CAF-8 · Chapter 3
Planning and Risk Assessment MCQs with Answers
10 multiple-choice questions on Planning and Risk Assessment for CAF-8 Audit and Assurance Essentials. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following defines 'Performance Materiality'?
- A) The maximum percentage of audit fees the firm can recover.
- B) An amount set below overall materiality to reduce the probability that aggregate uncorrected and undetected misstatements exceed overall materiality.
- C) A benchmark strictly used for evaluating management bonuses.
- D) The threshold at which an auditor must resign from the engagement.
Show answer & explanation
Answer: B) An amount set below overall materiality to reduce the probability that aggregate uncorrected and undetected misstatements exceed overall materiality.
Performance materiality is set lower than overall financial statement materiality to provide a buffer against the aggregation of small, undetected errors.
Question 2
An auditor assesses that a client has weak physical security at its warehouse and no segregation of duties in inventory management. Which component of the audit risk model does this directly increase?
- A) Detection Risk
- B) Inherent Risk
- C) Control Risk
- D) Sampling Risk
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Answer: C) Control Risk
Control risk is the risk that a misstatement could occur and not be prevented, or detected and corrected, on a timely basis by the entity's internal controls.
Question 3
During analytical procedures at the planning stage, the auditor notes that the client's gross profit margin has unexpectedly increased from 15% to 35% despite a market recession. What assertion related to revenue is at the highest risk?
- A) Completeness
- B) Occurrence
- C) Rights and obligations
- D) Classification
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Answer: B) Occurrence
An unexplained spike in gross profit margins during a recession strongly suggests that fake or fictitious sales may have been recorded, threatening the occurrence assertion.
Question 4
A client's executive compensation is heavily tied to meeting an aggressive 25% annual profit growth target. According to ISA 240, what does this primarily represent?
- A) An inherent limitation of the audit
- B) A fraud risk factor (incentive/pressure) for fraudulent financial reporting
- C) A strong control environment
- D) An opportunity for asset misappropriation
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Answer: B) A fraud risk factor (incentive/pressure) for fraudulent financial reporting
Management bonuses tied to aggressive targets create intense pressure to artificially inflate profits, which is a classic fraud risk factor for fraudulent financial reporting.
Question 5
If an auditor assesses the risk of material misstatement (Inherent Risk x Control Risk) as high, how must they adjust Detection Risk to keep overall Audit Risk acceptably low?
- A) Increase Detection Risk by performing fewer substantive procedures.
- B) Decrease Detection Risk by performing more robust and extensive substantive procedures.
- C) Detection Risk is controlled by management and cannot be adjusted.
- D) Keep Detection Risk equal to Control Risk.
Show answer & explanation
Answer: B) Decrease Detection Risk by performing more robust and extensive substantive procedures.
Audit Risk = IR x CR x DR. If IR and CR are high, the auditor must lower DR by doing more testing (larger samples, better evidence) to keep overall AR low.
Question 6
Which of the following is a primary difference between the Overall Audit Strategy and the Audit Plan?
- A) The strategy sets the scope, timing, and direction, while the plan details the specific nature, timing, and extent of risk assessment and further audit procedures.
- B) The plan is written by management, while the strategy is written by the auditor.
- C) The strategy deals only with taxes, while the plan deals with financial statements.
- D) The plan is completed before the engagement letter is signed, while the strategy is done afterward.
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Answer: A) The strategy sets the scope, timing, and direction, while the plan details the specific nature, timing, and extent of risk assessment and further audit procedures.
The audit strategy is the high-level framework setting the direction and resources, whereas the audit plan contains the detailed step-by-step procedures to be executed.
Question 7
When auditing an unlisted, not-for-profit charitable trust, what is generally the most appropriate benchmark for setting overall materiality?
- A) Total profit before tax
- B) Total dividends paid
- C) Total revenues or total expenses
- D) Earnings per share
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Answer: C) Total revenues or total expenses
For a not-for-profit entity, profit is not the primary focus of the users. Total revenue (donations/grants) or total expenses reflect the scale of operations and are the best benchmarks.
Question 8
Which of the following represents 'misappropriation of assets' rather than 'fraudulent financial reporting'?
- A) Intentionally delaying the recognition of expenses to the next year.
- B) An employee stealing physical inventory from the warehouse.
- C) Altering assumptions used to calculate the allowance for doubtful accounts.
- D) Creating fictitious revenue journal entries.
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Answer: B) An employee stealing physical inventory from the warehouse.
Misappropriation of assets involves the actual theft of company property (cash, inventory), while fraudulent financial reporting involves manipulating the accounting records.
Question 9
During a first-year audit engagement, an auditor must perform additional planning procedures. Which of the following is a critical additional step?
- A) Re-writing the company's prior year tax returns.
- B) Obtaining sufficient appropriate audit evidence regarding opening balances.
- C) Firing the client's internal audit department.
- D) Setting materiality to zero.
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Answer: B) Obtaining sufficient appropriate audit evidence regarding opening balances.
In an initial audit, the auditor lacks past experience with the client and must ensure the opening balances (brought forward from the prior year) are not materially misstated.
Question 10
If the auditor suspects that management is overriding internal controls to manipulate financial results, which specific audit procedure is strictly required by ISA 240?
- A) Testing the mathematical accuracy of the depreciation schedule.
- B) Testing the appropriateness of journal entries recorded in the general ledger and other adjustments.
- C) Sending negative confirmations to all suppliers.
- D) Verifying the physical existence of fully depreciated assets.
Show answer & explanation
Answer: B) Testing the appropriateness of journal entries recorded in the general ledger and other adjustments.
To address the risk of management override, ISA 240 specifically requires the auditor to test journal entries (especially year-end adjustments) for evidence of manipulation.