Solutions manual
to accompany
Audit and assurance
2nd edition
by
Leung et al.
© John Wiley & Sons Australia, Ltd 2023
, Chapter 3: Financial Report Audits
Chapter 3: Financial Report Audits
Review questions
3.11 What are the different phases in the audit process?
Phase I: Perform risk assessment procedures
Phase II: Assess the risk of material misstatement
Phase III: Respond to assessed risks
Phase IV: Perform further audit procedures
Phase V: Evaluate audit evidence
Phase VI: Communicate audit findings
3.12 What are the benefits of a financial report audit?
In addition to providing assurance to financial report users, financial report audits
enable companies to:
1. Obtain access to capital markets. Without an audit, companies may be denied
access to capital markets by the ASX.
2. Have a lower cost of capital. Given the reduced risk resulting from audited
financial reports, potential creditors may offer low interest rates and potential
investors may be willing to accept a lower rate of return on their investment.
3. Be a deterrent to inefficiency and fraud. Knowledge that an independent audit
is to be performed is likely to result in fewer errors in the accounting process
and reduce the likelihood of employee misappropriation of assets.
4. Control and operational improvements. Based on observations made during the
financial report audit, the independent auditor can suggest how controls could
be improved and how greater operating efficiencies within the entity’s
organisation may be achieved.
3.13 What are the main limitations of a financial report audit?
The main limitations are as follows.
Audit testing on selective samples, which has limitations due to sampling risk.
The assessment of materiality, with both quantitative and qualitative
considerations, requires a high degree of professional judgement. There are,
however, some guidelines, although by their nature they are necessarily
arbitrary.
Forming professional judgements in highly specialised areas can often result in
disagreements between auditors and clients.
Report format limitations and the consequent “expectation gap” often arises
with users of financial reports.
Time lapse – by the time the audit report is released the information is
relatively ‘old’.
© John Wiley & Sons Australia, Ltd 2023 3.2
, Solutions manual to accompany Audit and assurance 2e by Leung et al.
3.14 Explain the term ‘materiality’ in the context of financial reporting.
According to ASA 320.2 (ISA 320) misstatements, including omissions, are
considered to be material if they, individually or in the aggregate, could reasonably be
expected to influence the economic decisions of users taken on the basis of the
financial report.
In considering materiality, the auditor is required to consider both:
the circumstances pertaining to the entity, and
the information needs of those who will rely on the audited financial report.
Financial report auditors will set materiality thresholds to guide their audit procedures.
They consider these thresholds when:
(a) identifying and assessing the risks of material misstatement;
(b) determining the nature, timing and extent of further audit procedures, and
(c) evaluating the effect of uncorrected misstatements, if any, on the financial report
and in forming the opinion in the auditor’s report (ASA320.A1).
3.15 Under what circumstances would the auditor request the accounts
to be adjusted for individually immaterial errors?
ASA 320 requires an auditor to assess whether the uncorrected misstatements that
have been identified during the audit are material individually or in aggregate.
Therefore, when errors are individually immaterial but are collectively material all the
errors should be adjusted for. For example, if materiality is set at $100 000 and two
errors which both reduce profits have been found for $40 000 and for $70 000 then
both will be adjusted for because the total error is $110 000 which is material.
3.16 What is the difference between quantitative and qualitative
materiality considerations?
Materiality judgements involve an assessment of both the amount (quantity) and the
nature (quality) of the misstatements. An auditor determines the overall quantitative
materiality level for planning purposes by selecting a base and applying a percentage
to that base. For profit-maximising companies, the most commonly used base is profit
before tax and materiality is usually set between 5 and 10 percent of this base. Other
bases and applicable percentages that may be used, depending on a company’s
circumstances, are: total assets (0.5–1.5%), total revenue (0.5–1%) or total equity (1–
3%). Thus, quantitative materiality is the dollar level used to determine if
misstatements are material (either individually or aggregated).
Qualitative factors are also applicable to materiality levels for particular classes of
transactions, account balances or disclosures. The auditor must consider the nature of,
and other related matters about, the items that might give rise to the risk of material
misstatements. Qualitative considerations relate to the causes of misstatements or to
misstatements that do not have a quantifiable effect. A misstatement that is
quantitatively immaterial may be qualitatively material, such as when the
misstatement is attributable to a control weakness, an irregularity or an illegal act by
© John Wiley & Sons Australia, Ltd 2023 3.3
to accompany
Audit and assurance
2nd edition
by
Leung et al.
