9 58 9 21 the auditor should revise the components of

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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 for understatements. 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) e. 1. 2. 9-26 a. This may occur because total tolerable misstatement was allowed to exceed the preliminary judgment (see Part b for explanation). 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 population value. ($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 misstatements. 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. STATEMENT COMPONENT PERCENT GUIDELINES Earnings from continuing operations before taxes Current assets Current liabilities Total assets b. 3 - 6% 3 - 6% 3 - 6% 1 - 3% DOLLAR RANGE (IN MILLIONS) $12.5 $67.6 $36.5 $38.6 - $ 25.1 - $135.2 - $72.9 - $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...
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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.

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