CHAPTER 9

Multiple-Choice Questions
1.
easy
a
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 !"# "tatement $o. %&
a. material.
b. insignificant.
c. significant.
d. relevant.
%.
easy
'he 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.
b a. minimum
b. ma(imum
c. mean average
d. median average
).
easy
!uditors are responsible for determining whether financial statements are materially
misstated, so upon discovering a material misstatement they must bring it to the attention of&
d a. regulators.
b. the audit firm*s managing partner.
c. no one in particular.
d. the client*s management.
+. 'he !"# definition of materiality emphasi,es what class of financial statement users-
easy a. .egulators.
c b. Informed investors.
c. .easonable persons.
d. /otential investors.
0.
easy
1hen auditors allocate the preliminary judgment about materiality to account balances, the
materiality allocated to any given account balance is referred to as&
d a. the materiality range.
b. the error range.
c. tolerable materiality.
d. tolerable misstatement.
2. 1hy do auditors establish a preliminary judgment about materiality-
easy a. 'o determine the appropriate level of audit e(perience re3uired for the wor4.
c b. "o that the client can 4now what records to ma4e available to the auditor.
c. 'o plan the appropriate audit evidence to accumulate and develop an overall audit
strategy.
d. $one of the above.
5.
easy
!uditors are 66666 to decide on the combined amount of misstatements in the financial
statements that they would consider material early in the audit.
b a. permitted
b. re3uired
c. not allowed
d. strongly encouraged
7-1
8. If an auditor establishes a relatively high level for materiality, then the auditor will&
easy a. accumulate more evidence than if a lower level had been set.
b b. accumulate less evidence than if a lower level had been set.
c. accumulate appro(imately the same evidence as would be the case were materiality lower.
d. accumulate an undetermined amount of evidence.
7.
easy
'he preliminary judgment about materiality and the amount of audit evidence accumulated are
66666 related.
d a. directly
b. indirectly
c. not
d. inversely
19. !fter the preliminary judgment about materiality has been established, auditors may&
easy a. not adjust it.
d b. adjust it downward only.
c. adjust it upward only.
d. adjust it either downward or upward.
11. In an audit area that has a higher inherent ris4, it would be prudent to&
easy a. increase the amount of audit evidence gathered.
d b. assign more e(perienced staff to that area.
c. reduce the tolerable misstatement for the area.
d. do all of the above.
1%.
easy
1hich of the following is least li4ely to be appropriate as the basis for determining the
preliminary judgment about materiality in the audit of financial statements-
d a. $et income before ta(es.
b. Current assets.
c. :wners* e3uity.
d. Inventory.
1).
easy
!uditing standards 66666 that the basis used to determine the preliminary judgment about
materiality be documented in the audit files.
c a. permit
b. do not allow
c. re3uire
d. strongly encourage
1+.
easy
!mounts involving fraud are usually considered 66666 important than unintentional errors of
e3ual dollar amounts.
d a. less
b. no less
c. no more
d. more
7-%
10.
easy
1hich of the following 3ualitative factors may significantly influence whether an item is
deemed to be material-
d a. Misstatements that are otherwise minor may be material if there are possible
conse3uences arising from contractual obligations.
b. Misstatements that are otherwise immaterial may be material if they affect a trend in
earnings.
c. !mounts involving fraud are usually considered more important than unintentional
errors of e3ual dollar amounts.
d. !ll of the above may influence materiality.
12. !uditors generally allocate the preliminary judgment about materiality to the&
easy a. balance sheet only.
a b. income statement only.
c. income statement and balance sheet.
d. statement of cash flows.
15. 1hich of the following statements regarding inherent ris4 is correct-
easy
c
a. 'he inherent ris4 assigned in the audit ris4 model is unaffected by the auditor*s
e(perience with client*s organi,ation.
b. Most auditors set a low inherent ris4 in the first year of an audit and increase it if
e(perience shows that it was incorrect.
c. Most auditors set a high inherent ris4 in the first year of an audit and reduce it in
subse3uent years as they gain e(perience, even when there is inherent ris4.
d. 'he inherent ris4 assigned in the audit ris4 model is dependent upon the strengths in
client*s internal control system.
