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ICAB PL Audit & Assurance study materials
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ICAB PL Audit & Assurance practice questions

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Question 1Audit framework and regulation

Which body is responsible for issuing International Standards on Auditing (ISAs) that are used as the benchmark for audit regulation in many jurisdictions?

  1. The International Federation of Accountants Council
  2. The International Ethics Standards Board for Accountants
  3. The International Auditing and Assurance Standards Board Correct answer.
  4. The Public Interest Oversight Board

Explanation

The IAASB develops and issues ISAs and other assurance pronouncements under the oversight of the Public Interest Oversight Board, operating within the IFAC structure. It is the standard-setting board, not a council or ethics board.

Question 2Audit framework and regulation

Under the IESBA Code, which threat arises when an audit partner has a close family member employed as the financial controller of the audit client?

  1. Self-interest threat
  2. Familiarity threat Correct answer.
  3. Advocacy threat
  4. Intimidation threat

Explanation

A close family relationship with a client employee in a position to influence the financial statements creates a familiarity threat because the auditor may become too sympathetic to the client's interests. Close personal or family ties are the classic source of familiarity threats.

Question 3Audit framework and regulation

What is the primary purpose of an audit of financial statements?

  1. To advise the entity on improving the efficiency of its internal controls
  2. To express an opinion on whether the statements are prepared, in all material respects, in accordance with the applicable framework Correct answer.
  3. To detect every instance of employee fraud and report it to management
  4. To provide an absolute guarantee that the statements are free from error

Explanation

An audit gives reasonable, not absolute, assurance that the financial statements as a whole are free from material misstatement, and the auditor reports an opinion on fair presentation or compliance with the framework. Fraud detection and advisory work are not the objective of the audit.

Question 4Audit framework and regulation

Which of the following best describes the 'expectation gap' in auditing?

  1. The gap between the auditor's actual responsibilities and what the public believes them to be Correct answer.
  2. The period between the financial year end and the date the audit report is signed
  3. The difference between the sample size planned and the sample size actually tested
  4. The difference between the audit fee charged and the cost of performing the audit

Explanation

The expectation gap is the divergence between what society expects auditors to do, particularly regarding fraud and going concern, and what the audit framework actually requires. It is a perception issue rather than a timing or cost issue.

Question 5Audit framework and regulation

Which of the following is an element of an assurance engagement as defined in the international framework?

  1. A three-party relationship involving the practitioner, the responsible party and intended users Correct answer.
  2. A statutory power to impose penalties on the responsible party
  3. A requirement that the practitioner be an employee of the responsible party
  4. A guarantee that the subject matter is free from all misstatement

Explanation

An assurance engagement requires a three-party relationship: the practitioner, the responsible party and the intended users. It also requires an appropriate subject matter, suitable criteria, sufficient appropriate evidence and a written report.

Question 6Audit framework and regulation

Which of the following is a key difference between reasonable assurance and limited assurance engagements?

  1. Limited assurance engagements are only permitted for historical financial information
  2. Reasonable assurance engagements never use sampling
  3. Reasonable assurance obtains more persuasive evidence and gives a positive-form conclusion Correct answer.
  4. Limited assurance engagements do not require a written report

Explanation

Reasonable assurance involves a reduction of assurance risk to an acceptably low level, gathering more evidence and expressing a positive opinion, whereas limited assurance gathers less evidence and expresses a negative-form conclusion. Both require a written report.

Question 7Audit framework and regulation

What does the concept of auditor independence in appearance refer to?

  1. The requirement that the auditor holds no professional qualifications
  2. The avoidance of facts and circumstances that a reasonable informed third party would perceive as compromising objectivity Correct answer.
  3. The auditor's physical separation from the client's premises
  4. The auditor's actual state of mind being free from bias

Explanation

Independence has two components: independence of mind, which is the actual state of mind, and independence in appearance, which concerns how a reasonable and informed third party would perceive the auditor's objectivity. Both must be maintained.

Question 8Audit framework and regulation

Which of the following is normally the responsibility of those charged with governance rather than the external auditor?

  1. Assessing the going concern assumption for the purpose of the audit opinion
  2. Forming an opinion on the financial statements
  3. Designing and implementing a system of internal control Correct answer.
  4. Evaluating the adequacy of audit evidence obtained

Explanation

Management and those charged with governance are responsible for designing and maintaining internal control and preparing the financial statements. The auditor's responsibility is to obtain evidence and express an opinion.

