Excel Professional Services, Inc.

Management Firm of Professional Review and Training Center (PRTC)

(LUZON) Manila 87339344 * Calamba City, Laguna * Dasmariñas City, Cavite * Lipa City,

Batangas (0917) 8852769 * (VISAYAS) Bacolod City (034) 4346214 * Cebu City (032)

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AUDITING THEORY
AT.300 7 – Considering Materiality R.C.P. SOLIMAN/ K.J. UY
and Audit Risk MAY 2021

Reference:
a. PSA 315 (Redrafted), Identifying and Assessing the Risks of Material Misstatement Through Understanding the
Entity and its Environment
b. PSA 320 (Revised and Redrafted), Materiality in Planning and Performing an Audit
c. PSA 450 (Revised and Redrafted), Evaluation of Misstatements Identified During the Audit

DISCUSSION QUESTIONS
Concept of Materiality
1. Which of the following is incorrect regarding the
concept of materiality of financial information?
a. Misstatements, including omissions, are
considered to be material if they, individually
or in the aggregate, could reasonably be
expected to influence the economic decisions of
users taken on the basis of the financial
statements.
b. Judgments about materiality are made in the
light of surrounding circumstances, and are
affected by the size (amount or quantitative) or
nature (qualitative) of a misstatement, or a
combination of both.
c. Judgments about matters that are material to
users of the financial statements are based on
a consideration of the common financial
information needs of users as a group. The
possible effect of misstatements on specific
individual users, whose needs may vary widely,
is not considered.
d. The determination of materiality is mechanical,
mathematical and straightforward in nature.
2. Materiality is a matter of professional judgment
influenced by the needs of
a. Management of the entity.
b. Users of the financial statements.
c. Auditor of the financial statements.
d. Regulatory bodies.
3. Which one of the following statements is correct
concerning the concept of materiality?
a. Materiality is determined by references to
guidelines established by the AASC.
b. Materiality depends only on the dollar amount
of an item relative to other items in the
financial statements.
c. Materiality depends on the nature of an item
rather than the dollar amount.
d. Materiality is a matter of professional
judgment.
4. The auditors must consider materiality in planning
an audit engagement. Materiality for planning
purposes is:
a. The auditors' preliminary estimate of the largest
amount of misstatement that would be material to any
one of the client's financial statements.
b. The auditors' preliminary estimate of the smallest
amount of misstatement that would be material to any
one of the client's financial statements.
c. The auditors' preliminary estimate of the amount of
misstatement that would be material to the client's
balance sheet.
d. An amount that cannot be quantitatively stated since
it depends on the nature of the item.
5. In considering materiality for planning purposes, an
auditor believes that misstatements aggregating P100,000
would have a material effect on an entity’s income
statement, but that misstatements would have to
aggregate P200,000 to materially affect the balance
sheet. Ordinarily, it would be appropriate to design
auditing procedures that would be expected to detect
misstatements that aggregate
a. P100,000 c. P200,000
b. P150,000 d. P300,000
6. The preliminary judgment about materiality is the
_________ amount by which the auditor believes the
statements could be misstated and still not affect the
decisions of reasonable users.
a. Minimum c. Mean average
b. Maximum d. Median average
Materiality and The Auditor's Overall Objectives
7. The auditor has responsibility to plan and perform the
audit to obtain reasonable assurance that misstatements,
whether caused by errors or fraud, that are ________ are
detected.
a. important to the financial statements
b. statistically significant to the financial statements
c. material to the financial statements
d. identified by the client
8. Materiality is:
a. Addressed within a practitioner’s audit and other
assurance reports
b. Expressed only in terms of pesos
c. Measured using guidelines established by PICPA
d. Not applicable to assurance engagements

