CHAPTER # 6: RISK ASSESSMENT

1. Full description of the auditors objectives are given

in:
(a) ISA 201
(b) ISA 200 (correct)
(c) ISA 202
(d) ISA 203
Answer (b)
Explanation:
Full descriptions of the auditor’s objectives are
given in ISA 200, “Overall objectives of the
independent auditor and the conduct of an audit in
accordance with International Standards on
Auditing”.
2. Professional skepticism is:
(a) The application of relevant training,
knowledge and experience in making
informed decisions about the courses of
action that are appropriate in the
circumstances of the audit engagement.
(b) An attitude that includes a questioning mind,
being alert to conditions which may indicate
possible misstatement due to error or fraud,
and a critical assessment of audit evidence.
(correct)
Answer (b)
Explanation:

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 • Professional judgment is the application of
relevant training, knowledge and experience
in making informed decisions about the
courses of action that are appropriate in the
circumstances of the audit engagement.
• Professional skepticism is an attitude that
includes a questioning mind, being alert to
conditions which may indicate possible
misstatement due to error or fraud, and a
critical assessment of audit evidence.
3. Audit risk is:
(a) = (inherent risk + control risk) * detection
risk
(b) = inherent risk * (control risk + detection
risk)
(c) = (inherent risk - control risk) * detection risk
(d) = inherent risk * control risk * detection risk
(correct)
Answer (d)
Explanation:
Audit risk is the risk that the auditor expresses an
inappropriate audit opinion when the financial
statements are materially misstated. It is a function
of the risk of material misstatement (inherent risk
and control risk) and the risk that the auditor will
not detect such misstatement (detection risk).
4. In the context of audit risk point out detection risk?
(a) That the auditor's substantive procedures
will not detect and correct material errors
which exist in the financial statements
(correct)
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 (b) That the company's control system will fail
to detect and correct material errors in the
processing of transactions
(c) That the susceptibility of financial statement
transactions and balances to material errors
which may or may not be detected
Answer (a)
Explanation:
As per ISA 200 Overall Objectives of the
Independent Auditor and the Conduct of an Audit
in Accordance with International Standards of
Auditing - Detection risk is auditor related and
controlled.
5. Control risk would be increased by which
circumstance?
(a) There is a high turnover of staff in the
finance department (correct)
(b) The client operates in a highly regulated
industry
(c) The auditor is relying on tests of controls
and reducing substantive procedures
accordingly
Answer (a)
Explanation:
There is a risk that control procedures are not
followed due to the unfamiliarity of staff with the
requirements of those procedures. (b) increases
inherent risk. (c) increases detection risk.
6. What are the two elements of the risk of material
misstatement at the assertion level?
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 (a) Detection risk and control risk
(b) Inherent risk and detection risk
(c) Audit risk and detection risk
(d) Inherent risk and control risk (correct)
Answer (d)
Explanation:
The risk of material misstatement at the assertion
level is made up of inherent risk and control risk.
Detection risk is the risk that the auditor's
procedures will not detect a misstatement that
exists in an assertion that could be material. Audit
risk is the risk that the auditor gives an
inappropriate audit opinion when the financial
statements are materially misstated. Audit risk is
made up of inherent risk, control risk and detection
risk (AR = IR x CR x DR)
7. Audit procedures designed to evaluate the
operating effectiveness of controls in preventing,
or detecting and correcting, material misstatement
at the assertion level. It is known as:
(a) Substantive tests
(b) Tests of controls (correct)
(c) Analytical procedures
(d) Tests of detail
Answer (b)
Explanation:
Tests of controls are audit procedures designed to
evaluate the operating effectiveness of controls in
preventing, or detecting and correcting, material
misstatement at the assertion level.

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8. During the course of the audit, a team member
traced the annual lunch payment, of the client,
from the credit card bill and found the figure to be
different from the lunch invoice. The team member
informed the senior personal of the team. Which of
the following best describes the team member's
attitude?
(a) Professional judgment
(b) Professional estimate
(c) Professional skepticism (correct)
(d) Professional behavior
Answer (c)
Explanation:
Professional skepticism is an attitude that includes
a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or
fraud, and a critical assessment of audit evidence.
9. Point out which statement is not true?
(a) Materiality may depend on either the nature
of an item or its monetary amount
(b) Materiality is a matter of professional
judgment
(c) Materiality depends on the monetary
amount of an item (correct)
Answer (c)
Explanation:

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 Materiality can be both quantitative and qualitative.
10. Point out material misstatements?
I. An error of PKR 5,000 in relation to assets
of PKR 2m.
II. A payroll fraud of PKR 100 in a company
where profit before tax is PKR 10,000.
III. Non-disclosure of a material uncertainty.
IV. Financial statements have been prepared
on a going concern basis when the
company is in the process of being
liquidated.

(a) I and II
(b) II and III
(c) III and IV (correct)
(d) I and IV
Answer (c)
Explanation:
I is not material being only 0.25% of assets. II is
not material being only 1% of PBT. III is material
by nature as disclosures are required to aid the
understandability of the Financial Statements. IV is
material and pervasive as the basis of preparation
is incorrect which will affect whole of the financial
statements.
11. Is this statement true or false?
“Performance materiality levels are higher than the
materiality for the financial statements as a whole.
“
(a) True
(b) False (correct)
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 Answer (b)
Explanation:
The statement is false. Performance materiality
levels are set lower than materiality for the
financial statements as a whole.

