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Chapter 06 Audit Planning, Understanding the Client, Assessing Risks, and

Responding Answer Key

True / False Questions

1. Audit committees should be made up of the most qualified directors regardless of whether
they are part of management of the company.
FALSE

Difficulty: Hard

2. Analytical procedures are seldom used for planning an audit engagement because they are
substantive procedures.
FALSE

Difficulty: Easy

3. Preliminary arrangements with clients should be set forth in the management letter.
FALSE

Difficulty: Easy

4. An audit plan includes a detailed listing of the audit procedures to be performed in the
verification of items in the financial statements.
FALSE

Difficulty: Medium
5. The auditors' tests of controls are designed to substantiate the fairness of specific financial
statement accounts.
FALSE

Difficulty: Medium

6. At least a portion of the auditors' consideration of internal control usually is performed at an


interim date rather than at the balance sheet date.
TRUE

Difficulty: Medium

7. The substantive approach to an audit is appropriate for many small businesses.


TRUE

Difficulty: Medium

8. Confirming a bank account establishes existence but not rights to the cash balance.
FALSE

Difficulty: Hard

9. The completeness of recording of assets is generally verified by tracing from the source
documents to the recorded entry.
TRUE

Difficulty: Hard

10. Vouching the acquisition of assets is an audit procedure that is often performed to establish
the valuation of the assets.
TRUE

Difficulty: Hard
Multiple Choice Questions

11. Which of the following factors most likely would cause a CPA to not accept a new audit
engagement?
A. The prospective client has fired its prior auditor.
B. The CPA lacks a thorough understanding of the prospective client's operations and industry.
C. The CPA is unable to review the predecessor auditor's working papers.
D. The prospective client is unwilling to make financial records available to the CPA.

Difficulty: Medium
Source: AICPA

12. Which of the following factors most likely would heighten an auditor's concern about the risk
of fraudulent financial reporting?
A. Large amounts of liquid assets that are easily convertible into cash.
B. Low growth and profitability as compared to other entity's in the same industry.
C. Financial management's participation in the initial selection of accounting principles.
D. An overly complex organizational structure involving unusual lines of authority.

Difficulty: Hard
Source: AICPA

13. Which of the following factors would most likely cause a CPA to decide not to accept a new
audit engagement?
A. Lack of understanding of the potential client's internal auditors' computer-assisted audit
techniques.
B. Management's disregard for internal control.
C. The existence of related party transactions.
D. Management's attempt to meet earnings per share growth rate goals.

Difficulty: Hard
14. Which of the following matters is generally included in an auditor's engagement letter?
A. Limitations of the engagement.
B. Factors to be considered in establishing preliminary judgments about materiality.
C. Management's liability for illegal acts committed by its employees.
D. The auditor's responsibility to obtain negative assurance relating to the occurrence of illegal
acts.

Difficulty: Hard

15. Which of the following would heighten an auditor's concern about the risk of fraudulent
financial reporting?
A. Inability to generate positive cash flows from operations, while reporting large increases in
earnings.
B. Management's lack of interest in increasing the dividend paid on common stock.
C. Large amounts of liquid assets that are easily convertible into cash.
D. Inability to borrow necessary capital without obtaining waivers on debt covenants.

Difficulty: Hard
Source: AICPA

16. To best test existence, an auditor would sample from the:


A. General Ledger to source documents.
B. General Ledger to the financial statements.
C. Source documents to the general ledger.
D. Source documents to journals.

Difficulty: Medium

17. The auditors' understanding established with a client should be established through a(an)
A. Oral communication with the client.
B. Written communication with the client.
C. Written or oral communication with the client.
D. Completely detailed audit plan.

Difficulty: Easy
18. Which of the following would be least likely to be considered an audit planning procedure?
A. Use an engagement letter.
B. Develop the overall audit strategy
C. Perform the risk assessment.
D. Develop the audit plan.

Difficulty: Medium

19. While assessing the risks of material misstatement auditors identify risks, relate risk to what
could go wrong, consider the magnitude of risks and
A. Assess the risk of misstatements due to illegal acts.
B. Consider the complexity of the transactions involved.
C. Consider the likelihood that the risks could result in material misstatements.
D. Determine materiality levels.

