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Audit Risk and Materiality

MULTIPLE CHOICE: 1. An auditor compares 2002 revenues and expenses with those of the prior year and investigates all changes exceeding 10%. By this procedure the auditor would be most likely to learn that a. An increase in property tax rates has not been recogni ed in the client!s accrual. b. "he 2002 provision for uncollectible accounts is inade#uate$ because of worsening economic conditions. c. %ourth #uarter payroll taxes were not paid. d. "he client changed its capitali ation policy for small tools in 2002. A&'()*+ 2. ,

"he element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the a. "iming of inventory observation procedures to be performed. b. )vidence to be gathered to provide a sufficient basis for the auditor!s opinion. c. -rocedures to be undertaken to discover litigation$ claims$ and assessments. d. -ending legal matters to be included in the in#uiry of the client!s attorney. A&'()*+ A

3.

(hen a .-A is approached to perform an audit for the first time$ the .-A should make in#uiries of the predecessor auditor. "his is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining a. (hether the predecessor!s work should be utili ed. b. (hether the company follows the policy of rotating its auditors. c. (hether$ in the predecessor!s opinion$ internal control of the company has been satisfactory. d. (hether the engagement should be accepted. A&'()*+ ,

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

/.

0aving evaluated inherent risk and control risk$ the auditor determines detection risk a. As the complement of overall audit risk. b. By performing substantive audit tests. c. As a product of further study of the business and industry and application of analytical procedures. d. At a level that e#uates the 1oint probability of inherent risk$ control risk$ and detection risk with overall audit risk. A&'()*+ ,

2.

(hich of the following is not a factor that affects the auditor!s 1udgment$ during audit planning$ as to the #uantity$ type$ and content of working papers3 a. "he auditor!s preliminary assessment of control risk. b. "he auditor!s preliminary evaluation of inherent risk based on discussions with the client. c. "he nature of the client4s business. d. "he type of report to be issued by the auditor. A&'()*+ ,

6.

0ow can the audit program best be described at the beginning of the audit process3 a. "entative. b. .onclusive. c. .omprehensive. d. 5ptional. A&'()*+ A

6.

"he auditor!s analytical procedures will be facilitated if the client a. 7ses a standard cost system that produces variance reports. b. 'egregates obsolete inventory before the physical inventory count. c. .orrects material weaknesses in internal control before the beginning of the audit. d. *educes inventory balances to the lower of cost or market. A&'()*+ A

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality 8. )xperience has shown that certain conditions in an organi ation are symptoms of possible management fraud. (hich of the following conditions would not be considered an indicator of possible fraud3 a. 9anagers regularly assuming subordinates! duties. b. 9anagers dealing in matters outside their profit center!s scope. c. 9anagers not complying with corporate directives and procedures. d. 9anagers sub1ect to formal performance reviews on a regular basis. A&'()*+ :. ,

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(hich of the following underlies the application of generally accepted auditing standards$ particularly the standards of field work and reporting3 a. "he elements of materiality and relative risk. b. "he element of internal control. c. "he element of corroborating evidence. d. "he element of reasonable assurance. A&'()*+ A

10.

(hich of the following is not a purpose served by the application of analytical procedures3 a. b. c. d. As part of audit planning to assist in locating significant changes in revenues and expenses. "o provide a basis for lowering materiality thresholds where significant earnings inflation is indicated. "o determine the economic substance of related party transactions. As part of audit review to determine that all significant abnormalities have been resolved to the auditor!s satisfaction. .

A&'()*+ 11. is

"he probability of an auditor!s procedures leading to the conclusion that a material error does not exist in an account balance when$ in fact$ such error does exist referred to as a. -revention risk. b. ;nherent risk. c. .ontrol risk. d. ,etection risk.

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

A&'()*+ 12.

(hich of the following concepts is most useful in assessing the scope of an auditor!s program relating to various accounts3 a. Attribute sampling. b. 9ateriality. c. "he reliability of information. d. 9anagement fraud. A&'()*+ B

1<.

