AUD #11 Audit Risk

d. Extent of tests of details. Choice "d" is correct. An increase in the assessed level of control risk means that the assessed risk of material misstatement has also increased, and this requires a corresponding decrease in detection risk to maintain the same (presumably low) level of overall audit risk. Increasing the extent of tests of details will result in a reduction in detection risk. Choice "b" is incorrect. If the auditor has already determined that certain control activities are ineffective, increasing the extent of those tests is not likely to be helpful. The auditor needs to find a way to compensate for the increased level of risk in order to keep overall audit risk to a low level.

a. Affects the level of detection risk that the auditor may accept. Choice "a" is correct. The auditor uses the assessed level of control risk (together with the assessed level of inherent risk) to determine the assessed risk of material misstatement, which in turn affects the acceptable level of detection risk for financial statement assertions. Choice "b" is incorrect. The auditor assesses control risk after obtaining an understanding of internal control. Assessment is not required to obtain an understanding of the control environment or any of the other four components of internal control.

d. Postpone the planned timing of substantive tests from interim dates to the year-end. As the acceptable level of detection risk decreases, the assurance provided from substantive tests should increase. Consequently, the auditor should do one or more of the following: 1) change the nature of substantive tests from a less effective to a more effective procedure, 2) change the timing of the substantive tests, such as performing them at year-end rather than at an interim date, or 3) change the extent of substantive tests, such as using a larger sample size.

b. Financial statement assertions. The auditor identifies internal controls relevant to specific financial statement assertions, and then performs tests of controls to evaluate their effectiveness in preventing material misstatements in those assertions. Control risk should be assessed in terms of financial statement assertions.

d. Assurance provided by substantive tests. Choice "d" is correct. The acceptable level of detection risk is inversely related to the assurance provided by substantive tests. For example, if the acceptable level of detection risk decreases, more assurance is required from substantive tests. Choice "a" is incorrect. The acceptable level of detection risk is directly related to the risk of failing to discover material misstatements (audit risk).

a. Timing of substantive tests from year-end to an interim date. Choice "a" is correct. As the acceptable level of detection risk increases, the assurance (effectiveness) that must be provided from substantive tests can decrease. Thus, the auditor may change the timing of substantive tests from year-end to an interim date. Choice "b" is incorrect. The assessed level of control risk is used to determine the acceptable level of detection risk, not vice versa.

d. Substantive tests to restrict detection risk for significant transaction classes. Choice "d" is correct. Regardless of the assessed level of control risk, an auditor would perform some level of substantive tests to restrict detection risk for significant transaction classes. Even with the lowest possible assessed level of control risk, substantive testing cannot be entirely eliminated for significant transaction classes or balances. Choice "b" is incorrect. An auditor generally would not perform tests of controls if it would not be efficient to do so.

c. Extent of tests of details. Choice "c" is correct. As the assessed level of control risk increases, the acceptable level of detection risk for financial statement assertions decreases. To attain a decreased level of detection risk, greater assurance is needed from substantive tests. Increasing the extent of tests will provide greater assurance. Choice "b" is incorrect. As the assessed level of control risk increases, the acceptable level of detection risk decreases. In this way, the auditor can keep total audit risk to an acceptable level.

a. Decrease detection risk. Overall audit risk is made up of the risk of material misstatement and detection risk. The risk of material misstatement is itself comprised of two separate risks, inherent risk and control risk. When the assessed level of control risk is increased, the risk of material misstatement also increases, and detection risk must be decreased to achieve an overall audit risk level that is substantially the same as the planned audit risk level. Choice "b" is incorrect. If the assurance directly provided from substantive tests decreased, detection risk would increase because direct tests have become less beneficial.

d. Can be changed at the auditor's discretion. Choice "d" is correct. Detection risk can be changed at the auditor's discretion, whereas control risk and inherent risk exist independently of the financial statement audit, and cannot be changed by the auditor. Choice "b" is incorrect. Detection risk is a function of the effectiveness of audit procedures and of the manner in which they are applied, so it does not exist independently of the financial statement audit.

a. The risk that a material misstatement will not be prevented or detected on a timely basis by the client's internal controls. Choice "a" is correct. Control risk is the risk that a material misstatement that could occur in a relevant assertion will not be prevented or detected (and corrected) on a timely basis by the entity's internal control. Choice "d" is incorrect. This statement describes inherent risk.

c. When the combined assessed level of inherent and control risk over the sale is high. The auditor would consider confirming a large complex sale when the risk of material misstatement (RMM) is high. The risk of material misstatement includes both inherent risk and control risk. If both inherent risk and control risk are high, then RMM is high and the auditor would minimize detection risk by performing more reliable auditing procedures, such as confirmation of the terms of large complex sale. Choice "d" is incorrect. High detection risk implies a low risk of material misstatement. If the risk of material misstatement is low, the auditor is less likely to confirm the terms of a large complex sale.

a. Select more effective substantive tests. Choice "a" is correct. When the auditor determines that the overall risk of material misstatement is high, the acceptable level of detection risk decreases and the auditor must perform more effective substantive procedures. Choice "d" is incorrect. The performance of substantive tests on an interim basis is inappropriate when the risk of material misstatement is high because interim testing increases (rather than reduces) the risk that the auditor will not detect material misstatements in the financial statements.

b. The procedures to be applied on a particular engagement are a matter of the auditor's professional judgment. Choice "b" is correct. The nature of tests to be applied on a particular engagement is a matter of the auditor's professional judgment. Choice "c" is incorrect. The use of test of controls should be considered when deciding the level of assurance required and the nature of tests to be used. For example, if test of controls indicate that controls are not operating effectively, this will result in a lower detection risk. As the acceptable level of detection risk decreases, the assurance provided from substantive procedures should increase. In this case, the auditor may change the nature of substantive tests from a less effective to more effective procedure.

a. Use more experienced audit team members to perform year-end testing. Choice "a" is correct. Numerous unexpected errors would result in an increase in the assessment of risk. An increase in risk of material misstatement would result in a decrease in detection risk, which means the assurance provided from substantive procedures should increase. Performing testing at year-end as well as utilizing more experienced audit team members to perform those tests would be an appropriate response. Choice "d" is incorrect. Moving procedures from year-end to interim results in less assurance and would be an incorrect response to an increase in assessment of risk.

a. The risk that material misstatements in the MD&A presentation will not be prevented in a timely manner. Choice "a" is correct. Control risk is the risk that a material misstatement that could occur in an assertion within MD&A will not be prevented or detected on a timely basis. Choice "c" is incorrect. Inherent risk is the susceptibility of an assertion within MD&A that will lead to a material misstatement, assuming that there are no related controls.

a. An auditor's best estimate of misstatements in a population extrapolated from misstatements identified in an audit sample. Choice "a" is correct. Projected misstatement is an auditor's best estimate of misstatements in a population extrapolated from misstatements identified in an audit sample. Choice "d" is incorrect. Expected misstatement is the auditor's best estimate, before performing audit procedures, of misstatements that the auditor expects to find during the audit.