Difficulty: Medium

20. Which of the following is correct concerning requirements about auditor communications
about fraud?
A. Fraud that involves senior management should be reported directly to the audit committee
regardless of the amount involved.
B. All fraud with a material effect on the financial statements should be reported directly by the
auditor to the Securities and Exchange Commission.
C. Fraud with a material effect on the financial statements should ordinarily be disclosed by the
auditor through use of an "emphasis of a matter" paragraph added to the audit report.
D. The auditor has no responsibility to disclose fraud outside the entity under any circumstances.

Difficulty: Hard
21. A predecessor auditor is required to attempt to initiate communication with the successor
auditor:

A. Option A
B. Option B
C. Option C
D. Option D

Difficulty: Hard

22. Which measure of materiality (or both) considers quantitative

considerations?
A. Option A
B. Option B
C. Option C
D. Option D

Difficulty: Medium
23. Which of the following factors most likely would lead a CPA to conclude that a potential
audit engagement should not be accepted?
A. There are significant related party transactions that management claims occurred in the
ordinary course of business.
B. Internal control activities requiring the segregation of duties are subject to management
override.
C. Management continues to employ an inefficient system of information technology to record
financial transactions.
D. It is unlikely that sufficient evidence is available to support an opinion on the financial
statements.

Difficulty: Medium
Source: AICPA

24. In using the information on the statement of cash flows while obtaining an understanding of a
profitable, growing company, which of the following would ordinarily be least surprising to an
auditor?
A. Decreases in accounts payable.
B. Decreases in accounts receivable.
C. Negative cash flows from investing.
D. Negative operating cash flows.

Difficulty: Hard

25. Audits of financial statements are designed to obtain reasonable assurance of detecting
material misstatements due to:

A. Option A
B. Option B
C. Option C
D. Option D

Difficulty: Medium
26. Which of the following is not one of the assertions made by management about an account
balance?
A. Relevance.
B. Existence.
C. Valuation.
D. Rights and obligations.

Difficulty: Easy

27. When a company has changed auditors, according to the Professional Standards:
A. The successor auditor has the responsibility to initiate contact with the predecessor auditor to
ask about the client before the engagement is accepted; the predecessor has no responsibility to
initiate this contact, even when aware of matters bearing on the integrity of management.
B. The predecessor must respond fully to all inquiries made by the successor auditor.
C. The successor must discuss with the predecessor matters bearing on the engagement prior to
accepting the engagement.
D. The successor may choose not to attempt any communication with the predecessor auditor.

Difficulty: Hard

28. Which of the following procedures is not performed as a part of planning an audit
engagement?
A. Reviewing the working papers of the prior year.
B. Performing analytical procedures.
C. Confirmation of all major accounts.
D. Designing an audit program.

Difficulty: Hard
29. The risk of a material misstatement occurring in an account, assuming an absence of internal
control, is referred to as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.

Difficulty: Medium

30. Which of the following is least likely to be considered a financial statement audit risk
factor?
A. Management operating and financing decisions are dominated by top management.
B. A new client with no prior audit history.
C. Rate of change in the entity's industry is rapid.
D. Profitability of the entity relative to its industry is inconsistent.

Difficulty: Hard

31. Which of the following is an example of fraudulent financial reporting?


A. Company management falsifies inventory count tags thereby overstating ending inventory and
understating cost of goods sold.
B. An employee diverts customer payments to his personal use, concealing his actions by
debiting an expense account, thus overstating expenses.
C. An employee steals inventor and the "shrinkage" is recorded in cost of goods sold.
D. An employee "borrows" tools from the company and neglects to return them; the cost is
reported as a miscellaneous operating expense.

Difficulty: Medium

32. Which of the following is most likely to be considered a risk factor relating to fraudulent
financial reporting?
A. Low turnover of senior management.
B. Extreme degree of competition within the industry.
C. Capital structure including various operating subsidiaries.
D. Sales goals in excess of any of the preceding three years.

Difficulty: Hard
33. Which of the following conditions identified during the audit increases the risk of employee
fraud?
A. Large amounts of cash in the bank.
B. Existence of a mandatory vacation policy for employees performing key functions.
C. Inventory items of small size, but high value.
D. Presence of reconciling items on a client prepared year-end proof of cash.

Difficulty: Medium

34. Which of the following statements is accurate about "fraud risk factors" considered when
conducting an audit?
A. Factors whose presence indicates that fraud exists.
B. Factors whose presence often have been observed in circumstances where frauds have
occurred.
C. Factors whose presence will require modification to planned audit procedures.
D. Factors obtained during the audit which lead to required communications with the audit
committee.

