Chapter 8

8-25 (Objectives 8-1, 8-3, 8-4) The following questions concern the planning of
the engagement. Select the best response.
a. Which of the following will most likely indicate the existence of related
parties?
(1) Writing down obsolete inventory prior to year end
(2) Failing to correct deficiencies in the client’s internal control
(3) An unexplained increase in gross margin
(4) Borrowing money at a rate significantly below the market rate
Answer (4)

b. Which of the following is least likely to be included in the auditor’s

engagement letter?
(1) Details about the preliminary audit strategy
(2) Overview of the objectives of the engagement
(3) Statement that management is responsible for the financial statements
(4) Description of the level of assurance obtained when conducting the audit
Answer (1)

c. Analytical procedures used in planning an audit should focus on identifying:

(1) material weaknesses in internal control.
(2) the predictability of financial data from individual transactions.
(3) the various assertions that are embodied in the financial statements.
(4) areas that may represent specific risks relevant to the audit.
Answer (4)

1
8-26 (Objective 8-2) The following questions pertain to client acceptance. Choose
the best response.

a. When approached to perform an audit for the first time, the CPA should make
inquiries of the predecessor auditor. This is a necessary procedure because the
predecessor may be able to provide the successor with information that will assist
the successor in determining whether:
(1) the predecessor’s work should be used.
(2) the company follows the policy of rotating its auditors.
(3) in the predecessor’s opinion, internal control of the company has been satisfactory.
(4) the engagement should be accepted.
Answer (4)

b. A successor would most likely make specific inquiries of the predecessor

auditor regarding:
(1) specialized accounting principles of the client’s industry.
(2) the competency of the client’s internal audit staff.
(3) the uncertainty inherent in applying sampling procedures.
(4) disagreements with management as to auditing procedures.
Answer (4)

c. Which of the following circumstances would most likely pose the greatest risk in
accepting a new audit engagement?
(1) Staff will need to be rescheduled to cover this new client.
(2) There will be a client-imposed scope limitation.
(3) The firm will have to hire a specialist in one audit area.
(4) The client’s financial reporting system has been in place for 10 years.
Answer (2)

2
8-27 (Objectives 8-5, 8-6) The following questions deal with materiality. Choose
the best response.

a. Which one of the following statements is correct concerning the concept of

materiality?
(1) Materiality is determined by reference to guidelines established by the AICPA.
(2) Materiality depends only on the dollar amount of an item relative to other items in
the financial statements.
(3) Materiality depends on the nature of an item rather than the dollar amount.
(4) Materiality is a matter of professional judgment.
Answer (4)

b. In considering materiality for planning purposes, an auditor believes that

misstatements aggregating $10,000 will have a material effect on an entity’s
income statement, but that misstatements will have to aggregate $20,000 to
materially affect the balance sheet. Ordinarily, it is appropriate to design audit
procedures that are expected to detect misstatements that aggregate:
(1) $10,000.
(2) $15,000.
(3) $20,000.
(4) $30,000.
Answer (1)

c. A client decides not to record an auditor’s proposed adjustments that

collectively are not material and wants the auditor to issue the report based on the
unadjusted numbers. Which of the following statements is correct regarding the
financial statement presentation?
(1) The financial statements are free from material misstatement, and no disclosure is
required in the notes to the financial statements.
(2) The financial statements do not conform with generally accepted accounting
principles (GAAP).
(3) The financial statements contain unadjusted misstatements that should result in a
qualified opinion.
(4) The financial statements are free from material misstatement, but disclosure of the
proposed adjustment is required in the notes to the financial statements.
Answer (1)

3
8-28 (Objectives 8-1, 8-2, 8-6) The following questions deal with client acceptance,
audit planning, and materiality. Choose the best response.
a. Which of the following procedures would a CPA least likely perform during
the planning stage of the audit?
(1) Determine the timing of testing
(2) Take a tour of the client’s facilities
(3) Perform inquiries of outside legal counsel regarding pending litigation
(4) Determine the effect of information technology on the audit
Answer (3)
Because this is generally part of the execution phase where the impact on
financial statements is directly assessed.

