Audit Final Ch 9 Materiality And Risk

Front 1

Why do auditors put the phrase obtain reasonable assurance in the scope paragraph?

Back 1

to inform users that auditors do not guarentee or ensure the fair presentation of the financial statements

Front 2

Why do auditors put the phrase free of material misstatement in the scope paragraph?

Back 2

to inform users that the auditors responsibility is limited to material financial information.

Front 3

Materiality

Back 3

The magnatude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have changed or influenced by the omission or misstatement.

Front 4

What happens when the auditor discovers a material misstatement?

Back 4

they must bring it to the clients attention so that a correction can be made.

Front 5

What happens when if the client refuses to correct the statements?

Back 5

the auditor must issue a qualified or an adverse opinion, depending on how material the misstatement is.

Front 6

Step 1 in applying materiality

Back 6

Set preliminary judgment about materiality

Front 7

Step 2 in Applying materiality

Back 7

allocate preliminary judgment about materiality to segments

Front 8

Planning extent of tests

Back 8

Setting preliminary judgment about materiality and allocating it to segments. (steps 1 and 2)

Front 9

Step 3 in Applying Materiality

Back 9

Estimate total misstatement in segment

Front 10

Step 4 in Applying Materiality

Back 10

estimate the combined misstatement

Front 11

Step 5 in Applying materiality.

Back 11

Compare combined estimate with preliminary or revised judgment about materiality.

Front 12

Preliminary judgment about materiality

Back 12

Auditors decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit as they are developing the overall strategy for the audit.

Front 13

why do auditors set a preliminary judgement about materiality

Back 13

to help plan the appropriate evidence to accumulate.

Front 14

The lower the dollar amount of the preliminary judgement

Back 14

the more evidence is required.

Front 15

100 dollar misstatement vs 10 million dollar misstatement

Back 15

100 dollar misstatement will require a ton of evidence vs a 10million dollar misstatement which is too big.

Front 16

Revised judgment about materiality

Back 16

when auditors change the preliminary judgment about materiality. Make the revision because of changes in one of the factors used to determine the preliminary judgment.

Front 17

Factors that affect the auditors preliminary judgment about materiality for a given set of financial statements

Back 17

1. materiality is relative rather than an absolute concept
2. bases are needed for evaluating materiality
3. qualitative factors also affect materiality

Front 18

materiality is a relative concept

Back 18

A misstatement of a given magnitude might be material for a small company, whereas the same dollar misstatement could me immaterial for a large company.

Front 19

Bases are needed for evaluating materiality

Back 19

It is necessary to have bases for establishing whether misstatemtnes are material.

Front 20

what is the primary base for deciding what is material for profit-oriented businesses.

Back 20

Net income before taxes

Front 21

Primary bases

Back 21

net sales, gross profit, total or net assets.

Front 22

After establishing a primary base, what should the auditor do?

Back 22

auditors should also decide whether the misstatements could materiall affect the reasonableness of the other bases such as current assets.

Front 23

what is the primary preliminary materilaity level?

Back 23

100,000 for most tests

Front 24

Why are amounts involving fraud considrered more important than unintentional errors of equal dollar amounts?

Back 24

because fraud reflects on the honesty and reliablity of management. They have bad thoughts in there head and they can be up to some shady shit that wont come up.`

Front 25

When are minor misstatements considered material?

Back 25

When it affects contractual regulations. Such as a few hundred dollars can affect a working capital requirement and thus put an entire loan into default.

When a trend is broken.

Front 26

What is step 2 in Applying Materiality

Back 26

the allocation of pelimiary judgment about materiality to segments.

Front 27

Why is the allocation of the preliminary judgment about materiality to segments necessary?

Back 27

because auditors accumulate evidence by segments rather than for financial statements as a whole.

Front 28

is preliminary judgement allocated to balance sheet or income statement accounts?

Back 28

Balance sheet, because most income statement misstatements have an equal effect on the balance sheet due to the double entry book keeping system.

Front 29

Why is it innapropriate to allocate the preliminary judgment to both the income statement and balance sheet accounts?

