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CHAPTER 9

MULTIPLE CHOICE QUESTIONS

1. If it is probable that the judgment of a reasonable person would have been
changed or influenced by the omission or misstatement of information, then
that information is, by definition of FASB Statement No. 2.
A. Material
B. Insignificant
C. Significant
D. Relevant

2. The preliminary judgment about materiality is the __________ amount by

which the auditor believes the statements could be misstated and still not
affect the decisions of reasonable users.
A. Minimum
B. Maximum
C. Mean average
D. Median average

3. When auditors allocate the preliminary judgment about materiality to account

balances, the materiality allocated to any given account balance is referred to
in SAS No. 39 as
A. The materiality range
B. The error range
C. Tolerable materiality
D. Tolerable misstatement

4. Why do auditors establish a preliminary judgment about materiality?

A. To help the auditor plan the appropriate evidence to accumulate.
B. So that the client can what records to make available to the auditor.
C. To determine what level of staffing (i.e., work experience) is required for
the audit.
D. None of the above

5. If an auditor establishes a relatively low level for materiality, then the auditor
will
A. Accumulate more evidence than if a higher level had been set.
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B. Accumulate less evidence than if a higher level had been set.

C. Accumulate approximately the same evidence as would be the case were
a higher level set..
D. Accumulate an undetermined amount of evidence.

6. After the preliminary judgment about materiality has been established,

auditors may
A. Not adjust it
B. Adjust it downward only
C. Adjust it upward only
D. Adjust it either downward or upward.

7. In an audit area that has a higher inherent risk, it would be prudent to

A. Increase the amount of audit evidence gathered.
B. Assign more experienced staff to that area
C. Review the completed audit files more thoroughly
D. Do all of the above

8. Which of the following is least likely to be appropriate as the basis for

determining the preliminary judgment about materiality in the audit of a set
of financial statements?
A. Net income before taxes
B. Current assets
C. Owner’s equity
D. Inventory

9. Which of the following might not be a signal of a lack of integrity in

management?
A. Prior criminal conviction of an assembly line foreman.
B. Frequent turnover of key internal audit personnel.
C. Frequent disagreements with previous auditors
D. Frequent turnover of key financial personnel

10. Which of the following qualitative factors may significantly influence

whether an item is deemed to be material?
A. Misstatements that are otherwise minor may be material if there are
possible consequences arising from contractual obligations.
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B. Misstatements that are otherwise immaterial may be material if they affect

a trend in earnings.
C. Amounts involving fraud are usually considered more important than
unintentional errors of equal dollar amounts.
D. All of the above may influence materiality.

11. Auditors generally allocate the preliminary judgment about materiality to

A. The balance sheet only
B. The income statement only
C. The income statement and balance sheet
D. The statement of cash flows

12. Which of the following statements regarding inherent risk is correct?

A. The inherent risk assigned in the audit risk model is unaffected by the
auditor’s experience with client’s organization.
B. Most auditors set a low inherent risk in the first year of an audit and
increase it if experience shows that it was incorrect.
C. Most auditors set a high inherent risk in the first year of an audit and
reduce it in subsequent years as they gain experience, even when there is
inherent risk.
D. The inherent risk assigned in the audit risk model is dependent upon the
strengths in client’s internal control system.
13. Auditors begin their assessments of inherent risk during the planning phase.
Which of the following would not be a topic of the planning phase that would
also help to assess inherent risk?
A. Obtaining client’s agreement on the engagement letter.
B. Obtaining knowledge about the client’s business and industry.
C. Touring the client’s plant and offices.
D. Identifying related parties.