b. A successor auditor’s inquiries of the predecessor auditor should include

questions regarding:
(1) the number of engagement personnel the predecessor assigned to the engagement.
(2) the assessment of the objectivity of the client’s internal audit function.
(3) communications to management and those charged with governance regarding
significant deficiencies in internal control.
(4) the response rate for confirmations of accounts receivable.
Answer (3)
Choice “A” is incorrect. The successor auditor generally would not inquire about
the number of personnel assigned to the predecessor’s engagement.
Choice “B” is incorrect. The successor auditor is responsible for making his or her
own judgments regarding the audit and would not typically inquire regarding the
predecessor auditor’s judgments with respect to the internal audit function.
Choice “D” is incorrect. The successor auditor generally would not specifically
inquire about the response rate for confirmations of accounts receivable. However,
the successor auditor would be able to obtain this information when reviewing the
predecessor’s workpapers.

c. In which of the following circumstances would an auditor of an issuer be least

likely to reevaluate established materiality levels?
(1) The materiality level was established based on preliminary financial statement
amounts that differ significantly from actual amounts.
(2) The client disposed of a major portion of the client’s business.
(3) The client released third-quarter results before the SEC-prescribed deadline.
(4) Significant new contractual arrangements draw attention to a particular aspect of a
client’s business that is separately disclosed in the financial statements.
Answer (3)

4
 Chapter 9
9-25 (Objectives 9-1, 9-3, 9-4) The following questions concern the assessment of
the risk of material misstatements. Choose the best response.
a. Which of the following circumstances most likely would cause the auditor to
suspect that there are material misstatements in the entity’s financial statements?
(1) The entity’s management places no emphasis on meeting publicized earnings
projections.
(2) Significant differences between the physical inventory count and the accounting
records are not investigated.
(3) Monthly bank reconciliations ordinarily include several large outstanding
checks.
(4) Cash transactions are electronically processed and recorded, leaving no paper audit
trail.
Answer (2)

b. 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?
(1) Audit procedures that are effective for detecting an unintentional misstatement may
be ineffective for an intentional misstatement that is concealed through collusion.
(2) An audit is designed to provide reasonable assurance of detecting material errors,
but there is no similar responsibility concerning fraud.
(3) The factors considered in assessing control risk indicated an increased risk of
intentional misstatements, but only a low risk of unintentional errors in the financial
statements.
(4) The auditor did not consider factors influencing audit risk for account balances that
have effects pervasive to the financial statements as a whole.
Answer (1)

c. 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?
(1) Presumptive
(2) Judgmental
(3) Criticizing
(4) Questioning
Answer (4)

5
9-26 (Objectives 9-5, 9-7) The following questions concern the audit risk model.
Choose the best response.
a. 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:
(1) audit risk.
(2) detection risk.
(3) inherent risk.
(4) sampling risk.
Answer (3)

b. As the acceptable level of detection risk decreases, the auditor may do one or
more of the following except change the:
(1) nature of audit procedures to more effective procedures.
(2) timing of audit procedures, by perhaps performing them at year-end rather than an
interim date.
(3) extent of audit procedures, by perhaps using larger sample sizes.
(4) assurances provided by audit procedures to a lower level.
Answer (4)

c. Inherent risk and control risk differ from planned detection risk in that they:
(1) arise from the misapplication of auditing procedures.
(2) may be assessed in either quantitative or nonquantitative terms.
(3) exist independently of the financial statement audit.
(4) can be changed at the auditor’s discretion.
Answer (3)

6
9-27 (Objective 9-8) The following questions deal with audit risk and evidence.
Choose the best response.

a. Which of the following does not increase the need for sufficient appropriate
audit evidence?
(1) A lower acceptable level of detection risk
(2) An increase in the assessed control risk
(3) A lower acceptable audit risk
(4) A decrease in the assessed inherent risk
Answer (4)

b. As lower acceptable levels of both audit risk and materiality are established, the
auditor should plan more work on individual accounts to:
(1) find smaller misstatements.
(2) find larger misstatements.
(3) increase the performance materiality in the accounts.
(4) increase inherent risk in the accounts.
Answer (1)

c. Based on 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 could:
(1) decrease detection risk.
(2) increase materiality levels.
(3) decrease substantive testing.
(4) increase inherent risk.
Answer (1)

7
9-28 (Objectives 9-1, 9-2, 9-5, 9-6, 9-8) The following questions concern auditor
responsibilities related to the assessment of risks of material misstatement. Choose
the best response.