Question 9Audit framework and regulation

An audit firm has provided bookkeeping services to a listed audit client for several years. Under the IESBA Code, what is the most appropriate conclusion?

  1. The service creates a self-review threat that cannot be reduced to an acceptable level for a listed audit client Correct answer.
  2. The service is permitted because bookkeeping is a routine administrative task
  3. The service is permitted provided the audit fee is disclosed in the financial statements
  4. The service is permitted if the client's management reviews the records before the audit

Explanation

For listed audit clients, providing accounting and bookkeeping services that involve preparing the financial statements creates a self-review threat that safeguards cannot reduce to an acceptable level, so the firm should not provide the service. Management review does not eliminate the threat.

Question 10Audit framework and regulation

A company's audit committee is considering appointing an audit firm whose former partner retired two years ago and now serves as the company's finance director. What is the primary concern?

  1. A familiarity threat arising from the prior relationship between the firm and the individual Correct answer.
  2. An intimidation threat arising from management's control over the audit fee
  3. A self-interest threat arising from a contingent fee arrangement
  4. An advocacy threat arising from the firm promoting the company's shares

Explanation

A former partner of the firm joining the client in a senior financial role creates a familiarity and self-interest threat because of the prior close relationship and possible influence over the audit. Safeguards or a cooling-off period and independent review are typically considered.

Question 11Audit framework and regulation

An auditor identifies a material uncertainty related to going concern that has been adequately disclosed by management. How should the auditor report this?

  1. Issue a qualified opinion because of the uncertainty
  2. Make no reference to the uncertainty because it has been disclosed
  3. Include a separate section headed 'Material Uncertainty Related to Going Concern' in the audit report Correct answer.
  4. Issue an adverse opinion because the going concern basis is inappropriate

Explanation

Where a material uncertainty exists but disclosure in the financial statements is adequate, the auditor expresses an unmodified opinion and includes a separate section drawing attention to the uncertainty. The section describes the uncertainty and refers to the relevant note.

Question 12Audit framework and regulation

Which of the following best describes the role of the audit committee in the external audit process?

  1. It oversees the relationship with the external auditor and monitors the integrity of financial reporting Correct answer.
  2. It guarantees the accuracy of the financial statements to shareholders
  3. It performs the detailed audit testing on behalf of the external auditor
  4. It sets the auditing standards that the external auditor must apply

Explanation

An audit committee, composed of independent non-executive directors, oversees financial reporting, internal control and the external auditor relationship, including appointment and independence. It does not perform audit work or set standards.

Question 13Audit framework and regulation

An auditor is offered a holiday by the client's chief executive after the audit report is signed. Accepting the gift would most likely create which threat?

  1. A self-review threat because the auditor reviewed the gift
  2. Self-interest and familiarity threats to objectivity Correct answer.
  3. An advocacy threat because the auditor would be promoting the client
  4. No threat because the audit is already complete

Explanation

Accepting a gift from a client can create self-interest and familiarity threats because the auditor may be influenced by the benefit or the relationship. The IESBA Code requires firms to evaluate the significance of gifts and prohibit them where they are not clearly trivial.

Question 14Audit framework and regulation

Which statement best explains the concept of professional scepticism?

  1. A tendency to disbelieve all client representations
  2. A requirement to obtain absolute proof before accepting any evidence
  3. A preference for relying on management explanations over documentary evidence
  4. A questioning mind and critical assessment of evidence, remaining alert to possible misstatement Correct answer.

Explanation

Professional scepticism means approaching the audit with a questioning mind, being alert to conditions indicating possible misstatement and critically evaluating evidence. It does not mean distrusting everything or demanding absolute proof.

Question 15Audit framework and regulation

A firm is asked to accept an engagement where the predecessor auditor has resigned and refuses to communicate with the successor. What is the most appropriate response?

  1. Accept the engagement and report the predecessor to the regulator
  2. Accept the engagement immediately because the client has the right to change auditors
  3. Decline the engagement unless the client permits communication with the predecessor and the matter is resolved Correct answer.
  4. Accept the engagement but perform no procedures on opening balances

Explanation

ISA 300 requires the successor auditor to communicate with the predecessor before accepting the engagement, subject to client permission. If the client refuses permission or communication is blocked, the auditor should consider the implications and may decline the engagement.