12. During the course of the audit, a team member

calculated the audit risk for revenue to be low.
Which of the following did the team member use
while calculating the audit risk of the account head
mentioned?
(a) Professional judgment (correct)
(b) Professional estimate
(c) Professional skepticism
(d) Professional behavior
Answer (a)
Explanation:
Professional judgment is the application of
relevant training, knowledge and experience in
making informed decisions about the courses of
action that are appropriate in the circumstances of
the audit engagement.
13. In accordance with ISA 315 Identifying and
assessing the risks of material misstatement
through understanding the entity and its
environment, identify which procedures must the
auditor use to obtain an understanding of the
entity and its environment?

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I. Analytical procedures
II. Inquiry
III. Confirmation
IV. Reperformance

(a) I, II and III

(b) II, III and IV
(c) I and II (correct)
(d) I and IV
Answer (c)
Explanation:
ISA 315 requires auditors to use analytical
procedures and inquiry when obtaining an
understanding of the entity and its environment. In
addition, they should also use observation and
inspection.
14. Identify which procedure is not likely to result in
the discovery of possible non-compliance with
laws and regulations?
(a) Performing tests of details of transactions
(b) Making inquiries of management or the
entity's lawyer
(c) Reviewing internal control questionnaires
(correct)
Answer (c)
Explanation:
Reviewing internal control questionnaires provides
information about control policies and procedures,
but is not likely to provide information about actual
transactions or events and is therefore unlikely to

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 uncover non-compliance with laws and
regulations.
15. Identify the primary purpose of planning an audit?
(a) To ensure that the client obtains added
value from the audit to increase the chances
of retaining the audit for next year
(b) To ensure that appropriate team members
are selected to enable the development of
their competencies and capabilities
(c) To organize and manage the audit so that it
is performed in an effective and efficient
manner
(d) To reduce the risk of giving an inappropriate
audit opinion to an acceptable level (correct)
Answer (d)
Explanation:
(d) is the primary purpose of planning an audit,
whereas (b) and (c) may be reasons to plan the
audit.

16. During the audit of Atiq Company, the auditors

assessed that there is a high risk that revenue
might not be recorded completely. What will be the
level of detection risk acceptable to auditors?
(a) Low detection risk will be acceptable
(correct)
(b) Moderate level of detection risk will be
acceptable
(c) High detection risk will be acceptable

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 (d) Detection risk will increase to 100%
Answer (a)
Explanation:
Detection risk is the risk that the procedures
performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement
that exists and that could be material, individually
or when aggregated with other misstatements.
17. Point out the categories of risk that can be
controlled by the auditor?
Category of risk:
I. Control risk
II. Detection risk
III. Sampling risk

(a) I and II
(b) II and III (correct)
(c) II only
(d) I and III
Answer (b)
Explanation:
Control risks (together with inherent risk) are
components of the risk of material misstatement,
which is governed by the circumstances of the
audit client and therefore is outside the control of
the auditor. Sampling risk is a component of
detection risk, which is controlled by the auditor.
The correct answer is therefore option (b).

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18. Risk that inventory has a lower net realizable
value than cost and is therefore overstated. Some
possible responses to this risk are as follows:
I. Focus on testing internal controls over those
assets.
II. Examine the instructions to identify slow
moving inventory lines when attending the
inventory count.
III. Increase the emphasis on reviewing the
year end aged inventory analysis for
evidence of slow moving inventory.
IV. Ascertain sales values for items sold post
year end that were in inventory at the year
end to ensure their NPV was higher than the
cost recorded as part of the inventory value
in the financial statements.

Which is not the correct response to above

mentioned risk?
(a) I (correct)
(b) II
(c) III
(d) IV
Answer (a)
Explanation:
Focus on testing internal controls over those
assets is the possible responses of assets are
desirable/more susceptible to theft leading to a
risk that recorded assets do not exist.
19. Is this statement true or false?

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 "The materiality level calculated at the planning
stage should not be revised during later stages of
the audit."
(a) True
(b) False (correct)
Answer (b)
Explanation:
The materiality level calculated when planning the
audit may need to be revised as the audit
progresses. For example, where it appears that
the actual financial results for the period are
significantly different from those that were used in
calculating the materiality level at the planning
stage.

20. ___________ is a function of the effectiveness of

an audit procedure and of its application by the
auditor.
(a) Audit Risk
(b) Control Risk
(c) Inherent Risk
(d) Detection Risk (correct)
Answer (d)
Explanation:
Detection risk is a function of the effectiveness of
an audit procedure and of its application by the
auditor.
21. Detection risk would be reduced by:
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 (a) Decrease the materiality level (correct)
(b) Decrease supervision
(c) Decrease in sample sizes
Answer (a)
Explanation:
Increasing supervision and increasing sample
sizes would decrease detection risk. Whereby,
detection risk would be reduced by decreasing the
materiality level.
22. Point out the correct statements about materiality?
I. Information is material if its omission or
misstatement could influence the economic
decisions of users of the financial
statements.
II. Materiality is based on the auditor's
experience and judgment.
III. Materiality is always based on revenue.
IV. Materiality should only be calculated at the
planning stage of the audit.

(a) I, II and III

(b) I and II (correct)
(c) I, III and IV
(d) II and IV
Answer (b)
Explanation:
Statements I and II are correct. Materiality may be
based on other criteria, not just revenue, such as
net assets and profit before tax. Materiality should

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 be revisited throughout the audit and revised if
necessary.