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EXCEL PROFESSIONAL SERVICES, INC.
9. Auditors are _____ to decide on the combined
amount of misstatements in the financial
statements that they would consider material early
in the audit.
a. Permitted c. Not allowed
b. Strongly encouraged d. Required
Application of Materiality
10. The concept of materiality is applied in which of
the following areas of audit of financial
statements?
a. b. c. d.
Planning the audit Yes Yes Yes Yes
Designing risk assessment Yes Yes Yes No
procedures
Designing further auditor
procedures Yes Yes Yes Yes
Designing additional Yes No No Yes
procedures
Evaluating the results of
procedures Yes Yes No No
Forming opinion on the
fairness of financial Yes Yes Yes Yes
statements
11. Materiality is least important to an external auditor
in determining the:
a. Extent of his audit of certain accounts
b. Effects of exceptions upon his opinion in the
audit report
c. Specific transactions which should require a
detailed review
d. Effect on independence of his direct financial
interest in the client
Materiality vs. Audit Procedures, Audit Evidence, and
Audit
Risk
12. If an auditor establishes a relatively high level for
materiality, then the auditor will:
a. accumulate more evidence than if a lower level
had been set.
b. accumulate less evidence than if a lower level
had been set.
c. accumulate approximately the same evidence
as would be the case were materiality lower.
d. accumulate an undetermined amount of
evidence.
13. Materiality and audit risk are inversely related.
Why should the auditor plan more work on
individual accounts as lower acceptable levels of
both audit risk and materiality are established?
a. To find smaller errors.
b. To find larger errors.
c. To increase the tolerable error in the accounts.
d. To decrease the risk of overreliance.
14. Which of the following statements is true with
regard to the relationship among audit risk, audit
evidence, and materiality?
a. The lower the inherent risk and control risk,
the lower the aggregate materiality threshold.
b. Under conditions of high inherent and control
risk, the auditor should place more emphasis
on obtaining external evidence and should
reduce reliance on internal evidence.
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c. Where inherent risk is high and control risk is low, the
auditor may safely ignore inherent risk.
d. Aggregate materiality thresholds should not change
under conditions of changing risk levels.
15. Which of the following statements concerning materiality
thresholds is incorrect?
a. Aggregate materiality thresholds are a function of the
auditor's preliminary judgment concerning audit risk.
b. In general, the more misstatements the auditor
expects, the higher should be the aggregate
materiality threshold.
c. The smallest aggregate level of errors or fraud that
could be considered material to any of the financial
statements is referred to as a "materiality threshold."
d. Materiality thresholds may change between the
planning and review stages of the audit. These
changes may be due to quantitative and/or qualitative
factors.
Establishing Materiality Levels
16. Audit risk and materiality are considered at the level of
a. Overall financial statements.
b. Assertions relating to individual account balance, class
of transactions, or disclosure.
c. Both a and b.
d. Neither a nor b.
Financial Statements Level Materiality
17. In determining a materiality level for the financial
statements as a whole, a percentage is often applied to a
chosen benchmark as a starting point in that
determination. Which of the following factors may affect
the identification of an appropriate benchmark?
a. The elements of the financial statements (e.g., assets,
liabilities, equity, income, expenses).
b. Whether there are items on which the attention of the
users of the particular entity’s financial statements
tends to be focused (e.g., for the purpose of
evaluating financial performance users may tend to
focus on profit, revenue or net assets).
c. The nature of the entity, where the entity is at in its
life cycle, and the industry and economic environment
in which the entity operates.
d. All of the above.
18. In determining a materiality level for the financial
statements as a whole, a percentage is often applied to a
chosen benchmark as a starting point in that
determination. Which of the following factors may affect
the identification of an appropriate benchmark? a. Entity’s
ownership structure and financing.
b. Volatility of the benchmark.
c. The need to normalize the benchmark.
d. All of the above.
19. In determining a materiality level for the financial
statements as a whole, a chosen benchmark may need
adjustments to be relevant. Adjustments may include a.
Removing unusual items.
b. Using a simple average of two or more periods.
c. Using another method to estimate the amount.
d. All of the above.
20. Which of the following would an auditor most likely use in
determining the auditor’s preliminary judgment about
materiality?
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EXCEL PROFESSIONAL SERVICES, INC.