Difficulty: Hard

35. Which of the following is not an example of a likely adjustment in the auditors' overall audit
approach when significant risk is found to exist?
A. Apply increased professional skepticism about material transactions.
B. Increase the assessed level of detection risk.
C. Assign personnel with particular skill to areas of high risk.
D. Obtain increased evidence about the appropriateness of management's selection of accounting
principles.

Difficulty: Medium

36. Which of the following is least likely to be required on an audit?


A. Evaluate the business rationale for significant, unusual transactions.
B. Make a legal determination of whether fraud has occurred.
C. Review accounting estimates for biases.
D. Test appropriateness of journal entries and adjustments.

Difficulty: Medium
37. Which of the following is (are) considered a further audit procedure(s) that may be designed
after assessing the risks of material
misstatement?

A. Option A
B. Option B
C. Option C
D. Option D

Difficulty: Easy

38. Which of the following circumstances would an auditor most likely consider a risk factor
relating to misstatements arising from fraudulent financial reporting?
A. Several members of management have recently purchased additional shares of the entity's
stock.
B. Several members of the board of directors have recently sold shares of the entity's stock.
C. The entity distributes financial forecasts to financial analysts that predict conservative
operating results.
D. Management is interested in maintaining the entity's earnings trend by using aggressive
accounting practices.

Difficulty: Medium
Source: AICPA

39. A successor auditor is required to attempt communication with the predecessor auditor prior
to
A. Performing test of controls.
B. Testing beginning balances for the current year.
C. Making a proposal for the audit engagement.
D. Accepting the engagement.

Difficulty: Medium
Source: AICPA
40. If the business environment is experiencing a recession, the auditor most likely would focus
increased attention on which of the following accounts?
A. Purchase returns and allowances.
B. Allowance for doubtful accounts.
C. Common stock.
D. Noncontrolling interest of a subsidiary purchased during the year.

Difficulty: Hard
Source: AICPA

41. The risk that the auditors' procedures will lead them to conclude that a material misstatement
does not exist in an account balance when in fact such a misstatement does exist is referred to
as:
A. Account risk.
B. Control risk.
C. Detection risk.
D. Inherent risk.

Difficulty: Medium

42. Which of the following statements is correct regarding the auditor's determination of
materiality?
A. The planning level of materiality should normally be the larger of the amount considered for
the balance sheet versus the income statement.
B. The auditors' planning level of materiality may be disaggregated into smaller "tolerable
misstatements" for the various accounts.
C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not
for determining the planning level of materiality.
D. The amount used for the planning should equal that used for evaluation.

Difficulty: Hard
43. The auditors must consider materiality in planning an audit engagement. Materiality for
planning purposes is:
A. The auditors' preliminary estimate of the largest amount of misstatement that would be
material to any one of the client's financial statements.
B. The auditors' preliminary estimate of the smallest amount of misstatement that would be
material to any one of the client's financial statements.
C. The auditors' preliminary estimate of the amount of misstatement that would be material to
the client's balance sheet.
D. An amount that cannot be quantitatively stated since it depends on the nature of the item.

Difficulty: Medium

44. Which of the following topics is not normally included in an engagement letter?
A. The auditors' preliminary assessment of internal control.
B. The auditors' estimate of the fee for the engagement.
C. Limitations on the scope of the engagement.
D. A description of responsibility for the detection of fraud.

Difficulty: Hard

45. Which of the following is most likely to be an overall response to fraud risks identified in an
audit?
A. Only use certified public accountants on the engagement.
B. Place increased emphasis on the audit of objective transactions rather than subjective
transactions.
C. Supervise members of the audit team less closely and rely more upon judgment.
D. Use less predictable audit procedures.

Difficulty: Hard
46. Which of the following is not an assertion that is made in the financial statements by
management concerning each major account balance?
A. Completeness.
B. Rights and obligations.
C. Legality.
D. Valuation.

Difficulty: Easy

47. Tests for unrecorded assets typically involve tracing from:


A. Source documents to recorded journal entries.
B. Source documents to observations.
C. Recorded journal entries to documents.
D. Recorded journal entries to observations.

Difficulty: Hard

48. Tracing from source documents forward to ledgers is most likely to address which assertion
related to posted entries:
A. Completeness.
B. Existence.
C. Rights.
D. Valuation.