23. _____________ is an audit procedure designed to

detect material misstatements at the assertion
level:
(a) Test of Detail
(b) Analytical procedure
(c) Substantive Procedure (correct)
(d) Test of Control
Answer (c)
Explanation:
Substantive procedure is an audit procedure
designed to detect material misstatements at the
assertion level. They consist of tests of details of
classes of transactions, account balances and
disclosures, and substantive analytical
procedures.
24. Which of these examples are related to fraudulent
financial reporting?
I. Manipulation of accounting records.
II. Misrepresentation of events.
III. Embezzling receipts.
IV. Intentional misapplication of accounting
principles.
V. Using assets for personal use.

(a) I and III

(b) I, IV and V
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 (c) III and V
(d) I, II and IV (correct)
Answer (d)
Explanation:
Embezzling receipts and using assets for personal
use are the examples of misappropriation of
assets.
25. One of company named Top-Ten has financial
problems, a dominant chief executive, and poor
internal control and unusual transactions. All these
factors are indicative of?
(a) Inadequacies in the systems of reporting
(b) A higher than normal risk audit (correct)
(c) The presence of going concern problems
(d) Increased scope for potential fraud
Answer (b)
Explanation:
All of the factors listed would be indicative of a
higher than normal risk audit. Going concern
problems also implies a higher than normal risk
audit.
26. Inherent risk would be increased by which
circumstance?
(a) Customers are allowed a PKR 100,000
initial credit limit before a formal credit limit
is agreed following credit checks
(b) The audit client manufactures computer
equipment (correct)
(c) The finance director has resigned and is yet
to be replaced
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 Answer (b)
Explanation:
There is a risk of obsolescence of inventory,
leading to inappropriate valuation. (a) and (c)
gives rise to control risks.

27. _______________ is a function of the

effectiveness of the design, implementation and
maintenance of internal control.

(a) Audit Risk

(b) Control Effectiveness
(c) Control Risk (correct)
(c) Control Efficiency
Answer (c)

Explanation:

Control risk is a function of the effectiveness of the

design, implementation and maintenance of
internal control.
28. Who is responsible for the prevention and
detection of fraud?
(a) The audit committee
(b) Those charged with governance and
management (correct)
(c) Internal auditors
(d) External auditors

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 Answer (b)
Explanation:
The external auditor is responsible for obtaining
reasonable assurance that the financial
statements are free from material misstatement
whether caused by fraud or error. The internal
audit function may assist management and those
charged with governance in its monitoring and
reviewing role but are not ultimately responsible.
29. Auditors have a duty to detect fraud:
(a) True
(b) False (correct)

Answer (b)
30. The audit team is required to discuss the
susceptibility of the financial statements to
material misstatements:
(a) True (correct)
(b) False
Answer (a)

31. Which of the following give rise to inherent

limitations of an audit?

(a) The nature of the industry in which client is

operating.
(b) The need for the audit to be conducted
without the limitation of cost and time.

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 (c) Auditors have to rely on the data provided
by the client, only.
(d) The nature of audit procedures. (correct)
Answer (d)
Explanation:
Inherent risk is affected by the nature of the entity
and also the nature of the strategies it adopts.
32. Identify which items of information that comes to
an auditor's attention would be most likely to
suggest non-compliance with laws and
regulations?
(a) The presence of several difficult-to-audit
transactions affecting expense accounts
(b) An exchange of property for similar property
(c) The discovery of unexplained payments
made to government employees (correct)
(d) The client's failure to develop adequate
internal controls that prevent or detect
unauthorized purchases
Answer (c)
Explanation:
The discovery of unexplained payments to
government employees is a possible indicator of
non-compliance with laws and regulations. (d) is
an internal control weakness. (a) and (b) are not
indicators of non-compliance.
33. In relation to laws and regulations which best
describes the auditor's responsibilities?

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 (a) The auditor has no responsibility in respect
of laws and regulations
(b) The auditor must consider whether the
financial statements are materially misstated
as a result of non-compliance with laws and
regulations (correct)
(c) The auditor must detect all instances of non-
compliance and report them to the police
Answer (b)
Explanation:
The auditor has to consider the risk of material
misstatement in the financial statements. Non-
compliance may lead to unrecorded liabilities
which may have a material effect on the financial
statements.

34. You are performing the audit, for the year ended
31 March 2011, of Company G. During the course
of the audit, you received the working papers of
the period ended 30 September 2010. According
to the working papers, the controls of the entity
were effective. Since then, no change has been
made in the controls of the company. Which of the
following is true?
(a) You will not perform test of controls as you
have audit evidence of the operating
effectiveness of the controls and no change
has been made in the controls. (correct)
(b) You will perform test of controls only on the
six months ending 31 March 2001 as

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 remaining six months were tested by other
auditors of your firm.
(c) You will not perform test of controls as
substantive procedures are enough if
controls are operating effectively.
(d) You will perform test of controls as the audit
evidence covers only 6 months of the period
for which you intend to rely on those
controls.
Answer (a)
Explanation:
You will not perform test of controls as you have
audit evidence of the operating effectiveness of
the controls and no change has been made in the
controls.

35. Point out an appropriate response to the risks of

material misstatement at the assertion level?
(a) Increasing sample sizes for inspecting
recorded assets where assets are more
susceptible to theft (correct)
(b) Emphasizing the need to maintain
professional skepticism
(c) Increasing supervision on the audit
(d) Making changes to the nature of the audit
procedures
Answer (a)
Explanation:

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 (b), (c) and (d) are overall responses.

