A retail entity uses electronic data interchange (EDI) in executing and recording most of its purchase transactions. The entity's auditor recognizes that the documentation of the transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would:
Answer(s): B
Choice "b" is correct. When an entity transmits, processes, maintains, or accesses significant information electronically, some accounting data and source documents may be available only in electronic form, or only at a certain point in time. The auditor would generally perform tests of controls several times during the year to compensate for this limitation. Choice "a" is incorrect. Increasing the sample size related to cutoff testing will not provide evidence about transactions occurring throughout the period under audit, since cutoff testing relates to year- end.Choice "c" is incorrect. Auditing 100% of the year-end inventory does not provide evidence about transactions occurring throughout the period under audit. Choice "d" is incorrect. Failure to retain documentation for longer periods of time would not imply that control risk is reduced. If anything, this might lead to an increase in control risk, making it less likely that phony transactions would be detected after the fact.
An auditor assesses control risk because it:
Answer(s): D
Choice "d" 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 "a" 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.Choice "b" is incorrect. Assessment of control risk is unrelated to assessments of materiality levels. Choice "c" is incorrect. Inherent risk is assessed independently of any consideration of relevant controls.Control risk does not affect inherent risk.
As the acceptable level of detection risk decreases, an auditor may:
Choice "b" is correct. 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.Choice "a" is incorrect. As acceptable detection risk decreases, the extent of substantive tests should increase rather than decrease. The auditor cannot reassess inherent risk and control risk to compensate for the lower acceptable detection risk.Choice "c" is incorrect. Inherent risk is an integral part of the risk of material misstatement and cannot be eliminated from the computation of acceptable detection risk. Choice "d" is incorrect. The auditor cannot lower the assessed level of control risk unless tests of controls support that assessment.
Control risk should be assessed in terms of:
Answer(s): C
Choice "c" is correct. 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.Choice "a" is incorrect. Control risk is not assessed in terms of specific controls. Choice "b" is incorrect. Control risk is not assessed in terms of types of potential fraud. Choice "d" is incorrect. Control risk is not assessed in terms of control environment factors.
The acceptable level of detection risk is inversely related to the:
Answer(s): A
Choice "a" 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 "b" is incorrect. The acceptable level of detection risk is determined independently of the risk of misapplying auditing procedures (non-sampling risk). Choice "c" is incorrect. The acceptable level of detection risk is determined independently of the preliminary judgment about materiality levels (tolerable error). Choice "d" is incorrect. The acceptable level of detection risk is directly related to the risk of failing to discover material misstatements (audit risk).
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