18.
easy
!uditors begin their assessments of inherent ris4 during audit planning. 1hich of the
following would not help in assessing inherent ris4 during the planning phase-
a a. :btaining client*s agreement on the engagement letter.
b. :btaining 4nowledge about the client*s business and industry.
c. 'ouring the client*s plant and offices.
d. Identifying related parties.
17.
medium
b
!uditors commonly allocate materiality to balance sheet accounts rather than income
statement accounts because most income statement misstatements have a;n< 66666 effect on
the balance sheet.
a. less
b. e3ual
c. undetermined
d. more
%9.
medium
1hich of the following is not a correct statement regarding the allocation of the preliminary
judgment about materiality to balance sheet accounts-
b a. !uditors e(pect certain accounts to have more misstatements than others.
b. 'he allocation has virtually no effect on audit costs because the auditor must collect
sufficient appropriate audit evidence.
c. !uditors e(pect to identify overstatements as well as understatements in the accounts.
d. .elative audit costs affect the allocation.
7-)
%1. 1hat is the primary means of dealing with ris4 in planning decisions related to audit
evidence-
medium a. "election of more effective tests of details of balances.
b b. !pplication of the audit ris4 model.
c. =stablish a lower preliminary judgment about materiality.
d. !ll of the above.
%%. 'he phrase >in our opinion? in the auditor*s report is intended to inform users that auditors&
medium a. guarantee fair presentation of the financial statements.
d b. act as insurers of the accuracy of the statements.
c. certify the material presented in the statements by management.
d. base their conclusions about the statements on professional judgment.
%).
medium
!n overstatement of an asset account has 6666 effect on the income statement than an
understatement of a liability account.
c a. a greater
b. less of an
c. the same
d. none of the above
%+.
medium
Inherent ris4 is 6666666 related to detection ris4 and 6666666 related to the amount of audit
evidence.
d a. directly, inversely
b. directly, directly
c. inversely, inversely
d. inversely, directly
%0. 'he five steps in applying materiality are listed below in random order.
medium 1. =stimate the combined misstatement.
b %. =stimate the total misstatement in the segment.
). "et preliminary judgment about materiality.
+. !llocate preliminary judgment about materiality to segments.
0. Compare combined estimate with preliminary judgment about materiality.
'he correct se3uence from start to finish would be&
a. 1 % 0 + ).
b. ) + % 1 0.
c. + ) 1 0 %.
d. 0 1 ) % +.
%2. 1hich of the following statements is not correct-
medium a. Materiality is a relative rather than an absolute concept.
b b. 'he most important base used as the criterion for deciding materiality is total assets.
c. Qualitative factors as well as 3uantitative factors affect materiality.
d. @iven e3ual dollar amounts, frauds are usually considered more important than errors.
%5.
medium
"ince materiality is relative, it is necessary to have bases for establishing whether
misstatements are material. $ormally, the most common base for deciding materiality is&
a a. net income before ta(es.
b. net wor4ing capital.
c. net income after ta(es.
d. total assets.
7-+
%8.
medium
Certain types of misstatements are li4ely to be more important than other types to users, even if
the dollar amounts are the same. 1hich of the following does not demonstrate this-
d a. !mounts involving frauds are considered more important than errors of e3ual amount.
b. Misstatements that are otherwise minor may be considered material if there are possible
conse3uences arising from contractual obligations.
c. Misstatements that are otherwise immaterial may be material if they affect a trend in
earnings.
d. =ach of the above demonstrates this concept.
%7.
medium
'he more effective the internal controls, the lower the ris4 factor that 666666 assigned to
control ris4.
b a. should be
b. could be
c. is
d. must be
)9.
medium
!llocating the preliminary judgment about materiality to financial statements segments is
necessary because&
b a. evidence is accumulated for the financial statements as a whole so materiality does not
apply to them.
b. evidence is accumulated by segments rather than for the financial statements as a whole.
c. it is re3uired by the !IC/!*s Code of Professional Conduct.
d. it is re3uired by the "=C.