36. The auditor shall exercise _______________ in

planning and performing an audit of financial
statements.
(a) Professional judgment (correct)
(b) Audit risk
(c) Absolute assurance
(d) Sampling
Answer (a)
Explanation:
ISA 200 requires the auditor to exercise
professional judgment in planning and performing
an audit of financial statements.
37. Identify which matter would an auditor need to
consider when gaining an understanding of the
specific business operations of an audit client?
(a) Products or services and markets of the
client's business (correct)
(b) Accounting principles and industry specific
practices relevant to the client's business
(c) Acquisitions or disposals of the client's
business activities
(d) Leasing of property, plant or equipment for
use in the client's business
Answer (a)
Explanation:

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 The matters mentioned in option (a) relate
specifically to business operations. The matters
mentioned in the other options relate specifically to
financial reporting (option (b)), investments (option
(c)) and financing (option (d)).
38. Best way of describing a material item is?
(a) It is large in relation to the same figure in
previous years
(b) It amounts to more than 10% of the total of
which it forms a part
(c) Its omission or disclosure would reasonably
influence the decisions of a user of the
financial statements (correct)
(d) It is one which would reduce a company's
profits
Answer (c)
Explanation
ISA 320 Materiality in Planning and Performing an
Audit.

39. During the course of an audit, you find several

weaknesses in control design of Sana Company.
Which of the following will be your next course of
action?
(a) You will perform test of controls as ISA 330
requires not relying on controls for
determining the extent of substantive
procedures if there is weakness in operating
effectiveness of controls
(b) Your audit strategy will be influenced by
assessment of audit risk in the relevant

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 account balance, disclosure and assertion
and not on the design and effectiveness of
controls.
(c) You will not perform test of controls as you
cannot rely on operating effectiveness' of
controls, hence, your control risk will
increase
(d) You will not perform test of controls as you
cannot rely on controls to determine the
extent of substantive procedures (correct)
Answer (d)
Explanation:
As you find several weaknesses in control design
of Sana Company you will not perform test of
controls as you cannot rely on controls to
determine the extent of substantive procedures.
40. You are planning the audit of Delta Co. and this is
your first year. As a result there is a lack of
cumulative audit knowledge and experience which
increases detection risk. Point out an appropriate
auditor's response to the risk described?
(a) Reduce reliance on tests of controls
(b) Extended controls testing should be
performed
(c) More time and resource will need to be
devoted to obtaining an understanding of
Delta Co. at the start of the audit (correct)
(d) Consideration should be given to relying on
an independent expert
Answer (c)

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 Explanation:
The risk arises due to the lack of knowledge of the
client - in order to address this, the auditor must
spend time obtaining that knowledge. This will
include, but is not restricted to, documenting their
understanding of the internal controls in place.

41. "Risk of material Misstatement" at assertion level

consists of two components:
(a) Detection risk and control risk

(b) Detection risk and inherent risk

(c) Control risk and inherent risk (correct)

(d) Control risk, detection risk and inherent risk

Answer (c)
Explanation:
Audit risk is the risk that the auditor expresses an
inappropriate audit opinion when the financial
statements are materially misstated. It is a function
of the risk of material misstatement (inherent risk
and control risk) and the risk that the auditor will
not detect such misstatement (detection risk).
42. Is this statement true or false?
“The definition of the risk of material misstatement
is ‘Inherent Risk x Control Risk x Detection Risk’.”
(a) True
(b) False (correct)
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 Answer (b)
Explanation:
The statement is false. The risk of material
misstatement is a function of inherent risk and
control risk, calculated by multiplying these two
factors. Audit risk is computed by multiplying the
risk of material misstatement by detection risk.
43. Identify the test of controls which provides
evidence that a company performs regular credit
checks on customers?
(a) Review of the aged receivables report to
ensure no debts are overdue
(b) Enquiry of management to confirm credit
checks are performed
(c) Inspect of the customers file to ensure a
credit report has been obtained and the date
on the report is within the last year (correct)
(d) Review of the customer's account to verify
that credit limits are in place
Answer (c)
Explanation:
The best procedure to confirm the credit check
takes place is to view the credit report. The fact
that a company has no overdue debts does not
confirm that a credit check was performed.
Enquiry of management is not the most reliable
method of testing the control. Credit limits may be
set by the client without reference to a credit
report.

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44. Which of the following shall an auditor consider
while determining the significant risk?
(a) The controls in place to identify that risk
(b) Whether the risk is a financial risk
(c) The assertions effected by that risk
(d) The degree of subjectivity in the
measurement of financial information related
to that risk (correct)
Answer (d)
Explanation:
Significant risks are complex or unusual
transactions that may indicate fraud, or other
special risks. Significant risks are those that
require special audit consideration. The following
factors indicate that a risk might be significant:
 Risk of fraud
 Its relationship with recent economic, accounting
or other developments
 The degree of subjectivity in the financial
information
 It is an unusual transaction
 It is a significant transaction with a related party
 The complexity of the transaction
45. Which procedures might an auditor use in gaining
an understanding of the entity?
I.

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 ___________________________________
____
II.

