9) The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement.
2. Estimate the total misstatement in the segment.
3. Set materiality for the financial statements as a whole.
4. Determine performance materiality.
5. Compare combined estimate with preliminary judgment about materiality.
The first three steps in correct sequence would be
A) 1, 2, 5
B) 3, 4, 2
C) 2, 1, 5
D) 3, 2, 4
10) 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 dollar amounts, frauds are usually considered more important than errors.
11) Certain types of misstatements are likely to be more important than other types to users, even
if the dollar amounts are the same. Which of the following demonstrates this?
A)
Amounts involving frauds are
considered more important than
errors of equal amount.
Misstatements that are otherwise
immaterial may be material if they
affect a trend in earnings.
Yes
Yes
B)
Amounts involving frauds are
considered more important than
errors of equal amount.
Misstatements that are otherwise
immaterial may be material if they
affect a trend in earnings.
No
No
C)
Amounts involving frauds are
considered more important than
errors of equal amount.
Misstatements that are otherwise
immaterial may be material if they
affect a trend in earnings.
Yes
No
D)
Amounts involving frauds are
considered more important than
errors of equal amount.
Misstatements that are otherwise
immaterial may be material if they
affect a trend in earnings.
No
Yes
12) When setting a preliminary judgment about materiality,
A) more evidence is required for a low dollar amount than for a high dollar amount.
B) less evidence is required for a low dollar amount than for a high dollar amount.
C) the same amount of evidence is required for either low or high dollar amounts.
D) there is no relationship between materiality and the dollar amount of evidence needed.
13) Lewis Corporation has a few large accounts receivable that total one million dollars, whereas
Clark Corporation has many small accounts receivable that total one million dollars.
Misstatement in any one account is more significant for Lewis corporation because of the
concept of
A) materiality.
B) audit risk.
C) reasonable assurance.
D) comparative analysis.
14) When determining materiality,
A) the preliminary judgment about materiality can be increased, but not decreased during the
audit.
B) auditing standards provide specific materiality guidelines to practitioners.
C) only one benchmark can be used.
D) the application of guidelines requires considerable professional judgment.
15) Audit standards require the auditor to consider the combined amount of misstatement early in
the audit. This is known as preliminary materiality judgment. List and discuss the three main
factors that affect an auditor’s preliminary judgment about materiality.
16) 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.
17) Determining materiality requires professional judgment.
18) The auditor’s preliminary judgment about materiality is the maximum amount by which the
auditor believes the financial statements could be misstated and still not affect the decisions of
reasonable users.
19) Preliminary judgments about materiality are often changed during the course of the
engagement.
20) Net assets are the most often used base for deciding materiality.
21) The lower the dollar amount of the preliminary judgment, the more audit evidence is
required.
22) Amounts involving fraud are not usually considered qualitative factors affecting the
preliminary materiality judgment.
23) CPA firms can establish policy guidelines to help their auditors determine materiality.
24) Statements on Auditing Standards provide detailed, objective guidance on how auditors are
to establish a preliminary materiality level, thus eliminating the need for subjective auditor
judgment in this task.
25) If the preliminary judgment of materiality increases, the amount of audit evidence required
will decrease.
26) Net income before taxes is the normal base used to determine materiality for a not-for-profit
organization.
8.7 Learning Objective 8-7
1) The amount(s) set by the auditor at less than the materiality for the financial statements as a
whole to reduce to an appropriately low level the probability that the aggregate of uncorrected
and undetected misstatements exceeds materiality for the financial statements as a whole is
referred to as
A) the materiality range.
B) the error range.
C) tolerable materiality.
D) performance materiality.
2) Auditors generally allocate the preliminary judgment about materiality to the:
A) balance sheet only.
B) income statement only.
C) income statement and balance sheet.
D) statement of cash flows.
3) Which of the following is an incorrect statement regarding the allocation of the preliminary
judgment about materiality to balance sheet accounts?
A) Auditors expect certain accounts to have more misstatements than others.
B) The allocation has virtually no effect on audit costs because the auditor must collect sufficient
appropriate audit evidence.
C) Auditors expect to identify overstatements as well as understatements in the accounts.
D) Relative audit costs affect the allocation.
4) Which of the following statements is true concerning the allocation of preliminary
materiality?
A) It is necessary to allocate preliminary materiality to financial statements as a whole rather
than by segments.
B) Preliminary materiality should be allocated to income statement accounts only.
C) Preliminary materiality is required by the SEC.
D) The PCAOB term used when preliminary materiality is allocated to segments is tolerable
misstatement.
5) Which of the following statements is false?
A) Either an overstatement of an asset account or an understatement of a liability account would
have the same effect on the income statement.
