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AUDITING THEORY
AT.1809-Materiality and Risks

LECTURE NOTES
Concept of Materiality Benchmarks

The auditor is expected to design and conduct an audit Factors that may affect the identification of an appropriate
that provides reasonable assurance that material benchmark include:
misstatements will, whether due to fraud or error, be  The elements of the financial statements (e.g., assets,
detected. liabilities, equity, revenue, expenses)
 Whether there are items on which the attention of the
The auditor is required to determine materiality for the users of the particular entity’s FSs tends to be focused
financial statements as a whole when establishing the  The nature of the entity, where the entity is in its life
overall audit strategy, which is part of planning an audit. cycle, and the industry and economic environment in
which the entity operates
In financial reporting, materiality is any information that  The entity’s ownership structure and the way it is
may influence user’s economic decisions. On the other financed
hand, materiality in audit is considered in terms of the  The relative volatility of the benchmark.

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smallest aggregate level of misstatements that could be

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considered material to any one of the statements that Profit before tax from continuing operations is often used
comprise the financial statements. for profit-oriented entities.

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For any given client, materiality is not simply a function of
specific amounts in the financial statements. An auditor
Materiality for Particular Classes of Transactions,
Account Balances, or Disclosures

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must understand who the potential users are and the type
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of judgments made by those users when relying on For certain entities, there may be one or more particular
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financial statements. classes of transactions, account balances, or disclosures


for which misstatements of lesser amounts than
Application of Materiality materiality for the financial statements as a whole could
reasonably be expected to influence the economic
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Materiality is applied both in planning, performing and decisions of users taken on the basis of the financial
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concluding on the audit. In particular, when: statements.


 Identifying material classes of transactions, account
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balances and disclosures Factors that may indicate such classes of transactions,
 Determining the nature, timing and extent of risk account balances, or disclosures exist include the
assessment procedures following:
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 Identifying and assessing the risks of material  Whether law, regulation or the applicable financial
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misstatement reporting framework affect users’ expectations


 Determining the nature, timing and extent of further regarding the measurement or disclosure of certain
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audit procedures (testing of controls and performing items (e.g., related party transactions, and the
substantive procedures) remuneration of management and those charged with
 Evaluating the effect of uncorrected misstatements, if governance)
any, on the financial statements and in forming the  The key disclosures in relation to the industry in which
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opinion in our audit report. the entity operates (e.g., research and development
costs for a pharmaceutical company)
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Materiality Levels  Whether attention is focused on a particular aspect of


the entity’s business that is separately disclosed in the
The auditor establishes the following levels of materiality in financial statements (e.g., a newly acquired business).
an audit of financial statements:
a. Materiality for the financial statements as a whole Performance Materiality (a.k.a. Tolerable
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b. Materiality for particular classes of transactions, Misstatement)


account balances, or disclosures, if necessary
c. Performance materiality for (a) and (b) above Performance materiality is the amount or amounts set by
d. Clearly trivial materiality the auditor at less than materiality for the FSs as a whole
to reduce to an appropriately low level the probability that
Materiality for the Financial Statements as a whole the aggregate of uncorrected and undetected
(a.k.a. Preliminary/Planning Materiality) misstatements exceeds materiality for the FSs as a whole,
i.e., to provide a cushion, so that if misstatements are
The auditor’s determination of materiality is a matter of detected, the auditor may nevertheless be able to conclude
professional judgment, and is affected by the auditor’s with reasonable assurance that the total misstatement in
perception of the financial information needs of users of the FSs does not exceed materiality.
the financial statements. The determination of materiality
is not a mechanical exercise, if fact, there is no specific The auditor is required to determine performance
methodologies prescribed in the standard. However, a materiality for purposes of:
percentage is often applied to a chosen benchmark as a  assessing the risks of material misstatement; and
starting point to determine materiality. Qualitative  determining the nature, timing, and extent of further
conditions should also be considered in determining audit procedures.
materiality.