14. Which of the following is not a difficulty associated with allocating the
preliminary judgment about materiality to balance sheet accounts?
A. Auditors expect certain accounts to have more misstatements than others.
B. The allocation can have a significant effect on audit costs.
C. The auditor can expect to identify overstatements as well as
understatements in the accounts.
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D. All of the above are difficulties associated with the allocation of

materiality.
15. What is the primary means of dealing with risk in planning audit evidence?
A. Selection of more effective tests of details of balances
B. Application of the audit risk model
C. Establish a lower preliminary judgment about materiality.
D. All of the above

16. The opinion paragraph in auditors’ reports includes two important phrases
that are directly related to materiality and risk. The phrases are
A. “in our opinion” and “in all material respects.”
B. “presents fairly” and “ in all material respects.”
C. “in our opinion” and “presents fairly.”
D. “In all material respects” and “reasonable assurance.”

17. The phrase “in our opinion” in the auditor’s report is intended to inform users
that auditors
A. Guarantee fair presentation of the financial statements
B. Acts as insurers of the accuracy of the statements
C. Certify the material presented in the statements by management
D. Base their conclusions about the statements on professional judgement.

18. 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

19. The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement
2. Estimate the total misstatement in the segment.
3. Set preliminary judgment about materiality to segments.
4. Allocate preliminary judgment about materiality to segments.
5. Compare combined estimate with preliminary judgment about
materiality.
A. 1, 2, 5, 4, 3 C. 4, 3, 1, 5, 2
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B. 3, 4, 2, 1, 5 D. 5, 1, 3, 2, 4

20. SAS No. 47 defines the preliminary judgment about materiality as the
combined amount of misstatements in the financial statements that would be
considered material. This judgment
A. Need not be quantified
B. Must be quantified
C. Must be quantified in terms of dollars
D. Must be quantified in terms of both dollars and of a percentage of sales

21. Which of the following statements is not correct?

A. Materiality is a relative rather than an absolute concept
B. Normally, the most important base used as the criterion for deciding
materiality is total assets.
C. Qualitative factors as well as quantitative factors affect materiality.
D. Given equal dollar amounts, frauds are usually considered more important
than errors.

22. Since materiality is relative, it is necessary to have bases for establishing

whether misstatements are material. Normally, the most common base for
deciding what is material is
A. Net income before taxes
B. Net working capital
C. Net income after taxes
D. Total assets

23. Certain types of misstatements are likely to be more important than other
types to users, even if the dollar amounts are the same. Which of the
following does not demonstrate this?
A. Amounts involving frauds are considered more important than errors of
equal amount.
B. Misstatements that are otherwise minor may be considered material if
there are possible consequences arising from contractual obligations.
C. Misstatements that are otherwise immaterial may be material if they affect
a trend in earnings.
D. Each of the above demonstrates this concept.
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24. The more effective the internal controls, the lower the risk factor that
_________ assigned to control risk.
A. Should be
B. Could be
C. Is
D. Must be

25. Allocating the preliminary judgment about materiality to segments of the

financial statements is necessary because
A. Evidence is accumulated for the financial statements as a whole as the
materiality doesn’t apply to them
B. Evidence is accumulated by segments rather than for the financial
statements as a whole
C. It is required by the AICPA’s Code of Professional Conduct
D. It is required by the SEC

26. Which of the following statements is not correct

A. Either an overstatement of an asset account or an understatement of a
liability account would have the same effect on the income statement
B. A misclassification in the balance sheet will have no effect on operating
income.
C. Either an overstatement of an asset account or an overstatement of a
liability account would have the same effect on the income statement.
D. Either an understatement of an asset account or an overstatement of a
liability account would have the same effect on the income statement.

