The correct answer is D) Both (a) and (c).

Both the risk of over-reliance and the risk of incorrect acceptance significantly affect audit effectiveness. Let’s examine why these risks are crucial in the context of auditing and why the other options (b) and (c) are not correct for explaining audit effectiveness:

Why the correct answer is D) Both (a) and (c):

(a) Risk of Over-Reliance:

The risk of over-reliance refers to the auditor’s reliance on controls or information that may be inadequate, ineffective, or improperly implemented. In an audit, the auditor assesses the internal controls of the entity being audited to determine the extent to which reliance can be placed on those controls.

Over-reliance on controls that are weak or ineffective can lead to a failure to detect material misstatements in the financial statements. When the auditor overly relies on controls and doesn’t perform sufficient substantive testing, there is a higher risk of missing errors or fraud.

Therefore, the risk of over-reliance can adversely affect audit effectiveness by potentially allowing material misstatements to go undetected.

(c) Risk of Incorrect Acceptance:

The risk of incorrect acceptance refers to the risk that the auditor may conclude that the financial statements are fairly stated when, in fact, they contain material misstatements. If the auditor incorrectly accepts the financial statements as accurate and does not detect material misstatements, it impairs the overall effectiveness of the audit.

The financial statements must be free from material misstatements to provide reliable information to stakeholders, and an incorrect acceptance poses a significant threat to this reliability.

In summary, both the risk of over-reliance and the risk of incorrect acceptance can hinder the effectiveness of an audit by potentially allowing material misstatements to go undetected, undermining the accuracy and reliability of the financial statements.

Why the other options are not correct:

(b) Risk of Incorrect Rejection:

The risk of incorrect rejection, also known as the risk of over-audit, refers to the risk that the auditor may conclude that there is a material misstatement when, in fact, there is none. While this risk is indeed a consideration in audit planning and execution, it is not directly related to audit effectiveness in the same way that the risk of over-reliance and the risk of incorrect acceptance are.

The risk of incorrect rejection primarily affects audit efficiency rather than effectiveness. If an auditor is too conservative and over-audits, it can result in unnecessary time and resources expended on the audit. It doesn’t inherently compromise the overall effectiveness of the audit, as it errs on the side of caution to avoid missing material misstatements.

To further clarify:

• The risk of over-reliance (Option a) affects the effectiveness of the audit by potentially allowing material misstatements to go undetected due to excessive reliance on controls that may be ineffective.
• The risk of incorrect acceptance (Option c) affects audit effectiveness by potentially concluding that the financial statements are accurate when material misstatements exist.
• The risk of incorrect rejection (Option b) primarily affects audit efficiency by potentially over-auditing and using more resources than necessary to avoid missing material misstatements. It doesn’t directly compromise the overall effectiveness of the audit, as it is aimed at preventing false negatives.

In conclusion, the effectiveness of an audit is significantly impacted by both the risk of over-reliance and the risk of incorrect acceptance.

These risks have the potential to allow material misstatements in the financial statements to go undetected, affecting the reliability and accuracy of the audit’s conclusions. While the risk of incorrect rejection is relevant to audit efficiency, it does not have the same direct impact on audit effectiveness.