___________________________________
____
III.

___________________________________
____

Answer:
I. Inquiry
II. Analytical procedures
III. Observation and inspection

46. A material fraud was discovered at Water World

Co. shortly after the auditor had presented an
unmodified audit report to the annual general
meeting. His standard letter of engagement
indicated that he "would plan the audit so as to
have reasonable expectation of detecting material
misstatements in the financial statements resulting
from errors or fraud", but also stated that the,
primary responsibility for the prevention and
detection of fraud lay with management.
Which of the following statements most accurately
reflects the likelihood of the auditor being held
liable for the failure to find the fraud?
(a) He is likely to be liable because his
engagement letter accepted specific
responsibility to find material misstatements

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 (b) He is likely to be found liable if he found
indications of a possible fraud but dismissed
them as immaterial having failed to
adequately investigate them (correct)
(c) He is likely to be held liable if he has not
designed specific tests to look for fraud in all
areas of the accounting records
(d) He is unlikely to be held liable because the
engagement letter specifically stated that
management were responsible for the
prevention and detection of fraud
Answer (b)
Explanation:
(b) is the most accurate statement as the auditor
clearly suspected possible fraud but failed to
sufficiently investigate. (a) is incorrect as the
engagement letter refers to "reasonable
expectation". (d) is incorrect as the auditor has
specific duties in relation to fraud and error and
cannot pass them onto management. (c) is not
appropriate as the auditor should design his tests
to have "reasonable expectation" for those areas
he considers being at risk from fraud (not all
areas).

47. Audit Risk is a function of: (most suitable answer)

(a) Risk of material misstatements and
detection risk
(b) Control risk, detection risk and inherent risk
(c) Both (a) and (b) (correct)

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 (d) None of the above
Answer (c)
Explanation:
Both (a) and (b), since risk of material
misstatement comprises of control risk and
inherent risk. Audit risk is the risk that the auditor
expresses an inappropriate audit opinion when the
financial statements are materially misstated. It is
a function of the risk of material misstatement
(inherent risk and control risk) and the risk that the
auditor will not detect such misstatement
(detection risk).
48. Point out example of an audit risk?
(a) A customer has gone out of business
(b) The business is experiencing cash flow
problems
(c) A supplier has increased prices
(d) Inventory may be overstated due to
damaged items being valued at cost instead
of net realizable value (correct)
Answer (d)
Explanation:
(a), (b) and (c) are all business risks. (a) would be
an audit risk if the customer owed money to the
client which had not been written off. However,
there is no indication of that from the information
given.

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49. While performing the audit of Company W, you
came to know that the company has entered into
the lease for the first time. There has been no
change in the internal controls of the Company
from previous year. Which of the following is true?
(a) You will test the controls on the recognition
and calculation of lease liability and expense
because of the significant risk of error
inherent in the transaction (correct)
(b) You will not test the controls on the
recognition and calculation of lease liability
and expense because no change has been
made in internal controls from last year audit
(c) You will test the controls on the recognition
and calculation of lease liability and expense
because in previous audit controls on these
account balances were not tested
(d) You will not test the controls on the
recognition and calculation of lease liability
and expense, because, as per ISA 330, the
controls are tested once in three audits if no
change in control takes place
Answer (a)
Explanation:
The Company W has entered into the lease for the
first time and there has been no change in the
internal controls of the company from previous
year. Therefore, you will test the controls on the
recognition and calculation of lease liability and

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 expense because of the significant risk of error
inherent in the transaction.
50. Which of the following statements is/are true with
respect to analytical procedures?
I. Analytical procedures can be used
throughout the audit.
II. Analytical procedures must be used as risk
assessment procedures.

(a) I only
(b) II only
(c) Neither I nor II
(d) I and II (correct)
Answer (d)
Explanation:
Analytical procedures can be used throughout the
audit but must be used as risk assessment
procedures and at the review stage of the audit.

51. During the course of an audit, you identified few

weaknesses in the operating effectiveness of the
controls. What will be your next step?
(a) Move to test of details as no reliance can be
placed on the controls
(b) Increase the sample for test of controls
(correct)
(c) Move to analytical procedures as some
reliance can be placed on the controls

31
 (d) Check the financial impact of the breaches
and if immaterial continue with the test of
controls and if material then move t
substantive procedures, increasing their
extent
Answer (b)
Explanation:
In order to overcome the weaknesses in the
operating effectiveness of the controls you have to
increase the sample for test of controls.
52. If control risk and inherent risk are assessed as
sufficient low, substantive procedures can be
abandoned completely:
(a) True
(b) False (correct)
Answer (b)

53. Auditor is concerned with which of the following

type of frauds?
(a) Fraud that causes a material misstatement
in the financial statements (correct)
(b) Fraud that causes a misstatement in the
financial statements
(c) Fraud having either the financial impact or
non-financial impact
(d) All of the above
Answer (a)

32
 Explanation:
Auditor is concerned with the fraud that causes a
material misstatement in the financial statements.
54. Which of the following would be the best sources
of information about a company's financial
systems that the auditors may use as sources of
information?
I. The company's systems procedure manuals
II. The internal audit function's system notes
III. The prior year audit file
IV. Inquiries made of company staff
V. The company's website

(a) III, IV and V

(b) I, III and V
(c) I, II and IV (correct)
(d) I, II and III
Answer (c)
Explanation:
Whilst the prior year audit file will be useful, the
system may have changed in the intervening
period. The company's website is very unlikely to
contain details on the internal control system.
55. Definition of audit risk is?
(a) The risk the auditor expresses an
inappropriate opinion when the financial
statements are materially misstated (correct)
(b) The risk the auditor fails to detect material
misstatements in the financial statements
(c) The risk the auditor issues the correct
opinion in the circumstances
33
 Answer (a)
Explanation:
(b) is the definition of detection risk. (c) is not a
risk.

