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Chapter 9
Multiple-Choice Questions
1.
easy
a

If it is probable that the judgment of a reasonable person would have been changed or
influenced by the omission or misstatement of information, then that information is, by
definition of FASB Statement No. 2:
a. material.
b. insignificant.
c. significant.
d. relevant.

2.
easy
b

The preliminary judgment about materiality is the
amount by which the auditor
believes the statements could be misstated and still not affect the decisions of reasonable users.
a. minimum
b. maximum
c. mean average
d. median average

3.
easy
d

easy
c

Why do auditors establish a preliminary judgment about materiality?
a. To determine the appropriate level of audit experience required for the work.
b. So that the client can know what records to make available to the auditor.
c. To plan the appropriate audit evidence to accumulate and develop an overall audit
strategy.
d. To finalize the assessment of control risk.

7.
easy
b

Auditors are _____ to decide on the combined amount of misstatements in the financial
statements that they would consider material early in the audit.
a. permitted
b. required
c. not allowed
d. strongly encouraged

8.

If an auditor establishes a relatively high level for materiality, then the auditor will:

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easy
c

In an audit area that has a lower inherent risk, it would be prudent to:
a. increase the amount of audit evidence gathered.
b. assign more experienced staff to that area.
c. increase the tolerable misstatement for the area.
d. expand planning procedures.

12.
easy
d

Which of the following is least likely to be appropriate as the basis for determining the
preliminary judgment about materiality in the audit of financial statements?
a. Net income before taxes.
b. Current assets.
c. Owners’ equity.
d. Inventory.

13.
easy
c

Auditing standards _____ that the basis used to determine the preliminary judgment about
materiality be documented in the audit files.
a. permit
b. do not allow
c. require
d. strongly encourage

Misstatements that are otherwise
minor may be material if there are
possible consequences arising from
contractual obligations.
Yes
No
Yes
No

Misstatements that are otherwise immaterial
may be material if they affect a trend in
earnings
Yes
No
No
Yes


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16.
easy
a

Auditors generally allocate the preliminary judgment about materiality to the:
a. balance sheet only.
b. income statement only.
c. income statement and balance sheet.
d. statement of cash flows.


accounts because most income statement misstatements have a(n) _____ effect on the balance
sheet.
a. reduced
b. equal
c. undetermined
d. increased

20.
medium
b

Which of the following is not a correct statement regarding the allocation of the preliminary
judgment about materiality to balance sheet accounts?
a. Auditors expect certain accounts to have more misstatements than others.
b. The allocation has virtually no effect on audit costs because the auditor must collect
sufficient appropriate audit evidence.
c. Auditors expect to identify overstatements as well as understatements in the accounts.
d. Relative audit costs affect the allocation.

21.
medium
b

What is the primary means of dealing with risk in planning decisions related to audit evidence?
a. Selection of more effective tests of details of balances.
b. Application of the audit risk model.
c. Establishing a lower preliminary judgment about materiality.
d. Allocating materiality judgment to segments.

22.

medium
b

The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement.
2. Estimate the total misstatement in the segment.
3. Set preliminary judgment about materiality.
4. Allocate preliminary judgment about materiality to segments.
5. Compare combined estimate with preliminary judgment about materiality.
The correct sequence from start to finish would be:
a. 1 2 5 4 3.
b. 3 4 2 1 5.
c. 4 3 1 5 2.
d. 5 1 3 2 4.

25.
medium
b

Which of the following statements is not correct?
a. Materiality is a relative rather than an absolute concept.
b. The most important base used as the criterion for deciding materiality is total assets.
c. Qualitative factors as well as quantitative factors affect materiality.
d. Given equal dollar amounts, frauds are usually considered more important than errors.

26.
medium
a

Since materiality is relative, it is necessary to have bases for establishing whether misstatements

No
No
Yes

28.
medium
b

Allocating the preliminary judgment about materiality to financial statements segments is
necessary because:
a. evidence is accumulated for the financial statements as a whole so materiality does not
apply to them.
b. evidence is accumulated by segments rather than for the financial statements as a whole.
c. it is required by the AICPA’s Code of Professional Conduct.
d. it is required by the SEC.

29.
medium
c

Which of the following statements is not correct?
a. Either an overstatement of an asset account or an understatement of a liability account
would have the same effect on the income statement.
b. A misclassification in the balance sheet will have no effect on operating income.
c. Either an overstatement of an asset account or an overstatement of a liability account
would have the same effect on the income statement.
d. Either an understatement of an asset account or an overstatement of a liability account
would have the same effect on the income statement.

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_____ misstatements are those where the auditor can determine the amount of the misstatement
in the account.
a. Potential
b. Likely
c. Known
d. Projected
When a different extent of evidence is needed for the various cycles, the difference is caused
by:
a. errors in the client’s accounting system.
b. a client’s need to achieve an unqualified opinion.
c. an auditor’s need to follow auditing standards.
d. an auditor’s expectations of errors and assessment of internal control.