)1. 1hich of the following statements is not correct-
medium
c
a. =ither an overstatement of an asset account or an understatement of a liability account
would have the same effect on the income statement.
b. ! misclassification in the balance sheet will have no effect on operating income.
c. =ither an overstatement of an asset account or an overstatement of a liability account
would have the same effect on the income statement.
d. =ither an understatement of an asset account or an overstatement of a liability account
would have the same effect on the income statement.
)%.
medium
.egardless of how the preliminary judgment about materiality is allocated, the auditor must be
confident that total combined misstatements in all accounts are&
d a. less than the preliminary judgment.
b. e3ual to the preliminary judgment.
c. more than the preliminary judgment.
d. less than or e3ual to the preliminary judgment.
)).
medium
!uditors fre3uently refer to the terms audit assurance, overall assurance, and level of assurance
to refer to 66666666.
c a. detection ris4
b. audit report ris4
c. acceptable audit ris4
d. none of the above
)+.
medium
66666 misstatements are those where the auditor can determine the amount of the
misstatement in the account.
c a. /otential
b. Ai4ely
c. Bnown
d. /rojected
7-0
)0. 1hen a different e(tent of evidence is needed for the various cycles, the difference is caused
by&
medium a. errors in the client*s accounting system.
d b. a client*s need to achieve an un3ualified opinion.
c. an auditor*s need to follow auditing standards.
d. an auditor*s e(pectations of errors and assessment of internal control.
)2. If planned detection ris4 is reduced, the amount of evidence the auditor accumulates will&
medium a. increase.
a b. decrease.
c. remain unchanged.
d. be indeterminate.
)5. Ai4ely misstatements can result from&
medium a. differences between management*s and an auditor*s judgment about account balances.
c b. projections of misstatements based on an auditor*s tests of a sample from a population.
c. both a and b.
d. neither a nor b.
)8. 1hen discussing control ris4 ;C.< and the audit ris4 model, which of the following is false-
medium
b
a. C. is a measure of the auditor*s assessment of the li4elihood that misstatements will not
be prevented or detected by internal control.
b. If the auditor concludes that internal control is completely ineffective to prevent or detect
errors, heCshe would assign a low value ;e.g., 9D< to C..
c. 'he relationship between control ris4 and detection ris4 is inverse.
d. 'he relationship between control ris4 and evidence is direct.
)7.
medium
1hich of the following is not a good indicator of the degree to which statements are relied on
by e(ternal users-
d a. Client*s si,e, as measured by total assets or total revenue.
b. Eistribution of ownership among the public.
c. $ature and amount of liabilities.
d. !mount of net income or loss after ta(es.
+9.
medium
If an auditor believes the chance of financial failure is high and there is a corresponding
increase in business ris4 for the auditor, acceptable audit ris4 would li4ely&
a a. be reduced.
b. be increased.
c. remain the same.
d. be calculated using a computeri,ed statistical pac4age.
+1.
medium
1hen management has an ade3uate level of integrity for the auditor to accept the engagement
but cannot be regarded as completely honest in all dealings, auditors normally&
a a. reduce acceptable audit ris4 and increase inherent ris4.
b. reduce inherent ris4 and control ris4.
c. increase inherent ris4 and control ris4.
d. increase acceptable audit ris4 and reduce inherent ris4.
+%. :ne accounting issue that does not re3uire management to use significant judgments is&
medium a. the allowance for doubtful accounts.
b b. the useful life of e3uipment for ta( purposes.
c. obsolete inventory.
d. the liability for warranty payments.
7-2
+). Inherent ris4 is often low for an account such as&
medium a. inventory.
d b. mar4etable securities.
c. cash.
d. accounts receivable.