Question 16Audit framework and regulation

Which of the following is an inherent limitation of an audit that means auditors cannot provide absolute assurance?

  1. The requirement to issue a written report
  2. The use of judgement and testing rather than examining all transactions Correct answer.
  3. The need to comply with ethical requirements
  4. The existence of a three-party relationship

Explanation

Inherent limitations include the use of judgement, testing rather than examining every item, the nature of audit evidence being persuasive rather than conclusive, and the possibility of fraud concealed by collusion. These limit assurance to a reasonable level.

Question 17Audit framework and regulation

A regulator introduces a rule requiring audit firms to rotate the engagement partner every five years for listed entities. What is the main purpose of this rule?

  1. To transfer responsibility for the financial statements to the auditor
  2. To ensure the audit firm changes every five years
  3. To address familiarity threats that may impair objectivity Correct answer.
  4. To reduce audit fees over time

Explanation

Engagement partner rotation is a safeguard against familiarity and self-interest threats that can develop when the same individual audits a client for a long period. It does not change the audit firm itself or the allocation of responsibility for the financial statements.

Question 18Audit framework and regulation

Which of the following best describes the 'objective of the auditor' in an audit of financial statements under ISA 200?

  1. To provide an opinion on the effectiveness of the entity's internal control over financial reporting
  2. To certify that the entity will remain a going concern for the next five years
  3. To prepare the financial statements on behalf of management if they are not prepared
  4. To obtain reasonable assurance about whether the financial statements are free from material misstatement and to report in accordance with the auditor's findings Correct answer.

Explanation

ISA 200 states the auditor's objectives as obtaining reasonable assurance about whether the financial statements are free from material misstatement and reporting in accordance with the auditor's findings. Additional responsibilities, such as reporting on internal control, apply only where required by law or separate engagements.

Question 19Audit framework and regulation

A client asks the audit firm to accept a fee that is contingent on the audit opinion being unmodified. How should the firm respond?

  1. Accept the arrangement only if the engagement partner rotates
  2. Accept the arrangement because it aligns the auditor's interests with the client's
  3. Decline the arrangement because contingent fees on audit engagements create self-interest threats and are prohibited Correct answer.
  4. Accept the arrangement provided the fee is disclosed to the audit committee

Explanation

Contingent fees for audit engagements are prohibited because they create a self-interest threat that cannot be reduced to an acceptable level, since the auditor would have a financial interest in the opinion outcome. Disclosure or rotation does not cure the fundamental threat.

Question 20Audit framework and regulation

Which of the following is the most accurate description of the relationship between ISAs and national auditing standards?

  1. ISAs apply only to audits of listed entities
  2. National standards may be based on ISAs, and some jurisdictions adopt them with local additions Correct answer.
  3. ISAs automatically override all national standards in every jurisdiction
  4. National standards must be identical to ISAs in all respects

Explanation

ISAs are international benchmarks; jurisdictions may adopt them directly, adapt them or issue national standards based on them, sometimes adding local requirements. They do not automatically override national law.

Question 21Audit framework and regulation

An audit firm discovers that a partner has a material indirect financial interest in an audit client held through a diversified mutual fund. Under the IESBA Code, how should this be assessed?

  1. It may be permissible if the interest is indirect, immaterial and the fund is diversified, so the threat is insignificant Correct answer.
  2. It is always prohibited regardless of the fund's nature
  3. It is permitted because indirect interests are outside the Code
  4. It is prohibited only if the partner is the engagement partner

Explanation

The Code distinguishes direct financial interests, which generally create an unacceptable self-interest threat, from indirect interests such as holdings in diversified mutual funds, which may be acceptable if the interest is immaterial. The significance of the threat determines the response.

Question 22Audit framework and regulation

A listed entity's audit firm has a long-standing relationship with the client and the engagement quality control reviewer has been the same individual for eight years. Which action best addresses the threat to audit quality?

  1. Reduce the extent of testing because of the accumulated experience
  2. Increase the audit fee to reflect the additional risk
  3. Rely on management representations to confirm the adequacy of the audit
  4. Rotate the engagement quality control reviewer and document the rationale for the change Correct answer.

