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the level for each cycle must be no more than 2% so that the entire audit does not exceed
b Which of the following statements is not true?
a. Inherent risk is inversely related to detection risk.
b. Inherent risk is inversely related to evidence.
c. Inherent risk is the susceptibility of the financial statements to material error, assuming no
d. Inherent risk is the auditor’s assessment of the likelihood that errors exceeding a tolerable
amount exist in a segment before considering the effectiveness of internal controls. 55.
c Which of the following is not a primary consideration when assessing inherent risk?
a. Nature of client’s business.
b. Existence of related parties.
c. Frequency and intensity of management’s review of accounting transactions and records.
d. Susceptibility to defalcation. 56.
c Which of the following is an example of the concept of inherent risk?
a. Humans make more errors than computers; therefore, a manual accounting system is
riskier than a computerized system.
b. Accounting systems with vouchers have many more controls built in, so the risk that there
will be errors on the financial statements is reduced.
c. Loans receivable for a finance company are less likely to be collectible than those of a
d. Audits with larger sample sizes are less risky than those with smaller sample sizes. 1-167 57.
d Tolerable misstatement as set by the auditor:
a. decreases acceptable audit risk.
b. increases inherent risk and control risk.
c. affects planned detection risk.
d. does not affect any of the four risks. 58.
a Which of the following underlies the application of generally accepted auditing standards,
particularly the standards of fieldwork and reporting?
a. The elements of materiality and relative risk.
b. The element of internal control.
c. The element of corroborating evidence.
d. The element of reasonable assurance. Essay Questions
medium Discuss the three main factors that affect an auditor’s preliminary judgment about materiality.
The three main factors that affect an auditor’s judgment about materiality are:
• Materiality is a relative rather than an absolute concept . A misstatement of a given
size might be material for a small company, whereas the same dollar misstatement
could be immaterial for a larger one.
• Bases are needed for evaluating materiality. Since materiality is relative, it is
necessary to have bases for establishing whether misstatements are material. Net
income before taxes is normally the most commonly used base, but other possible
bases include current assets, total assets, current liabilities, and owners’ equity.
• Qualitative factors also affect materiality. Certain types of misstatements are likely to
be more important to users than others, even if the dollar amounts are the same, such
as misstatements involving frauds. 1-168 60.
medium Due to qualitative factors, certain types of misstatements are likely to be more important to
users than others, even if the dollar amounts are the same. Identify two qualitative factors that
might significantly affect an auditor’s materiality judgment, and give an example of each.
Qualitative factors that affect an auditor’s materiality judgment include:
• Amounts involving fraud. Amounts involving fraud are usually considered more
important than unintentional errors of equal dollar amounts because fraud reflects on
the honesty and reliability of the management or other personnel involved. For
example, an intentional misstatement of inventory would be more important to users
than a clerical error in inventory of the same amount.
• Misstatements affecting contractual obligations. Misstatements that are otherwise
minor may be material if there are possible consequences arising from contractual
obligations. For example, if a misstatement causes a required minimum account
balance to exceed the minimum, when the correct balance is less than the minimum,
this misstatement likely would be important to users.
• Profit vs. loss. Misstatements that cause a loss to be reported as a profit or
misstatements that affect trends in earnings are likely to be important to users. 61.
medium Explain why it is necessary to allocate the preliminary judgment about materiality to individual
accounts (segments) in the financial statements. Also explain why allocating to balance sheet
accounts is more common than allocating to income statement accounts.
Answer: Allocating the preliminary judgment about materiality to
individual accounts is necessary because evidence
is accumulated for accounts rather than for the
financial statements as a whole. Allocating to
accounts establishes a tolerable misstatement
amount for each account, which helps the auditor
decide the appropriate audit evidence to accumulate
for each account. Most practitioners allocate
materiality to balance sheet accounts rather than
income statement accounts because there are fewer
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- Fall '13