27. Regardless of how the allocation of the preliminary judgment about

materiality was done, when the audit is complete the auditor must be
confident that the combined errors in all accounts are
A. Less than the preliminary judgment
B. Equal to the preliminary judgment
C. More than the preliminary judgment
D. Less than or equal to the preliminary judgment

28. Auditors frequently refer to the terms audit assurance, overall assurance, and
level of assurance to refer to ____________ .
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A. Detection risk
B. Audit report risk
C. Acceptable audit risk
D. None of the above

29. When a different extent of evidence is needed for the various cycles, the
difference is caused by
A. Errors in the client’s accounting system
B. Client’s need to achieve an unqualified opinion
C. The auditor’s need to follow GAAS
D. The auditor’s expectations of errors and assessment of the control
structure

30. If planned detection risk is reduced, the amount of substantive evidence the
auditor accumulates will
A. Increase
B. Decrease
C. Remain unchanged
D. Be indeterminate

31. When discussing control risk (CR) and the audit risk model, which of the
following statements is not true?
A. CR is a measure of the auditor’s assessment of the likelihood that
misstatements exceeding a tolerable amount will not be prevented or
detected by the client’s internal controls.
B. If the auditor concludes that internal control is completely ineffective to
prevent or detect errors, he/she would assign a 0% to CR.
C. The relationship between control risk and detection risk is inverse.
D. The relationship between control risk and evidence is direct.

32. Which of the following is not a good indicator of the degree to which
statements are relied on by external users?
A. Client’s size, as measured by total assets or total revenue
B. Distribution of ownership among the public.
C. Nature and amount of liabilities
D. Amount of net income or loss after taxes.
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33. In situations in which the auditor believes the chance of financial failure or
loss is high, and there is a corresponding increase in client business risk for
the auditor, accessible audit risk should
A. Be reduced
B. Be increased
C. Remain the same
D. Be calculated using a computerized statistical package

34. When management has an adequate level of integrity for the auditor to accept
the engagement but cannot be regarded as completely honest in all dealings,
auditors normally
A. Reduce acceptable audit risk and increase inherent risk
B. Reduce inherent risk and control risk
C. Increase inherent risk and control risk
D. Increase acceptable audit risk and reduce inherent risk

35. Many account balances require estimates and/or a great deal of management
judgment. One area that does not require such judgment would be
A. Allowance for uncollectible accounts
B. Useful life of equipment for tax purposes
C. Obsolete inventory
D. Liability for warranty payments

36. Inherent risk is reduced where the likelihood of defalcations is low. This
would be true for an account such as
A. Inventory
B. Marketable securities
C. Cash
D. Accounts receivable

37. The auditor assesses control risk and inherent risk. On a typical engagement,
the auditor would be least likely to assess these for
A. Each audit objective
B. Each cycle
C. Each account
D. The overall audit
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38. Acceptable audit risk is ordinarily set by the auditor during planning and
A. Held constant for each major cycle and account
B. Held constant for each major cycle but varies by account
C. Varies by each major cycle and by each account
D. Varies by each major cycle but is constant by account

39. When the auditor is attempting to determine the extent to which external
users rely on a client’s financial statements, they may consider several factors
including
A. Client size
B. Concentration of ownership
C. Types and amounts of liabilities
D. All of the above

40. A major limitation in the application of the audit risk model is

A. The difficulty in defining the terms of the model
B. The difficulty in measuring the components of the model
C. The difficulty in understanding the effect on other factors in the model
when one factor is changed.
D. The failure of the Audit Standards Board (ASB) of the AICPA to accept it
and incorporate it into the SASs.

41. An auditor determines that a client has not accounted for a certain material
item in conformity with generally accepted accounting principles. This fact is
prominently disclosed in a footnote to the financial statements. The CPA
does not agree with this departure from GAAP and should
A. Issue a qualified the opinion because of the deviation from generally
accepted accounting principles.
B. Disclaim an opinion
C. Not allow the accounting treatment for this item to affect the type of
opinion because the deviation from generally accepted accounting
principles was disclosed.
D. Express an unqualified opinion and insert a middle paragraph
emphasizing the matter by reference to the footnote.
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42. In determining the type of opinion to express, an auditor assesses the nature
of the reporting qualifications and the materiality of their effects. Materiality
will be the primary factory considered in the choice between
A. An “except for” opinion and an adverse opinion
B. An “except for” opinion and a disclaimer of opinion
C. An adverse opinion and a disclaimer of opinion
D. A qualified opinion and a piecemeal opinion

43. When setting a preliminary judgment about materiality.

A. More evidence is required for a low dollar amount than for a high dollar
amount.
B. Less evidence is required for a low dollar amount than for a high dollar
amount
C. The same amount of evidence is required for either low or high dollar
amounts.
D. There is no relationship between it and the dollar amount of evidence
needed.