56. Which of the following best describes the Fraud

Risk Factor?
(a) An intentional act by one or more individuals
among management, those charged with
governance, employees, or third parties,
involving the use of deception to obtain an
unjust or illegal advantage
(b) Events or conditions that indicate an
incentive or pressure to commit fraud or
provide an opportunity to commit fraud
(correct)
(c) The risk of material misstatement due to
fraud
Answer (b)
Explanation:
Fraud risk factors are events or conditions that
indicate an incentive or pressure to commit fraud
or provide an opportunity to commit fraud.
57. The performance materiality has been set at PKR
100,000 by the auditor of Zaid Co. identify what
could be the materiality level set for the financial
statements as a whole for Zaid Co.?
(a) PKR 120,000 (correct)
34
 (b) PKR 95,000
(c) PKR 100,000
(d) PKR 80,000
Answer (a)
Explanation:
Performance materiality must be lower than
materiality for the financial statements as a whole.
58. Test of control is best describes by:
(a) An evaluation of likely relationships between
financial and non-financial data
(b) A procedure performed by the external
auditor to verify whether a control is in place
and operating effectively (correct)
(c) A process implemented by the audited entity
to mitigate a risk
(d) A procedure performed by the external
auditor to detect material misstatement at an
assertion level
Answer (b)
Explanation:
(c) is a control, not a test of control. (d) is a
substantive procedure. (a) is an analytical
procedure.

59. Who should an auditor inquire; if he suspects the

risks of material misstatement in the financial
statements, resulting from management fraud?
(a) Employees with different levels of authority
(correct)
35
 (b) Stakeholders of the company
(c) Those charged with governance
(d) Management
Answer (a)
Explanation:
The auditor should inquire from the employees
with different levels of authority if they suspect the
risks of material misstatement in the financial
statements.
60. Complete the definitions:
I. _______________ risk is the risk that
_______________ may give an
____________ opinion on the financial
statements.
II. ________________ risk is the
______________ of an assertion to a
______________ that could be material,
assuming there were no related
_____________________.

Answer:
I. Audit, auditors, inappropriate
II. Inherent, susceptibility, misstatement,
internal controls

Explanation:
I. Audit risk is the risk that auditors may give
an inappropriate opinion on the financial
statements.
II. Inherent risk is the susceptibility of an
assertion to a misstatement that could be
36
 material, assuming there were no related
internal controls.
61. An entity has few employees in its accounting
department; point out which audit risk should be
considered?
(a) Inherent
(b) Detection
(c) Control (correct)
Answer (c)
Explanation:
Control - few employees indicates limited
segregation of duties, which is a control
weakness.

62. In planning phase of audit, the risk of material

misstatement due to fraud shall be kept as:
(a) An inherent risk
(b) Control risk
(c) Detection risk
(d) Significant risk (correct)
Answer (d)
Explanation:
In planning phase of audit, the risk of material
misstatement due to fraud shall be kept as
significant risk. Significant risks are complex or
unusual transactions that may indicate fraud, or

37
 other special risks. Significant risks are those that
require special audit consideration.
63. Identify which is not an example of audit risk?
(a) Intangibles may be overstated due to
development costs not meeting the relevant
criteria of IAS 38 Intangibles
(b) There is a tight reporting deadline which
may mean there is material misstatements
due to a higher number of estimates
included in the financial statements
(c) Disclosures of going concern issues may
not be adequate
(d) The company may not be compliant with
relevant laws and regulations (correct)
Answer (d)
Explanation:
Compliance with laws and regulations is a
business risk. The audit risk would be potential
unrecorded liabilities as a result of non-
compliance.
64. Identify which actions could the auditor take to
reduce audit risk?
I. Increase sample sizes
II. Reduce control risk
III. Assign more experienced staff to the
engagement team

(a) I only
(b) I and III (correct)
(c) II only
(d) II and III

38
 Answer (b)
Explanation:
The auditor cannot affect control risk or inherent
risk. The auditor can reduce audit risk by
manipulating detection risk. Increasing sample
sizes and assigning more experienced staff to the
audit will both reduce detection risk and therefore
audit risk.

65. Which of the following is correct about Performance

Materiality?
(a) Performance materiality is the amount set by
auditor at financial statement level below
which no misstatement can be tolerated
(b) Performance materiality is set at a level
which is below the materiality at financial
statement level (correct)
(c) Performance materiality is the amount set
only at account balance level since
disclosures and classes of transactions are
not relevant in calculating materiality
(d) All of the above
Answer (b)

Explanation:

Performance materiality refers to the amount or

amounts set by the auditor at less than the

39
 materiality level or levels for particular classes of
transactions, account balances or disclosures.
66. The external auditor of Karachi Co. has set a
planning materiality threshold of PKR 40,000 and
a performance materiality of PKR 30,000. The
audit testing approach to the following financial
statement items is being considered:
I. Ali, a director of Karachi Co., owes PKR
1,000 to the company (borrowed during the
year).
II. Sundry income of PKR 35,000

Which of the two items should be tested?

(a) Neither I nor II
(b) Both I and II (correct)
(c) I only
(d) II only
Answer (b)
Explanation:
The director's loan from the company (an asset);
although less than the performance materiality
level should be tested as it is a statutory
requirement to disclose the exact amount.
Disclosure of transactions with directors is
considered to be material by nature. Sundry
income being greater than the performance
materiality level must also be tested.

67. The general ranges applied on Equity for

determining materiality are:
(a) 2.5%-7.5%
40
 (b) 1%-5% (correct)
(c) 3.5%-7.5%
(d) 1%-4%
Answer (b)
Explanation:
The general ranges applied on Equity for
determining materiality are 1% - 5%.
68. Point out example of an analytical procedure?
(a) Recalculation of a balance
(b) Comparing gross profit margin to the prior
year figure to identify significant changes
(correct)
(c) Enquiries of management regarding the
risks of the business
Answer (b)
Explanation:
Ratio analysis is one type of analytical procedure.
An analytical procedure requires evaluation of
likely relationships between financial and non-
financial information. Enquiry and recalculation are
different types of auditing techniques.

