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Chapter 11 Ans

Chapter 11 Ans

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Published by Dave Manalo
Auditing, Theory, Cabrera, Solution, Manual
Auditing, Theory, Cabrera, Solution, Manual

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Published by: Dave Manalo on Aug 04, 2010
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04/08/2013

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CHAPTER 11A RISK-BASED AUDIT APPROACH – PART II
I.
 Review Questions
1.Use the model AR = IR x CR x DR to solve for different values of Audit Ris(AR) when internal control risk (CR) is given different values. In all cases IR =0.90 and DR = 0.10, therefore, AR = 0.90 x CR x 0.10
When CR isAR is
0.100.009 or 0.9 percent0.500.045 or 4.5 percent0.700.063 or 6.3 percent0.900.081 or 8.1 percent1.000.090 or 9.0 percent2.a.
 Risk of Assessing Control Risk Too Low
or 
Overreliance
is a matter of  judgment about the importance (“key”) characteristic of a particular clientcontrol procedure. An auditor can take more risk of assessing control risk too low on unimportant controls than on important (“key”) ones.Alternatively, the risk of assessing control risk too low can be considered aconstant (say, 0.05) and the importance of a control can be measured interms of a smaller or larger tolerable rate. (The authors prefer the latter approach.) b.
 Risk of Assessing Control Risk Too High
or 
Underreliance
is a matter of  judgment about the efficiency of an audit engagement. The risk can bequite high when the audit team is willing to do extensive substantive work anyway. If the work budget is tight, auditors need to find objective ways(e.g., larger test of controls audit samples) to mitigate the risk.c.
Tolerable Deviation Rate
is a judgment about
how many
control deviationscan exist in the population, yet the control can still be considered effective.Auditors need to be careful about brushing aside findings of deviations.d.
 Expected Deviation Rate in the Population
is an estimate, usually based onassumptions or sketchy information, of the imbedded incidence of controldeviations. The only use of this estimate in classical attribute sampling is tofigure a sample size in advance. The statistical evaluation (CULcalculation) does not use it.
 
11-2
Solutions Manual - Principles of Auditing and Other AssuranceServices
e.
 Population Definition
might be called a judgment about identification of the population of control performances that correspond to an audit objective.For example, an auditor would want to be sure he is sampling from a file of recorded documents if his objective is to audit the controls over transaction
validity
.3.Assessing the control risk too low causes auditors to assign less control ris(CR) in planning procedures than proper evaluation would cause them to assign.The result could be (1) inadvertently conducting less audit work than properlynecessary and taking more audit risk (AR) than originally contemplated, perhapsto the unpleasant results of failing to detect material misstatements (damagingthe effectiveness of the audit) or (2) discovering in the course of the audit work that control is not as good as first believed, causing an increase in the auditwork, perhaps at a time when doing so is very costly (damaging the efficiency of the audit).4.The important consideration involved in judging an acceptable risk of 
assessing control risk too high
is the
efficiency
of the audit. Assessing control risk toohigh causes auditors to think they need to perform a level of substantive work which is greater than a proper evaluation of control would suggest.
 Assessing control risk too high
leads to
overauditing 
.Some auditors may be willing to accept high risks of assessing the control risk too high because they intend to overaudit anyway, and the audit budget cansupport the work.Other auditors want to minimize their work (within acceptable professional bounds of audit risk) and thus want to minimize the risk (probability) of overauditing by mistake.Technically, the risk of assessing control risk too high in relation to an attributesample is the probability of finding in the sample (n) one deviation more thanthe “acceptable number” for the sampling plan. For example, if the plan calledfor a sample of 100 units and a tolerable rate of 3 percent at a 0.10 risk of assessing control risk too low, the “acceptable number” is zero deviations.The probability of finding 1 or more deviations when the population rate isactually 2 percent is:Probability (x > 0 : n = 100, r = 0.02)=1 – (1 – r)
n
=1 (1 0.02)
100
 =0.867 or 86.7 percent5.All the elements of the risk model are products of auditorsprofessional judgments. Auditors must judge:
 
 A Risk-based Audit Approach – Part II 
 
11-3
 Inherent risk 
– the probability that material errors or irregularities have enteredthe accounting system used to develop financial statements.
 Internal control risk 
– the probability that client’s system of internal control policies and procedures will fail to detect material errors and irregularities, provided any enter the data accounting system in the first place.
 Analytical procedures risk 
– the probability that auditors’ analytical procedureswill fail to produce evidence of material errors and irregularities, providedany have entered the accounting system in the first place and have not beendetected and corrected by the client’s internal control procedures.
 Audit risk 
– the probability that auditors will not discover by any means errorsand irregularities that cause an account balance to be materially misstated.Test of detail risk appears at first glance to be the product of a formula and not a professional judgment. However, everything in the risk model is a judgment, sothe test of detail derived from the model is no less a judgment.6.An
incorrect acceptance
decision directly impairs the effectiveness of an audit.Auditors wrap up the work and the material misstatement appears in thefinancial statements.An
incorrect rejection
decision impairs the efficiency of an audit. Further investigation of the cause and amount of misstatement provides a chance toreverse the initial decision error.7.Detection risk is the component of audit risk that is controllable by the auditor.It may be raised or lowered by reducing or increasing the amount of substantiveaudit testing. It is determined by the auditor’s assessment of inherent risk andcontrol risk.8.The auditor deals with both inherent risk and control risk during the planning phase of the audit. Inquiry of client personnel, study of the business andindustry, application of analytical procedures, and documentation of theauditor’s initial understanding of internal control are all performed during the planning phase of the audit. Further study of internal control procedures mayoccur after the planning phase if the auditor wishes to further reduce theassessed level of control risk, and considers it economically feasible to do so.9.An auditor would assess control risk to be at maximum when (1) effectivecontrols for the assertion have either not been designed or not put in place, or (2)when the auditor believes performing substantive tests of the assertion is morecost effective. When an auditor assesses control risk to be below the maximum,the auditor should believe that effective controls are present to prevent or detectmisstatements in the financial statement assertions.

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