44. When allocating materiality, most practitioners choose to allocate to

A. The income statement accounts because they are more important
B. The balance sheet accounts because there are fewer.
C. Both balance sheet and income statement accounts because there could be
errors on either one.
D. All of the financial statement because there could be errors on other
statements besides the income statement and balance sheet.

45. The expectation of misstatement after considering the effect of internal

control is most appropriately thought of as
A. Control risk and acceptable audit risk
B. Inherent risk
C. The combination of inherent risk and control risk
D. None of the above

46. Which one of the following statements about the cycle approach to auditing
is not correct?
A. There are differences among cycles in the frequency and size of expected
errors.
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B. There are differences among cycles in the effectiveness of the internal

control structure.
C. There are differences among cycles on the auditor’s willingness that
material errors exist after the auditing is complete.
D. It is common for auditors to want an equally low likelihood of errors for
each cycle after the auditor is finished.

47. When the auditor has the same level of willingness to risk that material
errors will exist after the audit is finished for all five cycles.
A. A different extent of evidence is needed for various cycles.
B. The same amount of evidence will be gathered for each cycle.
C. He/She has not followed generally accepted auditing standards.
D. The level for each cycle must be no more than 2% so that the entire audit
does not exceed 10%.

48. Which of the following factors is least likely to contribute to opportunities

leading to misappropriation of assets?
A. Inadequate controls related to segregation of duties
B. Not requiring mandatory vacations
C. Disregard for the need to monitor or reduce risks of misappropriating
assets.
D. Presence of large sums of cash or inventory items of high value.

49. When discussing inherent risk (IR) and the audit risk model, which of the
following is not true?
A. IR is inversely related to planned detection risk
B. IR is inversely related to evidence.
C. IR is the susceptibility of the financial statements to material error,
assuming no internal controls.
D. IR is the auditor’s assessment of the likelihood that errors exceeding a
tolerable amount exist in a segment before considering the effectiveness
of internal accounting controls.

50. When discussing acceptable audit risk (AAR) and the audit risk model, which
of the following statements is true?
A. The terms audit assurance, overall assurance, or level of assurance are
synonyms for AAR.
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B. AAR is objectively determined by the auditor

C. AAR is the risk that the auditor is willing to take that the financial
statements are fairly stated after the audit is completed and an unqualified
opinion has been reached.
D. When the auditor decides on a lower acceptable audit risk, it means the
auditor wants to be more certain that the financial statements are not
materially misstated.

51. Which of the following is an example of the concept of inherent risk?

A. Humans make more errors than computers; therefore, a manual
accounting system is riskier than a computerized system
B. Accounting systems with vouchers have many more controls built in, so
the risk that there will be errors on the financial statements is reduced.
C. Loans receivable for a finance company are less likely to be collectible
than those of a bank.
D. Audits with larger sample sizes are less risky than those with smaller
sample sizes.

52. Tolerable misstatement as set by the auditor

A. Decreases acceptable audit risk
B. Increases inherent risk and control risk
C. Affects planned detection risk
D. Does not affect any of the four risks

53. The audit risk model is

A. A planning, testing, and evaluation model.
B. Useful in evaluating results but of limited use in planning.
C. Useful in planning, but of limited value in evaluating results.
D. Useful when performing the tests of balances, but of little value in either
the planning or evaluations stages.