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If materiality level(s) have been set for particular classes Types of Risk
of transactions, account balances, or disclosures,
performance materiality also refers to amount(s) set at The four critical components of risk that will affect the
less than these levels audit approach and audit outcome are:
1. Business Risk – the risk that affects the operations and
Clearly trivial materiality potential outcomes of the entity’s organizational
activities.
Clearly trivial materiality is the amount below which 2. Financial Reporting Risk – the risk that relates to the
misstatements would be clearly trivial and would not need recording of transactions and the presentation of
to be accumulated because such amounts clearly would financial data in an entity’s financial statements.
not have a material effect on the financial statements. 3. Audit Risk/Audit Engagement Risk – the risk that the
auditor may provide an unqualified opinion on financial
When there is any uncertainty about whether one or more statements that are materially misstated.
items are clearly trivial, the matter is considered not to be 4. Other Audit Engagement Risk – the risk auditors
clearly trivial. encounter by being associated with a particular client:
loss of reputation, inability of the client to pay the
Revision of Materiality auditor, or financial loss because management is not
honest and inhibits the audit process.
Materiality levels are not cast in stone once determined.
These may be adjusted, upward or downward, as Audit Risk and The Audit Risk Model
necessary as the audit progresses for example:
 Changes in entity’s circumstances Audit risk is the risk (likelihood) that the auditor gives an
 New information inappropriate audit opinion when the FSs are materially
 Change in understanding of entity and its operations misstated. Audit risk is a function of the risks of material

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misstatement and detection risk [AR = f(ROMM x DR)].
Documentation of Materiality

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The auditor shall document the following:
 Materiality for financial statements as a whole The ROMM refers to the likelihood that the financial

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 Materiality level(s) for particular items statements are materiality misstated prior to the audit.
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 Performance materiality for the above
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 Revisions to the above as the audit progresses The ROMM may exist at two levels:
 The overall financial statement level; and
Materiality and Audit Procedures  The assertion level for classes of transactions, account
balances, and disclosures.
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The level of materiality has an inverse relationship on audit


procedures. The lower the materiality (performance ROMM at the overall FSs level refer to risks of material
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materiality), the more extensive the required audit misstatement that relate pervasively to the FSs as a whole
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procedures to be able to gain reasonable assurance that and potentially affect many assertions.
the class of transactions, account balance, or disclosure is
not materiality misstated. ROMM at the assertion level are assessed in order to
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determine the nature, timing, and extent of further audit


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Identifying Material Classes of Transactions, Account procedures (test of controls and substantive procedures)
Balances and Disclosures necessary to obtain sufficient appropriate audit evidence.
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The risks of material misstatement at the assertion level


The auditor, after determining materiality and gaining consist of two components: inherent risk and control risk.
sufficient understanding of the entity and its environment Therefore, at the assertion level, audit risk can be
including internal control, identifies material classes of expressed through this model AR = f(IR x CR x DR).
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transactions, account balances and disclosures from the


entity trial balance, list of accounts and notes to financial Inherent risk and control risk (if the auditor does not
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statements. intend to rely on the entity’s internal control, hence control


risk will be assessed as high) can be assessed through
By identifying these items, the auditor focuses the audit risks assessment procedures. Control risk can also be
only on what is deemed material, thereby reduces its work assessed by performing test of controls, i.e., if the auditor
on what is determined not to be material. intends to rely on effectiveness of the entity’s internal
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control. In this case control is may be assessed as low if


The auditor applies its professional judgment and should the control are found effective, otherwise, it would still be
consider both the account’s nature and amount, assessed as high. After assessing the levels of ROMM, the
quantitatively and qualitatively, in deciding whether an auditor determines the acceptable level of detection risk.
account is material or not. Quantitative consideration may
involve comparison of an account’s amount with the Control Risk
materiality previously determined. If an account’s amount
exceeds materiality, this may be considered material. Control risk is the risk that a misstatement that could
However, there are accounts that may not be occur in an assertion about a class of transaction, account
quantitatively material but may deemed material balance or disclosure and that could be material, either
qualitatively, such as those accounts involving accounting individually or when aggregated with other misstatements,
estimates (e.g., allowance for doubtful accounts, will not be prevented, or detected and corrected, on a
retirement obligations, etc.) or suspicious account timely basis by the entity’s internal control.
(miscellaneous accounts, related party transactions).
Control risk is a function of the effectiveness of the design,
implementation and maintenance of internal control.
However, internal control, no matter how well designed
and operated, can only reduce, but not eliminate, risks of

