Audit and Assurance ServicesArensChapter 09.docx

Audit and Assurance ServicesArensChapter 09.docx

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AuditandAssuranceServicesArensChapter09

Chapter9

MaterialityandRisk

ReviewQuestions

9-1Theplanningphasesare:

acceptclientandperforminitialplanning,understandtheclient’sbusinessandindustry,assessclientbusinessrisk,performpreliminaryanalyticalprocedures,setmaterialityandassessacceptableauditriskandinherentrisk,understandinternalcontrolandassesscontrolrisk,gatherinformationtoassessfraudrisk,anddevelopoverallauditplanandauditprogram.Evaluationofmaterialityispartofphasefive.Riskassessmentispartofphasethree（clientbusinessrisk）,phasefive（acceptableauditriskandinherentrisk）,phasesix（controlrisk）,andphaseseven（fraudrisk）.

9-2Materialityisdefinedas:

themagnitudeofanomissionormisstatementofaccountinginformationthat,inlightofthesurroundingcircumstances,makesitprobablethatthejudgmentofareasonablepersonrelyingontheinformationwouldhavebeenchangedorinfluencedbytheomissionormisstatement.

"Obtainreasonableassurance,"asusedintheauditreport,meansthattheauditordoesnotguaranteeorinsurethefairpresentationofthefinancialstatements.Thereissomeriskthatthefinancialstatementscontainamaterialmisstatement.

9-3Materialityisimportantbecauseiffinancialstatementsaremateriallymisstated,users'decisionsmaybeaffected,andtherebycausefinanciallosstothem.Itisdifficulttoapplybecausethereareoftenmanydifferentusersofthefinancialstatements.Theauditormustthereforemakeanassessmentofthelikelyusersandthedecisionstheywillmake.Materialityisalsodifficulttoapplybecauseitisarelativeconcept.Theprofessionalauditingstandardsofferlittlespecificguidanceregardingtheapplicationofmateriality.Theauditormust,therefore,exerciseconsiderableprofessionaljudgmentintheapplicationofmateriality.

9-4Thepreliminaryjudgmentaboutmaterialityisthemaximumamountbywhichtheauditorbelievesthefinancialstatementscouldbemisstatedandstillnotaffectthedecisionsofreasonableusers.Severalfactorsaffectthepreliminaryjudgmentaboutmaterialityandareasfollows:

1.Materialityisarelativeratherthananabsoluteconcept.

2.Basesareneededforevaluatingmateriality.

3.Qualitativefactorsaffectmaterialitydecisions.

4.Expecteddistributionofthefinancialstatementswillaffectthepreliminaryjudgmentofmateriality.Ifthefinancialstatementsarewidelydistributedtousers,thepreliminaryjudgmentofmaterialitywillprobablybesetlowerthanifthefinancialstatementsarenotexpectedtobewidelydistributed.

5.Thelevelofacceptableauditriskwillalsoaffectthepreliminaryjudgmentofmateriality.

9-5Becausematerialityisrelativeratherthanabsolute,itisnecessarytohavebasesforestablishingwhethermisstatementsarematerial.Forexample,intheauditofamanufacturingcompany,theauditormightuseasbases:

netincomebeforetaxes,totalassets,currentassets,andworkingcapital.Foragovernmentalunit,suchasaschooldistrict,thereisnonetincomebeforetaxes,andthereforethatwouldbeanunavailablebase.Instead,theprimarybaseswouldlikelybefundbalances,totalassets,andperhapstotalrevenue.

9-6Thefollowingqualitativefactorsarelikelytobeconsideredinevaluatingmateriality:

a.Amountsinvolvingfraudareusuallyconsideredmoreimportantthanunintentionalerrorsofequaldollaramounts.

b.Misstatementsthatareotherwiseminormaybematerialiftherearepossibleconsequencesarisingfromcontractualobligations.

c.Misstatementsthatareotherwiseimmaterialmaybematerialiftheyaffectatrendinearnings.

9-7Apreliminaryjudgmentaboutmaterialityissetforthefinancialstatementsasawhole.Tolerablemisstatementisthemaximumamountofmisstatementthatwouldbeconsideredmaterialforanindividualaccountbalance.Theamountoftolerablemisstatementforanygivenaccountisdependentuponthepreliminaryjudgmentaboutmateriality.Ordinarily,tolerablemisstatementforanygivenaccountwouldhavetobelowerthanthepreliminaryjudgmentaboutmateriality.Inmanycases,itwillbeconsiderablylowerbecauseofthepossibilityofmisstatementsindifferentaccountsthat,intotal,cannotexceedthepreliminaryjudgmentaboutmateriality.

9-8Thereareseveralpossibleanswerstothequestion.Oneexampleis:

Cash$500Overstatement

Fixedassets$3,000Overstatement

Long-termloans$1,500Understatement

Note:

Cashandfixedassetsaretestedforoverstatementandlong-termloansforunderstatementbecausetheauditor'sobjectiveinthiscaseistotestforoverstatementsofowner'sequity.

Theleastamountoftolerablemisstatementwasallocatedtocashandlong-termloansbecausetheyarerelativelyeasytoaudit.Themajorityofthetotalallocationwastofixedas