54. Research in auditing has shown that if a revised risk is used in the audit risk
model to determine a revised planned detection risk, there is a danger of
A. Not decreasing the evidence sufficiently
B. Not increasing the evidence sufficiently
C. Over-auditing
D. Increased lawsuits against the auditor for failure to follow GAAS.
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55. The audit risk against which the auditor requires reasonable protection is a
combination of two separate risks. The first of these is that material errors
will occur in the accounting process by which the financial statements are
developed, and the second is that
A. A company’s system of internal control is not adequate to detect errors
and frauds
B. Those errors that occur will not be detected in the auditor’s examination
C. Management may possess an attitude that lacks integrity
D. Evidential matter is not competent enough for the auditor to form an
opinion based on reasonable assurance.

56. For financial reporting purposes, a change from straight-line to an accelerated

depreciation method was disclosed in a note to the financial statements and
has an immaterial effect on the current financial statements. It is expected,
however, that the change will have a significant effect on future periods. The
auditor should express a(n)
A. Qualified opinion
B. Unqualified opinion
C. Consistency exception
D. Adverse opinion

57. An auditor is confronted with an exception considered sufficiently material to

warrant some deviation from the standard unqualified auditor’s report. If the
exception relates to a departure from generally accepted accounting
principles, the auditor must decide between expressing a(n)
A. Adverse opinion and an unqualified opinion with an explanatory
paragraph.
B. Adverse opinion and an “except for” opinion
C. Adverse opinion and a disclaimer of opinion
D. Disclaimer of opinion and an unqualified opinion with an explanatory
paragraph.

58. Which of the following underlies the application of generally accepted

auditing standards, particularly the standards of field work and reporting?
A. The elements of materiality and relative risk
B. The element of internal control
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C. The element of corroborating evidence

D. The element of reasonable assurance.
59. For a reporting entity that has participated in related-party transactions that
are material, disclosure in the financial statements should include
A. The nature of the relationship and the terms and manner of settlement
B. Details of the transactions within major classifications.
C. A statement to the effect that a transaction was consummated on terms no
less favorable than those that would have been obtained if the transaction
had been with an unrelated party
D. A reference to deficiencies in the entity’s system of internal accounting
control.

ESSAY QUESTIONS
60. Discuss the three main factors that affect an auditors preliminary judgment
about materiality.
ANSWER:
The three main factors that affect an auditor’s judgment about materiality are:
 Materiality is a relative rather than an absolute concept. A misstatement
of a given size might be material for a small company, whereas the same
dollar misstatement could be immaterial for a larger one.
 Bases are needed for evaluating materiality. Since materiality is relative,
it is necessary to have bases for establishing whether misstatements are
material. Net income before taxes is normally the most commonly used
base, but other possible bases include current assets, total assets, current
liabilities, and owners’ equity.
 Qualitative factors also affect materiality. Certain types of misstatements
are likely to be more important to users than others, even if the dollar
amounts are the same such as misstatements involving frauds.

61. Due to qualitative factors, certain types of misstatements are likely to be

more important to users than others, even if the dollar amounts are the same.
Identify two qualitative factors that might significantly affect an auditor’s
materiality judgment, and give an example of each.

ANSWER:
Qualitative factors that affect an auditors’ materiality judgment include:
 Amounts involving fraud. Amounts involving fraud are usually
considered more important than unintentional errors of equal dollar
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amounts because fraud reflects on the honesty and reliability of the

management or other personnel involved. For example, an intentional
misstatement of inventory would be more important to users than a
clerical error in inventory of the same amount.
 Misstatements affecting contractual obligations. Misstatements that are
otherwise minor may be material if there are possible consequences
arising from contractual obligations. For example, if a misstatement
causes a required minimum account balance to exceed the minimum,
when the correct balance is less than the minimum, this misstatement
likely would be important to users.
 Profit vs. loss. Misstatements that cause a loss to be reported as a profit or
misstatements that affect trends in earnings are likely to be important to
users.