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material misstatement in the financial statements, because auditor does not examine the entire transactions and
of the inherent limitations of internal control. Accordingly, account balances) and human error.
some control risk will always exist.
Limitations of Audit Risk Model
Inherent risk
The audit risk model has the following limitations:
Inherent risk is the susceptibility of an assertion about a  Inherent risk is difficult to formally assess.
class of transaction, account balance or disclosure to a  Audit risk is judgmentally determined.
misstatement that could be material, either individually or  The model treats each risk component as separate and
when aggregated with other misstatements, before independent when in fact the components are not
consideration of any related controls (i.e., assuming that independent.
there were no related internal controls.)  Audit technology is not so precisely developed that
each component of the model can be accurately
Inherent risk is higher for some assertions and related assessed.
classes of transactions, account balances, and disclosures
than for others. For example, it may be higher for complex Because of these limitations, many auditors use the audit
calculations or for accounts consisting of amounts derived risk model as a functional one, rather than mathematical
from accounting estimates that are subject to significant model
estimation uncertainty. External circumstances giving rise
to business risks may also influence inherent risk. For Risks of Material Misstatements, Detection Risk and
example, technological developments might make a Audit Procedures
particular product obsolete, thereby causing inventory to
be more susceptible to overstatement. The higher the assessed level of risk of material
misstatement, the lower the detection risk the auditor

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Inherent risk and control risk are the entity’s risks; they sets, and vice versa. The lower the detection risk, the
exist independently of the audit of the financial more rigorous (nature, timing and extent) the substantive

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statements. Normally, the auditor combines the
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assessment of inherent risk and control risk known as the
environment risk or combined risk assessment.

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In summary:
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Detection Risk
Substantive Assessed level of Assessed level of
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Detection risk is the risk that the procedures performed by Audit procedures ROMM is high ROMM is low
the auditor to reduce audit risk to an acceptably low level Nature More effective Less effective
will not detect a misstatement that exists and that could Timing At year end At interim dates
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be material, either individually or when aggregated with Extent More extensive Less extensive
other misstatements.
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Audit Risk and Materiality


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For a given level of audit risk, the acceptable level of


detection risk bears an inverse relationship to the assessed There is an inverse relationship between materiality and
risks of material misstatement at the assertion level. The the level of audit risk, i.e., the higher the materiality, the
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higher the assessed level of risk of material misstatement, lower the audit risk, and vice versa. The auditor takes the
inverse relationship between materiality and audit risk into
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the lower the detection risk the auditor sets, and vice
versa. account when determining the nature, timing and extent of
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audit procedures.
Detection risk relates to the nature, timing, and extent of
the auditor’s procedures that are determined by the Materiality and Audit Evidence
auditor to reduce audit risk to an acceptably low level. It is
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therefore a function of the effectiveness of an audit Materiality and audit evidence are inversely related. The
procedure and of its application by the auditor. lower the level of materiality the auditor determines, the
more audit evidence must be obtained (and vice versa) in
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Therefore, from the given relationship above, detection order to gain more confidence (assurance) that the item is
risk cannot be set to zero (given that there is always risk not materiality misstated.
of material misstatement). This is also because of many
factors in audit such as sampling risk (remember, the - done -
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MULTIPLE CHOICE
Concept and Application of Materiality 2. In considering materiality for planning purposes, an
1. In audit of financial statements, it is considered in auditor believes that misstatements aggregating
terms of the smallest aggregate level of misstatements P100,000 would have a material effect on an entity’s
that could be considered material to any one of the income statement, but that misstatements would have
statements that comprise the financial statements, to aggregate P200,000 to materially affect the balance
while in financial reporting, it provides a threshold or sheet. Ordinarily, it would be appropriate to design
cutoff point rather than being a primary qualitative auditing procedures that would be expected to detect
characteristic which information must have if it is to be misstatements that aggregate
useful a. P100,000
a. Materiality b. P150,000
b. Reliability c. P200,000
c. Relevance d. P300,000
d. Misstatement

