Unit 2: Assessing Risk and Developing a Planned Response

• Topic 01

  Audit Planning

  51 questions
• Topic 02

  Internal Control

  49 questions
• Topic 03

  Risk Assessment Procedures

  45 questions
• Topic 04

  Identifying and Assessing Risks of Material Misstatement

  45 questions
• Topic 05

  Fraud Risk

  45 questions
• Topic 06

  Significant Risks and Risks Requiring Special Consideration

  45 questions
• Topic 07

  Developing Responses to Assessed Risks

  50 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. An auditor performs integrated audit procedures for a public company under PCAOB standards. A significant risk is identified for the valuation assertion of Level 3 financial instruments. Control testing over the fair value measurement process reveals a material weakness (insufficient review of model assumptions). Under PCAOB AS 2201, what are the implications for both the financial statement opinion and the ICFR opinion?

   • A
     The material weakness allows the auditor to issue a disclaimer on the valuation because the controls are inadequate
   • B
     An adverse ICFR opinion automatically requires a qualified financial statement opinion on the same account
   • C
     The material weakness means the auditor must withdraw from both opinions until management remedies the control
   • D
     The material weakness requires an adverse ICFR opinion; the financial statement auditor must also design more extensive substantive procedures for the Level 3 valuation to compensate for the lack of effective controls, because a material weakness increases detection risk requirements for the related assertion
     Correct answer
   Explanation

   Under PCAOB AS 2201, a material weakness — a significant deficiency or combination of deficiencies in ICFR that creates a reasonable possibility of a material misstatement — requires an adverse opinion on ICFR. This does not automatically create a qualified financial statement opinion, but it does have a direct impact on the financial statement audit: because the controls over Level 3 valuation are ineffective, the auditor cannot rely on them to reduce detection risk. The auditor must design more extensive substantive procedures (tests of details) to achieve the required low level of detection risk for the valuation assertion, compensating for the absence of effective controls.

2. An auditor compares the current year gross margin percentage to the prior year and notes an unexplained 5-point decline. What is the most appropriate next step based on this planning analytical procedure?

   • A
     Document the finding and conclude that the financial statements contain a material misstatement.
   • B
     Investigate the decline by inquiring of management and planning additional procedures focused on revenue recognition and cost of sales.
     Correct answer
   • C
     Issue a qualified opinion based on the unexplained margin decline detected during planning.
   • D
     Reduce the scope of inventory testing because the lower margin is likely due to increased costs.
   Explanation

   A planning analytical procedure that reveals an unexplained fluctuation signals a potential risk area. The appropriate response is to inquire of management and plan additional specific audit procedures targeting the accounts that could explain the variance — in this case, revenue recognition and cost of sales. Planning analytics do not constitute evidence of misstatement; they direct the auditor's attention. The auditor may not simply increase materiality or reduce scope in response to an anomaly.

3. Under AU-C 315, what is the purpose of the auditor's understanding of the entity's internal control in the context of RMM assessment?

   • A
     To satisfy the client's request for a comprehensive review of its internal control system.
   • B
     To assess control risk by evaluating whether controls are designed and implemented to prevent or detect material misstatements.
     Correct answer
   • C
     To identify whether the entity uses IT controls, which are automatically reliable without testing.
   • D
     To issue a report on the effectiveness of internal controls as part of every financial statement audit.
   Explanation

   Under AU-C 315, obtaining an understanding of internal control serves the specific purpose of assessing control risk — one of the two components of RMM. The auditor evaluates whether controls are designed and implemented in a way that would, if operating effectively, prevent or detect material misstatements at the assertion level. This understanding informs: (1) the initial control risk assessment; (2) whether to pursue a combined approach (testing controls); and (3) the design of further audit procedures. Issuing an opinion on ICFR is only required for certain public company audits.