Assume that you define materiality for this audit as a combined misstatement of earnings from continuing operations before income taxes of 5%. Also assume that you believe there is an equal likelihood of a misstatement of every account in the financial statements, and each misstatement is likely to result in an overstatement of earnings. Allocate materiality to these financial statements as you consider appropriate. As discussed in part b, net earnings from continuing operations before income taxes was used as a base for calculating materiality for the Wexler Industries audit. Discuss why most auditors use before-tax net earnings instead of after-tax net earnings when calculating materiality based on the income statement. Now, assume that you have decided to allocate 75% of your preliminary judgment to accounts receivable, inventories, and accounts payable because you believe all other accounts have a low inherent and control risk. How does this affect evidence accumu- lation on the audit? Assume that you complete the audit and conclude that your preliminary judgment about materiality for current assets, current liabilities, and total assets has been met. The actual estimate of misstatements in earnings exceeds your preliminary judgment. What should you do?
9-28 (Objectives 9-2, 9-3, 9-4, 9-6, 9-7, 9-8, 9-10) The following are concepts discussed in this chapter: Preliminary judgment about materiality 2. Control risk Risk of fraud Estimated total misstatement in a segment 5. Planned detection risk Estimate of the combined misstatement 7. Acceptable audit risk Tolerable misstatement Inherent risk Risk of material misstatement 11. Known misstatement March 30, 2011 March 31, 2010 $ 280,238 64,594 359,511 112,200 76,479 321,871
$ 113,411 12,336 380,395 63,557 89,151 _________ 269,672 1,214,893 730,987 146,687 142,344 51,018 149,177 (76,572) 1,554,170 928,522 390,687 80,586 119,715 50,992 148,584 — 1,462,723 (51,967)
(51,967) _________ _________ 1,625,826 1,610,332 _________ _________ $3,860,737 $3,129,842 _________ _________ _________ 280
a. Identify which items are audit planning decisions requiring professional judgment. Identify which items are audit conclusions resulting from application of audit pro- cedures and requiring professional judgment. Under what circumstances is it acceptable to change those items in part a after the audit is started? Which items can be changed after the audit is 95% completed? 9-29 (Objectives 9-6, 9-7) Describe what is meant by acceptable audit risk. Explain why each of the following statements is true: A CPA firm should attempt to achieve the same audit risk for all audit clients when circumstances are similar. A CPA firm should decrease acceptable audit risk for audit clients when external users rely heavily on the statements. A CPA firm should decrease acceptable audit risk for audit clients when there is a reasonably high likelihood of a client filing bankruptcy. Different CPA firms should attempt to achieve reasonably similar audit risks for clients with similar circumstances.
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