62. Explain why it is necessary to allocate the preliminary judgment about

materiality to individual accounts (segments) in the financial statements. Also
explain why allocating to balance sheet accounts is more common than
allocating to income statement accounts.
ANSWER:
Allocating the preliminary judgment about materiality to individual segments
is necessary because evidence is accumulated for segments rather than for the
financial statements as a whole. Allocating to segments establishes a
tolerable misstatement amount for each segments, which helps the auditor
decide the appropriate audit evidence to accumulate for each segments. Most
practitioners allocate materiality to balance sheet accounts rather than income
statement accounts because there are fewer balance sheet than income
statement accounts.

63. Why do most practitioners allocate the preliminary judgment about

materiality to balance sheet accounts?
ANSWER:
Most income statement misstatements have an equal effect on the balance
sheet because of the double-entry bookkeeping system. Because there are
fewer balance sheet accounts than income statement accounts in most audits
and most audit procedures focus on balance sheet accounts, allocating
materiality to balance sheet accounts is the most appropriate alternative.

64. Discuss how auditors use the audit risk model when planning an audit.
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ANSWER:
The audit risk model is used primarily for planning purposes in deciding how
much evidence to accumulate in each cycle. The auditor decides an
acceptable level of audit risk, assess inherent risk and control risk, and then
uses the relationship depicted in the following model to determine an
appropriate level for planned detection risk:

PDR = AAR
IR x CR

65. Describe the audit risk model and each of its components.
ANSWER:
The planning form of the audit risk model is stated as follows:
PDR = AAR
IR x CR

Where: PDR = planned detection risk

AAR = acceptable audit risk
IR = Inherent risk
CR = control risk
Planned detection risk is a measure of the risk that audit evidence for an
account will fail to detect misstatements exceeding a tolerable amount,
should such misstatements exist. Planned detection risk determines the
amount of substantive evidence that the auditor plans to accumulate.

Acceptable audit risk is 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. It is influenced
primarily by the degree to which external users will rely on the statements,
the likelihood that a client will have financial difficulties after the audit
report is issued, and the auditor’s evaluation of management’s integrity.

Inherent risk is a measure of the auditor’s assessment of the likelihood that

there are material misstatements in an account before considering the
effectiveness of internal control.

Control risk is a measure of the auditor’s assessment of the likelihood that

misstatements exceeding a tolerable amount in an account will not be
prevented or detected by the client’s internal controls.
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66. There are several factors that affect acceptable audit risk. Discuss three of
these factors.
ANSWER:
Acceptable audit risk is affected by:
 The degree to which external users will rely on the statements. For large,
publicly held clients, acceptable audit risk will be less, than for small,
privately held clients, ceteris paribus.
 The likelihood that a client will have financial difficulties after the audit
report is issued. Acceptable audit risk will be lower, when the client is
experiencing financial difficulties.
 The auditor’s evaluation of management’s integrity. Acceptable audit risk
will be lower, when the client’s management has questionable integrity.

67. Discuss each of the five steps in applying materiality in an audit, and identify
the audit phase(s) in which each step is performed.
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 accounts’ tolerable misstatement. 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
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performed after all substantive tests have been completed, in the final review
of the audit.

Other Objective Answer Format Questions

68. Below are four situations that involve the audit risk model as it is used for
planning audit evidence requirements in the audit of inventory. For each
situation, calculate planned detection risk.

SITUATION
1 2 3 4
Acceptable audit risk 1% 10% 10% 5%
Inherent risk 100% 100% 50% 20%
Control risk 100% 100% 40% 30%
Planned detection risk ____ ____ ____ ____
Answer: 1.1% 2. 10% 3. 50% 4. 83.3%

69. Using your knowledge of the relationships among acceptable audit risk,
inherent risk, control risk, planned detection risk, tolerable misstatement, and
planned evidence, state the effect on planned evidence (increase or decrease)
or changing each of the following factors, while the other factors remain
unchanged.

decrease 1. An increase in acceptable audit risk. _____________.