33.
medium
d

34.
medium
a

If planned detection risk is reduced, the amount of evidence the auditor accumulates will:
a. increase.
b. decrease.
c. remain unchanged.
d. be indeterminate.

35.
Medium
a

Yes
No
Yes
No

36.
medium
b

When discussing control risk (CR) and the audit risk model, which of the following is false?
a.
CR is a measure of the auditor’s assessment of the likelihood that misstatements will not
be prevented or detected by internal control.
b.
If the auditor concludes that internal control is completely ineffective to prevent or detect
errors, he/she would assign a low value (e.g., 0%) to CR.
c.
The relationship between control risk and detection risk is inverse.
d.
The relationship between control risk and evidence needed to support account balances is
direct.

37.

Which of the following is not a good indicator of the degree to which statements are relied on

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d. increase acceptable audit risk and reduce inherent risk.

40.
medium
b

One accounting issue that does not require management to use significant judgments is:
a. the allowance for doubtful accounts.
b. the useful life of equipment for tax purposes.
c. obsolete inventory.
d. the liability for warranty payments.

41.
medium
d

Inherent risk is often low for an account such as:
a. inventory.
b. marketable securities.
c. cash.
d. accounts receivable.

42.
medium
d

The auditor typically does not assess control risk and inherent risk for:
a. each audit objective.
b. each cycle.
c. each account.

d. varies by each major cycle but is constant by account.

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46.
medium
d

When the auditor is attempting to determine the extent to which external users rely on a client’s
financial statements, they may consider several factors except for:
a. client size.
b. concentration of ownership.
c. types and amounts of liabilities.
d. assessment of detection risk.

47.
medium
b

A major difficulty in the application of the audit risk model is:
a. defining the terms of the model.
b. measuring the components of the model.
c. understanding the effect on other factors in the model when one factor is changed.
d. the failure of the Audit Standards Board to accept it and incorporate it into standards.

48.
medium


Auditors may assess inherent risk and control risk:

medium
a
a.
b.
c.
d.

Jointly to determine the risk of
material misstatement
Yes
No
Yes
No

Separately and combine their effects in the
audit risk model
Yes
No
No
Yes

52.
challenging
c

Which one of the following statements about the cycle approach to auditing is not correct?
a. There are differences among cycles in the frequency and size of expected errors.


Which of the following statements is not true?
a. Inherent risk is inversely related to detection risk.
b. Inherent risk is inversely related to evidence.
c. Inherent risk is the susceptibility of the financial statements to material error, assuming no
internal controls.
d. Inherent risk is the auditor’s assessment of the likelihood that errors exceeding a tolerable
amount exist in a segment before considering the effectiveness of internal controls.

55.
challenging
c

Which of the following is not a primary consideration when assessing inherent risk?
a. Nature of client’s business.
b. Existence of related parties.
c. Frequency and intensity of management’s review of accounting transactions and records.
d. Susceptibility to defalcation.

56.
challenging
c

Which of the following is an example of the concept of inherent risk?
a. Humans make more errors than computers; therefore, a manual accounting system is
riskier than a computerized system.
b. Accounting systems with vouchers have many more controls built in, so the risk that there
will be errors on the financial statements is reduced.
c. Loans receivable for a finance company are less likely to be collectible than those of a
bank.

Materiality is a relative rather than an absolute concept. A misstatement of a given
size might be material for a small company, whereas the same dollar misstatement
could be immaterial for a larger one.
Bases are needed for evaluating materiality. Since materiality is relative, it is
necessary to have bases for establishing whether misstatements are material. Net
income before taxes is normally the most commonly used base, but other possible
bases include current assets, total assets, current liabilities, and owners’ equity.
Qualitative factors also affect materiality. Certain types of misstatements are likely to
be more important to users than others, even if the dollar amounts are the same, such
as misstatements involving frauds.

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60.
medium

Due to qualitative factors, certain types of misstatements are likely to be more important to
users than others, even if the dollar amounts are the same. Identify two qualitative factors that
might significantly affect an auditor’s materiality judgment, and give an example of each.
Answer:
Qualitative factors that affect an auditor’s materiality judgment include:
Amounts involving fraud. Amounts involving fraud are usually considered more

Why do most practitioners allocate the preliminary judgment about materiality to balance sheet
accounts?
Answer:
Most income statement misstatements have an equal effect on the balance sheet because of
the double-entry bookkeeping system. Because there are fewer balance sheet accounts than
income statement accounts in most audits and most audit procedures focus on balance
sheet accounts, allocating materiality to balance sheet accounts is the most appropriate
alternative.

