ACCT3322 Chapter Notes - Chapter 4: Audit Risk, Control Risks, Internal Control
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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 entity’s 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 entity’s warehouse personnel count the raw materials inventory.
h. performing test counts of the warehouse personnel’s count of the raw material.
i. obtaining a letter from the entity’s attorney indicating that there were no lawsuits in progress against the entity.
j. tracing the prices used by the entity’s billing program for pricing sales invoices to the entity’s 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)
Which of the following statements is most correct regarding the independent auditor's reliance on the tests of controls performed by the internal auditors to reduce their substantive testing?
| 1-The independent auditor must obtain assurance of the independence of the internal auditors but need not test their work. |
| 2-It is not acceptable for the independent auditor to rely upon the work of the internal auditors. |
| 3-There are no restrictions in relying upon the work of internal auditors. |
| 4-The independent auditor must evaluate the competency and objectivity of the internal auditors and must test a sample of the work of the internal auditors in order to rely upon their work. |
The term "materiality" as used in auditing is best described as the
| 1-substance of the auditing procedures. |
| 2-amount of misstatement on the financial statements that would influence a decision maker. |
| 3-underlying evidence upon which the audit opinion is based. |
| 4-amount of material the auditor gathers as evidence to support the audit opinion. |
Prior to accepting an audit client an auditor has a professional obligation to
| 1-contact the predecessor auditor. |
| 2-perform preliminary analytical review procedures. |
| 3-do all of the listed actions. |
| 4-obtain approval for the audit engagement from the SEC. |
Which of the following best represents financial statement fraud?
| 1-The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board of directors. |
| 2-The controller of the company decreases a contingent liability by $3 million so the company will meet analysts' expectations this quarter. |
| 3-The in-house attorney receives payments from the French government for negotiating the development of a new plant in Paris. |
| 4-The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without authorization. |
Sampling risk is the risk that
| 1-errors are inherent and may be present in the population without regard to the internal controls. |
| 2-the population will not contain characteristics representative of the sample such that inferences made about that sample will be incorrect. |
| 3-internal controls are not adequate to prevent or detect material errors. |
| 4-the sample will not contain characteristics representative of the population such that inferences made about that population will be incorrect. |
Control risk that is assessed excessively high (i.e. the auditor believes control risk is high when in reality it is moderate or low) leads to:
| 1-audit inefficiency. |
| 2-a less expensive audit. |
| 3-reduced substantive testing. |
| 4-errors that are more likely to occur than anticipated. |
The purchasing process consists of each of the following phases except
| 1-receipts of goods and services. |
| 2-approval of items for payment. |
| 3-authorized request for goods and services. |
| 4-cash receipts. |
