PART I TRUE OR FALSE

1. Professional judgment must be used when evaluating business risk.

2. The auditor must understand internal control before assessing inherent risk.
3. The risk of a material misstatement includes inherent risk and sampling risk.
4. Inherent risk is the susceptibility of an assertion to material misstatement, assuming no
related controls.
5. The combination of inherent risk and control risk is referred to as client risk.
6. Risk is the uncertainty about events and/or their outcomes that could have a material effect
on the organization.
7. Audit risk is the risk that the auditor will be sued by the client because of fraudulent actions.
8. The likelihood of misstatements in the financial statements increases if the client has poor
internal control.
9. Control risk can be referred to as the clients ability to mitigate overall audit risk.
10. Risk is cumulative. If business is extremely high, the auditor will likely make a decision to not
be associated with a client because engagement risk will be too high.
PART II MULTIPLE CHOICE
Introduction-Importance of Identifying and Assessing the ROMM of F/S
1. An auditor has assessed entitys business risk and the risk to material misstatements of its
financial statements. These are done in order to:
a. Apply the audit risk model in determining the appropriate audit procedures to perform.
b. Determine the reliance on the companys internal control systems for financial reporting.
c. Determine the test of balances to be performed by the audit team.
d. Assure the CPA firm that they can perform the audit effectively and efficiently.
2. Which of the following audit risk components may be assessed in quantitative and non-
quantitative terms?
Control Risk Detection Risk Inherent Risk
a. Yes Yes Yes
b. No Yes Yes
c. Yes Yes No
d. Yes No Yes
Identifying Material Accounts and Disclosures
3. An auditor judged an item to be immaterial when planning an audit. However, the auditor
may still include the item if it is subsequently determined that:
a. Sufficient staff is available.
b. Adverse effects related to the item are likely to occur.
c. Related evidence is reliable.
d. Miscellaneous income is affected.
The risk of Material Misstatement (ROMM) of F/S
4. Risk of material misstatement is
a. An identified and assessed risk of material misstatement that, in the auditors judgment,
requires special audit consideration.
b. A risk that may relate to the inaccurate or incomplete recording of routine and significant
classes of transactions or account balances, the characteristics of which often permit
highly automated processing with little or no manual intervention.
c. The risk that the financial statements are materially misstated prior to audit.
d. The risk that relate pervasively to the financial statements as a whole, and potentially
affect many assertions that could be considered material.
5. What is the auditor required to identify and assess the risks of material misstatement?
a. At the assertion level for each material account and disclosure consisting of two
components: inherent risk and control risk
b. At the financial statement level as a whole potentially affecting many assertions.
c. Either a or b
d. Both a and b
6. The risk of a material misstatement occurring in an account, assuming an absence of
internal control, is referred to as:
a. Account risk
b. Control risk
c. Detection risk
d. Inherent risk
7. Control risk is
a. The risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated.
b. The risk that a misstatement, that could occur in an account balance or class of
transactions and that could be material individually or when aggregated with
misstatements in other balances or classes, will not be prevented or detected and
corrected on a timely basis by the accounting and internal control systems.
Auditing-Cabarles Chapter 9
 c. The risk that an auditors substantive procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material, individually
or when aggregated with misstatements in other balances or classes.
d. The susceptibility of an account balance or class of transactions to misstatement that
could be material, individually or when aggregated with misstatements in other balances
or classes, assuming that there were no related internal controls.
8. Control risk should be assessed in terms of
a. Specific controls
b. Types of potential fraud
c. Financial statement assertions
d. Control environment factors
9. Which of the following best describes the relationship between IR, CR and DR?
a. DR does not vary from one assertion to another.
b. IR, CR and DR vary from assertion to assertion.
c. IR and CR do not vary from assertion to assertion, but DR does vary from assertion to
assertion.
d. When IR increases, DR decreases.