Increase 2. An increase in inherent risk __________.
Increase 3. A decrease in control risk __________ .
Decrease 4. An increase in planned detection risk ___________ .
Decrease 5. An increase in tolerable misstatement ____________ .

70. Match six of the terms (A-I) with the definitions provided below (1-6).
A. Business risk
B. Preliminary judgment about materiality
C. Inherent risk
D. Planned detection risk
E. Audit assurance
F. Acceptable audit risk
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G. Tolerable misstatement
H. Control risk
I. Materiality

D ______ 1. A measure of the risk that audit evidence for a segment will fail
to detect misstatements exceeding a tolerable amount, should
such misstatements exist.
A ______ 2. The risk that the client will fail to achieve its objectives.
H ______ 3. A measure of the auditor’s assessment of the likelihood that
misstatements exceeding as tolerable amount in a segment will
not be prevented or detected by the client’s internal controls.
F ______ 4. A measure of how much risk the audit 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.
G ______ 5. The materiality allocated to any given account balance.
B ______ 6. The maximum amount by which the auditor believes that the
statements could be misstated and still not affect the decisions
of reasonable users.

71. In practice, auditors rarely assign numerical probabilities to inherent risk,

control risk, or acceptable audit risk. It is more common to assess these risks
as high, medium, or low. For each of the four situations below, fill in the
blanks for planned detection risk and the amount of evidence you would plan
to gather (“planned evidence”) using the terms high, medium, or low.
SITUATION

1 2 3 4
Acceptable audit risk Low Low High High
Inherent risk High Low Low Low
Control risk High Low Medium Low
Planned detection risk ______ _______ ________ _____
Planned evidence ______ _______ ________ _____
Answer: 1. Low, high
2. High, low
3. Medium, Medium
4. High, low

72. The following graph shows three levels of acceptable audit risk (1%, 5%,
10%) three level of inherent risk x control risk (Low, Medium, High), nine
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intersections (A though I), and nine levels of required audit evidence (1

through 9). During a “typical” audit engagement in which the acceptable
level of audit risk is medium (5%) and the assessed levels of inherent risk and
control risk are medium, the required amount of audit evidence would be
medium (“5” in the graph). Use the graph to determine what effect (increase,
decrease, or none) a change in acceptable audit risk, inherent risk, or control
risk would have on the amount of audit evidence you would gather.

1 2 3 4 5 6

Example: Compared to a typical audit (e/5), a decision to reduce your

acceptable level of audit risk would change the intersection to _______,
causing the amount of required evidence to ___________ .

(Answer: f, increase to 6)

F, incr. to 6 1. Compared to (e/5), a change from auditing a privately held

company to auditing a publicly held company would change the
intersection to _________ , causing the amount of required
evidence to ___________ .
B, decr. to 2 2. Compared to (e/5), a decision to increase reliance on internal
control would change the intersection __________, causing
required evidence to ________ .
H, incr. to 8 3. Compared to (e/5), a large increase in an account balance from
the previous year would change the intersection to ________,
causing required evidence to ________ .
D, decr. to 4 4. You determined during the planning phase of the audit that there
has been a significant improvement in the client’s financial
condition relative to the previous year, in which acceptable audit
risk was 5% and assessed risk was medium. This year, you
 21

would change the intersection to _________ , causing required

evidence to __________ .
B, decr. to 2 5. This is the second-year engagement, and there were good audit
results in the previous year. Compared to (e/5), you would
change the intersection this year to _________, causing the
amount of required evidence to _________ .
H, incr. to 8 6. About halfway through the current year’s audit, you discover that
the client is constructing its own building during idle periods,
using factory personnel. This is the first time they have done this,
and it was done at your recommendation. Compared to (e/5), the
intersection for the audit of the fixed assets account will change
to _________, causing the amount of required evidence to
________.
I, decr. to 2 7. In a discussion with the client, you learn that management is
planning to sell the business in the next few months. Because of
the planned changes, several key accounting personnel quit
several months ago. Compared to (e/5), the intersection will
change to ________, causing the amount of required evidence to
_______ .
B, decr. to 2 8. Compared to the audit of inventory in a manufacturing company
in which acceptable audit risk was 5% and assessed risk was
medium (e/5), the intersection for the audit of prepaid expenses
will change to ________ , causing required evidence to
__________ .

