Certified Public Accountant Risk Assessment & Management 5 — Questions and Answers
Question 1: Which of the following is a leading indicator of liquidity risk for a company?
- Declining current ratio over multiple quarters (Correct answer)
- High gross profit margin
- Increasing return on equity
- Strong earnings before interest and taxes (EBIT)
Correct answer: Declining current ratio over multiple quarters
A declining current ratio signals that the company may struggle to meet short-term obligations, making it a leading indicator of liquidity risk.
Question 2: The concept of 'tone at the top' primarily relates to which COSO Internal Control component?
- Control Activities
- Monitoring
- Control Environment (Correct answer)
- Risk Assessment
Correct answer: Control Environment
Tone at the top refers to the ethical culture and commitment to integrity set by senior management and the board, which is a fundamental element of the Control Environment.
Question 3: Which risk response involves restructuring a business process to eliminate the source of a risk entirely?
- Risk mitigation
- Risk acceptance
- Risk avoidance (Correct answer)
- Risk transfer
Correct answer: Risk avoidance
Risk avoidance involves exiting or not engaging in activities that give rise to risk, effectively eliminating exposure by not participating in that activity.
Question 4: An auditor identifies that a client's revenue recognition policy is complex and subject to significant management judgment. This primarily affects which audit risk component?
- Detection risk
- Control risk
- Inherent risk (Correct answer)
- Audit sampling risk
Correct answer: Inherent risk
Inherent risk is elevated when transactions require significant judgment or complex accounting, independent of any related internal controls.
Question 5: A company purchases insurance to protect against potential property damage losses. This is an example of which risk response?
- Risk acceptance
- Risk avoidance
- Risk reduction
- Risk transfer (Correct answer)
Correct answer: Risk transfer
Purchasing insurance transfers the financial consequence of a risk to the insurer, making it a classic example of risk transfer.
Question 6: Which of the following best describes a 'material weakness' in internal control over financial reporting?
- A deficiency where a control does not operate as designed on one occasion
- A significant deficiency that has been remediated before year-end
- A deficiency or combination of deficiencies with a reasonable possibility of material misstatement not being prevented or detected (Correct answer)
- A control gap identified in operational processes with no financial statement impact
Correct answer: A deficiency or combination of deficiencies with a reasonable possibility of material misstatement not being prevented or detected
A material weakness is a deficiency (or combination) in ICFR where there is a reasonable possibility that a material misstatement will not be prevented or detected on a timely basis.
Question 7: Which of the following risk assessment approaches involves analyzing how multiple risks interact and compound each other?
- Standalone risk analysis
- Correlation and portfolio risk analysis (Correct answer)
- Single-factor sensitivity analysis
- Control self-assessment
Correct answer: Correlation and portfolio risk analysis
Correlation and portfolio risk analysis examines how risks are interrelated, recognizing that correlated risks can amplify aggregate exposure beyond individual risk estimates.
Certified Public Accountant Risk Assessment & Management 5
Which of the following is a leading indicator of liquidity risk for a company?