++. 'he auditor typically does not assess control ris4 and inherent ris4 for&
medium a. each audit objective.
d b. each cycle.
c. each account.
d. the overall audit.
+0. ;/ublic< 'o what e(tent do auditors typically rely on internal controls of their public company clients-
medium a. =(tensively
a b. :nly very little
c. Infre3uently
d. $ever
+2. 'o what e(tent do auditors typically rely on internal controls of their private company clients-
medium a. :nly as needed to complete the audit.
b b. :nly as the controls are e(pected to be effective.
c. :nly as the client as4s an auditor to test controls.
d. $one of the above.
+5. !cceptable audit ris4 is ordinarily set by the auditor during planning and&
medium a. held constant for each major cycle and account.
a b. held constant for each major cycle but varies by account.
c. varies by each major cycle and by each account.
d. varies by each major cycle but is constant by account.
+8.
medium
1hen the auditor is attempting to determine the e(tent to which e(ternal users rely on a
client*s financial statements, they may consider several factors including&
d a. client si,e.
b. concentration of ownership.
c. types and amounts of liabilities.
d. all of the above.
+7. ! major difficulty in the application of the audit ris4 model is&
medium a. defining the terms of the model.
b b. measuring the components of the model.
c. understanding the effect on other factors in the model when one factor is changed.
d. the failure of the !udit "tandards #oard to accept it and incorporate it into standards.
09. 1hen setting a preliminary judgment about materiality&
medium a. more evidence is re3uired for a low dollar amount than for a high dollar amount.
a b. less evidence is re3uired for a low dollar amount than for a high dollar amount.
c. the same amount of evidence is re3uired for either low or high dollar amounts.
d. there is no relationship between it and the dollar amount of evidence needed.
7-5
01. 1hen allocating materiality, most practitioners choose to allocate to&
challenging a. the income statement accounts because they are more important.
b b. the balance sheet accounts because there are fewer.
c. both balance sheet and income statement accounts because there could be errors on either.
d. all of the financial statements because there could be errors on other statements besides
the income statement and balance sheet.
0%. 'he ris4 of material misstatement refers to&
challenging a. control ris4 and acceptable audit ris4.
c b. inherent ris4.
c. the combination of inherent ris4 and control ris4.
d. none of the above.
0). !uditors may assess inherent ris4 and control ris4&
challenging a. jointly to determine the ris4 of material misstatement.
c b. separately and combine their effects in the audit ris4 model.
c. using the approach in choices a or b.
d. using an approach other than in choices a or b.
0+. 1hich one of the following statements about the cycle approach to auditing is not correct-
challenging a. 'here are differences among cycles in the fre3uency and si,e of e(pected errors.
c b. 'here are differences among cycles in the effectiveness of internal controls.
c. 'here are differences among cycles on the auditor*s willingness that material errors e(ist
after the auditing is complete.
d. It is common for auditors to want an e3ually low li4elihood of errors for each cycle after
the auditor is finished.
00.
challenging
1hen the auditor has the same level of willingness to ris4 that material misstatements will
e(ist after the audit is finished for all financial statement cycles&
a a. a different e(tent of evidence will li4ely be needed for various cycles.
b. the same amount of evidence will be gathered for each cycle.
c. heCshe has not followed generally accepted auditing standards.
d. the level for each cycle must be no more than %D so that the entire audit does not e(ceed
19D.
02. 1hich of the following statements is not true-
challenging a. Inherent ris4 is inversely related to detection ris4.
b b. Inherent ris4 is inversely related to evidence.
c. Inherent ris4 is the susceptibility of the financial statements to material error, assuming
no internal controls.
d. Inherent ris4 is the auditor*s assessment of the li4elihood that errors e(ceeding a
tolerable amount e(ist in a segment before considering the effectiveness of internal
controls.
05. 1hich of the following is not a primary consideration when assessing inherent ris4-
challenging a. $ature of client*s business.
c b. =(istence of related parties.
c. re3uency and intensity of management*s review of accounting transactions and records.
d. "usceptibility to defalcation.
