AUDIT RISK

You have received the latest management accounts from your client, Esperence Co, to help with your risk assessment for the forthcoming audit. The management accounts show actual results for the year to date, January to October inclusive. In October, Esperence Co received a claim from a customer as a result of a defective product.

1 Which of the following is an example of an audit risk for Esperence Co?

• The client is being sued by a customer for a defective product and if the claim is successful, the compensation awarded is likely to be significant

• The client is being sued by a customer for a defective product. The publicity of the case could damage the company’s reputation

• The client will have to spend a significant amount of money on improving its quality control procedures to avoid the same defects occurring again

• Provisions may be understated if the probable payment resulting from the court case is not recognised as a liability in the financial statements

Which of the following is the correct formula for calculating the payables payment period using the management accounts of Esperence Co?

• A Payables/Cost of sales × 304

• B Payables/Cost of sales × 365

• C Payables/Revenue × 304 D

• Payables/Revenue × 365

Which of the following is NOT an analytical procedure? D

• A Calculation of gross profit margin and comparison with prior year

• B Recalculation of a depreciation charge

• C Comparison of revenue month by month

• Comparison of expenditure for current year with prior year

Which of the following is NOT a ratio?

• A Gross profit margin

• B Acid test

• C Inventory turnover

• D Revenue growth

You have used the management accounts to calculate the gross profit margin and found it to be higher than the prior year figure. Which of the following would provide a possible explanation?

• A Sales prices have been reduced to increase sales volumes

• B Prices charged by suppliers have increased but the company has not increased sales prices to customers to cover the increased costs

• C Closing inventory has been overvalued

• D Administration expenses have decreased

II. You are the audit manager responsible for planning the audit of Fremantle Co. The draft financial statements show profit before tax of $3m and total assets of $50m. You have held a planning meeting with the client and have performed preliminary analytical procedures on the draft financial statements. You are currently assessing preliminary materiality for the audit and performing further risk assessment procedures.

1. 1. Which of the following statements is FALSE in relation to materiality?

• A Materiality can be assessed by size or nature

• B A balance which is omitted from the financial statements cannot be material

• C Materiality is a matter of professional judgement for the auditor

• D There is an inverse relationship between risk and materiality. If audit risk is high, the materiality level set by the audit will be lower

Which of the following procedures is NOT required to be performed in accordance with ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement?

• A Inspection

• B Observation

• C External confirmation

• D Enquiry

Based on the above draft figures, what would be an appropriate level at which to set preliminary materiality?

• A $150,000 for the statement of profit and loss and $500,000 for the statement of financial position

• B $500,000 for the statement of profit and loss and $150,000 for the statement of financial position

• C $1,500 for the statement of profit and loss and $50,000 for the statement of financial position

• D $50,000 for the statement of profit and loss and $1,500 for the statement of financial position

Performance materiality should be used by the auditor when performing substantive testing during the audit. Which of the following best describes performance materiality?

• A The maximum amount of misstatement the auditor is willing to accept

• B The amount at which the auditor deems the misstatement to be trivial

• C An amount which could influence the economic decisions of the users taken on the basis of the financial statements

• D An amount set below materiality for the financial statements as a whole to reduce, to an acceptably low level, the risk that misstatements could be material in aggregate

Professional scepticism must be applied by the auditor during the audit. Which of the following is NOT an application of professional scepticism?

• A A critical evaluation of the evidence

• B An open and questioning mind

• C The auditor should not believe anything the client tells them

• D The auditor must be alert to fraud and error