Explanation

Long association of the engagement quality control reviewer can impair objectivity and the effectiveness of the review, so rotation of the reviewer is a key safeguard. Firms should also consider the overall threats from long association and document their evaluation.

Question 23Audit framework and regulation

Under the IESBA Code, which situation would most likely require the audit firm to decline or terminate an audit engagement rather than apply safeguards?

  1. The firm has a direct material financial interest in the client that cannot be disposed of before the report is issued Correct answer.
  2. The client operates in a complex industry requiring specialist input
  3. The client's management has limited accounting expertise
  4. The audit requires consultation with an internal specialist

Explanation

Where a direct material financial interest exists and cannot be eliminated, no safeguard can reduce the self-interest threat to an acceptable level, so the firm must decline or withdraw. Complexity or lack of client expertise can be managed through other means.

Question 24Audit framework and regulation

A regulator questions why an auditor issued an unmodified opinion shortly before a client entered liquidation. Which response best reflects the auditor's responsibilities?

  1. The auditor is responsible for the entity's subsequent failure if the audit fee was material to the firm
  2. The auditor should have issued an adverse opinion because liquidation always indicates inadequate disclosure
  3. The auditor evaluates going concern using information available up to the date of the report and is not responsible for predicting future events Correct answer.
  4. The auditor must guarantee the entity's survival for at least twelve months after the report date

Explanation

The auditor assesses the appropriateness of the going concern basis using information available up to the date of the audit report and considers whether disclosures are adequate. The auditor does not guarantee future solvency, and subsequent events do not automatically mean the earlier judgement was wrong.

Question 25Audit framework and regulation

Which of the following best explains why the audit profession is subject to public oversight bodies in many jurisdictions?

  1. To replace the auditor's professional judgement with regulatory decisions
  2. To protect the public interest by monitoring audit quality and the standard-setting process independently of the profession Correct answer.
  3. To increase the fees auditors can charge for statutory audits
  4. To ensure that all audit firms are owned by the government

Explanation

Public oversight bodies exist to protect the public interest by independently monitoring audit quality, registration and the standard-setting process, thereby reinforcing confidence in audit. They do not set fees or replace professional judgement.

Question 26Audit framework and regulation

Which of the following best describes the primary purpose of an external audit of financial statements?

  1. To guarantee that the financial statements are free from all errors and fraud
  2. To assess the effectiveness of the entity's internal controls over financial reporting
  3. To provide an independent opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework Correct answer.
  4. To prepare the financial statements on behalf of management

Explanation

The purpose of an external audit is to enhance the degree of confidence of intended users in the financial statements by expressing an opinion on whether they are prepared, in all material respects, in accordance with the applicable financial reporting framework. It does not guarantee absolute accuracy, nor does it involve preparing the statements or providing an opinion on internal control effectiveness unless separately engaged.

Question 27Audit framework and regulation

What is the main role of the International Auditing and Assurance Standards Board (IAASB)?

  1. To enforce auditing standards through inspections of audit firms
  2. To set ethical standards for professional accountants
  3. To provide training to auditors in developing countries
  4. To issue International Standards on Auditing (ISAs) and other pronouncements Correct answer.

Explanation

The IAASB is an independent standard-setting body that develops and issues International Standards on Auditing (ISAs), as well as standards for assurance and related services. It does not enforce standards, provide training, or set ethical standards; those are roles of other bodies such as regulators, professional bodies, and the IESBA.

Question 28Audit framework and regulation

Which of the following is a fundamental ethical principle that auditors must comply with under the IESBA Code?

  1. Objectivity Correct answer.
  2. Confidentiality
  3. Profitability
  4. Independence

Explanation

Objectivity is one of the five fundamental principles of ethics in the IESBA Code, requiring auditors not to compromise professional or business judgment because of bias, conflict of interest, or undue influence. Independence is a related concept but applies specifically to audit and review engagements, while confidentiality is another fundamental principle.

Question 29Audit framework and regulation

Which of the following best describes the purpose of an engagement letter?

