The allocation would be then done on a percentage

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Unformatted text preview: te the tax effect on an aggregate basis to determine the effects on after tax net earnings. d. By allocating 75% of the preliminary estimate to accounts receivable, inventories, and accounts payable, there is far less materiality to be allocated to all other accounts. Given the total dollar value of those accounts, that may be a reasonable allocation. The effect of such an allocation would be that the auditor might be able to accumulate sufficient competent evidence with less total effort than would be necessary under part b. Under part b, it would likely be necessary to audit, on a 100% basis, accounts receivable, inventories, and accounts payable. On most audits it would be expensive to do that much testing in those three accounts. It would likely be necessary to audit accounts such as cash and temporary investments on a 100% basis. That would not be costly on most audits because the effort to do so would be small compared to the cost of auditing receivables, inventories, and accounts payable. e. It is necessary for you to be satisfied that the actual estimate of misstatements is less than the preliminary judgment about materiality for all of the bases. First you would reevaluate the preliminary judgment for earnings. Assuming no change is considered appropriate, you would likely require an adjusting entry or an expansion of certain audit tests. 9-62 9-28 a. The following terms are audit planning decisions requiring professional judgment: Preliminary judgment about materiality Acceptable audit risk Tolerable misstatement Inherent risk Risk of fraud Control risk Planned detection risk b. The following terms are audit conclusions resulting from application of audit procedures and requiring professional judgment: Estimate of the combined misstatements Estimated total misstatement in a segment c. It is acceptable to change any of the factors affecting audit planning decisions at any time in the audit if indicated by changes in circumstances. The planning process begins before the audit starts and continues throughout the engagement. 9-29 Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. a. True. A CPA firm should attempt to use reasonable uniformity from audit to audit when circumstances are similar. The only reasons for having a different audit risk in these circumstances are the lack of consistency within the firm, different audit risk preferences for different auditors, and difficulties of measuring audit risk. b. True. Users who rely heavily upon the financial statements need more reliable information than those who do not place heavy reliance on the financial statements. To protect those users, the auditor needs to be reasonably assured that the financial statements are fairly stated. That is equivalent to stating that acceptable audit risk is lower. Consistent with that conclusion, the auditor is also likely to face greatest legal exposure in situations where external users rely heavily upon the statements. Therefore, the auditor should be more certain that the financial statements are correctly stated. c. True. The reasoning for c is essentially the same as for b. d. True. The audit opinion issued by different auditors conveys the same meaning regardless of who signs the report. Users cannot be expected to evaluate whether different auditors take different risk levels. Therefore, for a given set of circumstances, every CPA firm should attempt to obtain approximately the same audit risk. 9-63 9-30 a. 1. 2. The auditor may set inherent risk at 100% because of lack of prior year information. If the auditor believes there is a reasonable chance of a material misstatement, 100% inherent risk is appropriate. Similarly, because the auditor does not plan to test internal controls due to the ineffectiveness of internal controls, a 100% risk is appropriate for control risk. Acceptable audit risk and planned detection risk will be identical. Using the formula: PDR = AAR / (IR x CR), if IR and CR equal 1, then PDR = AAR. 3. b. If planned detection risk is lower, the auditor must accumulate more audit evidence than if planned detection risk is higher. The reason is that the auditor is willing to take only a small risk that substantive audit tests will fail to uncover existing misstatements in the financial statements. 1. Using the formula in a., planned detection risk is equal to 20% [PDR = .05 / (.5 x .5) = .2]. Less evidence accumulation is necessary in b-1 than if planned detection risk were smaller. Comparing b-1 to a-2 for an acceptable audit risk of 5%, considerably less evidence would be required for b-1 than for a-2. 2. c. 1. 2. 3. The auditor might set acceptable audit risk high because Redwood City is in relatively good financial condition and there are few users of financial statements. It is common in municipal audits for the only major users of the financial statements to be state agencie...
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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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