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3. The preliminary judgment about materiality is the may tend to focus on profit, revenue or net
_________ amount by which the auditor believes the assets);
statements could be misstated and still not affect the c. The nature of the entity, where the entity is at in
decisions of reasonable users. its life cycle, and the industry and economic
a. Minimum environment in which the entity operates;
b. Maximum d. All of the above
c. Mean average
d. Median average 9. Which of the following would an auditor most likely use
in determining the auditor’s preliminary judgment
4. Auditors are _____ to decide on the combined amount about materiality?
of misstatements in the financial statements that they a. The anticipated sample size of the planned
would consider material early in the audit. substantive tests
a. Permitted b. The entity’s annual financial statements
b. Required c. The results of the internal control questionnaire
c. Not allowed d. The contents of the management representation
d. Strongly encouraged letter
5. Financial reporting frameworks often discuss the 10. Which of the following is least likely to be appropriate
concept of materiality in the context of the preparation as the basis for determining the preliminary judgment
and presentation of financial statements. Although about materiality in the audit of financial statements?
financial reporting frameworks may discuss materiality a. Net income before taxes
in different terms, they generally explain that b. Current assets
a. Misstatements, including omissions, are considered c. Owners’ equity
to be material if they, individually or in the d. Inventory
aggregate, could reasonably be expected to

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influence the economic decisions of users taken on 11. Why do auditors establish a preliminary judgment
the basis of the financial statements about materiality?

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b. Judgments about materiality are made in the light
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of surrounding circumstances, and are affected by experience required for the work.
the size or nature of a misstatement, or a b. So that the client can know what records to make

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combination of both available to the auditor.
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c. Judgments about matters that are material to c. To plan the appropriate audit evidence to
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users of the financial statements are based on a accumulate and develop an overall audit
consideration of the common financial information strategy.
needs of users as a group. The possible effect of d. To finalize the assessment of control risk.
misstatements on specific individual users, whose
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Performance Materiality/Tolerable Misstatement


needs may vary widely, is not considered.
12. Materiality should be considered by the auditor when
d. All of the above
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a. Determining the nature, timing and extent of


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6. Only the amount of misstatements need to be auditor’s further procedures


considered in assessing materiality. b. Identifying and assessing the risks of material
misstatements
Both the amount and nature of misstatements need to
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c. Both a and b
be considered in assessing materiality.
d. Neither a nor b
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a. True, True c. False, False


b. False, True d. True, False 13. When auditors allocate the preliminary judgment about
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materiality to account balances, the materiality


FSs Level Materiality
allocated to any given account balance is referred to
7. Which of the following is not true about materiality
as:
judgment?
a. The materiality range
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a. The auditor’s consideration of materiality is


b. The error range
influenced by the auditor’s perception of the needs
c. Tolerable materiality
(importance) of users of financial statements.
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d. Tolerable misstatement
b. The auditor considers materiality only in relation to
classes of transactions, account balances, and 14. Auditors commonly allocate materiality to balance
disclosures. sheet accounts rather than income statement accounts
c. Materiality judgments make sure that the auditor because most income statement misstatements have
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gathers sufficient evidential matter to obtain a(n) _____ effect on the balance sheet.
reasonable assurance about whether the financial a. Reduced
statements are free of material misstatement. b. Equal
d. Materiality decisions differ from one audit client to c. Undetermined
another. d. Increased
8. Determining a materiality level for the financial Revision and Documentation of Materiality
statements as a whole requires the exercise of 15. The materiality level for the financial statements as a
professional judgment. A percentage is often applied to whole (or the materiality level for a particular class of
a chosen benchmark as a starting point in that transactions, account balance or disclosure, if
determination. Factors that may affect the applicable) may need to be revised (adjusted either
identification of an appropriate benchmark include the downward or upward) as a result of the following
following: a. a change in circumstances that occurred during the
a. The elements of the financial statements (e.g., audit
assets, liabilities, equity, income, expenses) b. new information
b. Whether there are items on which the attention of c. a change in the auditor’s understanding of the
the users of the particular entity’s financial entity and its operations as a result of performing
statements tends to be focused (e.g., for the further audit procedures.
purpose of evaluating financial performance users
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d. all of the above c. Detection risk.


