ICAEW ARF · Chapter 12

Risk, information flows, sustainability assurance and reporting MCQs with Answers

9 multiple-choice questions on Risk, information flows, sustainability assurance and reporting for ICAEW ARF Assurance and Risk Fundamentals. Try each one before revealing the answer and explanation.

1. Question 1

   Which of the following best describes business risk, as distinct from the components of audit risk?

   • A) The risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated
   • B) The risk that the auditor's procedures will not detect a misstatement that could be material
   • C) The risk that the entity's internal controls will not prevent, or detect and correct, a material misstatement
   • D) The risk that conditions, events or actions could adversely affect the entity's ability to achieve its objectives and execute its strategies
   Show answer & explanation

   Answer: D) The risk that conditions, events or actions could adversely affect the entity's ability to achieve its objectives and execute its strategies

   Business risk arises from the entity's operations and environment, for example new competitors, loss of key customers or technological change, and threatens its ability to meet its objectives. Many business risks have financial consequences and so increase the risk of material misstatement. Option A describes audit risk, option B detection risk and option C control risk.

2. Question 2

   A manufacturer's main product is being displaced by a cheaper rival technology, and the manufacturer's sales volumes fell sharply in the last quarter of the financial year. Which risk of material misstatement in the financial statements arises most directly from this business risk?

   • A) Finished goods inventory may be overstated because its net realisable value may have fallen below cost
   • B) Trade payables may be overstated because supplier invoices have been recorded twice
   • C) Share capital may be misclassified within equity
   • D) Payroll costs may be overstated because fictitious employees have been added to the payroll
   Show answer & explanation

   Answer: A) Finished goods inventory may be overstated because its net realisable value may have fallen below cost

   Falling demand for a product means some inventory may be slow-moving and may have to be sold at reduced prices. Inventory must be measured at the lower of cost and net realisable value, so there is a risk that it is overstated if no write-down is made. The auditor would respond with procedures such as reviewing post year-end selling prices and inventory ageing. Duplicate invoices, share capital classification and ghost employees are not caused by this business risk.

3. Question 3

   Which sequence correctly shows the normal flow of documents and information in a credit sales system?

   • A) Sales invoice, customer order, credit check, goods despatched note
   • B) Goods despatched note, customer order, credit check, sales invoice
   • C) Customer order, sales invoice, credit check, goods despatched note
   • D) Customer order, credit check, goods despatched note, sales invoice
   Show answer & explanation

   Answer: D) Customer order, credit check, goods despatched note, sales invoice

   The process starts when a customer order is received. The customer's credit status is checked before the order is accepted, so that goods are not supplied to customers unlikely to pay. Goods are then despatched with a despatch note, and the sales invoice is raised from the despatch note so that only goods actually sent are invoiced. Understanding this flow helps the auditor identify where controls are needed, for example matching despatch notes to invoices.

4. Question 4

   In an unmodified auditor's report on the financial statements of a UK company, what does the auditor's opinion state?

   • A) Whether the company's internal controls are effective
   • B) Whether the company will be profitable next year
   • C) Whether every transaction has been recorded correctly
   • D) Whether the financial statements give a true and fair view and have been properly prepared in accordance with the applicable framework and the Companies Act 2006
   Show answer & explanation

   Answer: D) Whether the financial statements give a true and fair view and have been properly prepared in accordance with the applicable framework and the Companies Act 2006

   The opinion on UK company financial statements covers whether they give a true and fair view and have been properly prepared in accordance with the applicable financial reporting framework and the Companies Act 2006. The audit opinion does not certify internal control, predict future profits, or confirm that every transaction is correct.

5. Question 5

   A company processes all of its sales orders through a cloud-based system and keeps no manual records. Which control best mitigates the risk that a ransomware attack makes its sales data permanently unavailable?

   • A) Sales invoices generated by the system are sequentially numbered
   • B) Customer credit limits are approved by the credit controller
   • C) Regular back-ups are held securely, separated from the live network, and restoring data from them is tested periodically
   • D) Range checks are applied to quantities entered on sales orders
   Show answer & explanation

   Answer: C) Regular back-ups are held securely, separated from the live network, and restoring data from them is tested periodically

   Heavy dependence on a single IT system means a cyber attack could destroy or lock the company's records. Secure back-ups kept separately from the live network, with restoration tested, allow the data to be recovered if the live system is compromised. This is a general IT control. Sequential numbering, credit limits and range checks are controls over individual transactions and do nothing to recover lost data.

