This preview shows page 1. Sign up to view the full content.
Unformatted text preview: ne without the use of the audit
risk model. If the audit risk model is used to determine a revised planned
detection risk, there is a danger of not increasing the evidence sufficiently. Multiple Choice Questions From CPA Examinations 9-22 a. (4) b. (4) c (1) 9-23 a. (1) b. (1) c. (1) 9-24 a. (2) b. (3) c. (1) Discussion Questions And Problems 9-25 a. b. c. d. The justification for a lower preliminary judgment about materiality
for overstatements is directly related to legal liability and audit risk.
Most auditors believe that they have a greater legal and
professional responsibility to discover overstatements of assets
than understatements because users are likely to be more critical of
overstatements. That does not imply that there is no responsibility
There are two reasons for permitting the sum of tolerable
misstatements to exceed overall materiality. First, it is unlikely that
all accounts will be misstated by the full amount of tolerable
misstatement. Second, some accounts are likely to be overstated
while others are likely to be understated, resulting in net
misstatement that is likely to be less than overall materiality.
This results because of the estimate of sampling error for each
account. For example, the likely estimate of accounts receivable is
an understatement of $16,000 + or - a sampling error. You would
be most concerned about understatement for accounts receivable
because the estimated understatement of $18,500 exceeds the
tolerable misstatement of $15,000 for that account.
You would be most concerned about understatement amounts
since the total estimated understatement amount ($32,000)
exceeds the preliminary judgment about materiality for
understatements ($31,000). You would be most concerned about
accounts receivable given that the total misstatement for that
account exceeds tolerable misstatement for understatement. 9-59 9-25 (continued)
2. 9-26 a. This may occur because total tolerable misstatement was
allowed to exceed the preliminary judgment (see Part b for
The auditor must determine whether the actual total
overstatement amount actually exceeds the preliminary
judgment by performing expanded audit tests or by requiring
the client to make an adjustment for estimated
misstatements. The direct projection of error = (misstatements/amount) sampled x
($10,000/$1,000,000) x $2,500,000 = $25,000 b.
c. 9-27 a. No, the overall financial statements are not acceptable. Including
the projected error for inventory, the total overstatement errors are
$58,000 which exceeds materiality of $50,000.
The auditor should either propose an audit adjustment so that the
unadjusted statement amount is less than materiality, and/or
perform more testing to obtain a better estimate of the population
misstatements. The additional testing will likely focus on
receivables and inventory because they have the largest estimated
The profession has not established clear-cut guidelines as to the
appropriate preliminary estimates of materiality. These are matters
of the auditor's professional judgment.
The illustrative materiality guidelines in Fig 9-2 (p. 253) are
used in applying materiality for the problem. Other guidelines may
be equally acceptable.
GUIDELINES Earnings from continuing
operations before taxes
Total assets b. 3 - 6%
3 - 6%
3 - 6%
1 - 3% DOLLAR RANGE
$38.6 - $ 25.1
- $115.8 The allocation to the individual accounts is not shown. The difficulty
of the allocation is far more important than the actual allocation.
There are several ways the allocation could be done. The most
likely way would be to allocate only on the basis of the balance
sheet rather than the income statement. Even then the allocation 9-60 could vary significantly. One way would be to allocate the same 9-61 9-27 (continued)
amount to each of the balance sheet accounts on the consolidated
statement of financial position. Using a materiality limit of
$12,500,000 before taxes (because it is the most restrictive) and
the same dollar allocation to each account excluding retained
earnings, the allocation would be approximately $595,000,000 to
each account. There are 21 account summaries included in the
statement of financial position, which is divided into $12,500,000.
An alternative is to assume an equal percentage misstatement
in each of the accounts. Doing it in that manner, total assets should
be added to total liabilities and owners' equity, less retained
earnings. The allocation would be then done on a percentage basis.
c. Auditors generally use before tax net earnings instead of after tax
net earnings to develop a preliminary judgment about materiality
given that transactions and accounts being audited within a
segment are presented in the accounting records on a pretax basis.
Auditors generally project total misstatements for a segment and
accumulate all projected total misstatements across segments on a
pretax basis and then compu...
View Full Document
This note was uploaded on 02/04/2014 for the course ACCOUNTING 211 taught by Professor Alikapur during the Fall '13 term at American University of Sharjah.
- Fall '13