69. You are planning the audit of Abbas Limited, a

listed Company. The Profit before tax of the said
entity is Rs. 160,000,000. You have decided to
use 5% of PBT. You have also decided to use
another low level materiality that will be 50 % of
materiality as a whole. Select the correct answer:

41
 (a) Materiality at Financial statement level is Rs.
8,000,000 while Performance materiality is
Rs. 4,000,000 (correct)
(b) Materiality at Financial statement level is Rs.
8,000,000 while Rs. 4,000,000 is not the
performance materiality
(c) There is no need to compute a materiality
which is below Rs. 8,000,000
(d) ISA does not require computing
performance materiality in listed companies
Answer (a)
Explanation:
Option (a) is correct because performance
materiality refers to the amount or amounts set by
the auditor at less than the materiality level or
levels for particular classes of transactions,
account balances or disclosures i.e. performance
materiality Rs. 4,000,000 is less than the
materiality level of Rs. 8,000,000.
70. Is the following statement true or false?
“ACCA recommends that working papers should
be retained for a minimum period of five years“
(a) True
(b) False (correct)
Answer (b)
Explanation:
ACCA recommends a minimum retention period of
seven years.
42
71. Which of the following includes risk assessment
procedures?
(a) Test of details
(b) Analytical procedures (correct)
(c) Test of controls
(d) All of the above
Answer (b)
Explanation:
Analytical procedures can be used at all stages of
the audit. ISA 315 requires their use during the
risk assessment stage of the audit.
72. Point out which one is not a test of control?
(a) Inspection of a title deed for the name of the
client to confirm rights and obligations
(correct)
(b) Inspection of capital expenditure forms for
evidence that three quotations have been
obtained to ensure the best price is paid
(c) Inspection of the reconciliation of the non-
current asset register with the physical
assets to confirm the reconciliation has been
performed on a regular basis
(d) Inspection of non-current assets for
evidence of asset tags/barcodes that can be
used to trace assets
Answer (a)
Explanation:
43
 (a) is a substantive procedure as it is testing one
of the financial statement assertions. Test of
control is performed to verify that a control is in
place and working effectively. Evidence of
reconciliations being performed, quotations being
received and asset tagging are all tests of
controls.

73. Performance materiality is set for the following

purpose:
(a) The aggregate of individual immaterial
misstatements do not exceed the materiality,
at financial statement level (correct)
(b) So that maximum work on an audit can be
done even if efficiency of the audit is
compromised
(c) Both of the above
(d) None of the above
Answer (a)

Explanation:

The purpose of setting the performance materiality

is to ensure that the aggregate of individual
immaterial misstatements do not exceed the
materiality, at financial statement level.
74. As an experienced audit team member, you were
assigned to carry out a substantive test on
directors' expenses. The result of the test showed
that CFO had authorized the over payment of his
44
 expenses and each expense item was less than
the performance materiality level.
What action should be taken?
(a) Discuss with the CFO
(b) Draw conclusion
(c) Discuss with a senior member of the audit
team (correct)
(d) Extend sample
Answer (c)
Explanation:
A conclusion cannot yet be drawn as the reason
for the error has not been established. Although
each error is less than performance materiality,
cumulatively the error may be material. In addition,
as the CFO authorized the payments, suspicion of
potential fraud must be considered. Discussion
with the CFO would not be appropriate as he is a
prime suspect. At this stage, extending the sample
would not be appropriate as it is clear errors (or a
possible fraud) have occurred. Because of the
potential fraudulent authorization, a senior
member of the audit team should be involved to
provide guidance for the next step.
75. Calculate receivables days’ ratio:
Revenue PKR 1,267,000
Cost of sales PKR 1,013,000
Receivables PKR 121,000
Payables PKR 87,500
Inventory PKR 60,000
(a) 22
(b) 32

45
 (c) 35 (correct)
(d) 44
Answer (c)
Explanation:
Receivables days are calculated as
(receivables/revenue) x 365.
(121,000/1,267,000) x 365 = 35 days

76. Auditor may use any base whose percentage is set

as materiality. The said base is known as:
(a) Bench Mark (correct)
(b) Tolerable misstatement
(c) Performance materiality
(d) Uncorrected misstatement
Answer (a)
Explanation:
Determining materiality for the financial statements
as a whole involves the exercise of professional
judgment. Generally, a percentage is applied to a
chosen benchmark as a starting point for
determining materiality for the financial statements
as a whole.
77. In accordance with ISA 240 the auditor's
responsibilities relating to fraud in an audit of
financial statements, which point correctly
describes the auditors' responsibilities?

46
 (a) The auditor is responsible for obtaining
reasonable assurance that the financial
statements are free from material
misstatement whether caused by fraud or
error. (correct)
(b) The auditor is responsible for the prevention
and detection of fraud and error.
(c) The auditor is not responsible for the
prevention of fraud and error but is
responsible for detection.
(d) The auditor is responsible for detecting all
errors and should attempt to detect fraud
where information comes to light as a result
of standard audit procedures.
Answer (a)
Explanation:
The directors are ultimately responsible for the
prevention and detection of fraud and error. The
auditor needs to obtain reasonable assurance that
the financial statements are not materially
misstated.
78. The auditor of Woodland Co. is facing a legal
claim for negligence that the manager alleged a
fraud at one of the smallest of the company's 80
branches. According to rotational testing approach
the auditor not visited that branch for three years;
as a result the fraud had gone undetected for two
years. What is the auditor's best defense against
the claim?
(a) An up-to-date letter of engagement which
points out to the directors that the audit

47
 should not be relied upon to detect all frauds
which may exist
(b) Audit documentation shows that the audit
was carried out in accordance with
International Standards on Auditing (correct)
(c) Written representations from management
or other documentary evidence from the
directors in which they acknowledge primary
responsibility for the prevention and
detection of fraud
(d) Case law judgments which indicate that an
auditor should not be held responsible for
ingeniously laid frauds
Answer (b)
Explanation:
(b) is the best answer because it is a "positive"
rather than "negative" defense.
(b) is a better defense than just (a) or (c) since
both (a) and (c) (together) would be encompassed
by (b). (a) denial of responsibility (d) is not as good
as having evidence to show that the audit was
properly conducted.

