Audit - Chapter 9

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the scope paragraph contains which two important phrases that are directly related to materiality and risk?

obtain reasonable assurance and free of material misstatements

what is obtain reasonable assurance?

to inform users that auditors do not guarantee or ensure the fair representation of the financial statements

what is free of material misstatements?

to inform users that the auditor's responsibility is limited to material financial information

define materiality?

magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, make it probably that the judgement of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement

what should an auditor do upon discovering a material misstatement in the financial statements?

bring it to the client's attention so that the correction can be made

what happens if the client refuses to correct the financial statements?

auditor must issue a qualified or an adverse opinion

what is a preliminary judgement about materiality?

auditors decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit as they are developing the overall strategy for the audit

preliminary judgement about materiality is the ____ amount by which auditors believe the statements could be misstated and still not affect the decisions of reasonable users

maximum

if the dollar amount of the preliminary judgement is low, how much evidence is required?

more

what is the revised judgement about materiality?

when during the audit auditors change the preliminary judgement about materiality

what is the often primary base for deciding what is material for profit oriented businesses

net income before taxes

examples of other primary bases?

net sales, gross profit, total or net assets

what should auditors do after establishing a primary base?

decide whether misstatements could materially affect the reasonableness of other bases such as current assets, total assets, current liabilities, and owner's equity

why do auditors use a primary preliminary level of $100,000 for most tests?

because almost all misstatements affect both the income statement and balance sheet

what is the allocation of the preliminary judgement about materiliaty?

necessary because auditors accumulate evidence by segments rather than for the financial statements as a whole

where do most practioners allocate materiality to?

balance sheet

why do most practioners allocate materiality to the balance sheet?

because most income statement misstatements have an equal effect on the balance sheet due to the nature of double entry accounting

define tolerable misstatements?

when allocating the preliminary judgement about materiality to account balances

what are the three major difficulties in allocating materiality to balance sheet accounts?

auditors expect certain accounts to have more misstatements than others, both overstatements and understatements must be considered, relative audit costs affect the allocations

how many types of misstatements in an account are there?

two

what are the types of misstatements in an account?

known misstatements and likely misstatements

define known misstatements?

the auditor can determine the amount of the misstatements in the account

how many types of likely misstatements are there?

two

explain the two types of likely misstatements?

misstatements that arise from differences between management and the auditors judgement about estimates of account balances, and projections of misstatements based on the auditors tests of sample from a population

why do auditor's use the audit risk model?

to further identify the potential for misstatements in the overall financial statements and specific account balances, classes of transactions, and disclosure where misstatements are most likely to occur

define planned detection risk?

risk that audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement

what is the first key component of pdr?

it is dependent on the other three factors in the model

what is the second key component of pdr?

it determines the amount of substantive evidence that the auditor plans to accumulate, inversely with the size of pdr

if pdr is reduced, what does the auditor do?

accumulate more evidence

define inherent risk?

measures the auditor's assessment of the likelihood that there are material misstatements due to error or fraud in a segment before considering the effectiveness of internal control

if high likelihood of misstatements exist, what does the auditor do?

conclude that inherent risk is high

inherent risk is inversely related to what?

planned detection risk

inherent risk is directly related to what?

evidence

define control risk?

measures the auditor's assessment of whether misstatements exceeding a tolerable amount in a segment will be prevented or detected on a timely basis by the client's internal controls

if auditors believe internal controls are effective, what do they do?

lower the risk factor that can be assigned to control risk

define risk of material misstatements?

the combination of inherent risk and control risk

when is the relationship between cr and pdr inverse?

inherent risk

when is the relationship between cr and pdr direct?

control risk

if internal controls are effective, what happens to pdr and to evidence?

pdr increases evidence decreases

if internal controls are ineffective and ir is high, what happens to pdr and evidence?

pdr decreases and evidence increases

define acceptable audit risk?

measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued

in terms of acceptable audit risk, zero risk is?

certainty

in terms of acceptable audit risk, 100% risk is?

complete uncertainty

audit assurance can take place of?

acceptable audit risk

audit assurance is also called?

overall assurance or level of assurance

acceptable audit risk of 2% is the same as?

audit assurance of 98%

acceptable audit risk and planned detection risk have what kind of relationship?

direct

acceptable audit risk and planned evidence have what kind of relationship?

inverse

what happens if auditor decides to reduce acceptable audit risk?

pdr is reduced and planned evidence is increased

what are based on the auditor's expectations or predictions of client conditions?

inherent risk and control risk

what risk is dependent completely on the other three risks?

detection risk

define engagement risk?

risk that the auditor will suffer harm after the audit is finished even though the audit report was correct

engagement risk is closely related to what other risk?

business risk

what is done by control of acceptable audit risk?

when auditors modify evidence for engagement risk

what is the first factor that affects engagement risk?

degree to which external users rely on the statements

what is the second risk factor that affects engagement risk?

likelihood that a client will have financial difficulties after the audit report is issued

what is the third risk factor that affects engagement risk?

integrity of management

when external users place heavy reliance on the financial statements, what happens to aar?

decreases

if an auditor establishes a relatively high level of materiality, then the auditor will?

accumulate less evidence than if a lower level had been set

based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. to achieve an overall audit risk level that is substantially the same as the pdr, the auditor would?

decrease detection risk

the risk that audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement is?

planned detection risk

as the acceptable level of detection risk increases, an auditor may change the?

timing of substantive tests by performing them at an interim date rather than year end

proper segregation of functional responsibilities calls for separation of?

authorization, recording, and custody

which of the following components of the control environment define the existing lines of responsibility and authority?

organizational structure

audit evidence regarding the separation of duties is normally obtained by?

observation of an employee applying control activities

some account balances, such as those for pension and leases, are a result of complex calculations. the susceptibility to material misstatements in these types of account is defined as?

inherent risk

an auditor used assessed control risk to?

determine the acceptable level of detection risk for financial statement assertions

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