a. Which of the following procedures would a CPA most likely perform during the
planning stage of the audit?
(1) Evaluate the reasonableness of management’s allowance for doubtful accounts.
(2) Determine areas where there is a higher risk of material misstatement.
(3) Evaluate the significance of uncorrected misstatements.
(4) Confirm a sample of accounts receivable.
Answer (2)

b. 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?
(1) The furniture industry has experienced an overall increase in demand.
(2) Modern Home recently engaged in a complex derivative transaction.
(3) Modern Home experienced an increase in working capital.
(4) Modern Home purchased expensive new equipment in the current year.
Answer (2)

c. After making a preliminary assessment of the risk of material misstatement

during planning and beginning 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?
Auditor’s Desired Level Overall Level
of Detection risk of audit risk
1 Decrease Same
2 Increase Same
3 Same Higher
4 Decrease Lower
Answer (1)

8
 Cases on Chapter 9 (also found in the powerpoint file)
9-33 (Objective 9-6) Bohrer, CPA, is considering the following factors in assessing
audit risk at the financial statement level in planning the audit of Waste Remediation
Services (WRS), Inc.’s financial statements for the year ended December 31, 2016.
WRS is a privately held company that contracts with municipal governments to close
landfills. Audit risk at the financial statement level is influenced by the risk of material
misstatements, which may be indicated by factors related to the entity, management,
and the industry environment.
For each of the 14 factors listed below, indicate whether the item would likely
increase audit risk, decrease audit risk, or have no effect on audit risk.

1. This was the first year WRS operated at a profit since 2011 because the municipalities
received increased federal and state funding for environmental purposes.

2. WRS’s Board of Directors is controlled by Tucker, the majority shareholder, who

also acts as the chief executive officer.

3. The internal auditor reports to the controller and the controller reports to Tucker.

4. The accounting department has experienced a high rate of turnover of key personnel.

5. WRS’s bank has a loan officer who meets regularly with WRS’s CEO and controller
to monitor WRS’s financial performance.

6. WRS’s employees are paid bi-weekly.

7. Bohrer has audited WRS for five years.

8. During 2016, WRS changed its method of preparing its financial statements from the
cash basis to generally accepted accounting principles.

9. During 2016, WRS sold one half of its controlling interest in Sanitation Equipment
Leasing Co. (SEL). WRS retained a significant interest in SEL.

10. During 2016, litigation filed against WRS in 2003 alleging that WRS discharged
pollutants into state waterways was dropped by the state. Loss contingency disclosures
9
that WRS included in prior years’ financial statements are being removed for the 2016
financial statements.

11. During December 2016, WRS signed a contract to lease disposal equipment from
an entity owned by Tucker’s parents. This related party transaction is not disclosed in
WRS’s notes to its 2016 financial statements.

12. During December 2016, WRS increased its casualty insurance coverage on several
pieces of sophisticated machinery from historical cost to replacement cost.

13. WRS recorded a substantial increase in revenue in the fourth quarter of 2016.
Inquiries indicated that WRS initiated a new policy and guaranteed several
municipalities that it would refund state and federal funding paid to WRS on behalf of
the municipality if it failed a federal or state site inspection in 2017.

14. An initial public offering of WRS stock is planned in 2017.

Solution
1 Decrease Healthier financial condition leads to a decrease in audit risk.
2 Increase Audit risk increases when management is dominated by a single person.
Audit risk increases when internal audit reports to top management rather than the
3 Increase
audit committee.
4 Increase Audit risk increases when there is turnover in key management positions.
5 Decrease The monitoring by the bank loan officer decreases audit risk.
6 No effect The timing of payments to employees has no effect on audit risk.
7 Decrease Audit risk decreases due to the auditor’s previous experience with the client.
A change in the method of accounting increases the risk of misstatements due to the
8 Increase
new reporting method.
9 Increase The unusual transaction increases audit risk.
10 Decrease The resolution of the lawsuit decreases risk related to disclosure of the litigation.
11 Increase Related party transactions increase audit risk.
12 No effect The amount of insurance coverage has minimal effect on audit risk.
13 Increase The potential for improper revenue recognition increases audit risk.
A planned stock offering increases incentives to misstate the financial statements and
14 Increase
increases audit risk.