d. Both A and C.
16. Under which of the following conditions would you
consider lowering individual item materiality 23. Which of the following statements is not true regarding
thresholds. audit risk assessment?
a. Study of the business and industry, together with a. The auditor studies the business and industry and
the application of analytical procedures, reveals applies analytical procedures as a basis for
that the client has enjoyed a surge in sales and assessing inherent risk.
gross profit during an industry downturn. b. When control risk and inherent risk are high, the
b. Application of analytical procedures shows that the auditor increases detection risk to maintain overall
client's gross profit rate is significantly below last audit risk at the desired level.
year and also is materially lower than the industry c. The auditor studies and evaluates internal control
average. policies and procedures for assessing control risk.
c. Study of internal controls within the revenue cycle d. The auditor designs substantive audit procedures
reveal material weaknesses. to reduce detection risk to an acceptable level.
d. Study of internal controls within the payroll cycle
24. Which of the following audit risk components may be
confirm the auditor's belief that few errors have
assessed in nonquantitative terms?
occurred.
Control risk Detection risk Inherent risk
17. Auditing standards _____ that the basis used to a. Yes Yes Yes
determine the preliminary judgment about materiality b. No Yes Yes
be documented in the audit files. c. Yes Yes No
a. Permit d. Yes No Yes
b. Do not allow
25. Assume that control risk = 0.70, inherent risk = 0.80,
c. Require

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and audit risk = 0.05. If a material misstatement

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d. Strongly encourage
occurred and was not corrected by the auditee’s

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Relationships to Materiality internal controls, what is the risk that the

materiality, then the auditor will:


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18. If an auditor establishes a relatively high level for misstatement would not be detected by the audit
procedures?

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a. accumulate more evidence than if a lower level had a. 0.02
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been set. b. 0.07
b. accumulate less evidence than if a lower level had c. 0.09
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been set. d. 0.50


c. accumulate approximately the same evidence as
26. Which of the following best describes the relationship
would be the case were materiality lower.
between IR, CR, and DR?
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d. accumulate an undetermined amount of evidence.


a. DR does not vary from one assertion to another.
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19. Which of the following statements concerning b. IR, CR, and DR vary from assertion to assertion.
materiality thresholds is incorrect? c. IR and CR do not vary from assertion to assertion,
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a. Aggregate materiality thresholds are a function of but DR does vary from assertion to assertion.
the auditor's preliminary judgments concerning d. When IR increases, DR decreases.
audit risk.
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27. Which of the following statements is not true?


b. In general, the more misstatements the auditor
a. Inherent risk is inversely related to detection risk.
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expects, the higher should be the aggregate


b. Inherent risk is inversely related to evidence.
materiality threshold.
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c. Inherent risk is the susceptibility of the financial


c. The smallest aggregate level of errors or fraud that
statements to material error, assuming no internal
could be considered material to any one of the
controls.
financial statements is referred to as a "materiality
d. Inherent risk is the auditor’s assessment of the
threshold."
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likelihood that errors exceeding a tolerable amount


d. Materiality thresholds may change between the
exist in a segment before considering the
planning and review stages of the audit. These
effectiveness of internal controls.
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changes may be due to quantitative and/or


qualitative factors. 28. Inherent risk is often low for an account such as:
a. inventory.
20. Why should the auditor plan more work on individual
b. marketable securities.
accounts as lower acceptable levels of both audit risk
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c. cash.
and materiality are established?
d. accounts receivable.
a. To find smaller errors.
b. To find larger errors. 29. Audit risk consists of inherent risk, control risk, and
c. To increase the tolerable error in the accounts. detection risk. Which of the following statements is
d. To decrease the risk of overreliance. true?
a. Cash is more susceptible to theft than an inventory
Risks of coal because it has a greater inherent risk.
21. In the audit risk model, which of the risk components b. The risk that material misstatement will not be
can be assessed by the auditor? prevented or detected on a timely basis by internal
a. Inherent risk. control can be reduced to zero by effective
b. Control risk. controls.
c. Detection risk. c. Detection risk is a function of the efficiency of an
d. Both A and B. auditing procedure.
d. The existing levels of inherent risk, control risk,
22. In the audit risk model, its risk components are either
and detection risk can be changed at the discretion
determined, assessed, or manipulated. Which of the
of the auditor.
following risks are controllable by the auditor?
a. Audit risk. 30. Inherent risk and control risk differ from detection risk
b. Control risk. in that inherent risk and control risk
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a. arise from the misapplication of auditing internal control systems.


