors accept some level of risk in performing the audit function.
B) most risks that auditors encounter are relatively easy to measure.
C) the audit risk model is only used for classes of transactions.
D) most audit firms prefer to use a quantitative assessment for risk.
5) 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.
6) The risk that audit evidence for a segment will fail to detect misstatements exceeding
performance materiality levels is:
A) audit risk.
B) control risk.
C) inherent risk.
D) planned detection risk.
7) As the risk of material misstatement increases, detection risk should:
A) medium increase.
B) decrease.
C) stay the same.
D) Is indeterminate.
8) 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

9) 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

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