Back 29

because its double counting which will lead to smaller tolerable misstatements than is desirable.

Front 30

Tolerable misstatement

Back 30

The materiality allocated to any given account balance

Front 31

3 major difficulties in allocating materiality to balance sheet accounts.

Back 31

1. auditors expect certain acccounts to have more misstatements than others.
2. Both overstatements and understatements must be considered.
3. Relative audit costs affect the allocation.

Front 32

What does the auditor compare at the end of an audit?

Back 32

the actual and the estimated misstatements compared to the preliminary judgment about materiality.

Front 33

How will an overstatement in an asset account effect a liability account.

Back 33

By creating an understatement in a liability account.

Front 34

How will a miss classification in the balance sheet have an effect on the operating income?

Back 34

It will have no effect on the operating income.

Front 35

what should happen when allcoating materiality to a balance sheet account that is affecting the income statement.

Back 35

It must be considered seperately.

Front 36

Why do they establish guidelines and statistical methods for applying materiality to accounts?

Back 36

to help ensure the auditor appropriately documents in the audit fies, the tolerable misstatement amounts and the related basis used to determine those amounts.

Front 37

What is the the purpose of allocating the preliminary judgment about materiality to balance sheet accounts.

Back 37

help the auditor decide the appropriate evidence to accumulate for each account on both the balance sheet and income statement.

Front 38

What are the 2 kinds of misstatements?

Back 38

Known misstatements and likely misstatements.

Front 39

Known Misstatements

Back 39

those where the auditor can determine the amount of the misstatement in the account.

Front 40

What are the 2 types of likely misstatements

Back 40

the first are misstatements that arise from differences between managements and the auditors judgment about estimates of account balances.

Front 41

Sample error

Back 41

The risk that the sample does not accurately represent the population.

Front 42

Total estimated misstatement

Back 42

Known misstatement + Sampling Error= Total Misstatement

Front 43

What do you compare the total estimated misstatement number with?

Back 43

The tolerable misstatement.

Front 44

Risk

Back 44

uncertainty in performing the audit function. The auditor recognizes, for example, the inherent uncertainty about the appropriateness of evidence, uncertainty about the effectiveness of a clients internal controls, and uncertainty about whether the financial statements are fairly stated when the audit is completed.

Front 45

Planned detection risk

Back 45

The risk that the audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement.

Front 46

Planned detection risk is dependent on three other factors which ones?

Back 46

Inherent risk
Control risk
acceptable audit risk

Front 47

How does planned detection risk determine the amount of substantive evidence an auditor must accumulate?

Back 47

it varies inversely with the size of planned detection risk.

Front 48

Inherent risk

Back 48

Measures the auditors assessment of the likelyhood that there are material misstatements in a segment before considereing the effectiveness of internal control.

Front 49

If an auditor concludes there is a high likely hood of misstatements before evaluating internal control

Back 49

then there is a high inherent risk.

Front 50

Inherent risk is _____ related to planned detection risk and _______ related to evidence.

Back 50

Inversely, directly.

Front 51

Planned detection risk

Back 51

risk that Auditors test fail to detect a misstatement .Because there is something wrong with the collection of evidence. it could be because the auditor is using the wrong sample size.

Front 52

If you want to reduce the Planned detection risk.

Back 52

you have to collect more evidence.

Front 53

Acceptable Audit risk

Back 53

Risk that the auditor issues a clean opinion that is not appropriate. the chances auditor messes up and the financials are not fairly stated.

Front 54

To reduce acceptable audit risk

Back 54

you collect more evidence.

Front 55

Inherent risk

Back 55

The likelihood that accounts are inherently misstated before considering internal controls

Front 56

why does ibm have a high inherent risk?

Back 56

They are in the technology industry which is a fast changing industry and their inventory can go obeselete.

Front 57

When inherent risk goes up

Back 57

Evidence goes up

Front 58

When inherent risk goes down

Back 58

Evidence goes down.

Front 59

What are the factors affecting Inherent risk.

