Question 1

The definition of materiality indicates that both the users and auditors of financial statements are assumed to have knowledge of the likely preparers of the statements.

Accepted Answer

The definition of materiality in financial reporting refers to the significance of an amount, transaction, or discrepancy that could influence the decision-making of users of financial statements, not the knowledge of the likely preparers.

Question 2

Auditors will vary the acceptable audit risk for each segment of the audit.

Accepted Answer

The answer of Auditors will vary the acceptable audit risk...

Question 3

If an auditor believes internal controls are completely ineffective to prevent or detect misstatements, the auditor should assess control risk as high, perhaps 100%.

Accepted Answer

If the controls are considered completely ineffective, the auditor cannot rely on them and must assess control risk as high, which means the auditor believes there is a high risk of material misstatements occurring and not being detected or prevented by internal controls.

Question 4

The lower the dollar amount of the preliminary judgement of materiality, the less audit evidence is required.

Accepted Answer

The lower the dollar amount of materiality, the more audit evidence is required to ensure the accuracy of the financial statements. This is because lower materiality thresholds mean that smaller errors or misstatements can have a significant impact on the overall financial statements. Therefore, auditors must gather more evidence and perform more detailed procedures to ensure the financial statements are fairly presented.

Question 5

Risk and materiality are related; risk is a measure of uncertainty where materiality measures magnitude.

Accepted Answer

Risk and materiality are connected as they both affect the audit process. Risk refers to the potential threat of misstatement or error in the financial statements, while materiality refers to the magnitude of an error that could influence a reasonable user's decision-making. Risk and materiality are related but are not the same thing.

Question 6

If an auditor believes the client will have financial difficulties after the audit report is issued, and external users will be relying heavily on the financial statements, the auditor will probably set acceptable audit risk as high.

Accepted Answer

If the auditor believes that the client will have financial difficulties after the audit report is issued and external users will be relying heavily on the financial statements, the auditor will likely set acceptable audit risk as low to reduce the risk of issuing an incorrect or misleading audit report.

Question 7

The primary purpose of the audit risk model is to aid auditors in planning the extent of tests of controls and determining which particular controls should be tested.

Accepted Answer

The primary purpose of the audit risk model is to help auditors assess the risk of material misstatement in a financial statement audit, thereby determining the nature, timing, and extent of audit procedures.

Question 8

Australian auditing standards provide detailed, objective guidance on how auditors are to establish a preliminary materiality level, thus eliminating the need for subjective auditor judgement in this task.

Accepted Answer

While Australian auditing standards do provide guidance on establishing preliminary materiality levels, auditors are still required to exercise professional judgement in determining the appropriate level for the specific audit engagement.

Question 9

Unlike control risk and inherent risk, planned detection risk and required audit evidence will vary from cycle to cycle.

Accepted Answer

The answer of Unlike control risk and inherent risk, planned...

Question 10

Once the auditor determines the preliminary judgement about materiality for a particular engagement, that amount cannot be changed during the engagement.

Accepted Answer

The auditor may revise the preliminary judgement about materiality during the course of the engagement based on new information or changes in circumstances. However, any revisions to materiality must be documented and explained in the audit working papers.

Question 11

Acceptable audit risk and the amount of substantive evidence required are inversely related; i.e., as acceptable audit risk increases, the amount of substantive evidence the auditor plans to accumulate should decrease.

Accepted Answer

This statement is true according to generally accepted auditing standards (GAAS). As acceptable audit risk increases, the auditor is willing to tolerate a higher risk of material misstatement, which means they can reduce the amount of substantive evidence they plan to accumulate. Conversely, as acceptable audit risk decreases, the auditor needs to accumulate more substantive evidence to reduce the risk of material misstatement to an acceptable level.

Question 12

To maximise audit efficiency, the auditor should allocate less tolerable error to accounts that can be verified by using low- cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit.

Accepted Answer

This statement is true as allocating less tolerable error to accounts that can be verified by using low-cost audit procedures will result in a more efficient audit as the auditor can focus their resources and efforts on accounts that require more extensive or costly audit procedures.

Question 13

Most practitioners allocate the preliminary judgement about materiality to balance sheet, rather than income statement, accounts.

Accepted Answer

This is because balance sheet accounts generally have a longer-term impact on the financial position of a company, while income statement accounts have a more short-term impact on the profitability of a company. Therefore, materiality is typically considered more important for balance sheet accounts.

Question 14

If an auditor assigns a tolerable misstatement of $1000 to accounts payable, he or she would need to obtain more audit evidence for that account than if $100 000 had been assigned.

Accepted Answer

A tolerable misstatement of $1000 means that the auditor is willing to accept a misstatement in accounts payable up to that amount. In order to ensure that the financial statements are fairly presented, the auditor would need to obtain more audit evidence for that account to minimize the risk of exceeding the tolerable misstatement threshold. If a larger tolerable misstatement had been assigned (e.g. $100,000), the auditor may be able to obtain sufficient audit evidence with a lower level of testing as the potential impact of misstatement is much higher.

Question 15

Inherent risk and control risk normally vary for different accounts in the same audit, whereas acceptable audit risk is ordinarily held constant for each account in the same audit.

Accepted Answer

Inherent risk and control risk are account-specific and can vary based on the nature of the account and the entity's internal control. Acceptable audit risk, on the other hand, is determined at the overall financial statement level and is usually constant for each account in the same audit.

Question 16

One major limitation in the application of the audit risk model is the difficulty of measuring the components of the model.

Accepted Answer

Measuring the components of the audit risk model, such as inherent risk, control risk, and detection risk, can be subjective and challenging, which limits the accuracy and reliability of the model.

Question 17

Distinguish between tolerable misstatement and preliminary assessment of materiality. How are they related to each other?

Accepted Answer

The answer of Distinguish between tolerable misstatement and preliminary assessment...

Question 18

Auditors have difficulty applying the concept of materiality in practice because they often do not know who the users of the financial statements are or what economic decisions will be made.

Accepted Answer

Materiality is a subjective concept that depends on the size and nature of an item's impact on financial statements, and its significance to users' economic decisions. Since auditors may not know all potential users or their specific decision-making needs, applying materiality can be challenging in practice.

Question 19

When planned detection risk is high, inherent risk and control risk will also be high.

Accepted Answer

When planned detection risk is high, it means that the auditor is planning to rely more on substantive procedures (testing of transactions and balances) rather than controls, which may result in an increased risk of not detecting material misstatements. The level of inherent risk and control risk, however, is not influenced by the planned detection risk. Inherent risk is the susceptibility of a relevant assertion to a material misstatement, and control risk is the risk that a material misstatement could occur in an assertion and not be prevented, detected, and corrected by the entity's internal control. These risks are usually assessed based on the nature of the industry or business, and the control environment and processes in place, which do not change based on the planned detection risk.

Question 20

If acceptable audit risk is low, and inherent risk and control risk are both high, then planned detection risk should be high.

Accepted Answer

When acceptable audit risk is low, and both inherent risk and control risk are high, the auditor must reduce the planned detection risk to achieve an overall lower level of audit risk, meaning more substantive testing is needed, not less.

Quiz 7: Materiality and Risk