procedures c. The risk that an auditor's substantive procedures
b. may be assessed in either quantitative or will not detect a misstatement that exists in an
nonquantitative terms account balance or class of transactions that could
c. exist independently of the financial statement audit be material, individually or when aggregated with
d. can be changed at the auditor’s discretion misstatements in other balances or classes.
d. The susceptibility of an account balance or class of
31. Which of the following is an incorrect statement?
transactions to misstatement that could be
a. Detection risk cannot be changed at the auditor’s
material, individually or when aggregated with
discretion
misstatements in other balances of classes,
b. Detection risk bears an inverse relationship to
assuming that there were no related internal
inherent and control risks
controls.
c. The greater the inherent and control risks the
auditor believes exists, the less detection risk that 34. Which is a primary limitation of the audit risk model?
can be accepted a. The audit risk model does not adequately consider
d. The auditor might separate or combined external forces on the client organization.
assessments of inherent risk and control risk b. Components of audit risk are treated as
independent variables even though many
32. When discussing control risk (CR) and the audit risk
interdependencies exist between them.
model, which of the following is false?
c. The audit technology achieves approximate
a. CR is a measure of the auditor’s assessment of the
precision outside of a mathematical model.
likelihood that misstatements will not be prevented
d. Control risk must be adjusted at the hands of the
or detected by internal control.
auditor, not by an arbitrary estimation.
b. If the auditor concludes that internal control is
completely ineffective to prevent or detect errors, 35. Which of the following statements is true with regard

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he/she would assign a low value (e.g., 0%) to CR. to the relationship among audit risk, audit evidence,
c. The relationship between control risk and detection and materiality?

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risk is inverse. eH w a. The lower the inherent risk and control risk, the
d. The relationship between control risk and evidence lower the aggregate materiality threshold.
needed to support account balances is direct. b. Under conditions of high inherent and control risk,

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the auditor should place more emphasis on
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33. Detection risk is
obtaining external evidence and should reduce
a. The risk that the auditor gives an inappropriate
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reliance on internal evidence.


audit opinion when the financial statements are
c. Where inherent risk is high and control risk is low,
materially misstated.
the auditor may safely ignore inherent risk.
b. The risk that a misstatement, that could occur in
d. Aggregate materiality thresholds should not
an account balance or class of transactions and
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change under conditions of changing risk levels.


that could be material individually or when
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aggregated with misstatements in other balances


- now do the DIY drill -
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or classes, will not be prevented or detected and


corrected on a timely basis by the accounting and
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DO-IT-YOURSELF (DIY) DRILL


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1. The probability of an auditor's procedures leading to detailed review


the conclusion that a material error does not exist in
4. Materiality is:
an account balance when, in fact, such error does exist
a. Addressed within a practitioner’s audit and other
is referred to as
assurance reports
a. Prevention risk.
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b. Expressed only in terms of pesos


b. Inherent risk.
c. Measured using guidelines established by PICPA
c. Control risk.
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d. Not applicable to assurance engagements


d. Detection risk.
5. Materiality thresholds for accounting errors should be
2. When discussing control risk (CR) and the audit risk established for each financial statement element.
model, which of the following is false? However, they
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a. CR is a measure of the auditor’s assessment of the a. Must require correction of accounting errors in the
likelihood that misstatements will not be prevented subsequent year’s records.
or detected by internal control. b. Lead to rejection of financial statements found with
b. If the auditor concludes that internal control is unrecorded accounting records.
completely ineffective to prevent or detect errors, c. Tend to hamper objectivity of auditor’s judgment
he/she would assign a low value (e.g., 0%) to CR. concerning severity of errors.
c. The relationship between control risk and detection d. Must be established prior to execution of audit
risk is inverse. procedures.
d. The relationship between control risk and evidence
needed to support account balances is direct. 6. Since materiality is relative, it is necessary to have
bases for establishing whether misstatements are
3. Materiality is least important to an external auditor in material. Normally, the most common base for
determining the: deciding materiality is:
a. Effect on independence of his direct financial a. Net income before taxes
interest in the client b. Net working capital
b. Extent of his audit of certain accounts c. Net income after taxes
c. Effects of exceptions upon his opinion in the audit d. Total assets
report
d. Specific transactions which should require a