  1. To confirm the terms of the audit engagement and the respective responsibilities of the auditor and management Correct answer.
  2. To outline the audit procedures to be performed
  3. To document the auditor's assessment of inherent risk
  4. To provide a guarantee that the audit will detect all material misstatements

Explanation

An engagement letter is agreed between the auditor and management or those charged with governance to confirm the terms of the engagement, including the objective and scope of the audit, and the responsibilities of the auditor and management. It helps avoid misunderstandings and is required by ISA 210.

Question 30Audit framework and regulation

Under the IESBA Code, which of the following threats to independence arises when an auditor has a close family member employed by the client in a position to influence the financial statements?

  1. Self-interest threat
  2. Intimidation threat
  3. Self-review threat
  4. Familiarity threat Correct answer.

Explanation

A familiarity threat arises when an auditor has a close relationship with a client, such as a close family member in a position to influence the financial statements, which may compromise objectivity. Self-interest and self-review threats relate to financial interests or reviewing one's own work, while intimidation threat involves pressure from the client.

Question 31Audit framework and regulation

Which of the following is a key component of an audit firm's system of quality management under ISQM 1?

  1. Client acceptance and continuance
  2. Risk assessment process Correct answer.
  3. Engagement performance
  4. Audit documentation

Explanation

ISQM 1 requires a firm's system of quality management to include eight components, one of which is the firm's risk assessment process. The other components include governance and leadership, relevant ethical requirements, acceptance and continuance of client relationships, engagement performance, resources, information and communication, and monitoring and remediation.

Question 32Audit framework and regulation

An auditor is assessing whether to accept a new audit client. Which of the following factors would most likely cause the auditor to decline the engagement?

  1. The client's management has a reputation for aggressive accounting practices Correct answer.
  2. The client operates in a highly regulated industry
  3. The client's financial statements are due to be issued within a tight deadline
  4. The client has a complex group structure with numerous subsidiaries

Explanation

A client with a reputation for aggressive accounting practices may indicate increased risk of material misstatement and potential integrity issues, which could threaten the auditor's ability to perform the engagement ethically and in accordance with standards. Complex structures, regulated industries, or tight deadlines are challenges but not necessarily reasons to decline if the firm has the competence and resources.

Question 33Audit framework and regulation

Which of the following best describes the auditor's responsibility regarding laws and regulations in an audit of financial statements under ISA 250?

  1. The auditor should obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements Correct answer.
  2. The auditor is responsible for preventing non-compliance with laws and regulations
  3. The auditor must report all instances of non-compliance to the police
  4. The auditor has no responsibility to consider laws and regulations

Explanation

ISA 250 requires the auditor to obtain sufficient appropriate audit evidence regarding compliance with laws and regulations that have a direct effect on the determination of material amounts and disclosures in the financial statements. The auditor is not responsible for preventing non-compliance and does not necessarily report to the police, but may have a duty to report to those charged with governance or regulators.

Question 34Audit framework and regulation

Which of the following is an example of a self-review threat to auditor independence?

  1. The auditor is threatened with dismissal if they do not agree with management
  2. The auditor has a close family member working for the client
  3. The auditor has a financial interest in the client
  4. The auditor recently provided services to the client that are now being audited Correct answer.

Explanation

A self-review threat occurs when the auditor evaluates the results of previous services or work performed by the audit firm or its personnel, such as when the firm provided consultancy services that are now part of the audit. Financial interest creates a self-interest threat, family member creates a familiarity threat, and threats of dismissal create an intimidation threat.

Question 35Audit framework and regulation

Which of the following best describes the auditor's responsibility for communicating with those charged with governance under ISA 260?

  1. The auditor should communicate only matters required by law or regulation
  2. The auditor must obtain written approval from those charged with governance before issuing the audit report
  3. The auditor should communicate significant findings from the audit to those charged with governance Correct answer.
  4. The auditor must communicate all matters of governance interest to the public

Explanation

ISA 260 requires the auditor to communicate significant findings from the audit to those charged with governance, including the auditor's views about significant qualitative aspects of the entity's accounting practices, significant difficulties encountered, and other matters significant to the oversight of the financial reporting process. Communication is generally not public, and written approval before issuing the report is not required.

Question 36Audit framework and regulation

Which of the following is a key element of the auditor's report under ISA 700?