79. While determining the materiality for a listed

company, which of the following is the most
suitable bench mark for materiality?
(a) Equity
(b) Total Assets
(c) Net Assets

48
 (d) Profit before tax (correct)
Answer (d)
Explanation:
Profit before tax is the most suitable bench mark
for determining the materiality for a listed
company.
80. Audit risk is best describes by?
(a) The risk profits will decrease as a result of
intense competition in the market
(b) The risk a customer cannot pay their debts
(c) The risk the company's reputation may be
damaged by a product recall
(d) The risk a provision has not been
recognized resulting in understatement of
liabilities (correct)
Answer (d)
Explanation:
(a), (b) and (c) are all business risks. An audit risk
must be either a detection risk or a risk of material
misstatement in the Financial Statement.
81. Identify which option is not included in the
agreement obtained by the auditor?
(a) Management's responsibility to provide the
auditor with all information relevant to the
preparation of the financial statements
(b) Management's responsibility to prevent and
detect fraud (correct)
(c) Management's responsibility for preparing
the financial statements

49
 (d) Management's responsibility for internal
control to enable the preparation of financial
statements which are free from material
misstatement
Answer (b)
Explanation:
Although the directors are responsible for the
prevention and detection of fraud this is not one of
the matters included in the agreement obtained by
the auditors to establish that the preconditions of
an audit exist in accordance with ISA 210
Agreeing the terms of audit engagements.

82. While determining the materiality for a company,

whose production has not started yet (start-up
phase before the commissioning date), which of
the following is the most suitable bench mark for
materiality?
(a) Total Expenses or Equity (correct)
(b) Total Assets
(c) Net Assets
(d) Net Surplus
Answer (a)
Explanation:
Total expenses or Equity is the most suitable
bench mark for determining the materiality of that
company whose production has not started yet.

50
83. An auditor has discovered a PKR 100,000 wages
fraud by a director of a listed company. The
amount is not material and that fraud does not
constitute money laundering. To whom does the
auditor have a primary duty to report this matter
to?
(a) The company's shareholders
(b) Those charged with governance (correct)
(c) The tax authorities
Answer (b)
Explanation:
The auditor has a primary duty to report the fraud
to those charged with governance. As the
company is a listed company, this would initially
be to the audit committee as the fraud was carried
out by a director. It would only be reported in the
audit report if it affected the true and fair view.
84. In respect of audit risk which explanation is valid?
(a) Higher receivables days indicate a risk of
understatement of receivables
(b) Higher gross profit margin indicates either
overstatement or revenue or
understatement of cost of sales (correct)
(c) Higher payables days indicate a risk of
understatement of payables
(d) Higher inventory days indicate that cost of
sales may be overstated
Answer (b)
Explanation:

51
 Higher receivables days indicate overstatement or
receivables. Higher payables days would indicate
overstatement of payables or would be used to
assess the need for going concern disclosure due
to cash flow issues. Higher inventory days would
indicate overvaluation of closing inventory which
would decrease cost of sales and therefore lead to
understatement of cost of sales.

85. The general ranges applied on Profit before Tax

for determining materiality are:
(a) 2.5%-6%
(b) 5%-10% (correct)
(c) 5%-15%
(d) 15%-25%
Answer (b)
Explanation:
The general ranges applied on Profit before Tax
for determining materiality are 5% - 10%.
86. Which of the following must be included in an audit
engagement letter?
(a) Basis on which fees are computed
(b) Expected form and content of any reports
(correct)
(c) Arrangements concerning the use of experts
(d) Obligations to make audit working papers
available to other parties
Answer (b)
52
 Explanation:
In accordance with ISA 210 Agreeing the terms of
audit engagements the expected form and content
of any reports must be included. (a), (c) and (d)
however may be included but there is no
requirement to do so.
87. In relation to fraud and error, point out which
statement is correct regarding responsibilities?
(a) The auditor is responsible for preventing
and detecting fraud
(b) Auditors should plan and perform their work
to have a reasonable expectation of
detecting material misstatement caused by
fraud or error (correct)
(c) Management is responsible for preventing
fraud and auditors are responsible for
detecting fraud
(d) The auditor has no responsibility for
prevention or detection of fraud as this is
solely management's responsibility
Answer (b)
Explanation:
Prevention of fraud is solely the responsibility of
management. Both management and auditors
have some responsibility to detect fraud. However,
auditors are mainly concerned with material
misstatements. Auditors are not required to detect
all fraud.

88. The general ranges applied on Gross

Margin/Gross Profit for determining materiality are:
53
(a) 5%-10%
(b) 2%-5%
(c) 2.5%-7.5%
(d) 1%-4% (correct)
Answer (d)
Explanation:
The general ranges applied on Gross
Margin/Gross Profit for determining materiality are
1% - 4%.

54