CPA Exam — AUDAssessing Risk and Developing a Planned ResponseHard
An auditor is developing an audit plan for a client that has recently implemented a new, highly complex revenue recognition standard. The client's management has a strong incentive to meet aggressive earnings targets. This combination of factors would most likely lead the auditor to identify a significant risk related to:
- AThe client's ability to maintain sufficient cash flow.
- BThe occurrence assertion for revenue.
- CThe physical security of inventory assets.
- DThe completeness of accounts payable.
Show answer & explanationAnswer & explanation
Correct answer: B. The occurrence assertion for revenue.
A new, complex revenue recognition standard combined with management's incentive to meet aggressive earnings targets creates a high risk of misstatement. Management might be motivated to prematurely recognize revenue or recognize fictitious revenue to achieve targets, directly impacting the occurrence assertion (whether transactions and events that have been recorded have occurred and pertain to the entity).
Why the other options are wrong
- A. While earnings targets and revenue recognition ultimately affect cash flow, the direct audit risk is about the proper recording of revenue, not the operational aspect of cash flow generation.
- C. This scenario does not provide any information to suggest an increased risk for inventory physical security.
- D. The scenario focuses on revenue recognition and earnings targets, not on the completeness of accounts payable.
Significant Risk (Fraud & Revenue)
Significant risks often involve complex transactions, high management judgment, and areas susceptible to fraud, especially when management incentives align with misstatement.
- Revenue recognition is presumed to be a significant risk.
- Management override of controls is a common fraud risk.
- New accounting standards increase complexity and judgment.
Memory trick: New 'REVENUE' rules + 'TARGETS' = 'OCCURRENCE' fraud risk.