If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts?
Answer(s): B
Choice "b" is correct. During an economic downturn, it is more likely that customers will default on payments owed. The auditor should therefore focus increased attention on the allowance for doubtful accounts, to ensure that it has been adjusted to appropriately reflect this increased risk. Choice "a" is incorrect. A recession is not likely to affect purchase returns and allowances, though it might result in a decline in purchases.Choice "c" is incorrect. A recession is not likely to directly affect the common stock account. Choice "d" is incorrect. A recession is not likely to directly affect a pre-existing, noncontrolling interest in a subsidiary.
The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor:
Answer(s): A
Choice "a" is correct. The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor obtains "reasonable assurance" (as opposed to absolute assurance) about whether the financial statements are free of material misstatement. The existence of audit risk (the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements) is implied in this statement. Choice "b" is incorrect. Assessing the accounting principles used and evaluating the overall financial statement presentation relate to determining that the statements have been prepared in conformity with GAAP, not to recognizing the existence of audit risk. Choice "c" is incorrect. Realizing that some matters are more important than others illustrates the concept of materiality; however, this is not a statement included in the auditor's standard report. Choice "d" is incorrect. Indicating that the financial statements are the responsibility of management while the auditor's responsibility is to express an opinion on those financial statements delineates responsibility rather than illustrating the concept of audit risk.
As the acceptable level of detection risk decreases, the assurance directly provided from:
Choice "a" is correct. As the acceptable level of detection risk (the risk that an auditor will not detect a material misstatement that exists in an assertion) decreases, the assurance directly provided from substantive tests should increase. The level of detection risk will decline as the benefit of direct tests increases.Choice "b" is incorrect. If the assurance directly provided from substantive tests decreased, detection risk would increase because the direct tests have become less beneficial. Choices "c" and "d" are incorrect. Changing the extent of tests of controls does not affect the level of detection risk.
On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk, and therefore the risk of material misstatement, from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would:
Answer(s): D
Choice "d" is correct. 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 "a" is incorrect. The auditor cannot change inherent risk. Choice "b" is incorrect. The established materiality level is not a component of overall audit risk. Choice "c" is incorrect. If the assurance directly provided from substantive tests decreased, detection risk would increase because direct tests have become less beneficial.
Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality?
Answer(s): C
Choice "c" is correct. The auditor would most likely use the entity's financial statements of the prior year in the preliminary determination of materiality. The prior year financial statements would be a good starting point in estimating the current year's expected results, especially for a continuing client.Choice "a" is incorrect. The assessment of control risk affects the design of audit procedures but is not relevant in determining materiality.Choice "b" is incorrect. The anticipated sample size for planned substantive tests is set after the preliminary materiality level is determined.Choice "d" is incorrect. Management assertions embodied in the financial statements have little relationship to materiality.
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