© John Wiley & Sons Australia, Ltd 2023
, Chapter 3: Financial Report Audits
Chapter 3: Financial Report Audits
Review questions
3.11 What are the different phases in the audit process?
Phase I: Perform risk assessment procedures
Phase II: Assess the risk of material misstatement
Phase III: Respond to assessed risks
Phase IV: Perform further audit procedures
Phase V: Evaluate audit evidence
Phase VI: Communicate audit findings
3.12 What are the benefits of a financial report audit?
In addition to providing assurance to financial report users, financial report audits
enable companies to:
1. Obtain access to capital markets. Without an audit, companies may be denied
access to capital markets by the ASX.
2. Have a lower cost of capital. Given the reduced risk resulting from audited
financial reports, potential creditors may offer low interest rates and potential
investors may be willing to accept a lower rate of return on their investment.
3. Be a deterrent to inefficiency and fraud. Knowledge that an independent audit
is to be performed is likely to result in fewer errors in the accounting process
and reduce the likelihood of employee misappropriation of assets.
4. Control and operational improvements. Based on observations made during the
financial report audit, the independent auditor can suggest how controls could
be improved and how greater operating efficiencies within the entity’s
organisation may be achieved.
3.13 What are the main limitations of a financial report audit?
The main limitations are as follows.
Audit testing on selective samples, which has limitations due to sampling risk.
The assessment of materiality, with both quantitative and qualitative
considerations, requires a high degree of professional judgement. There are,
however, some guidelines, although by their nature they are necessarily
arbitrary.
Forming professional judgements in highly specialised areas can often result in
disagreements between auditors and clients.
Report format limitations and the consequent “expectation gap” often arises
with users of financial reports.
Time lapse – by the time the audit report is released the information is
relatively ‘old’.
© John Wiley & Sons Australia, Ltd 2023 3.2
, Solutions manual to accompany Audit and assurance 2e by Leung et al.
3.14 Explain the term ‘materiality’ in the context of financial reporting.
According to ASA 320.2 (ISA 320) misstatements, including omissions, are
considered to be material if they, individually or in the aggregate, could reasonably be
expected to influence the economic decisions of users taken on the basis of the
financial report.
In considering materiality, the auditor is required to consider both:
the circumstances pertaining to the entity, and
the information needs of those who will rely on the audited financial report.
Financial report auditors will set materiality thresholds to guide their audit procedures.
They consider these thresholds when:
(a) identifying and assessing the risks of material misstatement;
(b) determining the nature, timing and extent of further audit procedures, and
(c) evaluating the effect of uncorrected misstatements, if any, on the financial report
and in forming the opinion in the auditor’s report (ASA320.A1).
3.15 Under what circumstances would the auditor request the accounts
to be adjusted for individually immaterial errors?
ASA 320 requires an auditor to assess whether the uncorrected misstatements that
have been identified during the audit are material individually or in aggregate.
Therefore, when errors are individually immaterial but are collectively material all the
errors should be adjusted for. For example, if materiality is set at $100 000 and two
errors which both reduce profits have been found for $40 000 and for $70 000 then
both will be adjusted for because the total error is $110 000 which is material.
3.16 What is the difference between quantitative and qualitative
materiality considerations?
Materiality judgements involve an assessment of both the amount (quantity) and the
nature (quality) of the misstatements. An auditor determines the overall quantitative
materiality level for planning purposes by selecting a base and applying a percentage
to that base. For profit-maximising companies, the most commonly used base is profit
before tax and materiality is usually set between 5 and 10 percent of this base. Other
bases and applicable percentages that may be used, depending on a company’s
circumstances, are: total assets (0.5–1.5%), total revenue (0.5–1%) or total equity (1–
3%). Thus, quantitative materiality is the dollar level used to determine if
misstatements are material (either individually or aggregated).
Qualitative factors are also applicable to materiality levels for particular classes of
transactions, account balances or disclosures. The auditor must consider the nature of,
and other related matters about, the items that might give rise to the risk of material
misstatements. Qualitative considerations relate to the causes of misstatements or to
misstatements that do not have a quantifiable effect. A misstatement that is
quantitatively immaterial may be qualitatively material, such as when the
misstatement is attributable to a control weakness, an irregularity or an illegal act by
© John Wiley & Sons Australia, Ltd 2023 3.3