a. The anticipated sample size of the planned 26. Having set the level of materiality for the financial
substantive tests. statements as a whole, the auditor now turns his attention
b. The entity’s annualized interim (i.e., quarterly) to determining performance materiality. Which of the
financial statements. following statements about performance materiality is
c. The results of the internal control NOT true?
questionnaire. a. Performance materiality is used to reduce the risk that
d. The contents of the management the aggregate of uncorrected and undetected
representation letter. misstatements exceeds materiality for the financial
statements as a whole to an acceptable level
21. Which of the following is least likely to be b. Performance materiality refers to the amounts set by
appropriate as the basis for determining the the auditor at higher than the materiality level for
preliminary judgment about materiality in the audit particular classes of transactions, account balances or
of financial statements? disclosures where the materiality level might
a. Net income before taxes c. Owners’ otherwise mean that such items are not tested.
equity c. Once the materiality for the financial statements as
b. Total assets d. Inventory whole has been set, a lower level of performance
materiality is determined by the auditor using his or
22. Which of the following is least likely to be her professional judgement.
appropriate as the basis for determining the d. The performance materiality level is affected by the
preliminary judgment about materiality in the audit auditor's understanding of the entity and the nature
of financial statements? and extent of misstatements identified in prior audits.
a. Revenues c. Assets
b. Total liabilities d. Losses 27. Performance materiality should be considered when
a. Identifying and assessing the risks of material
23. Materiality for an audit of a not-for-profit misstatements
organization is most likely to be determined as a b. Determining the nature, timing and extent of auditor’s
percentage of which of the following? a. Total further procedures
assets c. Both a and b
b. Excess of revenue over expenses for the period d. Neither a nor b
c. Total expenses
d. Pre-tax income 28. Which of the following terms refers to the application of
performance materiality when performing variables audit
24. The auditor establishes a materiality level for the sampling procedure (i.e., test of details)? a. Tolerable
financial statements as a whole when developing deviation rate.
the overall audit strategy. But identified b. Tolerable misstatement.
misstatements below this level are not necessarily c. Expected deviation rate.
immaterial due to qualitative considerations, such d. Expected misstatement.
as
a. b. c. d. 29. When auditors allocate the preliminary judgment about
Possible bias of management Yes Yes Yes Yes materiality to account balances, the materiality allocated
to any given account is referred to as: a. The materiality
The cumulative effect in the Yes Yes Yes No range
future b. Tolerable materiality
Regulatory or contractual c. The error range
requirements Yes Yes Yes Yes d. Tolerable misstatement
Occurrence of fraud or illegal Yes No No Yes
acts 30. Auditors commonly allocate materiality to balance sheet
Whether the misstatement
accounts rather than income statement accounts because
conceals a negative trend Yes Yes No No most income statement misstatements have a(n) _____
in profitability
effect on the balance sheet.
a. Reduced
Particular Materiality
b. Undetermined
c. Equal
25. Sometimes, it is necessary to establish materiality
for specific transactions, account balances, or d. Increased
disclosures that could influence users’ economic
decisions. Factors that may indicate the need for 31. F Co is an oil and gas company mining for crude oil
specific materiality include: reserves in sub-Saharan Africa. In the external audit of F
a. Law, regulation or applicable financial reporting Co, to which of the following might specific performance
framework measurement or disclosure (e.g., materiality levels apply? (1) Directors' remuneration
related party). (2) Exploration and development costs
b. Key industry disclosures (e.g., R&D costs for a (3) The financial statements as a whole – to reduce to an
pharmaceutical company). appropriately low level the probability that the
c. Focus on entity’s particular business aspect aggregate of uncorrected and undetected
(e.g., a newly acquired business). misstatements exceeds materiality for the financial
d. All of the above. statements as a whole
(4) The financial statements as a whole – to determine
whether misstatements identified during the audit
Performance Materiality/Tolerable Misstatement
should be accumulated and communicated to
management