Difficulty: Hard

49. Determining that receivables are presented at net-realizable value is most directly related to
which management assertion?
A. Existence.
B. Rights.
C. Valuation.
D. Presentation and disclosure.

Difficulty: Medium
50. Which of the following is not a general objective for the audit of asset accounts?
A. Establishing existence of assets.
B. Establishing proper valuation of assets.
C. Establishing proper liabilities relating to assets.
D. Establishing the completeness of assets.

Difficulty: Medium

51. Which of the following is not used by auditors to establish the completeness of recorded
assets?
A. Assessing control risk.
B. Tracing from source documents to entries in the accounting records.
C. Performing analytical procedures.
D. Vouching transactions.

Difficulty: Hard

52. To test for unsupported entries in the journals, the direction of audit testing should be to the:
A. Ledger entries.
B. Journal entries.
C. Original source documents.
D. Financial statements.

Difficulty: Hard

53. A form filed with the SEC when a company changes auditors is a:
A. Form 8-K.
B. Form 10-K.
C. Form S-1.
D. Form B-1.

Difficulty: Medium
54. Which of the following is least likely to render material a quantitatively small misstatement
material?
A. Affects the registrant's compliance with regulatory requirements.
B. Masks a change in earnings or other trends.
C. Arises from an item not capable of precise measurement.
D. The Transaction involves a related party.

Difficulty: Hard

55. A successor auditor has accepted an engagement that was previously performed by a
predecessor auditor and, prior to accepting the engagement, has communicated with the
predecessor. When the successor believes that the predecessor has performed satisfactory
previous audits, which of the following is correct?
A. A second communication is required and must include details of previous audits.
B. Ordinarily the successor auditors may be able to accept the opening balances of the current
year with a minimum of verification work.
C. Absent ongoing litigation, a predecessor must provide all working papers requested by the
predecessor.
D. The client should be informed of the need to perform a detailed audit of all opening balances.

Difficulty: Hard

56. The first standard of field work recognizes that early appointment of the independent auditors
has many advantages to the auditors and the client. Which of the following advantages is least
likely to occur as a result of early appointment of the auditors?
A. The auditors will be able to plan the audit work so that it may be done expeditiously.
B. The auditors will be able to complete substantive procedures prior to year-end.
C. The auditors will be able to better plan for the observation of the physical inventories.
D. The auditors will be able to perform the examination more efficiently and will be finished at
an early date after the year-end.

Difficulty: Medium
Source: AICPA
57. Preliminary arrangements agreed to by the auditors and the client should be reduced to
writing by the auditors. The best place to set forth these arrangements is in:
A. A memorandum to be placed in the permanent section of the auditing working papers.
B. An engagement letter.
C. A client representation letter.
D. A confirmation letter attached to the constructive services letter.

Difficulty: Easy
Source: AICPA

58. The auditors are planning an audit engagement for a new client in a business that is
unfamiliar to the auditors. Which of the following would be the most useful source of
information for the auditors during the preliminary planning stage when they are trying to obtain
a general understanding of audit problems that might be encountered?
A. Client manuals of accounts and charts of accounts.
B. AICPA Industry Audit Guides.
C. Prior-year working papers of the predecessor auditors.
D. Latest annual and interim financial statements issued by the client.

Difficulty: Hard
Source: AICPA

59. The auditors will not ordinarily initiate discussion with the audit committee concerning the:
A. Extent to which the work of internal auditors will influence the scope of the examination.
B. Extent to which change in the company's organization will influence the scope of the
examination.
C. Details of potential problems which the auditors believe might cause a qualified opinion.
D. Details of the procedures which the auditors intend to apply.

Difficulty: Hard
Source: AICPA
60. Which statement is correct relating to a potential successor auditor's responsibility for
communicating with the predecessor auditors in connection with a prospective new audit client?
A. The successor auditors have no responsibility to contact the predecessor auditors.
B. The successor auditors should obtain permission from the prospective client to contact the
predecessor auditors.
C. The successor auditors should contact the predecessors regardless of whether the prospective
client authorizes contact.
D. The successor auditors need not contact the predecessors if the successors are aware of all
available relevant facts.