73. The auditor’s preliminary judgment about materiality is the maximum

amount by which the auditor believes the financial statements could be
misstated and still not affect the decisions of reasonable users.
A. True
B. False

74. There is no precise definition of materiality in the professional literature.

A. True
B. False

75. Net income before taxes is normally the most important base for deciding
what is material.
A. True
B. False
 22

76. Most practitioners allocate the preliminary judgment about materiality to

balance sheet, rather than income statement, accounts.
A. True
B. False

77. The primary purpose of allocating the preliminary judgment about materiality
to financial statement accounts is to help the auditor decide the appropriate
evidence to accumulate for each account.
A. True
B. False
78. Auditors often use prior year financial statement balances to establish their
preliminary judgment about materiality in planning the current year’s audit.
A. True
B. False

79. If acceptable audit risk is low, and inherent risk and control risk are both
high, then planned detection risk should be high.
A. True
B. False

80. Inherent risk and planned detection risk are inversely related; i.e., as inherent
risk increases, planned detection risk should decrease, ceteris paribus.
A. True
B. False

81. Acceptable audit risk and planned detection risk are inversely related; i.e., as
acceptable audit risk increases, planned detection risk should decrease,
ceteris paribus.
A. True
B. False

82. The most important element of the audit risk model is control risk.
A. True
B. False
 23

83. Auditors are required to test any internal controls they believe have not been
operating effectively during the period under audit.
A. True
B. False

84. If an auditor believes the client will have financial difficulties after the audit
report is issued, and external users will be relying heavily on the financial
statements, the auditor will probably set acceptable audit risk as high.
A. True
B. False

85. Auditors have difficulty applying the concept of materiality in practice

because they often do not know who the users of the financial statements are
or what
decisions will be made.
A. True
B. False

86. Statements on Auditing Standards provided detailed, objective guidance on

how auditors are to establish a preliminary materiality level, thus eliminating
the need for subjective auditor judgment in this task.
A. True
B. False

87. If the preliminary judgment of materiality increases, the amount of audit

evidence required will also increase.
A. True
B. False

88. Tolerable misstatement is the maximum combined total of all misstatements

in the financial statements that the auditor is willing to allow, or tolerate,
when issuing a standard unqualified opinion.
A. True
B. False
 24

89. If an auditor assigns a tolerable misstatement of $1,000 to accounts payable,

he or she would need to obtain more audit evidence for that account that if
$100,000 had been assigned.
A. True
B. False

90. To maximize audit efficiency, the auditor should allocate less tolerable
misstatement to accounts that can be verified by using low cost audit
procedures, such as analytical procedures, than to accounts that are more
costly to audit.
A. True
B. False

91. Acceptable audit risk and the amount of substantive evidence required are
inversely related; i.e., as acceptable audit risk increases, the amount of
substantive evidence the auditor plans to accumulate should decrease.
A. True
B. False

92. Control risk and the amount of substantive evidence required are directly
related; i.e., as control risk increases, the amount of substantive evidence the
auditor plans to accumulate should increase.
A. True
B. False

93. Inherent risk and control risk are directly related; i.e., as inherent risk
increases, control risk also increases.
A. True
B. False

94. An acceptable audit risk assessment of low indicates a risky client requiring
more extensive evidence, assignment of more experienced personnel, and/or
a more extensive review of audit files.
A. True
B. False
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95. Audit assurance is the complement of planned detection risk, that is, one
minus planned detection risk.
A. True
B. False
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