acct 5200 exam 2 || A Verified A+ Pass.
preliminary audit planning correct answers -understand the client's business and industry
-assess clients business risk
-perform preliminary analytical procedures
all of this happens before materiality is even set
engagement letter correct answers A letter that formalizes the contract between the auditor and
the entity and outlines the responsibilities of both parties.
materiality definition correct answers the magnitude of an omission or misstatement of
accounting information that, in light of surrounding circumstances, makes it probable that the
judgment of a reasonable person relying the information would have been changed or influenced
by the omission or misstatement
materiality is NOT an absolute- it requires professional judgment and varies by audit
qualitative factors that influence materiality correct answers misstatements due to management
fraud
misstatements related to contractual obligations
misstatements related to trend in earnings
-start w quantitative number and then adjust according to qualitative factors
steps in applying materiality correct answers 1. determine overall materiality
2. determine tolerable misstatement AKA performance materiality
3. evaluate audit findings
-estimate total misstatement in each account
-combine the estimated misstatement accounts
-compare the combined misstatement amount w materiality
steps 1 and 2 are done during planning, step 3 near the end of the audit
preliminary judgment about materiality correct answers -based on projections
-made during planning, but may change during engagement
-considers financial statements as a whole
-represents the MAXIMUM amount by which the auditor believes the F/S could be misstated
and not affect the decisions of reasonable users
-used to help plan appropriate evidence to accumulate (the lower $ materiality, the more
evidence needed)
-during the audit, auditors often change to revised judgment about materiality
factors affecting materiality correct answers -it is RELATIVE rather than absolute
-BENCHMARKS are needed for evaluation
-qualitative factors (fraud, contractual obligations, trend in earnings)
, benchmarks correct answers primary benchmark= net income before taxes (5% rule of thumb)
other benchmarks include net sales, gross profit, total/net assets
performance materiality (tolerable misstatement) correct answers materiality at
performance/segment/account level
we cant just audit materiality as a whole, need to break it down and leave room for aggregation
of errors
set AFTER setting preliminary judgment ab materiality
performance materiality can be set for the financial statements as a whole; commonly 50-75% of
materiality
or each segment/account can be assigned its own performance materiality
set at LESS THAN materiality as a whole to reduce to appropriately low level the probability
that aggregate of uncorrected/undetected misstatements exceeds materiality for F/S as a whole
set based on professional judgment and reflects amount of misstatement auditor is willing to
accept in a particular segment
auditors plan as if allocating total materiality across segments/accounts
if accounts are more expensive to audit, auditors want to look for bigger errors to balance costs
and benefits. so performance materiality is higher
sum of performance materiality can exceed overall materiality correct answers -it is unlikely that
all accounts will be misstated by full amount of performance materiality
-some accounts are likely to be overstated, others understated
-overall materiality serves as a safety net
known misstatements correct answers auditors identifies specifically
likely misstatements correct answers differences in estimates between auditors and management
projections based on sampling
aggregate misstatement compared to overall materiality correct answers if LESS, the auditor can
conclude that financial statements are fairly presented
if MORE, the auditor recommends adjustments to be made to FS before a clean opinion can be
issued
audit risk model correct answers PDR = AAR/(IR*CR)
or
AAR= (IR*CR) * PDR
PDR= planned detection risk
preliminary audit planning correct answers -understand the client's business and industry
-assess clients business risk
-perform preliminary analytical procedures
all of this happens before materiality is even set
engagement letter correct answers A letter that formalizes the contract between the auditor and
the entity and outlines the responsibilities of both parties.
materiality definition correct answers the magnitude of an omission or misstatement of
accounting information that, in light of surrounding circumstances, makes it probable that the
judgment of a reasonable person relying the information would have been changed or influenced
by the omission or misstatement
materiality is NOT an absolute- it requires professional judgment and varies by audit
qualitative factors that influence materiality correct answers misstatements due to management
fraud
misstatements related to contractual obligations
misstatements related to trend in earnings
-start w quantitative number and then adjust according to qualitative factors
steps in applying materiality correct answers 1. determine overall materiality
2. determine tolerable misstatement AKA performance materiality
3. evaluate audit findings
-estimate total misstatement in each account
-combine the estimated misstatement accounts
-compare the combined misstatement amount w materiality
steps 1 and 2 are done during planning, step 3 near the end of the audit
preliminary judgment about materiality correct answers -based on projections
-made during planning, but may change during engagement
-considers financial statements as a whole
-represents the MAXIMUM amount by which the auditor believes the F/S could be misstated
and not affect the decisions of reasonable users
-used to help plan appropriate evidence to accumulate (the lower $ materiality, the more
evidence needed)
-during the audit, auditors often change to revised judgment about materiality
factors affecting materiality correct answers -it is RELATIVE rather than absolute
-BENCHMARKS are needed for evaluation
-qualitative factors (fraud, contractual obligations, trend in earnings)
, benchmarks correct answers primary benchmark= net income before taxes (5% rule of thumb)
other benchmarks include net sales, gross profit, total/net assets
performance materiality (tolerable misstatement) correct answers materiality at
performance/segment/account level
we cant just audit materiality as a whole, need to break it down and leave room for aggregation
of errors
set AFTER setting preliminary judgment ab materiality
performance materiality can be set for the financial statements as a whole; commonly 50-75% of
materiality
or each segment/account can be assigned its own performance materiality
set at LESS THAN materiality as a whole to reduce to appropriately low level the probability
that aggregate of uncorrected/undetected misstatements exceeds materiality for F/S as a whole
set based on professional judgment and reflects amount of misstatement auditor is willing to
accept in a particular segment
auditors plan as if allocating total materiality across segments/accounts
if accounts are more expensive to audit, auditors want to look for bigger errors to balance costs
and benefits. so performance materiality is higher
sum of performance materiality can exceed overall materiality correct answers -it is unlikely that
all accounts will be misstated by full amount of performance materiality
-some accounts are likely to be overstated, others understated
-overall materiality serves as a safety net
known misstatements correct answers auditors identifies specifically
likely misstatements correct answers differences in estimates between auditors and management
projections based on sampling
aggregate misstatement compared to overall materiality correct answers if LESS, the auditor can
conclude that financial statements are fairly presented
if MORE, the auditor recommends adjustments to be made to FS before a clean opinion can be
issued
audit risk model correct answers PDR = AAR/(IR*CR)
or
AAR= (IR*CR) * PDR
PDR= planned detection risk