Difficulty: Medium
Source: AICPA

61. Which of the following situations would most likely require special audit planning by the
auditors?
A. Some items of factory and office equipment do not bear identification numbers.
B. Depreciation methods used on the client's tax return differ from those used on the books.
C. Assets costing less than $500 are expensed even though the expected life exceeds one year.
D. Inventory is comprised of precious stones.

Difficulty: Medium
Source: AICPA

62. When planning an audit, an auditor should:


A. Consider whether the extent of substantive procedures may be reduced based on the results of
the internal control questionnaire.
B. Make preliminary judgments about materiality levels for audit purposes.
C. Conclude whether changes in compliance with prescribed control procedures justifies reliance
on them.
D. Prepare a preliminary draft of the management representation letter.

Difficulty: Medium
Source: AICPA
63. An auditor who accepts an audit engagement and does not possess the industry expertise of
the business entity, should:
A. Engage financial experts familiar with the nature of the business entity.
B. Obtain a knowledge of matters that relate to the nature of the entity's business.
C. Refer a substantial portion of the audit to another CPA who will act as the principal auditor.
D. First inform management that an unqualified opinion cannot be issued.

Difficulty: Medium
Source: AICPA

64. With respect to the auditor's planning of a year-end audit, which of the following statements
is always true?
A. An engagement should not be accepted after the fiscal year-end.
B. An inventory count must be observed at the balance sheet date.
C. The client's audit committee should not be told of any specific audit procedures which will be
performed.
D. It is an acceptable practice to carry out parts of the examination at interim dates.

Difficulty: Medium
Source: AICPA

65. Hawkins requested permission to communicate with the predecessor auditor and review
certain portions of the predecessor auditor's working papers. The prospective client's refusal to
permit this will bear directly on Hawkins' decision concerning the:
A. Adequacy of the preplanned audit program.
B. Ability to establish consistency in application of accounting principles between years.
C. Apparent scope limitation.
D. Integrity of management.

Difficulty: Medium
Source: AICPA
66. The auditor faces a risk that the audit will not detect material misstatements in the financial
statements. In regard to minimizing this risk, the auditor primarily relies on:
A. Substantive procedures.
B. Tests of controls.
C. Internal control.
D. Statistical analysis.

Difficulty: Easy
Source: AICPA

67. An abnormal fluctuation in gross profit that might suggest the need for extended audit
procedures for sales and inventories would most likely be identified in the planning phase of the
audit by the use of:
A. Tests of transactions and balances.
B. An assessment of internal control.
C. Specialized audit programs.
D. Analytical procedures.

Difficulty: Easy
Source: AICPA

68. Before accepting an audit engagement, a successor auditor should make specific inquiries of
the predecessor auditor regarding the predecessor's:
A. Awareness of the consistency in the application of generally accepted accounting principles
between accounting periods.
B. Evaluation of all matters of continuing accounting significance.
C. Opinion of any subsequent events occurring since the predecessor's audit report was issued.
D. Understanding as to the reasons for the change of auditors.

Difficulty: Medium
Source: AICPA
69. Which of the following is least likely to be included in an auditor's inquiry of management
while obtaining information to identify the risks of material misstatement due to fraud?
A. Are all financial reporting operations at one location?
B. Does it have knowledge of fraud or suspect fraud?
C. Does it have programs to mitigate fraud risks?
D. Has it reported to the audit committee the nature of the company's internal control?

Difficulty: Hard

70. An auditor selects a sample from the file of shipping documents to determine whether
invoices were prepared. This test is performed to satisfy the audit objective of:
A. Accuracy.
B. Completeness.
C. Control.
D. Existence.

Difficulty: Hard
Source: AICPA

71. Individuals who commit fraud are ordinarily able to rationalize the act and also have

an:
A. Option A
B. Option B
C. Option C
D. Option D

Difficulty: Easy
72. Which of the following is not a required source of information for the auditors' assessment of
fraud risk?
A. Discussion among audit team members.
B. Fraud risk factors.
C. Results of tests of controls.
D. Inquiry of management and others.

Difficulty: Medium

73. Auditors must assess fraud risk on every audit and respond to the risks that are identified.
Which of the following is not a procedure required to further address the fraud risk of
management override of internal control?
A. Reviewing accounting estimates for biases.
B. Examining physical controls over assets.
C. Evaluating the business rationale for significant unusual transactions.
D. Examining journal entries and other adjustments for evidence of fraud.