7-8
08. 1hich of the following is an e(ample of the concept of inherent ris4-
challenging
c
a. Fumans ma4e more errors than computersG therefore, a manual accounting system is
ris4ier than a computeri,ed system.
b. !ccounting systems with vouchers have many more controls built in, so the ris4 that
there will be errors on the financial statements is reduced.
c. Aoans receivable for a finance company are less li4ely to be collectible than those of a
ban4.
d. !udits with larger sample si,es are less ris4y than those with smaller sample si,es.
07. 'olerable misstatement as set by the auditor&
challenging a. decreases acceptable audit ris4.
d b. increases inherent ris4 and control ris4.
c. affects planned detection ris4.
d. does not affect any of the four ris4s.
29. 'he audit ris4 model is&
challenging a. a planning, testing, and evaluation model.
c b. useful in evaluating results but of limited use in planning.
c. useful in planning, but of limited value in evaluating results.
d. useful when performing the tests of balances, but of little value in either the planning or
evaluation stages.
21.
challenging
1hich of the following underlies the application of generally accepted auditing standards,
particularly the standards of fieldwor4 and reporting-
a a. 'he elements of materiality and relative ris4.
b. 'he element of internal control.
c. 'he element of corroborating evidence.
d. 'he element of reasonable assurance.
=ssay Questions
2%.
medium
Eiscuss the three main factors that affect an auditor*s preliminary judgment about materiality.
!nswer&
'he three main factors that affect an auditor*s judgment about materiality are&
Materiality is a relative rather than an absolute concept . ! misstatement of a given
si,e 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. "ince materiality is relative, it is
necessary to have bases for establishing whether misstatements are material. $et
income before ta(es is normally the most commonly used base, but other possible
bases include current assets, total assets, current liabilities, and owners* e3uity.
Qualitative factors also affect materiality. Certain types of misstatements are li4ely
to be more important to users than others, even if the dollar amounts are the same,
such as misstatements involving frauds.
7-7
2).
medium
Eue to 3ualitative factors, certain types of misstatements are li4ely to be more important to
users than others, even if the dollar amounts are the same. Identify two 3ualitative factors that
might significantly affect an auditor*s materiality judgment, and give an e(ample of each.
!nswer&
Qualitative factors that affect an auditor*s materiality judgment include&
Amounts involving fraud. !mounts involving fraud are usually considered more
important than unintentional errors of e3ual dollar amounts because fraud reflects on
the honesty and reliability of the management or other personnel involved. or
e(ample, an intentional misstatement of inventory would be more important to users
than a clerical error in inventory of the same amount.
Misstatements affecting contractual obligations. Misstatements that are otherwise
minor may be material if there are possible conse3uences arising from contractual
obligations. or e(ample, if a misstatement causes a re3uired minimum account
balance to e(ceed the minimum, when the correct balance is less than the minimum,
this misstatement li4ely would be important to users.
Profit vs. loss. Misstatements that cause a loss to be reported as a profit or
misstatements that affect trends in earnings are li4ely to be important to users.
2+.
medium
=(plain why it is necessary to allocate the preliminary judgment about materiality to
individual accounts ;segments< in the financial statements. !lso e(plain why allocating to
balance sheet accounts is more common than allocating to income statement accounts.
!nswer&
!llocating the preliminary judgment about materiality to individual accounts is necessary
because evidence is accumulated for accounts rather than for the financial statements as a
whole. !llocating to accounts establishes a tolerable misstatement amount for each
account, which helps the auditor decide the appropriate audit evidence to accumulate for
each account. Most practitioners allocate materiality to balance sheet accounts rather than
income statement accounts because there are fewer balance sheet than income statement
accounts.
20.
medium
1hy do most practitioners allocate the preliminary judgment about materiality to balance sheet
accounts-
!nswer&
Most income statement misstatements have an e3ual effect on the balance sheet because
of the double-entry boo44eeping system. #ecause there are fewer balance sheet accounts
than income statement accounts in most audits and most audit procedures focus on
balance sheet accounts, allocating materiality to balance sheet accounts is the most
appropriate alternative.