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EXCEL PROFESSIONAL SERVICES, INC.
a. (1), (2) and (3)
b. (1), (2) and (4)
c. (1) and (2)
d. (2) and (4)
Clearly Trivial Misstatement
32. Which of the following statements is incorrect
relating to evaluating misstatements and findings
identified by the auditor?
a. The auditor should consider the individual
effects of misstatements not corrected by the
entity.
b. The auditor should consider the aggregate
effects of misstatements not corrected by the
entity.
c. The auditor should consider the likely
misstatements, not only known misstatements.
d. The auditor should consider misstatements that
are clearly trivial.
Revision and Documentation of Materiality
33. The materiality level for the financial statements as
a whole (or the materiality level for a particular
class of transactions, account balance or
disclosure, if applicable) may need to be revised
(adjusted either downward or upward) as a result
of the following
a. a change in circumstances that occurred during
the audit
b. new information
c. a change in the auditor’s understanding of the
entity and its operations as a result of
performing further audit procedures.
d. all of the above
34. Which of the following conditions suggest a
lowering of the aggregate materiality threshold?
a. Internal controls in the area of payroll
processing are found to be stronger.
b. The application of analytical procedures reveals a favorable sales budget variance that is material
35. Auditing standards _____ that the basis used to and that remains unexplained. determine the
preliminary judgment about materiality
c. Study of the business and industry reveals a be documented in the audit files. material decline in
revenue during the year. a. Permit
d. Tests of internal controls in nearly all transaction b. Require cycle subsets have produced
numerous and c. Strongly encourage
widespread errors.
DO-IT-YOURSELF (DIY) DRILL
1. In audit of financial statements, it is considered in
terms of the smallest aggregate level of
misstatements that could be considered material to
any one of the statements that comprise the
financial statements, while in financial reporting, it
provides a threshold or cutoff point rather than
being a primary qualitative characteristic which
information must have if it is to be useful
a. Materiality c. Relevance
b. Reliability d.
Misstatement
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2. Which of the following statements is not correct about
materiality?
a. The concept of materiality recognizes that some
matters are important for fair presentation of financial
statements in conformity with GAAP, while other
matters are not important
b. Materiality judgments are made in light of surrounding
circumstances and necessarily involve both
quantitative and qualitative judgments
c. An auditor's consideration of materiality is influenced
by the auditor's perception of the needs of a
reasonable person who will rely on the financial
statements
d. An auditor considers materiality for planning purposes
in terms of the largest aggregate level of
misstatements that could be material to any one of
the financial statements.
3. Materiality thresholds for accounting errors should be
established for each financial statement element.
However, they
a. Must require correction of accounting errors in the
subsequent year’s records.
b. Lead to rejection of financial statements found with
unrecorded accounting records.
c. Tend to hamper objectivity of auditor’s judgment
concerning severity of errors.
d. Must be established prior to execution of audit
procedures.
4. Which of the following statements is not correct?
a. Materiality is a relative rather than an absolute
concept.
b. The most important base used as the criterion for
deciding materiality is total assets.
c. Qualitative factors as well as quantitative factors
affect materiality.
d. Given equal amounts, frauds are usually considered
more important than errors.
5.
W
d. Do not allow
- now do the DIY drill –
hich of the following statements is correct concerning the
concept of materiality?
a. Materiality is determined by reference to PICPA
guidelines
b. Materiality depends only on the peso amounts of an
item relative to other items in the financial statements
c. Materiality depends on the nature of an item rather
than the peso amount
d. Materiality is a matter of professional judgment
6. Which of the following relatively small misstatements
most likely could have a material effect on an entity’s
financial statements?
AT.3007
EXCEL PROFESSIONAL SERVICES, INC.

a. An illegal payment to a foreign official that was

not recorded.
b. A piece of obsolete office equipment that was
not retired.
c. A petty cash fund disbursement that was not
properly authorized.
d. An uncollectible account receivable that was
not written off.

7. Which of the following is not a concern as to

whether a misstatement is qualitatively material?
a. The misstatement hides a failure to meet
analysts' expectations
b. The misstatement is less than 5% of pretax
income
c. The misstatement increases
management's compensation
d. The misstatement changes a small amount of
profit to a small reported loss

8. Tolerable misstatement is
a. Materiality allocated to an assertion
b. Materiality for the balance sheet as a whole
c. Materiality for the income statement as a whole
d. Materiality allocated to a specific account

9. Which of the following statements is correct

regarding the auditor's determination of
materiality?
a. The planning level of materiality should
normally be the larger of the amount
considered for the balance sheet versus the
income statement.
b. The auditors' planning level of materiality may
be disaggregated into smaller "tolerable
misstatements" for the various accounts.
c. Auditors may use various rules of thumb to
arrive at an evaluation level of materiality, but
not for determining the planning level of
materiality.
d. The amount used for the planning should equal
that used for evaluation.

10. Regardless of how the allocation of the preliminary

judgment about materiality about materiality was
done, when the audit is complete the auditor must
be confident that the combined misstatements in
all accounts are ______ the preliminary judgment.
a. less than c. more than
b. equal to d. less than or equal
to

- end of AT.3007 -

ANS: 1.A, 2.D, 3.D, 4.B, 5.D, 6.A, 7.B, 8.D, 9.B, 10.D

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