"he existence of a related party transaction may be indicated when another entity a. 'ells real estate to the corporation at a price that is comparable to its appraised value. b. Absorbs expenses of the corporation. c. Borrows from the corporation at a rate of interest d. which e#uals the current market rate. =ends to the corporation at a rate of interest$ which e#uals the current market rate. B

A&'()*+ 1/.

(hich of the following is an indicator of possible fraudulent financial reporting for the purpose of inflating earnings3 a. A trend analysis discloses+ >1? sales increases of 20 percent and >2? cost of goods sold increases of 22 percent. b. A ratio analysis discloses+ >1? sales of @20 million and >2? cost of goods sold of @22 million. c. A crossAsectional analysis of common si e statements discloses+ >1? the firm!s ratio of cost of goods sold to sales is ./ and >2? the industry average ratio of cost of goods sold to sales is .2. d. A crossAsectional analysis of common si e statements discloses+ >1? the firm!s ratio of cost of goods sold to sales is .2 and >2? the industry average ratio of cost of goods sold to sales is ./. A&'()*+ A

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality 12.

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An auditor 1udged an item to be immaterial when planning an audit. 0owever$ the auditor may still include the item if it is subse#uently determined that+ a. 'ufficient staff is available. b. Adverse effects related to the item are likely to occur. c. *elated evidence is reliable. d. 9iscellaneous income is affected. A&'()*+ B

1B. the

Civen that an audit in accordance with generally accepted auditing standards is influenced by the possibility of material errors and fraud$ the auditor should conduct audit with an attitude of a. -rofessional responsiveness. b. .onservative advocacy. c. 5b1ective 1udgment. d. -rofessional skepticism. A&'()*+ ,

16.

(arning signs that cause the auditor to #uestion management integrity must be taken seriously and pursued vigorously. (hich of the following may lead the auditor to suspect management dishonesty3 a. "he president and chief executive officer of the client corporation has held numerous meetings with the controller for the purpose of discussing accounting practices that will maximi e reported profits. b. "he client has been named as a defendant in a product liability suit. c. "he client has experienced a decrease in revenue from increased import competition. d. A new federal regulation making customer licenses more difficult to obtain may adversely affect the client!s operations. A&'()*+ A

18.

Auditors sometimes use comparison of ratios as audit evidence. %or example$ an unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities3 a. 7nrecorded purchases. b. 7nrecorded sales.

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality c. d. 9erchandise purchases being charged to selling and general expense. %ictitious sales.

1:.

A&'()*+ B ;n applying analytical procedures$ the auditor discovered that gross profit as a percent of sales declined sharply during the current year. A possible cause might be a. "he client has significant amounts of obsolete inventory carried at full cost. b. A significant #uantity of finished goods located in a distant warehouse was inadvertently omitted from the ending inventory. c. *ecorded sales included goods that were shipped the following year. d. ,epreciation of office e#uipment was overstated. A&'()*+ B

20.

(hich of the following is not a component of audit planning3 a. 5bserving the client!s annual physical inventory taking and making test counts of selected items. b. 9aking arrangements with the client concerning the timing of audit field work and use of the client!s staff in completing certain phases of the examination. c. 5btaining an understanding of the business. d. ,eveloping audit programs. A&'()*+ A

21.

Audit risk consists of all but the following components+ a. ;nherent risk. b. ,etection risk. c. 'ubstantive risk. d. .ontrol risk. A&'()*+ .

22. 'ignificant unexpected fluctuations identified by analytical procedures will usually necessitate a>an? a. .onsistency #ualification. b. *eview of internal control. c. )xplanation in the representation letter. d. Auditor investigation. A&'()*+ ,

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality 2<.

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(hich of the following conditions supports an increase in detection risk3 a. ;nternal control over cash receipts is excellent. b. Application of analytical procedures reveals a significant increase in sales revenue in ,ecember$ the last month of the fiscal year. c. ;nternal control over shipping$ billing$ and recording of sales revenue is weak. d. 'tudy of the business reveals that the client recently ac#uired a new company in an unrelated industry. A&'()*+ A

2/.