  1. The auditor's opinion on the financial statements Correct answer.
  2. A detailed analysis of the entity's financial performance
  3. A summary of the audit procedures performed
  4. A statement that the audit was conducted in accordance with the firm's internal policies

Explanation

The auditor's report must include a clear expression of opinion on the financial statements, either unmodified or modified, as required by ISA 700. It also includes other elements such as the basis for opinion, responsibilities of management and the auditor, and key audit matters for listed entities, but not a summary of procedures or financial analysis.

Question 37Audit framework and regulation

Under the IESBA Code, which of the following safeguards would be most appropriate when an audit firm provides a non-assurance service to an audit client that creates a self-review threat?

  1. Using different personnel to perform the non-assurance service and the audit Correct answer.
  2. Increasing the audit fee to compensate for the additional risk
  3. Reducing the scope of the audit to avoid reviewing the non-assurance work
  4. Disclosing the threat to the client's management

Explanation

A common safeguard to address self-review threat is to use different personnel for the non-assurance service and the audit, ensuring that those who performed the service are not involved in auditing it. Disclosure to management or increasing fees does not eliminate the threat, and reducing audit scope is not permissible.

Question 38Audit framework and regulation

Which of the following best describes the concept of 'professional competence and due care' under the IESBA Code?

  1. Acting in the best interest of the client at all times
  2. Maintaining professional knowledge and skill at the level required to ensure that a client receives competent professional service Correct answer.
  3. Guaranteeing that the financial statements are free from material misstatement
  4. Ensuring that all audit work is performed by a partner

Explanation

Professional competence and due care requires auditors to maintain professional knowledge and skill at the level required to ensure that clients receive competent professional service, and to act diligently in accordance with applicable technical and professional standards. It does not require acting in the client's best interest if that conflicts with ethical standards, nor does it guarantee the financial statements are error-free.

Question 39Audit framework and regulation

An audit firm is considering whether to provide tax advisory services to an audit client. Which of the following factors is most relevant in determining whether the service creates a self-review threat?

  1. The fee charged for the tax service
  2. Whether the tax advice will be subject to audit procedures Correct answer.
  3. The client's history of tax compliance
  4. The size of the client's tax department

Explanation

A self-review threat arises when the auditor may not be able to review objectively the results of a non-assurance service that the firm provided. If the tax advice will be subject to audit procedures, the firm may be reviewing its own work, which increases the threat. The size of the client's tax department, fee, or compliance history are less directly relevant to the self-review threat.

Question 40Audit framework and regulation

Which of the following best explains the relationship between the IAASB's International Standards on Auditing (ISAs) and national auditing standards?

  1. ISAs are automatically binding in all countries
  2. National standards may differ from ISAs but should not conflict with them Correct answer.
  3. ISAs override national standards in all cases
  4. National standards must be identical to ISAs

Explanation

The IAASB issues ISAs, but they do not override national standards. Countries may adopt ISAs as their national standards or develop their own standards, which may differ but should not conflict with ISAs. ISAs are not automatically binding; they must be adopted by national standard setters or regulators.

Question 41Planning and risk assessment

Which document must an auditor obtain acceptance of before commencing fieldwork on a new client?

  1. An engagement letter setting out scope, responsibilities and fee basis Correct answer.
  2. A signed trial balance agreed to the general ledger
  3. A prior-year audit report from the predecessor auditor
  4. A management representation letter signed by the finance director

Explanation

ISA 210 requires the auditor and client to agree terms of the engagement in writing before work begins, covering scope, responsibilities of each party and the basis of fees. The other documents are either produced later in the engagement or are evidence rather than contractual terms.

Question 42Planning and risk assessment

Under ISA 315, which of the following best describes the purpose of risk assessment procedures?

  1. To evaluate whether the going concern assumption remains appropriate for the entity
  2. To detect all material misstatements in the financial statements before the year end
  3. To satisfy the auditor's responsibility for obtaining sufficient appropriate audit evidence
  4. To obtain an understanding of the entity and its environment, including internal control, as a basis for identifying risks Correct answer.

Explanation

Risk assessment procedures are performed to build an understanding of the entity, its environment and its system of internal control, which then feeds into identifying and assessing risks of material misstatement. They do not by themselves provide sufficient appropriate evidence on which to base the opinion.

Question 43Planning and risk assessment

Inherent risk is best described as which of the following?