10. Inherent risk and control risk differ from detection risk in that inherent risk and control risk
a. Arise from the misapplication of auditing procedures
b. May be assessed in either quantitative or nonquantitative terms
c. Exist independently of the financial statement audit
d. Can be changed at the auditors discretion
11. Which of the following is an incorrect statement?
a. Detection risk cannot be changed at the auditors discretion
b. Detection risk bears an inverse relationship to inherent and control risk
c. The greater the inherent and control risk the auditor believes exists, the less detection
risk that can be accepted
d. The auditor might separate and combined assessments of inherent risk and control risk
12. Which is a primary limitation of audit risk model?
a. The audit risk model does not adequately consider internal forces on the client
organization.
b. Components of the audit risk are treated as independent variables even though many
interdependencies exist between them.
c. The audit technology achieves approximate precision outside of a mathematical model.
d. Control risk must be adjusted at the hands of the auditor, not by an arbitrary estimation.
Significant risk
13. Significant risk assessed risk of material misstatement that, in the auditors judgment,
requires special audit consideration. The auditor is __________ to determine whether any of
the risks identify are, in the auditors judgment, as significant risk.
a. Encouraged
b. Required
c. Not permitted
d. Allowed
14. Which of the following is required of the auditor when the assessed risk of material
misstatement is judged to be significant risk?
a. To obtain an understanding of the entitys controls, including control activities, relevant to
significant risks.
b. To perform test of controls.
c. To be audited by test of details substantive procedures in all cases.
d. All of the above
15. Which of the following risks of material misstatement may least likely be judged as
significant risk?
a. The risk is a risk of fraud.
b. The risk is related to recent significant economic, accounting or other development.
c. The risk relates to complex, unusual and subjective transactions.
d. The risk involves significant transactions with unrelated parties.
16. One accounting issue that does not require management to use significant judgments is:
a. The allowance for doubtful accounts.
b. The useful life of equipment tax purposes.
c. Obsolete inventory.
d. The liability or warranty payments.
Risk that Substantive Procedures Alone Are not Enough to Address
17. The following statements relate to risks for which substantive procedures alone do not
provide sufficient appropriate audit evidence. Which is incorrect?
a. Risks for which substantive procedures alone do not provide sufficient appropriate audit
evidence may be include risk of inaccurate or incomplete processing for routine and
Auditing-Cabarles Chapter 9
 significant classes of transactions such as entitys revenue, purchases and cash receipts
or cash payments.
b. The auditor may not obtain an understanding of relevant controls over risks for which
substantive procedures alone do not provide sufficient appropriate audit evidence.
c. Both a and b
d. None of the above
The Process of Identifying and Assessing ROMM
18. Determine the most logical order of assessing the risks of material misstatements as
indicated in PSA 315?
I. Consider the likelihood of misstatement, including the possibility if multiple
misstatements, and whether the potential misstatement is of a magnitude that could
result in a material misstatement.
II. Assess the identified risks (if it is a significant risk), and evaluate whether they relate
more pervasively to the financial statements as a whole and potentially affect many
assertions;
III. Identify risks throughout the process of obtaining an understanding of the entity and
its environment, including relevant controls that relate to the risks, and by considering
the classes of transactions, account balances and disclosures in the financial
statements.
IV. Relate the identified risks to what can go wrong at the assertion level, taking account
of relevant controls that the auditor intends to test;
a. I, II, III and IV
b. III, II I and IV
c. III, II, IV and I
d. IV, III, I and II
19. Which of the following statements is not true regarding audit risk assessment?
a. The auditor studies the business and industry and applies analytical procedures as a
basis for assessing inherent risk.
b. The auditor studies and evaluates internal control policies and procedures for assessing
control risk.
c. The auditor designs substantive audit procedures to reduce detection risk to an
acceptable level.
d. When control risk and inherent risk are high, the auditor increases detection risk to
maintain overall audit risk at the desired level.