(hich of the following statements best describes the auditor!s responsibility regarding the detection of fraud3 a. "he auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance of audit procedures specifically described in the engagement letter. b. "he auditor should design audit procedures that will provide reasonable assurance that the financial statements are free from material misstatement due to errors andDor fraud. c. "he auditor must extend auditing procedures to actively search for evidence of fraud where the examination indicates that fraud may exist. d. "he auditor is responsible for the failure to detect fraud only when an un#ualified opinion is issued. A&'()*+ B

22.

An independent auditor observed that only one of the company!s ten divisions had a large number of material sales transactions close to the end of the fiscal year. ;n terms of risk analysis$ this would most likely lead the auditor to conclude that+ a. "here is a relatively higher risk of overstatement of revenues for this division than for other divisions. b. *isks associated with auditing this division are not affected by this information. c. "here is a high risk that liabilities of this division are understated. d. "here is a high risk that the other nine divisions have understated revenues. A&'()*+ A

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

2B.

An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the planning phase of the audit by the use of a. "ests of transactions and balances. b. A preliminary review of internal control. c. 'peciali ed audit programs. d. Analytical procedures. A&'()*+ 26. ,

;nherent risk is defined as the susceptibility of an account balance or class of transactions to error that could be material assuming that there were no related internal controls. 5f the following conditions$ which one does not increase inherent risk3 a. "he client has entered into numerous related party transactions during the year under audit. b. ;nternal control over shipping$ billing$ and recording of sales revenue is weak. c. "he client has lost a ma1or customer accounting for approximately <0% of annual revenue. d. "he board of directors approved a substantial bonus for the president and chief executive officer$ and also approved an attractive stock option plan for themselves. A&'()*+ B

28. are

"he understanding between the client and the auditor as to the degree of responsibilities to be assumed by each normally set forth in a>an? a. *epresentation letter. b. )ngagement letter. c. 9anagement letter. d. .omfort letter. A&'()*+ B

2:.

"he element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the a. 9ethods of statistical sampling to be used in confirming accounts receivable. b. -ending legal matters to be included in the in#uiry of the client!s attorney.

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality c. d. )vidence to be gathered to provide a sufficient basis for the auditor!s opinion. 'chedules and analyses to be prepared by the client!s staff. ,

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A&'()*+ <0.

(hich of the following statements concerning materiality thresholds is incorrect3 a. Aggregate materiality thresholds are a function of the auditor!s preliminary 1udgments concerning audit risk. b. ;n general$ the more misstatements the auditor expects$ the higher should be the aggregate materiality threshold. c. "he smallest aggregate level of errors or fraud that could be considered material to any one of the financial statements is referred to as a Emateriality threshold.E d. 9ateriality thresholds may change between the planning and review stages of the audit. "hese changes may be due to #uantitative andDor #ualitative factors. A&'()*+ B

<1.

(ith respect to errors and fraud$ the auditor should plan to a. 'earch for errors or fraud that would have a material effect on the financial statements. b. ,iscover errors or fraud that would have a material effect on the financial statements. c. 'earch for errors that would have a material effect and for fraud that would have either material or immaterial effects on the financial statements. d. 'earch for fraud that would have a material effect and for errors that would have either material or immaterial effects on the financial statements. A&'()*+ <2. B

(hy should the auditor plan more work on individual accounts as lower acceptable levels of both audit risk and materiality are established3 a. "o find smaller errors. b. "o find larger errors. c. "o increase the tolerable error in the accounts. d. "o decrease the risk of overreliance.

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

A&'()*+ <<.

"he auditor notices significant fluctuations in key elements of the company!s financial statements. ;f management is unable to provide an acceptable explanation$ the auditor should a. .onsider the matter a scope limitation. b. -erform additional audit procedures to investigate the matter further. c. ;ntensify the examination with the expectation of detecting management fraud. d. (ithdraw from the engagement. A&'()*+ B

</.

(hich of the following audit risk components may be assessed in nonA#uantitative terms3 ;nherent .ontrol ,etection risk risk risk a. b. c. d. A&'()*+ , Fes Fes &o Fes Fes &o Fes Fes &o Fes Fes Fes

<2.