22.
medium
Eiscuss how auditors use the audit ris4 model when planning an audit.
!nswer&
'he audit ris4 model is used primarily for planning purposes in deciding how much
evidence to accumulate in each cycle. 'he auditor decides an acceptable level of audit
ris4, assesses inherent ris4 and control ris4, and then uses the relationship depicted in the
following model to determine an appropriate level for planned detection ris4&
/E. H !!.
I. ( C.
25.
medium
Eescribe the audit ris4 model and each of its components.
7-19
!nswer&
'he planning form of the audit ris4 model is stated as follows&
/E. H !!.
I. ( C.
where& /E. H planned detection ris4
!!. H acceptable audit ris4
I. H inherent ris4
C. H control ris4
/lanned detection ris4 is a measure of the ris4 that audit evidence for an account will fail
to detect misstatements e(ceeding a tolerable amount, should such misstatements e(ist.
/lanned detection ris4 determines the amount of substantive evidence that the auditor
plans to accumulate.
!cceptable audit ris4 is 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
un3ualified opinion has been issued. It is influenced primarily by the degree to which
e(ternal users will rely on the statements, the li4elihood that a client will have financial
difficulties after the audit report is issued, and the auditor*s evaluation of management*s
integrity.
Inherent ris4 is a measure of the auditor*s assessment of the li4elihood that there are
material misstatements in an account before considering the effectiveness of internal
control.
Control ris4 is a measure of the auditor*s assessment of the li4elihood that misstatements
e(ceeding a tolerable amount in an account will not be prevented or detected by the
client*s internal controls.
28.
medium
'here are several factors that affect an audit firm*s business ris4 and, therefore, acceptable
audit ris4. Eiscuss three of these factors.
!nswer&
#usiness ris4 and acceptable audit ris4 are affected by&
The degree to which external users will rely on the statements. or large, publicly
held clients, business ris4 is greater, and acceptable audit ris4 will be less, than for
small, privately held clients, all things being e3ual.
The lielihood that a client will have financial difficulties after the audit report is
issued. #usiness ris4 is greater, and acceptable audit ris4 will be lower, when the
client is e(periencing financial difficulties.
The auditor!s evaluation of management!s integrity. #usiness ris4 is greater and
acceptable audit ris4 will be lower when the client*s management has 3uestionable
integrity.
7-11
27.
challenging
Eiscuss each of the five steps in applying materiality in an audit, and identify the audit
phase;s< in which each step is performed. Aist these steps in the order in which they occur.
!nswer&
"tep #. "et preliminary $udgment about materiality. 'his is the combined amount of
misstatements in the financial statements that would be considered material. 'his
decision is made in the planning stage of the audit.
"tep %. Allocate preliminary $udgment about materiality to segments. In this step, the
auditor normally allocates the preliminary judgment about materiality to the balance
sheet accounts. 'he amount of materiality allocated to an account is referred to as that
account*s tolerable misstatement. 'his allocation is performed in the audit planning
stage.
"tep &. 'stimate total misstatement in segment. In this step, the auditor projects the
sample results to the population. !n allowance for sampling ris4 is also calculated. 'his
would be performed after the substantive tests for each account are completed.
"tep (. 'stimate the combined misstatement. In this step, the projected errors for each
account are added, along with total sampling error, to calculate the combined
misstatement. 'his would be performed after all substantive tests have been completed.
"tep ). Compare combined estimated misstatement with preliminary or revised $udgment
about materiality. If the combined estimated misstatement is less than or e3ual to the
judgment about materiality, then the auditor concludes the financial statements are fairly
presented. 'his would be performed after all substantive tests have been completed, in the
final review stage of the audit.
:ther :bjective !nswer ormat Questions
59.
easy
#elow are four situations that involve the audit ris4 model as it is used for planning audit
evidence re3uirements in the audit of inventory. or each situation, calculate planned detection
ris4.
