CHAPTER 5
Audit Evidence and Documentation
Review Questions
5-1  Audit risk is the possibility that the auditors may unknowingly fail to appropriately modify their
opinion on financial statements that are materially misstated. It is composed of the possibility that (1)
a material misstatement in an assertion about an account has occurred (inherent risk and control risk),
and (2) the auditors do not detect the misstatement (detection risk). Detection risk is this second
component, the risk that the auditors' procedures will lead them to conclude that a material
misstatement does not exist in an assertion when in fact such misstatement does exist. All other
factors held constant, audit risk increases with increases in detection risk.
5-2  The two components of the risk of material misstatement include inherent risk and control risk.
Inherent risk is the risk of material misstatement of an assertion about an account, class of transaction,
or disclosure without considering internal control, and control risk is the risk that internal control will
fail to prevent or detect and correct the material misstatement.
5-3  Inherent risk refers to the possibility of a material misstatement occurring in an assertion assuming no
related internal controls. Accordingly, since it exists independently of the auditors, the auditors
cannot “reduce” inherent risk. Rather, they gather evidence that allows them to make an accurate
assessment of the existing inherent risk.
5-4 Routine transactions involve recurring financial activities recorded in the accounting records in the
normal course of business. Examples include sales transactions, purchase transactions, cash
disbursements, cash receipts, and payroll transactions. Nonroutine transactions involve activities
that occur only periodically. Examples include taking physical inventories, calculating depreciation,
and consolidating financial results. Estimation transactions are financial reporting activities that
involve creating an accounting estimate. Examples include estimating the allowance for
uncollectible accounts, estimating warranty reserves, and assessing assets for impairment.
5-5  Because inherent risk and control risk are a result of characteristics of the client and its internal
controls, auditors assess them. Because detection risk is a function of the effectiveness of the audit
procedures used to gather evidence, it is restricted to the appropriate level based on the scope of
procedures performed.