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7. Which of the following elements of the audit risk model a. Balance sheet only.
is most likely to be the same across a range of audits b. Income statement only.
performed by a professional accounting firm? c. Income statement and balance sheet.
a. Audit risk d. Statement of cash flows.
b. Control risk
c. Detection risk 15. Engagement risk has been defined as the risk of
d. Inherent risk potential losses that are incurred by the auditor in
being associated with a particular client. Which of the
8. Which of the following statements is not correct?
following factors are not associated with increased
a. Materiality is a relative rather than an absolute
engagement risk for the auditor?
concept.
a. Management with questionable integrity.
b. The most important base used as the criterion for
b. A failed company.
deciding materiality is total assets.
c. Materially misstated financial statements.
c. Qualitative factors as well as quantitative factors
d. All of these factors increase engagement risk.
affect materiality.
d. Given equal amounts, frauds are usually 16. In implementing the audit risk model, which of the
considered more important than errors. following is not a limitation of the model that makes its
implementation difficult?
9. The preliminary judgment about materiality and the
a. Inherent risk is difficult to formally assess.
amount of audit evidence accumulated are _____
b. Audit risk is objectively determined.
related.
c. The model treats each risk component as separate
a. Directly
and independent.
b. Indirectly
d. Audit technology is not precisely developed in
c. Not
assessing each component.
d. Inversely

m
er as
17. Residual risk is defined as
10. Which of the following statements is correct concerning
a. susceptibility of a transaction or accounting

co
the concept of materiality?
eH w adjustment to be recorded in error, or for the
a. Materiality is determined by reference to PICPA
transaction not to be recorded in the absence of
guidelines
internal controls.

o.
b. Materiality depends only on the peso amounts of
b. the risk that the client’s internal controls system
rs e
an item relative to other items in the financial
will fail to prevent or detect a misstatement.
statements
ou urc

c. the risk left in an account balance after application


c. Materiality depends on the nature of an item rather
of internal controls.
than the peso amount
d. risk that the audit procedures will fail to detect a
d. Materiality is a matter of professional judgment
material misstatement.
o

11. In determining audit risk, the auditor decides how


18. Madison Corporation has a few large accounts
aC s

much risk will be taken on by the firm. Which of the


receivable that total P1,000,000. Nass Corporation
following is correct regarding this decision by the
vi re

has a greater number of small accounts receivable that


auditor?
also total P1,000,000. The importance of an error in
a. The auditor may decide to intentionally render an
any one account is, therefore, greater for Madison than
inappropriate opinion.
y

for Nass. This is an example of the auditor’s concept


b. The auditor may decide not to take the audit
of
ed d

engagement.
a. Materiality
c. The auditor may decide to accept audit risk at
ar stu

b. Comparative analysis
100%.
c. Relative risk
d. The auditor may decide that engagement risk is an
d. Reasonable assurance
appropriate measure of audit risk.
19. Regardless of how the preliminary judgment about
is

12. Auditors frequently refer to the terms audit assurance,


overall assurance, and level of assurance to refer to materiality is allocated, the auditor must be confident
________. that total combined misstatements in all accounts are:
Th

a. detection risk a. Less than the preliminary judgment.


b. audit report risk b. Equal to the preliminary judgment.
c. acceptable audit risk c. More than the preliminary judgment.
d. inherent risk d. Less than or equal to the preliminary judgment.
sh

13. Inherent risk is _______ related to detection risk and 20. What is the primary difference between financial
_______ related to the amount of audit evidence. reporting risk and audit risk?
a. directly, inversely a. The application of accounting principles.
b. directly, directly b. Responsibilities of the respective parties involved.
c. inversely, inversely c. Demands of users of financial statements.
d. inversely, directly d. Risks of being sued by third parties.
14. Auditors generally allocate the preliminary judgment
about materiality to the:  - end of AT.1809 - 

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