  1. The risk that the auditor's procedures fail to detect a material misstatement
  2. The risk arising from the entity's dependence on a small number of key customers
  3. The risk that a control does not operate effectively to prevent misstatement
  4. The susceptibility of an assertion to misstatement before consideration of any related controls Correct answer.

Explanation

Inherent risk is assessed at the assertion level and reflects susceptibility to misstatement assuming no related controls exist. It is one component of the risk of material misstatement, alongside control risk.

Question 44Planning and risk assessment

An auditor sets a lower materiality level for the audit. What is the most likely effect on the planned extent of substantive procedures?

  1. The extent of substantive procedures will remain unchanged
  2. The extent of substantive procedures will increase Correct answer.
  3. The extent of substantive procedures will decrease
  4. The auditor will rely more heavily on analytical procedures alone

Explanation

A lower materiality threshold means smaller misstatements become significant, so the auditor must gather more evidence and therefore generally increases the extent of substantive testing. Materiality and the quantity of evidence required move in opposite directions.

Question 45Planning and risk assessment

Which of the following is an example of a risk assessment procedure performed by the auditor?

  1. Attending the year-end physical inventory count
  2. Making enquiries of management about changes in the business during the year Correct answer.
  3. Recalculating depreciation charged on plant and machinery
  4. Sending a bank confirmation request to the entity's principal banker

Explanation

Enquiries of management and others within the entity are expressly identified in ISA 315 as risk assessment procedures, together with analytical procedures and observation and inspection. The other options are substantive or test-of-control procedures performed in response to assessed risks.

Question 46Planning and risk assessment

The auditor's understanding of the entity's system of internal control is required primarily because it assists in which activity?

  1. Identifying and assessing risks of material misstatement at the assertion level Correct answer.
  2. Confirming that the financial statements are free from fraud
  3. Determining the exact fee to be charged for the engagement
  4. Deciding whether the entity will remain a going concern

Explanation

ISA 315 requires an understanding of the control environment, the entity's risk assessment process, information systems, control activities and monitoring, so that the auditor can identify and assess risks of material misstatement. The understanding informs the design of further procedures rather than guaranteeing any outcome.

Question 47Planning and risk assessment

Which of the following best describes the audit strategy?

  1. It records the auditor's conclusions on each significant risk identified
  2. It documents the entity's accounting policies and estimation methods
  3. It lists every audit procedure to be performed and the staff assigned to each
  4. It sets the scope, timing and direction of the audit and guides the development of the audit plan Correct answer.

Explanation

ISA 300 distinguishes the overall audit strategy, which establishes scope, timing, direction and resourcing, from the more detailed audit plan that sets out the nature, timing and extent of procedures. The strategy is established first and informs the plan.

Question 48Planning and risk assessment

The risk that the auditor's own procedures will not detect a material misstatement is known as which of the following?

  1. Control risk
  2. Business risk
  3. Inherent risk
  4. Detection risk Correct answer.

Explanation

Detection risk arises because the auditor's procedures may fail to identify a misstatement that exists, for example through sampling or inappropriate procedure selection. It is the only component of audit risk that the auditor can directly influence through the nature, timing and extent of procedures.

Question 49Planning and risk assessment

An audit team plans to use analytical procedures as risk assessment procedures at the planning stage. Which comparison is most appropriate for this purpose?

  1. A review of the board minutes for the full year
  2. Current-year gross margin compared with prior years and industry averages Correct answer.
  3. A recalculation of the accrued payroll balance at the year end
  4. A test of a sample of purchase invoices to receiving reports

Explanation

Planning analytical procedures compare current information with prior periods, budgets or industry data to highlight unusual relationships that may indicate risk. The other options are substantive tests of detail or inspection procedures rather than analytical comparisons.

Question 50Planning and risk assessment

Which of the following circumstances would most likely increase the auditor's assessment of inherent risk for revenue recognition?

  1. All sales are made for cash at the point of sale
  2. Monthly revenue is stable and consistent with prior years
  3. Sales are made on complex multi-element contracts with variable consideration Correct answer.
  4. The entity uses a standard price list with no discounts

Explanation

Complex contracts with variable consideration create greater judgement, estimation and potential for error or manipulation, raising inherent risk. Simple, stable cash transactions with fixed pricing present lower susceptibility to misstatement.