Chat with AIExam 7: Materiality and Risk
A) Discuss each of the six steps in applying materiality in an audit and identify the audit phase(s) in which each step is performed.
B) Discuss the three main factors that affect an auditor's preliminary judgment about materiality.
(96) 
VerifiedA)Step 1. Set materiality. This is the combined amount of misstatements in the financial statements that would be considered material. This decision is made in the planning stage of the audit.
Step 2. Establish performance materiality. Materiality is adjusted for the effect of net anticipated misstatements to determine materiality available for unanticipated misstatements. This is done during the planning stage.
Step 3. Allocate planning materiality to segments (not commonly done). In this step, some auditors allocate the preliminary judgment about materiality to the balance sheet accounts. This allocation is performed in the audit planning stage.
Step 4. Estimate total misstatement in segment. In this step, the auditor projects the sample results to the population. An allowance for sampling risk is also calculated. This would be performed after the substantive tests for each account are completed.
Step 5. Estimate the combined misstatement. In this step, the projected errors for each account are added, along with total sampling error, to calculate the combined misstatement. This would be performed after all substantive tests have been completed.
Step 6. Compare combined estimated misstatement with materiality. If the combined estimated misstatement is less than or equal to materiality, then the auditor concludes the financial statements are fairly presented. This would be performed after all substantive tests have been completed, in the final review stage of the audit.
B)The three main factors that affect an auditor's judgment about materiality are:
•Materiality is a relative rather than an absolute concept. A misstatement of a given size might be material for a small company, whereas the same dollar misstatement could be immaterial for a larger one.
•Bases are needed for evaluating materiality. Since materiality is relative, it is necessary to have bases for establishing whether misstatements are material. Net income before taxes is normally the most commonly used base, but other possible bases include total assets, revenue, gross profit, and owners' equity.
•Qualitative factors also affect materiality. Certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same, such as misstatements involving irregularities.
Further possible misstatement considers
(71) VerifiedC
Lauralye Leasing Limited (LLL) provides lease financing to companies and individuals for equipment other than automobiles. Leases on commercial signs make up 50% of total leases; computer and telecommunications equipment are 30%; and restaurant equipment makes up most of the remainder. LLL's customers arrange to buy new equipment from equipment dealers, then contact LLL to arrange lease financing.
LLL was founded over thirty years ago by Laura and Al Ye. It is now run by Mr. and Mrs. Ye's daughter, Betsy, who is the President of LLL. LLL owns a small building downtown, where the offices of the business are located. Unused office space is rented out to other commercial tenants.
Betsy was a classmate of yours at in university and you have kept loosely in touch over the years. This year, she moved LLL's audit to your firm (a local firm with five partners), after deciding that the firm her parents had hired many years ago did not really understand her business' needs.
LLL has a small loan that is used to cover blips in working capital. The company has two salespeople. Most loans are received from stores throughout the city with whom LLL has standing agreements. If customers require financing, they fill in an application and fax it to LLL for approval. LLL will reply within two business days.
The company has been profitable for many years. There are no extraordinary items in the current year's financial statements.
Selected financial information is as follows:
Required:
A) Which base would you use to calculate materiality? Why?
B) Calculate materiality. Choose a specific number and explain why you chose that amount.
Required:
A) Which base would you use to calculate materiality? Why?
B) Calculate materiality. Choose a specific number and explain why you chose that amount.
(79) VerifiedA)Normally, net income before taxes and bonus would be used to calculate materiality. The company has been profitable for many years and there is no need to consider other bases. Gross profit applies more to companies that sell products or have direct costs associated with products. Total assets, equity, and revenue are used as bases if net income fluctuates or if the company is experiencing losses.
B)The range applied to net income is 5% to 10%, which would result in a materiality range of
$230 000 to $460 000. The company is a private company with the shareholders and the bank as users. Due to the few users, we would likely go towards the larger end of this range, i.e., $460 000.
When external users place heavy reliance on the financial statements it is appropriate that
(76) The inherent risks of data compromise (such as privacy violations) or data loss increase when
(76) CAS 320 (materiality in planning and performing an audit) defines materiality in terms of three key concepts. The first and second concepts are that a material misstatement should be considered in the context of knowledgeable users and the effect on decision making; and that material is relative to circumstances surrounding the decision and nature of the information. The third concept is
(76) Since materiality is relative, it is necessary to have benchmarks for establishing whether misstatements are material. Normally, the most important base for deciding what is material, because it is regarded as a critical item of current period information for users, is
(92) The risk that an auditor's procedures will lead to the conclusion that a material error does not exist in an account balance when, in fact, such error does exist is referred to as
(62) If an auditor were to calculate an estimate of the errors by direct projection from the sample to the population and found $7000 of net overstatement errors in a sample of $100 000 out of a total population of $900 000, the estimate of errors in the population is
(81) A PA recently finished the audit of a family-owned business. Now she is working on a large client with about 50 times the assets and 30 times total revenue. For the larger client, the PA will likely have
(86) The auditors have decided upon a materiality level of $100 000 for their audit of ABC Manufacturing. Which one of the following errors would be considered more important by the auditors?
(85) The purpose of allocating planning materiality to balance sheet accounts is to
(80) The inherent risks of programming errors with resulting data loss increases when
(90) What is the role of internal controls during the assessment of inherent risk?
(85) If audit risk is increased, what happens to detection risk?
(89) Below are four situations that involve the audit risk model as it is used for planning audit evidence requirements in the audit of inventory. For each situation, calculate planned detection risk.
SITUATION
(87) Use of electronic funds transfers (such as electronic data interchange and online banking) has which of the following effects on the audit risk model?
(89) An inherent risk (IR) of 40% and a control risk (CR) of 60% affect detection risk and planned evidence differently than an
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