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1、Chapter 9Materiality and Risk Review Questions9-1The planning phases are: accept client and perform initial planning, understand the clients business and industry, assess client business risk, perform preliminary analytical procedures, set materiality and assess acceptable audit risk and inherent ri
2、sk, understand internal control and assess control risk, gather information to assess fraud risk, and develop overall audit plan and audit program. Evaluation of materiality is part of phase five. Risk assessment is part of phase three (client business risk), phase five (acceptable audit risk and in
3、herent risk), phase six (control risk), and phase seven (fraud risk).9-2Materiality is defined as: the magnitude of an omission or misstatement of accounting information that, in light of the surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the informa
4、tion would have been changed or influenced by the omission or misstatement.Obtain reasonable assurance, as used in the audit report, means that the auditor does not guarantee or insure the fair presentation of the financial statements. There is some risk that the financial statements contain a mater
5、ial misstatement.9-3Materiality is important because if financial statements are materially misstated, users decisions may be affected, and thereby cause financial loss to them. It is difficult to apply because there are often many different users of the financial statements. The auditor must theref
6、ore make an assessment of the likely users and the decisions they will make. Materiality is also difficult to apply because it is a relative concept. The professional auditing standards offer little specific guidance regarding the application of materiality. The auditor must, therefore, exercise con
7、siderable professional judgment in the application of materiality.9-4The 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. Several factors affect the prelimina
8、ry judgment about materiality and are as follows:1.Materiality is a relative rather than an absolute concept.2.Bases are needed for evaluating materiality.3.Qualitative factors affect materiality decisions.4.Expected distribution of the financial statements will affect the preliminary judgment of ma
9、teriality. If the financial statements are widely distributed to users, the preliminary judgment of materiality will probably be set lower than if the financial statements are not expected to be widely distributed.5.The level of acceptable audit risk will also affect the preliminary judgment of mate
10、riality.9-5Because materiality is relative rather than absolute, it is necessary to have bases for establishing whether misstatements are material. For example, in the audit of a manufacturing company, the auditor might use as bases: net income before taxes, total assets, current assets, and working
11、 capital. For a governmental unit, such as a school district, there is no net income before taxes, and therefore that would be an unavailable base. Instead, the primary bases would likely be fund balances, total assets, and perhaps total revenue.9-6The following qualitative factors are likely to be
12、considered in evaluating materiality:a.Amounts involving fraud are usually considered more important than unintentional errors of equal dollar amounts.b.Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations.c.Misstatements that
13、 are otherwise immaterial may be material if they affect a trend in earnings.9-7A preliminary judgment about materiality is set for the financial statements as a whole. Tolerable misstatement is the maximum amount of misstatement that would be considered material for an individual account balance. T
14、he amount of tolerable misstatement for any given account is dependent upon the preliminary judgment about materiality. Ordinarily, tolerable misstatement for any given account would have to be lower than the preliminary judgment about materiality. In many cases, it will be considerably lower becaus
15、e of the possibility of misstatements in different accounts that, in total, cannot exceed the preliminary judgment about materiality.9-8There are several possible answers to the question. One example is:Cash$500OverstatementFixed assets$3,000OverstatementLong-term loans$1,500UnderstatementNote:Cash
16、and fixed assets are tested for overstatement and long-term loans for understatement because the auditors objective in this case is to test for overstatements of owners equity.The least amount of tolerable misstatement was allocated to cash and long-term loans because they are relatively easy to audit. The majority of the total allocation was to fixed assets because there is