6. Question 6

   Which of the following misstatements is most likely to result from fraud rather than error?

   • A) A clerk misreads a supplier invoice and posts £1,890 instead of £1,980
   • B) The sales director instructs staff to date despatch notes for goods despatched on 3 January as 31 December, so that an annual bonus target is met
   • C) An accountant misunderstands an accounting standard and capitalises staff training costs
   • D) A depreciation rate is keyed in incorrectly when a new asset is added to the asset register
   Show answer & explanation

   Answer: B) The sales director instructs staff to date despatch notes for goods despatched on 3 January as 31 December, so that an annual bonus target is met

   The distinguishing factor between fraud and error is whether the act causing the misstatement was intentional. Deliberately misdating despatch notes to record sales in the wrong period is fraudulent financial reporting, and the bonus target provides an incentive. The transposed figure, the misunderstanding of a standard and the keying mistake are unintentional, so they are errors, even though they still need correcting if material.

7. Question 7

   Late in an audit, the finance director explains a large, unusual journal entry posted just before the year end and says that no supporting documentation is available. Which response best demonstrates professional scepticism?

   • A) Accept the explanation, because the finance director has always been honest in previous audits
   • B) Record the explanation on file and move on, because management is responsible for the financial statements
   • C) Seek evidence to corroborate the explanation and consider whether the entry may indicate fraud or management override of controls
   • D) Conclude that the entry is fraudulent and report the finance director to the police immediately
   Show answer & explanation

   Answer: C) Seek evidence to corroborate the explanation and consider whether the entry may indicate fraud or management override of controls

   Professional scepticism is an attitude that includes a questioning mind and a critical assessment of evidence. Unusual entries made close to the year end without documentation are a recognised fraud risk indicator, so the auditor should seek corroborating evidence rather than rely on management's word or on past experience of the client's honesty. Scepticism does not mean assuming fraud without evidence, and simply recording management's explanation does not evaluate it.

8. Question 8

   Which of the following is a typical role of an entity's internal audit function?

   • A) Expressing the statutory opinion on whether the financial statements give a true and fair view
   • B) Monitoring and evaluating the effectiveness of internal control and risk management, and reporting findings to management or the audit committee
   • C) Preparing the annual financial statements for approval by the board
   • D) Setting the materiality level and sample sizes to be used by the external auditor
   Show answer & explanation

   Answer: B) Monitoring and evaluating the effectiveness of internal control and risk management, and reporting findings to management or the audit committee

   Internal audit is part of the entity's monitoring of its internal control and risk management. It reviews systems and processes, tests controls and recommends improvements, usually reporting to the audit committee to support its independence. The statutory opinion is given by the external auditor, the financial statements are prepared by management, and the external auditor sets its own materiality and sample sizes.

9. Question 9

   A company prepares sustainability-related disclosures in accordance with IFRS Sustainability Disclosure Standards and engages a practitioner to provide assurance on them. Which of the following statements is correct?

   • A) IFRS Sustainability Disclosure Standards are issued by the International Auditing and Assurance Standards Board
   • B) Assurance on sustainability information can only be given at the reasonable assurance level
   • C) Once the engagement is accepted, the practitioner becomes responsible for preparing the sustainability disclosures
   • D) The engagement may give limited or reasonable assurance, and either level increases users' confidence in the disclosures
   Show answer & explanation

   Answer: D) The engagement may give limited or reasonable assurance, and either level increases users' confidence in the disclosures

   Assurance on sustainability information can be provided at a limited or a reasonable level, depending on the terms of the engagement and the evidence available, and in either case an independent conclusion adds credibility for investors and other users. IFRS Sustainability Disclosure Standards are issued by the International Sustainability Standards Board (ISSB), not the IAASB, which sets auditing and assurance standards. Management remains responsible for preparing the disclosures, as in any assurance engagement.