Identify and Risks to the F/S
20. Which statement is correct regarding business risk?
a. The risk of material misstatement of the financial statements is broader than business
risk, though it includes the latter.
b. The auditor should identify or assess all business risks
c. All business risks give rise to risks of material misstatements
d. A business risk may have an immediate consequence for the risk of misstatement for
classes of transactions, account balances, and disclosures in the assertion level or the
financial statements as a whole.
21. The following are examples of conditions and events that may indicate the existence of risks
of material misstatement, except
a. Operations in regions that are economically stable
b. Pending litigation and contingent liabilities
c. Application of new accounting pronouncements
d. High degree of complex regulation
22. Which of the following conditions and events may most likely indicate the existence of risks
of material misstatements?
a. Having personal with appropriate accounting and financial reporting skills.
b. Accounting measurements that involve simple processes.
c. Significant amount of routine or systematic transactions.
d. Constraints on the availability of capital and credit.
23. Which of the following industries is usually considered high risk by audit firms?
a. High technology companies such as Internet firms.
b. Manufacturing companies such as toy procedures.
c. Legal services such as attorney firms.
d. Non-profit companies such as trade associations.
24. A potential business risk created by new products may most likely include
a. Increased product liability
b. Increased legal exposure
c. The entity does not have the personnel or expertise to deal with the changes in the
industry
d. Loss of financing due to the entitys inability to meet financing requirements
Auditing-Cabarles Chapter 9
Assess Identified Risks and Evaluate Whether Relate Pervasively to F/S
25. The following risks relate to financial statements as a whole, except
a. Management override of internal control
b. Fraud risks
c. Weak control environment, such as managements lack of competence
d. Risk of theft of cash on hand
26. If the business environment experiences a recession, the auditor most likely would focus
increased attention on which of the following accounts?
a. Purchase returns and allowances
b. Allowance for doubtful accounts
c. Common stock
d. Noncontrolling interest of a subsidiary purchased during the year
27. Auditors often assess which of the risks for liabilities and expense accounts of the entity?
a. Overstatement
b. Understatement
c. Either a or b
d. Both a and b
28. Auditors often assess which of the risks for assets and income accounts of the entity?
a. Overstatement
b. Either a or b
c. Understatement
d. Both a and b
Relate Identified Risks to What Can Go Wrong at the Assertion Level and Relevant Controls
29. Auditors may assess inherent risk and control risk:
Jointly to determine the risk of material Separately and combine their effects in
misstatement the audit risk model
a. Yes Yes
b. No No
c. Yes No
d. No Yes
30. Determining that the receivables are presented at net-realizable value is most directly
related to which management assertion?
a. Existence
b. Rights
c. Valuation
d. Presentation and disclosure
31. A common inventory observation procedure is to be alert for items that are damaged, rust-,
or dust-covered, or located in inappropriate places. The balance-related audit objective
being achieved by this procedure is:
a. Classification
b. Realizable value
c. Cutoff
d. Rights
32. Which assertion are auditors most concerned with regarding the audit of asset accounts?
a. Completeness
b. Existence
c. Accuracy
d. Proper period
33. Which of the following balance-related audit objectives typically is assessed as having high
inherent risk for cash?
a. Existence
b. Detail tie-in
c. Presentation and disclosure
d. Cutoff
34. The auditors internal control objective to determine that recorded acquisitions are for goods
and services received satisfies the audit objective of:
a. Accuracy
b. Authorization
c. Occurrence
d. Completeness
35. Failure to record the acquisition of goods is a violation of which audit objective?
a. Accuracy
b. Authorization
c. Occurrence
d. Completeness

Auditing-Cabarles Chapter 9
 36. During an audit of the production cycle, you noted a control procedure requiring the
accounting clerk to look up the material invoice and match the material unit costs to the unit
cost of material shown on the job cost sheet for all government contract work. This
procedure is designed to meet the control objective of
a. Existence
b. Valuation
c. Right and obligation
d. Classification
Consideration Likelihood and Magnitude of Risks to Assess Level of ROMM
37. While assessing the risks of material misstatement auditors identify risks, relate risk to what
could go wrong, consider the magnitude and
a. Assess the risk of misstatement due to illegal acts
b. Consider the complexity of the transaction involved
c. Consider the likelihood that the risk could result in material misstatements
d. Determine materiality levels
38. Auditors begin their assessments of inherent risk during audit planning. Which of the
following would not help in assessing inherent risk during the planning phase?
