Question

12. when discussing acceptable audit risk (AAR) and the audit risk model which of the following statements is true

		A. AAR is objectively determined by the auditor
		B. 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
		C. AAR is the risk that the auditor is willing to take that the financial statements are fairly stated
		D. The terms audit assurance overall assurance or level of assurance are synonyms for AAR

13. When discussing control risk (CR) and the audit risk model, which of the following statements not true?

		A. If the auditor concludes that internal control is completely ineffective to prevent or detect errors he/she would assign a 0% to CR
		B. CR is a measure of the auditor’s assessment of the likelihood that errors will not be prevented or detected by the client’s internal control
		C. The relationship between control risk and evidence is direct
		D. There is no relationship between control risk and inherent risk

14.

Inherent risk is often high for an account such as

		A. Cash
		B. Land
		C. Prepaid insurance
		D. Notes payable

15. Which of the following statements regarding inherent risk is correct

		A. Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect
		B. Inherent risk is unaffected by the auditor’s experience with client’s organization
		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
		D. Inherent risk is dependent upon the strengths in client’s internal control system

Answer 1

Answer to Question No. 12

The audit is the risk that the auditor may give an inappropriate opinion when the financial statements are materially misstated & hence it is a risk that the auditor may fail to express an appropriate opinion in an audit assignment.

Audit risk has three components

• Inherent Risk
• Control Risk
• Detection Risk

Inherent risk & control risk are collectively known as the risk of material misstatement.

When auditor decides to accept lower acceptable audit risk in such a situation, they want to be more certain that financial statements are not material misstated.

Accordingly, Option (B) is correct & rest other options are incorrect.

Answer to Question No. 13

Audit risk has three components:

• Inherent Risk: Inherent risk is the susceptibility of an account balance or class of transaction to a material misstatement, assuming that there were no internal controls. Inherent risk arises at the level of financial statement & at the level of account balance & transaction

• Control Risk: Control risk is the risk that material misstatement will not be prevented or detected and corrected on a timely basis by the internal control system.
• Detection Risk: It is the risk that the substantive procedure performed by the auditor fails to detect a material misstatement.

Management often reacts to inherent risk situations by designing accounting & internal control systems to prevent or detect & correct misstatements & therefore, Inherent risk & control risk are highly interrelated.

Accordingly, Option (D) is correct as all other statements except (D) are incorrect.

Answer to Question No. 14

Inherent risk is the susceptibility of an account balance or class of transaction to a material misstatement, assuming that there were no internal controls. Inherent risk arises at the level of financial statement & at the level of account balance & transaction.

Inherent risk is often high for an account such as Quality of Accounting system, Complex transaction, Judgement involve in determining balances, Assets prone to misstatements.

Accordingly, Option (A) is correct as here the chances of misstatements are more & the other option such as Land, Notes payable & Prepaid insurance is easily traceable using the appropriate evidence.

Answer to Question No. 15

Inherent risk is the susceptibility of an account balance or class of transaction to a material misstatement, assuming that there were no internal controls.

To assess inherent risk, the auditor should evaluate numerous factor having regard to his experience of the entity from previous audit engagement, control established by management to compensate for a high level of inherent risk & his knowledge of significant changes which might have taken place since his last assessment.

Accordingly, Option (C) is correct as most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain experience