B) A misclassification in the balance sheet will have no effect on operating income.
C) Either an overstatement of an asset account or an overstatement of a liability account would
have the same effect on the income statement.
D) Either an understatement of an asset account or an overstatement of a liability account would
have the same effect on the income statement.
6) Which of the following are major difficulties auditors face when allocating materiality to
balance sheet accounts?
A)
Certain accounts contain
more misstatements
than others.
Only overstatements
need be considered.
Audit costs can
affect allocation.
Yes
No
Yes
B)
Certain accounts contain
more misstatements
than others.
Only overstatements
need be considered.
Audit costs can
affect allocation.
Yes
Yes
No
C)
Certain accounts contain
more misstatements
than others.
Only overstatements
need be considered.
Audit costs can
affect allocation.
Yes
Yes
Yes
D)
Certain accounts contain
more misstatements
than others.
Only overstatements
need be considered.
Audit costs can
affect allocation.
No
Yes
No
7) When allocating performance materiality,
A) it is easy to predict in advance which accounts are most likely to be misstated.
B) only overstatements need to be considered.
C) professional judgment is critical.
D) the sum of all the performance materiality levels cannot exceed the preliminary judgment
about materiality.
8) When allocating materiality, most practitioners choose to allocate to
A) the income statement accounts because they are more important.
B) the balance sheet accounts because most audits focus on the balance sheet.
C) both balance sheet and income statement accounts because there could be errors on either.
D) all of the financial statements because it is required by GAAS.
9) Which of the following is a correct statement regarding performance materiality?
A) Determining performance materiality is necessary because auditors accumulate evidence by
segments.
B) The level of performance materiality does not affect the amount of evidence needed.
C) Performance materiality cannot vary for different classes of transactions.
D) Performance materiality is required for public companies, but not for private companies.
10) 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.
11) Auditor’s allocate the preliminary judgment about materiality to financial statement segments
rather than by financial statements as a whole. What is the term for the auditor’s allocation of
preliminary misstatement to account balances? What are three difficulties auditors face when
allocating materiality to balance sheet accounts?
12) Most practitioners allocate the preliminary judgment about materiality to both the balance
sheet and income statement accounts.
13) The primary purpose of allocating the preliminary judgment about materiality to financial
statement accounts is to help the auditor decide the appropriate evidence to accumulate.
14) Both overstatements and understatements must be considered when allocating materiality to
balance sheet accounts.
15) If an auditor assigns a tolerable misstatement of $1,000 to accounts payable, he or she would
need to obtain more audit evidence for that account than if $100,000 had been assigned.
16) To maximize audit efficiency, the auditor should allocate less tolerable misstatement 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.
8.8 Learning Objective 8-8
1) Auditors are ________ to document the known and likely misstatements in the financial
statements under audit.
A) permitted
B) required
C) not allowed
D) strongly encouraged
2) ________ misstatements are those where the auditor can determine the amount of the
misstatement in the account.
A) Potential
B) Likely
C) Known
D) Projected
3) Likely misstatements can result from
A)
Computation of the
sampling error for the
cash account
Differences between
management’s and an
auditor’s judgment about
account balances
Projections of
misstatements based on
an auditor’s tests of a
sample from a
population
No
Yes
Yes
B)
Computation of the
sampling error for the
cash account
Differences between
management’s and an
auditor’s judgment about
account balances
Projections of
misstatements based on
an auditor’s tests of a
sample from a
population
Yes
Yes
No
C)
Computation of the
sampling error for the
cash account
Differences between
management’s and an
auditor’s judgment about
account balances
Projections of
misstatements based on
an auditor’s tests of a
sample from a
population
No
No
Yes
D)
Computation of the
sampling error for the
cash account
Differences between
management’s and an
auditor’s judgment about
account balances
Projections of
misstatements based on
an auditor’s tests of a
sample from a
population
Yes
No
No
4) When evaluating the audit findings, the auditor should be satisfied that the
A) amount of known misstatement is documented in the management representation letter.
B) estimate of the total known and likely misstatements is less than a material amount.
C) estimate of the total likely misstatement includes sample error.
D) amount of known misstatement is acknowledged and recorded by the client.
5) List the five steps in applying materiality in an audit.
6) The preliminary judgment on materiality is compared to the total estimated misstatement
amount to determine if an account balance is materially misstated.
7) Total estimated misstatements include known misstatements and projected misstatements plus
a sampling error.
8) If the total misstatement of an account is known, a sampling error still needs to be determined.
9) Sampling risk results if the sample accurately represents the population.
10) If the auditor approaches the audit of the accounts in s sequential manner, the findings of the
audit of accounts audited earlier can be used to revise the performance materiality established for
accounts audited later.