a. Obtaining clients agreement on the engagement letter.
b. Obtaining knowledge about the clients business and industry.
c. Touring the clients plant and offices.
d. Identifying related parties.

39. Which of the following is not a primary consideration when assessing inherent risk?
a. Nature of clients business.
b. Existence of related parties.
c. Frequency and intensity of managements review of accounting transactions and
records.
d. Susceptibility to defalcation.
40. Most auditors assess inherent risk as high for related parties and related-party transactions
because:
a. Of the unique classification of related-party transactions required on the balance sheet
b. Of the lack of independence between the parties
c. Of the unique classification of related-party transactions required on the income
statement
d. It is required by generally accepted accounting principles
41. Inherent risk is defined as the susceptibility of an account balance or class of transactions to
error that could be material assuming that there were no related internal controls. Of the
following conditions, which one does not increase inherent risk?
a. The client has entered into numerous related party transactions during the year under
audit.
b. Internal control over shipping, billing and recording of sales revenue is weak.
c. The client has lost a major customer accounting for approximately 30% of annual
revenue.
d. The board of directors approved a substantial bonus for the president and chief
executive officer, and also approved an attractive stock option plan for themselves.
42. Inherent risk is often low for an account such as:
a. Accounts receivable
b. Cash
c. Marketable securities
d. Inventory
43. When planning an audit, the auditors assessed level of control risk is:
a. Determined by using actuarial tables.
b. Calculated by using the audit risk model.
c. A judgment issue, based on auditor knowledge.
d. Calculated by using the formulas provided in PSAs.
44. In the assessment of control risk, the auditor is basically concerned that the clients internal
control provides reasonable assurance that
a. Management cannot override the system.
b. Operational efficiency has been achieved in accordance with management plans.
c. Errors and fraud have been prevented and detected.
d. Controls have not been circumvented by collusion.
45. A clients internal control appears strong, but the CPA has elected not to perform any tests
of controls. The planned assessed level of control risk is at what level?
a. Zero
b. Low
c. Moderate
Auditing-Cabarles Chapter 9
 d. Maximum
46. In the audit of a company, the auditor will test controls when control risk is initially assessed
at:
LOW MODERATE HIGH
a. Yes No Yes
b. No No Yes
c. Yes Yes No
d. No Yes No
47. Assessing control risk below maximum involves all of the following except
a. Identifying specific controls to rely on
b. Concluding that controls are ineffective
c. Performing tests of controls
d. Analyzing the achieved level of control risk after performing tests of controls
48. The conclusion reached as a result of assessing control risk is referred to as the:
a. Assessed level of control risk
b. Assurance provided by entitys internal control
c. Determined level of acceptable detection risk
d. Product of the understanding of internal control
49. An auditor assesses control risk because it
a. Is relevant to the auditors understanding of the control environment
b. Provides assurance that the auditors materiality levels are appropriate
c. Indicates to the auditor where inherent risk may be the greatest
d. Affects the level of detection risk that the auditor may accept
50. The ultimate purpose of assessing control risk is to contribute to the auditors evaluation of
the risk that:
a. Specific internal control activities are not operating as designed.
b. The collective effect of the control environment may not achieve the control objectives.
c. Tests of controls may fail to identify activities relevant to assertions.
d. Material misstatements may exist in the financial statements.

Auditing-Cabarles Chapter 9