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1
1. Which of the following is least likely to be appropriate as the basis for determining the preliminary judgment about materiality in the audit of a set of financial statement?
a. Net income before taxes.
b. Current assets
c. Owners' equity
d. Inventory
2. Which of the following statements regarding inherent risk is correct?
a. The inherent risk assigned in the audit risk model is unaffected by the auditor's experience with client's organization.
b. Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect.
c. Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain experience, even when there is inherent risk.
d. The inherent risk assigned in the audit risk model is dependent upon the strengths in client's internal control system.
3. When a different extent of evidence is needed for the various cycles. The difference is caused by
a. Errors in the client's accounting system
b. Client's need to achieve an unqualified opinion.
c. The auditor's need to follow GAAS.
d. The auditor's expectations of errors and assessment of the control structure.
4. Inherent risk is reduced where the likelihood of defalcations is low.
This would be true for an account such as
a. inventory
b. marketable securities
c. cash
d. accounts receivable
Expert Solution
1. Materiality thresholds are determined by the effects a material item may have on the income statement or balance sheet. Since every error affects the income statement and/or the balance sheet, it becomes the cutoff point expressed in dollars below which no one will care. Owners' equity would hardly be involved in these decisions.
2. Inherent risk has to do with the client's system of internal control. The stronger the controls, the lesser the risk. But there is always some inherent risk. I'd choose d.
3. The question is talking about planning an audit, and at that stage, errors in the system aren't known. B and c are a given, but d. is where the decisions are made about the extent of testing.
4. Defalcations (cheating) occur in accounts where there are many transactions, and where there is something to steal. Inventory, cash and accounts receivable all fit. Marketable securities would have fewer transactions and would usually be held offsite in a street account at a brokerage firm.
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