"I'I!'I:$
1 % ) +
!cceptable audit ris4 1D 19D 19D 0D
Inherent ris4 199D 199D 09D %9D
Control ris4 199D 199D +9D )9D
/lanned detection ris4 666666 666666 666666 666666
!nswer& 1. 1DG %. 19DG ). 09DG +. 8).)D
7-1%
51.
easy
Ising your 4nowledge of the relationships among acceptable audit ris4, inherent ris4, control
ris4, planned detection ris4, tolerable misstatement, and planned evidence, state the effect on
planned evidence ;increase or decrease< of changing each of the following factors, while the
other factors remain unchanged.
decrease 1. !n increase in acceptable audit ris4. .
increase %. !n increase in inherent ris4. .
decrease ). ! decrease in control ris4. .
decrease +. !n increase in planned detection ris4. .
decrease 0. !n increase in tolerable misstatement. .
5%. Match nine of the terms ;a-i< with the definitions provided below ;1-7<&
medium
a. #usiness ris4
b. /reliminary judgment about materiality
c. Inherent ris4
d. /lanned detection ris4
e. !udit assurance
f. !cceptable audit ris4
g. 'olerable misstatement
h. Control ris4
i. Materiality
d 1. ! measure of the ris4 that audit evidence for a segment will fail to detect
misstatements e(ceeding a tolerable amount, should such misstatements e(ist.
a %. 'he ris4 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.
h ). ! measure of the auditor*s assessment of the li4elihood that misstatements
e(ceeding a tolerable amount in a segment will not be prevented or detected by
the client*s internal controls.
f +. ! measure of how much ris4 the auditor is willing to ta4e that the financial
statements may be materially misstated after the audit is completed and an
un3ualified audit opinion has been issued.
g 0. 'he materiality allocated to any given account balance.
b 2. 'he ma(imum amount by which the auditor believes that the statements could
be misstated and still not affect the decisions of reasonable users.
e 5. 'his term is synonymous with acceptable audit ris4.
i 8. 'he magnitude of an omission or misstatement of accounting information that
ma4es it probable that the judgment of a reasonable person would have been
changed.
c 7. ! measure of the auditor*s assessment of the li4elihood that there are material
misstatements before considering the effectiveness of internal control.
7-1)
5).
medium
In practice, auditors rarely assign numerical probabilities to inherent ris4, control ris4, or
acceptable audit ris4. It is more common to assess these ris4s as high, medium, or low. or
each of the four situations below, fill in the blan4s for planned detection ris4 and the amount of
evidence you would plan to gather ;>planned evidence?< using the terms high, medium, or low.
"I'I!'I:$
1 % ) +
!cceptable audit ris4 Aow Aow Figh Figh
Inherent ris4 Figh Aow Aow Aow
Control ris4 Figh Aow Medium Aow
/lanned detection ris4 666666 666666 666666 666666
/lanned evidence 666666 666666 666666 666666
!nswer& 1. low, high
%. medium, medium
). medium, medium
+. high, low
5+.
easy
a
'he auditor*s preliminary judgment about materiality is the ma(imum amount by which the
auditor believes the financial statements could be misstated and still not affect the decisions of
reasonable users.
a. 'rue
b. alse
50.
easy
a
'here is no precise definition of materiality in the professional literature.
a. 'rue
b. alse
52.
easy
b
'he !"# definition of materiality focuses on potential users of financial statements.
a. 'rue
b. alse
55.
easy
a
$et income before ta(es is normally the most important base for deciding materiality.
a. 'rue
b. alse
58.
easy
b
Most practitioners allocate the preliminary judgment about materiality to income statement
accounts.
a. 'rue
b. alse
57.
easy
a
'he primary purpose of allocating the preliminary judgment about materiality to financial
statement accounts is to help the auditor decide the appropriate evidence to accumulate.
a. 'rue
b. alse
7-1+
89.
