Suppose a firmâs planning audit guidelines specify the following risk level ranges for AR, RMM and DR.The firmâs risk ranges, for any materiality amount, are:
VERY LOW5%
LOW
MODERATE10% to 30%
HIGH
(The reason that the upper end of each range equals to the lower end of the next riskier range is for practicality, in view of the fact that the specifications are inherently imprecise.) These ranges are modified according to the type of risk, as described below.
Audit Risk: If an auditor doesnât specify a risk level for AR, the auditor must specify a category (VL, L or M, but not H). The firmâs planning software will then assume that VL=1%, L=5% and M=10%.
Risk of Material Misstatement: If the auditor doesnât specify a risk level for RMM, the auditor must specify a category (VL, L or M or H). The firmâs planning software will then assume that VL=5%, L=5%, M=10% and H=100%.
Detection Risk: The auditor should specify a percentage for DR that is consistent with AR and RMM. That is, DR = AR / RMM and is dependent on the auditorâs choices of AR and RMM. If application of the risk levels for AR and RMM, pursuant to the above guidelines, results in DRâ¥50%, then the auditor sets DR=50%.
Suppose the auditor specifies only the categories for AR and RMM. Briefly explain the reason for the firmâs software planning tool setting AR to the low end of the range for each category and RMM to the high end of the range for each category.
A. The auditor sets AR to LOW, and RMM to MODERATE. Calculate DR in accordance with the planning guideline.
B. The auditor sets AR to LOW, and RMM to HIGH.Calculate DR in accordance with the planning guideline.
C. The auditor sets AR to MODERATE, and RMM to LOW.Calculate DR in accordance with the planning guideline.
3. A. Assuming that scope of the examination remains constant , what effect does increasing the
Materiality amount have on DR? On AR?
B. If M is increased but AR and DR are unchanged, what is the effect on the scope of the
examination
Suppose a firmâs planning audit guidelines specify the following risk level ranges for AR, RMM and DR.The firmâs risk ranges, for any materiality amount, are:
VERY LOW5%
LOW
MODERATE10% to 30%
HIGH
(The reason that the upper end of each range equals to the lower end of the next riskier range is for practicality, in view of the fact that the specifications are inherently imprecise.) These ranges are modified according to the type of risk, as described below.
Audit Risk: If an auditor doesnât specify a risk level for AR, the auditor must specify a category (VL, L or M, but not H). The firmâs planning software will then assume that VL=1%, L=5% and M=10%.
Risk of Material Misstatement: If the auditor doesnât specify a risk level for RMM, the auditor must specify a category (VL, L or M or H). The firmâs planning software will then assume that VL=5%, L=5%, M=10% and H=100%.
Detection Risk: The auditor should specify a percentage for DR that is consistent with AR and RMM. That is, DR = AR / RMM and is dependent on the auditorâs choices of AR and RMM. If application of the risk levels for AR and RMM, pursuant to the above guidelines, results in DRâ¥50%, then the auditor sets DR=50%.
Suppose the auditor specifies only the categories for AR and RMM. Briefly explain the reason for the firmâs software planning tool setting AR to the low end of the range for each category and RMM to the high end of the range for each category.
A. The auditor sets AR to LOW, and RMM to MODERATE. Calculate DR in accordance with the planning guideline.
B. The auditor sets AR to LOW, and RMM to HIGH.Calculate DR in accordance with the planning guideline.
C. The auditor sets AR to MODERATE, and RMM to LOW.Calculate DR in accordance with the planning guideline.
3. A. Assuming that scope of the examination remains constant , what effect does increasing the
Materiality amount have on DR? On AR?
B. If M is increased but AR and DR are unchanged, what is the effect on the scope of the
examination
Related questions
A424
Homework #3
Due Tuesday, February 28
Worth 100 Points
Note: Students are expected to work independently (i.e., on your own) on all homework assignments. Please type and post to Canvas.
Part I. Risk Assessments
| 1. For each illustration, select the component of audit risk that is most directly illustrated. The components of audit risk may be used once, more than once, or not at all. (10 points, 1 point each). |
| Components: Inherent Risk (IR), Control risk (CR), or Detection Risk (DR) |
a. A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.
b. Cash is more susceptible to theft than an inventory of coal.
c. Confirmation of receivables by an auditor fails to detect a material misstatement.
d. Disbursements have occurred without proper approval.
e. There is inadequate segregation of duties.
f. A necessary substantive audit procedure is omitted.
g. Notes receivable are susceptible to material misstatement, assuming there are no related internal controls.
h. Technological developments make a major product obsolete.
i. The client is very close to violating debt covenants.
j. XYZ Company, a client, lacks sufficient working capital to continue operations.
2. Read Case 1.6, Nextcard, Inc. from our Casebook. Pretend you are the auditor for Nexcard, Inc. in the planning phase of the audit for FY 2000 and perform the following risk assessment procedures. That is, just focus on the information in the case prior to the discovery of the fraud (pages 83-86). (50 points total)
a. Perform a risk assessment as part of your audit plan for fiscal year 2000. Set or assess each component/factor of the audit risk model. Describe in detail how you set or assessed each factor (i.e., include specific risk factors from the case and explain how they influenced your assessment). (25 points)
b. Perform a fraud risk assessment for the risk of material misstatement due to fraudulent financial reporting. That is, identify and briefly describe specific fraud risk factors (i.e., more than 1) for each of the three components of the fraud risk triangle, specific to fraudulent financial reporting. (15 points)
c. Identify and describe one significant pervasive risk present during the Nextcard audit. In doing so, explain how the pervasive risk affects the risk of material misstatement. Then, describe how the auditor could respond to that pervasive risk (how could they change the audit plan to address that risk). (5 points)
d. Identify and describe one significant specific risk present during the Nextcard audit. In doing so, explain how the specific risk affects the risk of material misstatement. Then, describe how the auditor could respond to that specific risk (how could they change the audit plan to address that risk). (5 points)
Part II. Evidence and Management Assertions
1. For each of the following specific audit procedures, indicate the type of audit procedure it represents: (1) inspection of records or documents, (2) inspection of tangible assets, (3) observation, (4) inquiry, (5) confirmation, (6) recalculation, (7) reperformance, (8) analytical procedures, and (9) scanning. (10 points, 1 point each)
a. sending a written request to the entityâs customers requesting that they report the amount owed to the entity
b. examining large sales invoices for a period of two days before and after year-end to determine if sales are recorded in the proper period.
c. agreeing the total of the accounts receivable subsidiary ledger to the accounts receivable general ledger account.
d. discussing the adequacy of the allowance for doubtful accounts with the credit manager.
e. comparing the current-year gross profit percentage with the gross profit percentage for the last four years.
f. examining a new plastic extrusion machine to ensure that this major acquisition was received.
g. watching the entityâs warehouse personnel count the raw materials inventory.
h. performing test counts of the warehouse personnelâs count of the raw material.
i. obtaining a letter from the entityâs attorney indicating that there were no lawsuits in progress against the entity.
j. tracing the prices used by the entityâs billing program for pricing sales invoices to the entityâs approved price list.
2. For each of the audit procedures listed above in Part II. 1. (a-j), identify the category (assertions about classes of transactions and events, or assertions about account balances) and identify the primary management assertion being tested. (30 points, 3 points each)