63.
medium

Discuss how auditors use the audit risk model when planning an audit.
Answer:
The audit risk model is used primarily for planning purposes in deciding how much
evidence to accumulate in each cycle. The auditor decides an acceptable level of audit risk,
assesses inherent risk and control risk, and then uses the relationship depicted in the
following model to determine an appropriate level for planned detection risk:
PDR

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to detect misstatements exceeding a tolerable amount, should such misstatements exist.
Planned detection risk determines the amount of substantive evidence that the auditor
plans to accumulate.
Acceptable audit risk is a measure of how willing the auditor is to accept that the financial
statements may be materially misstated after the audit is completed and an unqualified
opinion has been issued. It is influenced primarily by the degree to which external users
will rely on the statements, the likelihood that a client will have financial difficulties after
the audit report is issued, and the auditor’s evaluation of management’s integrity.
Inherent risk is a measure of the auditor’s assessment of the likelihood that there are
material misstatements in an account before considering the effectiveness of internal
control.
Control risk is a measure of the auditor’s assessment of the likelihood that misstatements
exceeding a tolerable amount in an account will not be prevented or detected by the
client’s internal controls.

65.
medium

There are several factors that affect an audit firm’s business risk and, therefore, acceptable audit
risk. Discuss three of these factors.
Answer:
Business risk and acceptable audit risk are affected by:
The degree to which external users will rely on the statements. For large, publicly
held clients, business risk is greater, and acceptable audit risk will be less, than for
small, privately held clients, all things being equal.
The likelihood that a client will have financial difficulties after the audit report is
issued. Business risk is greater, and acceptable audit risk will be lower, when the
client is experiencing financial difficulties.
The auditor’s evaluation of management’s integrity. Business risk is greater and
acceptable audit risk will be lower when the client’s management has questionable

final review stage of the audit.

Other Objective Answer Format Questions
67.
easy

Below are four situations that involve the audit risk model as it is used for planning audit
evidence requirements in the audit of inventory. For each situation, calculate planned detection
risk.
SITUATION
1

2

3

4

1%

10%

10%

5%

Inherent risk

100%


2. 10%; 3. 50%;

4. 83.3%

______


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68.
easy

Using your knowledge of the relationships among acceptable audit risk, inherent risk, control
risk, planned detection risk, tolerable misstatement, and planned evidence, state the effect on
planned evidence (increase or decrease) of changing each of the following factors, while the
other factors remain unchanged.

decrease

1.

An increase in acceptable audit risk.

increase

2.

An increase in inherent risk.

decrease

f.
g.
h.
i.

.
.
.

Business risk
Preliminary judgment about materiality
Inherent risk
Planned detection risk
Audit assurance
Acceptable audit risk
Tolerable misstatement
Control risk
Materiality

d

1.

A measure of the risk that audit evidence for a segment will fail to detect
misstatements exceeding a tolerable amount, should such misstatements exist.

a

2.


be misstated and still not affect the decisions of reasonable users.

e

7.

This term is synonymous with acceptable audit risk.

i

8.

The magnitude of an omission or misstatement of accounting information that
makes it probable that the judgment of a reasonable person would have been
changed.

c

9.

A measure of the auditor’s assessment of the likelihood that there are material
misstatements before considering the effectiveness of internal control.

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70.
medium

Low

Low

Control risk

High

Low

Medium

Low

Planned detection risk

______

______

______

______

Planned evidence

______

______


b. False

73.
easy
b

The FASB definition of materiality focuses on potential users of financial statements.
a. True
b. False

74.
easy
a

Net income before taxes is normally the most important base for deciding materiality.
a. True
b. False

75.
easy
b

Most practitioners allocate the preliminary judgment about materiality to income statement
accounts.
a. True
b. False

76.
easy
a

easy
a

Inherent risk and planned detection risk are inversely related; i.e., as inherent risk increases,
planned detection risk should decrease, ceteris paribus.
a. True
b. False

80.
easy
b

Acceptable audit risk and planned detection risk are inversely related; i.e., as acceptable audit
risk increases, planned detection risk should decrease, ceteris paribus.
a. True
b. False

81.
easy
b

The most important element of the audit risk model is control risk.
a. True
b. False

82.
easy
b

For a private company client, auditors are required to test any internal controls they believe


86.
medium
b

The audit risk model that must be used for planning audit procedures and evaluating audit
results is: AcAR = IR x CR x AcDR.
a. True
b. False

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87.
medium
b

Statements on Auditing Standards provide detailed, objective guidance on how auditors are to
establish a preliminary materiality level, thus eliminating the need for subjective auditor
judgment in this task.
a. True
b. False

88.
medium
b

If the preliminary judgment of materiality increases, the amount of audit evidence required will


92.
medium
a

To maximize audit efficiency, the auditor should allocate less tolerable misstatement to
accounts that can be verified by using low-cost audit procedures, such as analytical procedures,
than to accounts that are more costly to audit.
a. True
b. False

93.
medium
b

To maximize audit effectiveness, the auditor should establish a high preliminary judgment
about materiality and allocate most of the amount to balance sheet accounts.
a. True
b. False

94.
medium
a

Acceptable audit risk and the amount of substantive evidence required are inversely related.
a. True
b. False

95.
medium

98.
medium
a

Engagement risk is effectively the audit firm’s business risk.
a. True
b. False

99.
medium
b

Audit assurance is the complement of planned detection risk, that is, one minus planned
detection risk.
a. True
b. False

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