CA Auditing & Assurance Services 3 — Questions and Answers
Question 1: Which of the following best describes 'audit risk'?
- The risk that the client will suffer a financial loss
- The risk that the auditor expresses an inappropriate opinion on materially misstated financial statements (Correct answer)
- The risk that the auditor will lose the client engagement
- The risk that internal controls will fail to prevent errors
Correct answer: The risk that the auditor expresses an inappropriate opinion on materially misstated financial statements
Audit risk is the risk that an auditor issues an incorrect opinion (typically unmodified) on financial statements that are materially misstated.
Question 2: A company's inventory balance is $5 million and the auditor sets materiality at $250,000. Using 5% of a balance as a rule of thumb, what does this suggest about the inventory audit?
- Inventory is immaterial and can be skipped
- The threshold is met, so inventory warrants focused audit attention (Correct answer)
- All inventory items must be counted regardless of size
- The auditor must reduce materiality before testing inventory
Correct answer: The threshold is met, so inventory warrants focused audit attention
When an account balance represents a significant portion of total assets relative to materiality, it warrants substantive testing to detect potential misstatements.
Question 3: Which sampling method gives every item in the population an equal chance of selection?
- Systematic selection
- Haphazard selection
- Random number selection (Correct answer)
- Block selection
Correct answer: Random number selection
Random number selection (using random number tables or generators) gives each item an equal and independent probability of being chosen.
Question 4: What is the primary difference between a 'review' and an 'audit' engagement?
- A review provides reasonable assurance while an audit provides limited assurance
- An audit provides reasonable assurance while a review provides limited (negative) assurance (Correct answer)
- Reviews require the same procedures as audits but with a smaller sample size
- There is no difference; the terms are interchangeable
Correct answer: An audit provides reasonable assurance while a review provides limited (negative) assurance
An audit provides reasonable (positive) assurance through extensive evidence-gathering, while a review provides limited (negative) assurance primarily through inquiries and analytical procedures.
Question 5: Under ISA 580, why are written representations from management considered necessary audit evidence?
- They replace the need for all other audit evidence
- They confirm matters that cannot be evidenced through other means and acknowledge management's responsibility (Correct answer)
- They are required only when the auditor finds a misstatement
- They satisfy third-party requirements for liability protection
Correct answer: They confirm matters that cannot be evidenced through other means and acknowledge management's responsibility
Written representations support other evidence by confirming matters that are known only to management and acknowledging management's responsibility for the financial statements.
Question 6: An auditor is assessing the risk of material misstatement for revenue. Which condition represents a fraud risk factor under the fraud triangle?
- Management has strong ethical values and oversight
- Revenue recognition is straightforward with standard terms
- Management compensation is heavily tied to meeting earnings targets (Correct answer)
- The company has experienced stable revenue growth for 10 years
Correct answer: Management compensation is heavily tied to meeting earnings targets
Incentive/pressure is a fraud triangle element; heavy compensation tied to earnings targets creates incentive to manipulate revenue recognition.
Question 7: Which of the following represents a 'test of controls' rather than a 'substantive test'?
- Confirming accounts receivable balances with customers
- Observing the physical inventory count
- Inspecting 30 purchase orders to verify proper approval signatures (Correct answer)
- Recalculating depreciation expense for a sample of fixed assets
Correct answer: Inspecting 30 purchase orders to verify proper approval signatures
Inspecting purchase orders for approval signatures tests whether the control (authorization of purchases) is operating effectively.
CA Auditing & Assurance Services 3
Which of the following best describes 'audit risk'?