Back 59

Nature of the client’s business
Results of previous audits
Initial versus repeat engagement
Related parties
Nonroutine transactions
Judgment required to correctly record
account balances and transactions
Makeup of the population
Factors related to fraudulent financial reporting
and misappropriation of assets

Front 60

When control risk goes up

Back 60

Evidence goes up.

Front 61

If internal controls are good

Back 61

we collect less evidence

Front 62

Control risk goes down (aka internal controls are good)

Back 62

Evidence goes down.

Front 63

PDR changes ..

Back 63

when the components of the audit risk model change. PDR doesnt change by itself.

Front 64

what makes acceptable audit risk acceptable.

Back 64

The riskiness of the company. the more the user the company has, the more riskier it is.

Front 65

The more users the company has the ______ the AAR it has.

Back 65

less

Front 66

Whats more risky
short or long term liabilities.

Back 66

short term liabilities.

Front 67

How is AAR applied compared to Inherent risk?

Back 67

AAR is applied to the whole company while inherent risk is different for each account balance.

Front 68

Nature of clients business (bank)

Back 68

Mortgages have high uncollectabilty, so high risk.

Front 69

Results of previous audits

Back 69

Inherent risk factor.
If an auditor finds mistakes consistantly from year to year.

Front 70

Initial vs engagement inherent risk

Back 70

an initial client is more risky as you dont know about them asm mcuh as a company coming back.

Front 71

Main concerns about Related party transactions.

Back 71

Not at arms length, so keep a close eye on them.

Front 72

If an employee is taking a loan out from the company

Back 72

it has to have it in a journal entry, and a disclosure . Db Loan recievable, cr Cash.

Front 73

Factors Affecting Inherent Risk Nature of the Clients business

Back 73

An electronics maufactureer faces a cgreateer iklihood of obsolete inventory than a steel fabricator. Inherent risk will affect accounts such as inventory, receivable accounts and property, plant and equipment.

Front 74

Factors Affecting Inherent Risk Results of Previous Audits

Back 74

Misstatements found in the previous years audit have a high likelihood of occuring again in the current years audit. An auditor is negligent if they ignore the the results of the preceding years audit.

Front 75

Factors Affecting Inherent Risk Initial Versus Repeat Engagement

Back 75

Auditors gain experience and knoledge about the liklihood of misstatements after auditing a client for several years.

Front 76

Factors Affecting Inherent Risk Related Parties

Back 76

Transactions between parent and subsidiary companies, and those between management and the corporate entity

Front 77

Factors Affecting Inherent Risk Nonroutine Transactions

Back 77

Transactions that are unusual for a client are more likely to be incorrectly recorded than routine transactions because the client often lacks experience recording them

Front 78

Factors Affecting Inherent Risk Judgement Required to Correctly Record Account Balances and Transactions

Back 78

Many account balances such as
Allowance for uncolletable a/r
Obsolete inventory
liability for warranty payments
major repairs v/s partial replacement
bank loan loss
Require lots of estimates and a great deal of mangement judgment. Because they require considerable judgment, the likelihood of misstatements increases, and as a result the auditor should increase inherent risk.

Front 79

Factors Affecting Inherent Risk Makeup of the Population

Back 79

individual items making up the total population also affect the auditors expectation of material misstatement. Most auditors use a higher inherent risk for AR where most accounts are overdue rather than current.

Front 80

Factors Affecting Inherent Risk Factors related to Fraudulent Financial Reporting and Missappropriation of Assets

Back 80

It is difficult to conceptualize fraud into numbers as the managers are dirty people you cant tell how much they are going to misstate the numbers.

Front 81

how can the risk of fraud be assessed?

Back 81

By cycle, account and objective.

Front 82

Making the Inherent risk decision

Back 82

must decide on an apprpriate inherent risk factor for each cycle, account, and many times, for each audit objective. some factors, such as an initial versus repeat engagement, will affect many or perhaps all cycle.

Front 83

the inherent risk for inventory assumptions

Back 83

1. a large number of misstatements were found inthe previous year and
2. inventory turnover has slowed in the current year.

auditors will set it as high.

Front 84

Obtaining information to assess inherent risk.

Back 84

During the planning phase and update the assessments throughout the audit.