easy
b
!uditors cannot use prior year financial statement balances to establish their preliminary
judgment about materiality in planning the current year*s audit.
a. 'rue
b. alse
81.
easy
b
If acceptable audit ris4 is low, and inherent ris4 and control ris4 are both high, then planned
detection ris4 should be high.
a. 'rue
b. alse
8%.
easy
a
Inherent ris4 and planned detection ris4 are inversely relatedG i.e., as inherent ris4 increases,
planned detection ris4 should decrease, ceteris paribus.
a. 'rue
b. alse
8).
easy
b
!cceptable audit ris4 and planned detection ris4 are inversely relatedG i.e., as acceptable audit
ris4 increases, planned detection ris4 should decrease, ceteris paribus.
a. 'rue
b. alse
8+.
easy
b
'he most important element of the audit ris4 model is control ris4.
a. 'rue
b. alse
80.
easy
b
or a private company client, auditors are re3uired to test any internal controls they believe
have not been operating effectively during the period under audit.
a. 'rue
b. alse
82.
easy
a
If an auditor believes the client will have financial difficulties after the audit report is issued,
and e(ternal users will be relying heavily on the financial statements, the auditor will probably
set acceptable audit ris4 as low.
a. 'rue
b. alse
85.
medium
b
!chieved detection ris4 can be reduced only by accumulating more audit evidence.
a. 'rue
b. alse
88.
medium
a
!uditors have difficulty applying the concept of materiality in practice because they often do
not 4now who the users of the financial statements are or what decisions will be made.
a. 'rue
b. alse
87.
medium
b
'he audit ris4 model that must be used for planning audit procedures and evaluating audit
results is& !c!. H I. ( C. ( !cE..
a. 'rue
b. alse
7-10
79.
medium
b
"tatements on !uditing "tandards provide detailed, objective guidance on how auditors are to
establish a preliminary materiality level, thus eliminating the need for subjective auditor
judgment in this tas4.
a. 'rue
b. alse
71.
medium
b
If the preliminary judgment of materiality increases, the amount of audit evidence re3uired
will also increase.
a. 'rue
b. alse
7%.
medium
b
Insert ris4 and control ris4 are normally assessed for the overall audit.
a. 'rue
b. alse
7).
medium
b
'olerable misstatement is the ma(imum combined total of all misstatements in the financial
statements that the auditor is willing to allow, or tolerate, when issuing a standard un3ualified
opinion.
a. 'rue
b. alse
7+.
medium
a
If an auditor assigns a tolerable misstatement of J1,999 to accounts payable, he or she would
need to obtain more audit evidence for that account than if J199,999 had been assigned.
a. 'rue
b. alse
70.
medium
a
'o ma(imi,e audit efficiency, the auditor should allocate less tolerable misstatement to
accounts that can be verified by using low-cost audit procedures, such as analytical procedures,
than to accounts that are more costly to audit.
a. 'rue
b. alse
72.
medium
b
'o ma(imi,e audit effectiveness, the auditor should establish a high preliminary judgment
about materiality and allocate most of the amount to balance sheet accounts.
a. 'rue
b. alse
75.
medium
a
!cceptable audit ris4 and the amount of substantive evidence re3uired are inversely related.
a. 'rue
b. alse
78.
medium
a
!s control ris4 increases, the amount of substantive evidence the auditor plans to accumulate
should increase.
a. 'rue
b. alse
77.
medium
b
Inherent ris4 and control ris4 are directly related.
a. 'rue
b. alse
7-12
199.
medium
a
!n acceptable audit ris4 assessment of low indicates a ris4y client re3uiring more e(tensive
evidence, assignment of more e(perienced personnel, andCor a more e(tensive review of audit
files.
a. 'rue
b. alse
191.
medium
a
=ngagement ris4 is effectively the audit firm*s business ris4.
a. 'rue
b. alse
19%.
medium
b
!udit assurance is the complement of planned detection ris4, that is, one minus planned
detection ris4.
a. 'rue
b. alse
7-15