10
9-34 (Objectives 9-5, 9-8) Following are six situations that involve the audit risk
model as it is used for planning audit evidence requirements in the audit of
inventory.
Risk 1 2 3 4 5 6
Acceptable audit risk High High Low Low High Medium
Inherent risk Low High High Low Medium Medium
Control risk Low Low High High Medium Medium
Planned detection risk ……. …… …… …… …… ……
Planned evidence …….. …… …… …… …… ……
a. Explain what low, medium, and high mean for each of the four risks and planned
evidence.
b. Fill in the blanks for planned detection risk and planned evidence using the terms
low, medium, or high.
c. Using your knowledge of the relationships among the foregoing factors, state the
effect on planned evidence (increase or decrease) of changing each of the following five
factors, while the other three remain constant:
(1) A decrease in acceptable audit risk
(2) A decrease in control risk
(3) A decrease in planned detection risk
(4) A decrease in inherent risk
(5) A decrease in inherent risk and an increase in control risk of the same amount

Solution
a. Low, medium, and high for the four risks and planned evidence have meaning
only in comparison to each other. For example, an acceptable audit risk that
is high means the auditor is willing to accept more risk than in a situation where
there is medium risk without specifying the precise percentage of risk. The same
is true for the other three risk factors and planned evidence.

b.

1 2 3 4 5 6
Acceptable High High Low Low High Medium
Audit Risk
IR x CR Low Medium High Medium Medium Medium
PDR = High Medium Low Low Medium Medium
AAR / (IR x
CR)
Planned Low Medium High High Medium Medium
Evidence

11
 c.

EFFECT ON PDR EFFECT ON EVIDENCE

(1) Decrease Increase

(2) Increase Decrease
(3) NA Increase
(4) Increase Decrease
(5) No effect No effect

9-35 (Objectives 9-5, 9-7, 9-8) Mark Hopper is planning the audit of the investments
account for audit client Garden Supply Co. (GSC). GSC invests excess cash at the end
of the summer sales season through an investment manager who invests in equity and
debt securities for GSC’s account. Hopper has assessed the following risks as low,
medium, or high for the relevant balance-related audit objectives in the investment
account.
Risk of Material Misstatements
Balance-related Acceptable Inherent risk Control risk planned
audit Objectives audit risk Detection risk
Existence Medium Medium Medium
Completeness Medium Low Medium
Accuracy Low High Medium
Classification Medium Low Low
Cutoff Medium Medium Low
Detail tie-in Low Medium Low
Realizable value Low High Medium
Rights and Medium Medium Low
obligations
Required:

a. Describe each of the four identified risks in the columns of the table above.
b. Fill in the blank for planned detection risk for each balance-related audit objective
using the terms low, medium, or high.
c. Which audit objectives require the greatest amount of evidence and which require the
least?
d. Through audit testing, Hopper finds the investment manager’s controls over
recording purchases and sales of securities are not as effective as originally assessed.
What should Hopper do?

12
Solution
a. Acceptable audit risk 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. This is the risk that the auditor will
give an incorrect audit opinion.

Inherent risk A measure of the auditor’s assessment of the susceptibility of an

assertion to material misstatement before considering the effectiveness of internal
control. This risk relates to the auditor’s expectation of misstatements in the
financial statements, ignoring internal control.

Control risk A measure of the auditor’s assessment of the risk that a material
misstatement could occur in an assertion and not be prevented or detected by
the client’s internal controls. This risk is related to the effectiveness of a client’s
internal controls.

Planned detection risk A measure of the risk that audit evidence for an audit
objective will fail to detect misstatements exceeding performance materiality,
should such misstatements exist. This risk is determined by using the other three
factors in the risk model using the formula PDR = AAR / (IR x CR).
b.
Risk of Material Misstatements
Balance- Acceptable Inherent Risk Control Risk Planned
Related Audit Audit Risk Detection Risk
Objectives
Existence Medium Medium Medium Medium
Completeness Medium Low Medium Medium
Accuracy Low High Medium Low
Classification Medium Low Low High
Cut-off Medium Medium Low Medium
Detail tie-in Low Medium Low Low/Medium
Realizable Low High Medium Low
value
Rights and Medium Medium Low Medium
obligations

c. The accuracy and realizable value audit objectives require the greatest amount of
evidence in order to reduce detection risk to a low level. The classification audit
objective requires the least amount of evidence as planned detection risk is at a high
level.

d. John may increase his assessment of control risk in the existence, completeness
and cutoff audit objectives, which would result in a decrease in acceptable audit risk
and a decrease in planned detection risk. If Mark decides it is appropriate to lower
planned detection risk, he will increase the amount of audit evidence gathered.

13