(hich of the following statements is true with regard to the relationship among audit risk$ audit evidence$ and materiality3 a. "he lower the inherent risk and control risk$ the lower the aggregate materiality threshold. b. 7nder conditions of high inherent and control risk$ the auditor should place more emphasis on obtaining external evidence and should reduce reliance on internal evidence. c. (here inherent risk is high and control risk is low$ the auditor may safely ignore inherent risk. d. Aggregate materiality thresholds should not change under conditions of changing risk levels. A&'()*+ B

<B.

;n evaluating the effectiveness of a company!s credit and collection policies$ the ratio most likely to be used by an auditor is

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality a. b. c. d. Guick ratio. Accounts receivable turnover. (orking capital turnover. *eturn on sales. B

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A&'()*+ <6.

(hich of the following models expresses the general relationship of risks associated with the auditor!s evaluation of internal control >.*?$ study of the business and application of analytical procedures >;*?$ and overall audit risk >A*?$ that would lead the auditor to conclude that additional substantive tests of details of an account balance are not necessary3 ;* .* A* a. 20% /0% 10% b. 20% B0% 2% c. 10% 60% /.2% d. <0% /0% 2.2% A&'()*+ <8. A

5f the following procedures$ which is the most important that an auditor should use when performing an analytical review of the income statement3 a. 'elect sales and expense items and trace amounts to related supporting documents. b. .ompare actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences. c. 5btain from the proper client representatives$ inventory certificates for the beginning and ending inventory amounts that were used to determine cost of sales. d. Ascertain that the net income amount in the statement of changes in financial position >statement of cash flows? agrees with the net income amount in the income statement. A&'()*+ <:. B

"he risk of fraudulent financial reporting increases in the presence of a. ;ncentive systems based on operating income.

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality b. c. d. ;mproved control systems. 'ubstantial increases in sales. %re#uent changes in suppliers. A

A&'()*+ /0.

(hich of the following might be considered a Ered flagE indicating possible fraud in a large manufacturing company with several subsidiaries3 a. "he existence of a financial subsidiary. b. A consistent record of above average return on investment for all subsidiaries. c. .omplex sales transactions and transfers of funds between affiliated companies. d. 7se of separate bank accounts for payrolls by each subsidiary. A&'()*+ .

COMPLETION: /1. ;n satisfying the re#uirements of 'A' 82$ the auditor must assess the risk of material misstatement due to fraud$ develop an appropriate audit response$ and HHHHHHHHHHH the response. A&'()*+ 42. ,5.79)&"

A preliminary expectation of few errors$ followed by subse#uent discovery of numerous errors should lead to a in the aggregate materiality threshold. A&'()*+ ,).*)A') >=5()*;&C$ *),7.";5&?

/<.

0igh inherent risk$ combined with high control risk$ should lead the auditor to the aggregate materiality threshold. A&'()*+ =5()* >,).*)A')$ *),7.)?

//. the

A scheme perpetrated by top management to inflate reported earnings and net assets for the purpose of maximi ing value of stock options andDor bonuses is an example of HHHHHHHHHHHHH.

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality A&'()*+ %*A7,7=)&" %;&A&.;A= *)-5*";&C

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/2. "he main factor that distinguishes errors from fraud is . A&'()*+ /B. ;&")&"

"he two factors that contribute to the probability that unaudited financial statements contain material errors or fraud are and . A&'()*+ ;&0)*)&" *;'I$ .5&"*5= *;'I

/6.

;nasmuch as its complement forms the basis for the audit opinion$ overall audit risk should be set . A&'()*+ =5( risk is the

/8.

;n the audit risk e#uation$ controllable variable. A&'()*+ ,)").";5&

/:.

"he auditor4s primary goal in considering the client acceptance decision is to avoid associating with clients whose managements lack . A&'()*+ ;&")C*;"F

50.

;n a recurring audit$ the best source of business and industry information may be found in the . A&'()*+ -)*9A&)&" %;=)

21.

"he financial statement impact of a single error is referred to as materiality$ whereas the total effect of a series of errors is termed materiality. A&'()*+ ;&,;J;,7A= ;")9$ ACC*)CA")

22.

