Chapter 9

Question 1

A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified audit opinion has been issued

Answer 1

Acceptable Audit Risk

Question 2

The process of assigning to each balance sheet account the misstatement amount considered to be material for that account based on the auditor’s preliminary judgment

Answer 2

Allocation of the Preliminary Judgment About Materiality

Question 3

A complement to acceptable audit risk: Acceptable audit risk of 2% is equivalent to a BLANK of 98%

Answer 3

Audit Assurance

Question 4

A formal model reflecting the relationships between acceptable audit risk (AAR), inherent risk (IR), and planned detection risk (PDR). PDR = AAR / (IRxCR)

Answer 4

Audit Risk Model

Question 5

A measure of the auditor’s assessment of the risk that a material misstatement could occur in an assertion and not be prevented or detected on a timely basis by the client’s internal controls

Answer 5

Control Risk

Question 6

The risk that the auditor or audit firm will suffer harm because of a client relationship, even though the audit report rendered for the client was correct

Answer 6

Engagement Risk

Question 7

A measure of the auditor’s assessment of the susceptibility of an assertion to material misstatement before considering the effectiveness of internal control

Answer 7

Inherent Risk

Question 8

Specific misstatements in a class of transactions or account balance identified during the audit

Answer 8

Known Misstatements

Question 9

Misstatements that arise from either differences between management’s and the auditor’s judgment about estimates of account balances or from projections of misstatements based on the auditor’s test of a sample from a population

Answer 9

Likely Misstatements

Question 10

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

Answer 10

Materiality

Question 11

The materiality amount for segments of the audit, set by the auditor at less than materiality for the financial statements as a whole

Answer 11

Performance Materiality

Question 12

A measure of the risk that audit evidence for a segment will fail to detect misstatements that could be material, should such misstatements exist

Answer 12

Planned Detection Risk

Question 13

The maximum amount by which the auditor believes that the statements could be misstated and still not affect the decisions of reasonable users; used in the audit plan

Answer 13

Preliminary Judgment about Materiality

Question 14

A change in the auditor’s preliminary judgment made when the auditor determines that the preliminary judgment was too large or too small

Answer 14

Revised Judgement about Materiality

Question 15

The acceptance by auditors that there is some level of uncertainty in performing the audit function

Answer 15

Risk

Question 16

The risk that the financial statements are materially misstated prior to the audit

Answer 16

Risk of Materiality Misstatements

Question 17

Results because the auditor has sampled only a portion of the population

Answer 17

Sampling Error

Question 18

The application of performance materiality to a sampling procedure (AICPA standards) or the materiality allocated to any given account balance (PCAOB standards)

Answer 18

Tolerable Misstatements

Question 19

What are the three major difficulties that auditors face in allocating materiality to the balance sheet account?

Answer 19

1. Auditors expect certain accounts to have more misstatements than others.
2. Both over statements and understatements must be considered.
3. Relative audit costs affect the allocation.

Question 20

What are the steps in applying materiality?

Answer 20

Step 1. Set materiality for the whole financial statement as a whole.
Step 2. Determine performance materiality.
Step 3. Estimate total misstatement in segment.
Step 4. Estimate the combined misstatements.
Step 5. Compare combined estimate with preliminary or revised judgement about materiality.

Question 21

What are the most important factors which affect the auditor’s preliminary judgement about materiality?

Answer 21

Materiality is a relative rather than an absolute concept, benchmarks are needed for evaluating materiality, and qualitative factors also affect materiality.

Question 22

Moore’s allocation approach uses judgement in the allocation, subject to the following two arbitrary requirements established by Berger and Anthony, CPA’s:

Answer 22

• Performance materiality for any account cannot exceed 60 percent of the preliminary judgement.
• The sum of all performance materiality levels cannot exceed twice the preliminary judgement about materiality.

Question 23

What are the two reasons for permitting the sum of performance materiality to exceed overall materiality?

Answer 23

1. It is unlikely that all accounts will be misstated by the full amount of performance materiality
2. some accounts are likely to be overstated, whereas others are likely to be understated, resulting in the net amount that is likely to be less than the preliminary judgement.

Question 24

The calculation of the direct projection estimate of misstatement is:

Answer 24

(Net misstatements in the sample/ Total sampled) X Total recorded population value

Question 25

What are the two types of likely misstatements?

Answer 25

1. Misstatements that arise from differences between management's and auditor's judgement about estimates of account balances. 2. Projections of misstatements based on the auditor's tests of a sample from a population.

Question 26

Audit risk model

Answer 26

``` PDR = AAR / (IR X CR) PDR - Planned detection risk AAR - Acceptable audit risk IR - Inherent risk CR - Control risk ```

Question 27

In additions to modifying audit evidence, there are two other ways that auditors can change the audit to respond to risks:

Answer 27

1. The engagement may require more experienced staff. | 2. The engagement will be reviewed more carefully than usual.

Question 28

Special care must be exercised when the auditor decides, on the basis of accumulated evidence, that the original assessment of control risk or inherent risk was understated or acceptable audit risk was overstated. In such a circumstance, the auditor should follow what two steps?

Answer 28

1. The auditor must revise the original assessment of the appropriate risk. It violates due care to leave the original unchanged if the auditor knows it is inappropriate. 2. The auditor should consider the effect of the revision on evidence requirements, without use of the audit risk model. If a revised risk is used in the audit risk model to determine a revised planned detection risk, there is a danger of not increasing the evidence sufficiently.

Question 29

The degrees to which external users rely on the statements are based on what factors?

Answer 29

Client's size of the company, distribution of ownership, and nature and amounts of liability.

Question 30

It is difficult for an auditor to predict financial failure before it occurs, but certain factors are good indicators of increased probability:

Answer 30

1. Liquidity position 2. Profits (losses) in previous years 3. Method of financing growth 4. Nature of the client's operations 5. Competence of management

Question 31

What factors should the auditor consider when assessing inherent risk?

Answer 31

1. Nature of client's business 2. Results of previous audits 3. Initial versus repeat engagement 4. Related parties 5. Complex or non-routine transactions 6. Judgement required to correctly record account balances and transactions 7. Makeup of the population 8. Factors related to fraudulent financial reporting 9. Factors related to misappropriation of assets