Chapter 9 Flashcards
Review for final
If it is probable that the judgment of a reasonable person would have been changed or influenced by the omission or misstatement of information, then that information is, by definition of FASB Statement No.
material
The preliminary judgment about materiality is the amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users.
maximum
Auditors are responsible for determining whether financial statements are materially misstated, so upon discovering a material misstatement they must bring it to the attention of:
the client’s management.
The FASB definition of materiality emphasizes what class of financial statement users?
Reasonable persons.
When auditors allocate the preliminary judgment about materiality to account balances, the materiality allocated to any given account balance is referred to as:
tolerable misstatement.
Why do auditors establish a preliminary judgment about materiality?
To plan the appropriate audit evidence to accumulate and develop an overall audit strategy.
Auditors are _____ to decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit.
required
If an auditor establishes a relatively high level for materiality, then the auditor will:
accumulate less evidence than if a lower level had been set.
The preliminary judgment about materiality and the amount of audit evidence accumulated are _____ related.
inversely
After the preliminary judgment about materiality has been established, auditors may:
adjust it either downward or upward.
In an audit area that has a lower inherent risk, it would be prudent to:
increase the tolerable misstatement for the area.
Which of the following is least likely to be appropriate as the basis for determining the preliminary judgment about materiality in the audit of financial statements?
Inventory.
Auditing standards _____ that the basis used to determine the preliminary judgment about materiality be documented in the audit files.
require
Amounts involving fraud are usually considered _____ important than unintentional errors of equal dollar amounts.
more
Auditors generally allocate the preliminary judgment about materiality to the:
balance sheet only.
Which of the following statements regarding inherent risk is correct?
Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain experience, even when there is inherent risk.
Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in assessing inherent risk during the planning phase?
Obtaining client’s agreement on the engagement letter.
Auditors commonly allocate materiality to balance sheet accounts rather than income statement accounts because most income statement misstatements have a(n) _____ effect on the balance sheet.
equal
Which of the following is not a correct statement regarding the allocation of the preliminary judgment about materiality to balance sheet accounts?
The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence.
What is the primary means of dealing with risk in planning decisions related to audit evidence?
Application of the audit risk model
The phrase “in our opinion” in the auditor’s report is intended to inform users that auditors:
base their conclusions about the statements on professional judgment.
Inherent risk is _______ related to detection risk and _______ related to the amount of audit evidence.
inversely, directly
The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement.
2. Estimate the total misstatement in the segment.
3. Set preliminary judgment about materiality.
4. Allocate preliminary judgment about materiality to segments.
5. Compare combined estimate with preliminary judgment about materiality.
The correct sequence from start to finish would be:
3 4 2 1 5.
Which of the following statements is not correct?
The most important base used as the criterion for deciding materiality is total assets.
Since materiality is relative, it is necessary to have bases for establishing whether misstatements are material. Normally, the most common base for deciding materiality is:
net income before taxes.
Allocating the preliminary judgment about materiality to financial statements segments is necessary because:
evidence is accumulated by segments rather than for the financial statements as a whole
- Which of the following statements is not correct?
Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.
Regardless of how the preliminary judgment about materiality is allocated, the auditor must be confident that total combined misstatements in all accounts are:
less than or equal to the preliminary judgment.
Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance to refer to ________.
acceptable audit risk
_____ misstatements are those where the auditor can determine the amount of the misstatement in the account
Known
When a different extent of evidence is needed for the various cycles, the difference is caused by:
an auditor’s expectations of errors and assessment of internal control
If planned detection risk is reduced, the amount of evidence the auditor accumulates will:
increase.
Likely misstatements can result from:
Computation of the sampling error for the cash account
Differences between management’s and an auditor’s judgment about account balances Projections of misstatements based on an auditor’s tests of a sample from a population
No Yes Yes
When discussing control risk (CR) and the audit risk model, which of the following is false?
If the auditor concludes that internal control is completely ineffective to prevent or detect errors, he/she would assign a low value (e.g., 0%) to CR.
Which of the following is not a good indicator of the degree to which statements are relied on by external users?
Amount of net income or loss after taxes
If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk for the auditor, acceptable audit risk would likely:
be reduced.
When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as completely honest in all dealings, auditors normally:
reduce acceptable audit risk and increase inherent risk.
One accounting issue that does not require management to use significant judgments is:
the useful life of equipment for tax purposes.
Inherent risk is often low for an account such as:
accounts receivable.
The auditor typically does not assess control risk and inherent risk for:
the overall audit.
To what extent do auditors typically rely on internal controls of their public company clients?
Extensively
Auditors typically rely on internal controls of their private company clients:
Only if the controls are determined to be effective.
Acceptable audit risk is ordinarily set by the auditor during planning and:
held constant for each major cycle and account.
When the auditor is attempting to determine the extent to which external users rely on a client’s financial statements, they may consider several factors except for:
assessment of detection risk.
A major difficulty in the application of the audit risk model is:
measuring the components of the model.
When setting a preliminary judgment about materiality:
more evidence is required for a low dollar amount than for a high dollar amount.
When allocating materiality, most practitioners choose to allocate to:
the balance sheet accounts because there are fewer.
The risk of material misstatement refers to:
the combination of inherent risk and control risk.
Which of the following underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting?
The elements of materiality and relative risk.
Tolerable misstatement as set by the auditor:
does not affect any of the four risks.
Which one of the following statements about the cycle approach to auditing is not correct?
There are differences among cycles on the auditor’s willingness to accept risk that material errors exist after the auditing is complete.
When the auditor has the same level of willingness to risk that material misstatements will exist after the audit is finished for all financial statement cycles:
a different extent of evidence will likely be needed for various cycles
Which of the following statements is not true?
Inherent risk is inversely related to evidence.
Which of the following is not a primary consideration when assessing inherent risk?
Susceptibility to defalcation
Which of the following is an example of the concept of inherent risk?
Loans receivable for a finance company are less likely to be collectible than those of a bank.
A measure of the risk that audit evidence for a segment will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist.
Planned detection risk
- 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.
Business risk
A measure of the auditor’s assessment of the likelihood that misstatements exceeding a tolerable amount in a segment will not be prevented or detected by the client’s internal controls.
Control risk
A measure of how much risk the auditor is willing to take that the financial statements may be materially misstated after the audit is completed and an unqualified audit opinion has been issued.
Acceptable audit risk
A measure of the auditor’s assessment of the likelihood that there are material misstatements before considering the effectiveness of internal control.
Inherent risk
The materiality allocated to any given account balance.
Tolerable misstatement
The maximum amount by which the auditor believes that the statements could be misstated and still not affect the decisions of reasonable users.
Preliminary judgment about materiality
This term is synonymous with acceptable audit risk.
Audit assurance
The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person would have been changed.
Materiality
A measure of the risk that audit evidence for a segment will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist.
Planned detection risk
- 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.
Business risk
A measure of the auditor’s assessment of the likelihood that misstatements exceeding a tolerable amount in a segment will not be prevented or detected by the client’s internal controls.
Control risk
A measure of how much risk the auditor is willing to take that the financial statements may be materially misstated after the audit is completed and an unqualified audit opinion has been issued.
Acceptable audit risk
A measure of the auditor’s assessment of the likelihood that there are material misstatements before considering the effectiveness of internal control.
Inherent risk
The materiality allocated to any given account balance.
Tolerable misstatement
The maximum amount by which the auditor believes that the statements could be misstated and still not affect the decisions of reasonable users.
Preliminary judgment about materiality
This term is synonymous with acceptable audit risk.
Audit assurance
The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person would have been changed.
Materiality