An audit approach that allocates proportionately more audit resources to areas of high audit risk is referred to as a audit. A&'()*+ *;'IA,*;J)&

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

2<.

"he $ in addition to the permanent file$ is an effective means for familiari ing members of the audit team with the nature of the client!s business and for highlighting those areas presenting the highest audit risk. A&'()*+ -*)AA7,;" .5&%)*)&.)

2/.

"he is an effective device for planning and controlling audit field work. A&'()*+ ";9) B7,C)"

55.

;llegal payments$ fraud detected during the audit$ and contingencies are examples of HHHHHHHHHHHHH aspects of materiality. A&'()*+ G7A=;"A";J)

MATCHING 2B. ;ndicate by letter the appropriate auditor4s response to each of the listed audit environments. 9ore than one response may be applicable to each environment. HHHH 1. "he auditor assesses control risk at a high level and suspects earnings inflation in the form of premature revenue recognition. HHHH 2. Although the auditor has found internal control to be highly effective$ analytical procedures suggest that repairs and maintenance expenses may have been debited to plant asset accounts$ thereby materially overstating net income. HHHH <. "he auditor perceives internal control over sales and cash receipts as excellentK but internal control over purchases$ inventory$ and cash payments is considered weak. HHHH /. ,ebits to the account$ L.onstruction in -rogressM have increased dramatically during the year under auditK during the same period$ however$ L*epairs and 9aintenance )xpenseM$ as well as L*esearch and ,evelopmentM have experienced significant declines. ;nternal control is considered good in all areas.

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

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HHHH 2. Although salespersons are granted 2% commissions on all sales$ the current year4s rate$ based on unaudited sales and commissions data$ is <%. ;nternal control over sales and cash receipts is strong. HHHH B. Based on past experience and analytical procedures applied to unaudited data$ the auditor suspects that the controller has understated net income to reduce the company4s tax liability. ;nternal control for the company is weak in all areas. HHHH 6."ests of internal control revealed it to be much more effective than the auditor had perceived during the preliminary planning stages. a. b. c. d. e. f. g. the h. =ower the individual item materiality threshold *aise the individual item materiality threshold =ower the aggregate materiality threshold *aise the aggregate materiality threshold ;ncrease reliance on external evidence .onsider internal evidence as possessing enhanced reliability *ely on external evidence for the expenditure cycle$ while accepting internal evidence as reliable for revenue cycle *ely on external evidence for the revenue cycle$ while accepting internal evidence as reliable for the expenditure cycle

'5=7";5&+ 1. 2. <. /. 2. B. 6. PROBLEM/E a$c$e a$f c$g a a b$c$e d$f A!

26. =ouis 0ernande set the following materiality thresholds for the 'anders (holesale audit+

73

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality ;ndividual item materiality A income statement+ @<0$000 >2% of unaudited net income$ @B00$000? ;ndividual item materiality A balance sheet+ >2% of unaudited net assets$ @<$200$000?@60$000 Aggregate materiality >20% of individual item? ;ncome statement @B$000 Balance sheet @1/$000

*e#uired+ a. b. (hat factors should 0ernande have considered in setting the above thresholds3 (hy is the aggregate threshold set at 20% rather than$ say 10% or 2%3 ;n the process of testing 'anders4 internal controls$ 0ernande discovered significant weaknesses that$ in his opinion$ may have materially impacted the financial statements. 9oreover$ the application of analytical procedures revealed the likelihood of a material overstatement of unaudited net income and net assets. (hat effect should these findings have on the materiality thresholds3

'5=7";5&+ a. ;n setting the individual item thresholds$ 0ernande should have considered the impact that a single misstatement would have on the decisions of a reasonably informed investor. "he income statement threshold determines whether proposed audit adjustments will be drafted$ while the balance sheet threshold relates to audit reclassifications. ;n setting the aggregate thresholds$ 0ernande should have considered the #uality of 'anders4 existing internal control. ;n this case$ the high percentage means that 0ernande believed 'anders4 internal control to be effective for the year under audit. "he stronger the internal control is perceived to be$ the fewer the expected errors$ and the higher the aggregate threshold. b. "he internal control weaknesses suggest that 0ernande should lower the aggregate materiality threshold percentage from 20% to a much lower figure. (eak internal control increases the probability that numerous small errors have occurred and$ in the aggregate$ have materially impacted the financial statements. "he high probability of material overstatement of net income and net assets suggests a lowering of the individual item thresholds. (hen materiality is related to a lower monetary base$ the minimum dollar amount that impacts decisions is also reduced. "he threshold may be lowered by reducing the

Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality percentages$ or by lowering the income and asset bases to which the percentages are applied.