Difficulty: Medium

Essay Questions

74. Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.
b. List four items that are normally included in an engagement letter.

a. The purpose of an engagement letter is to establish a written contract between the auditors and
the client. Thus, the letter tends to prevent misunderstandings between those two parties.
b. Items that are normally included in an engagement letter include (only four required):
 Name of the entity and statements to be examined.
 Scope of services.
 Description of responsibility for detecting fraud.
 Obligations of the client's staff to prepare schedules.
 Fee or method of determining fee.
 Provision for client's acceptance signature.
 Management's obligation to conclude about the materiality of misstatements not recorded.

Difficulty: Medium
75. As a part of the planning process, the auditors often prepare an audit plan, an audit program,
and a time budget.
a. Describe an audit plan and explain its purpose.
b. Describe an audit program and explain its purpose.
c. Describe a time budget and explain its purpose.

a. The audit plan is an overview of the engagement, outlining the nature and characteristics of the
client and its environment and the overall audit strategy. The audit plan documents the major
considerations in planning the engagement.
b. The audit program is a detailed listing of audit procedures to be performed in the engagement.
It is a tool for scheduling and controlling the work.
c. The time budget includes an estimate of the time required for each audit task. It serves as a
basis for the fee estimate, controls the audit work, and may be used to evaluate performance by
the audit staff.

Difficulty: Medium
76. Auditors perform various tasks in planning an audit engagement. Provide an overall
description of how each task is performed and its purpose.
a. Obtain an understanding of the client's business.
b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts and
classes of transactions.

a. The auditors obtain an understanding of the client's business through procedures such as
inquiry of client personnel, observing client operations, studying AICPA Audit and Accounting
Guides and Industry Risk Alerts and other industry publications, and reviewing prior annual
reports, SEC filings, tax returns, and interim financial statements. An understanding of the
client's business is necessary to the evaluation of the appropriateness of the client's transactions,
accounting principles used, and the estimates and assumptions embodied in the financial
statements. In addition, it provides part of the information to assess the risks of material
misstatement.
b. Materiality for planning purposes is the auditors' preliminary estimate of the smallest amount
of misstatement that would affect the decisions of reasonable users of the financial statements.
The auditors use judgment to determine the amount of planning materiality, usually based on
some rule of thumb. Audit risk is the possibility that the auditors will fail to modify the opinion
on financial statements that are materially misstated. The auditors assess this risk by considering
characteristics of management, operations, and the engagement.
Audit risk and materiality determine the overall scope of the engagement. The lower the amount
of planning materiality, the more extensive the scope of the audit. The higher the risk of
misstatement of the financial statements, the more extensive the scope of the audit.
c. The auditors are required to assess fraud risk on every audit. This assessment is based on
information derived from (1) the discussion among the audit staff about the risk of fraud, (2)
inquiries of management, the audit committee, internal auditors and others, (3) the results of
planning analytical procedures, and consideration of fraud risk factors. If the auditors identify
fraud risks they may respond with (1) an overall response to the way the audit is conducted, or
(2) a response specifically to address the identified risk. In all audits they must include responses
to further address the risk of management override of internal control.
d. The auditors assess the risk of material misstatement (composed of inherent risk and control
risk) for each significant assertion about financial statement accounts and classes of assertions by
considering the information about the client and its environment including internal control, and
the nature of the account. These risk assessments are used to determine the nature, timing, and
extent of the substantive procedures that will reduce the detection risk to the appropriate level.

Difficulty: Hard
77. Many auditors take an approach to assessing the risk of material misstatement by beginning
with an assessment of business risks.
a. Define business risks.
b. Why have auditors found it effective to take the approach of assessing business risks?
c. Identify a business risk and explain how it might affect the auditor's audit procedures.

a. Business risks are those that threaten management's ability to achieve the organization's
objectives.
b. Auditors have found this approach effective because significant business risks often create
related risks of material misstatement (inherent risks) that the auditors should address in
designing their audit procedures.
c. Students may provide a number of examples. The textbook provides the following:
Assume that the auditors have identified as a significant business risk and audit risk that sales
personnel, informally or through written side agreements, may be modifying the terms of
contracts with customers which may affect the amount of revenue that should be recognized. The
auditors must design tests that are focused on determining whether such modifications of terms
have been made, perhaps by obtaining tailored confirmations from customers about the existence
of such side agreements.

Difficulty: Hard