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28. %or each of the listed scenarios$ determine whether inherent risk or control risk or both should be assessed at a high level. "hen describe an appropriate audit approach. ;n developing your approach$ consider whether the auditor should decrease reliance on internal evidence and suggest specific kinds of audit evidence you would recommend in the circumstances. 1. ;n planning the audit of Nayco .orporation$ .harles =awson$ the inAcharge senior auditor found Nayco4s internal controls to be effective in all transaction cycles. Analytical procedures revealed that Nayco4s operating income declined <0% in 2000$ based on unaudited data. ;ncreased competition from imports$ combined with more stringent emission re#uirements$ contributed to the decline. =awson is concerned$ however$ that Nayco reported operating income while its nearest competitors reported losses. 0e notes that Nayco is not showing a capacity loss notwithstanding a significant decrease in production and fixed overhead absorption. )nding inventories seem high relative to cost of goods sold for the year. 2. Although the internal controls for 9ontrose$ ;nc.$ a local cable broadcasting company$ are effective for the revenue cycle$ they are lacking in the expenditure cycle. 5f particular concern to )va Bresky$ the inAcharge auditor$ is the absence of internal control over the processing of invoices from and payments to network providers. "he 9ontrose engagement is an initial audit for Bresky4s firm and a first audit for 9ontrose. Analytical procedures do not reveal any apparent abnormalities. '5=7";5&+ 1. Civen the effectiveness of internal control$ =awson may assess control risk at a low level and should plan to rely on internal evidence in most areas of the audit. "he results of applying analytical procedures suggests a high level of inherent risk. Although operating income declined in 2000 relative to the preceding year$ =awson$ in light of the competition and the absence of a capacity loss$ should consider the probability of a material income overstatement. ;ncreased emphasis on auditing Nayco4s ending inventories$ including a careful analysis of overhead application$ is indicated. 2. Civen weaknesses in internal control over expenditures$ Bresky should assess control risk at a high level

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Chapter 5 Audit Planning: Assessment of Inherent Risk and Materiality

for the expenditure cycle and rely on external evidence > e.g.$ confirmations of charges and payments with network providers? over internal evidence. A lower assessment of control risk and greater reliance on internal evidence may be appropriate for the revenue cycle >but see below?. &otwithstanding the failure of analytical procedures to produce any abnormalities$ inherent risk should be assessed at 100%. "he fact that this is a firstAtime audit for 9ontrose$ suggests that prior years4 data$ as well as the current year$ may be materially misstated. -hysical evidence$ mathematical evidence$ and confirmation evidence should be emphasi ed over analytical evidence$ documentary evidence$ and hearsay evidence$ at least for this year4s audit. Assuming that 9ontrose is a relatively small client$ and given that this is a firstAtime audit for the company$ Bresky should probably perform a Lprimarily substantiveM audit. 2:. ;n assessing the probability of fraud$ the auditor considers two types. ;dentify and define these two types of fraud. (hat is the auditor4s responsibility for detecting fraud3 '5=7";5&+ "he two types of fraud considered by the auditor in assessing the probability of fraud are misappropriation and fraudulent financial reporting. 9isappropriation is the fraudulent transfer of assets from the firm to one or more dishonest employees$ either preceded or followed by some form of concealment. %raudulent financial reporting consists of deliberate attempts by management to misstate the financial statements to deceive financial statement users. AICPA Professional Standards assign the auditor responsibility for designing the audit to provide reasonable assurance of detecting misstatements >errors or fraud? that are material to the financial statements.