chapter 7 audit risk an materiality

What are qualitative materiality factors?

Considerations that may render a quantitatively immaterial misstatement material.

What can render a quantitatively immaterial misstatement material if it masks a change in earnings or trends?

If the trend line changes significantly, investors may change their perception of the company.

What happens if a company fails to meet analysts' consensus expectations?

The market can react negatively, even for a small quantitative adjustment.

What does an item changing loss into income signal to investors?

Investors prefer a small break-even net income over a small break-even loss.

What should auditors do if an item concerns a significant segment of the business?

They should book an adjustment, as investors will care more about that segment.

What is the impact if an item affects regulatory compliance?

The regulator will care, hence the adjustment needs to be booked.

Why is management compensation important in materiality assessments?

Adjustments affecting management’s bonus targets matter to the board of directors.

What indicates whether an adjustment might conceal an unlawful transaction?

If it hides such transactions, law enforcement will care.

How do we determine what is material?

Based on magnitude of financial statement impact and user expectations.

What is performance materiality?

An amount less than planning materiality, used to determine which accounts to test.

What is the purpose of the clearly trivial threshold?

To ignore misstatements that are below a certain threshold to increase efficiency.

How should auditors address misstatements below clearly trivial thresholds?

These misstatements don't affect overall materiality and can be ignored.

What must auditors do if they find several material errors during the audit?

Revise materiality thresholds and potentially do more work.

What is audit risk?

The risk that an auditor expresses an inappropriate audit opinion when financial statements are misstated.

What are the components of audit risk?

Inherent risk, control risk, and detection risk.

How can auditors mitigate audit risk?

By minimizing the probability of loss or minimizing the magnitude of loss.

What is inherent risk?

The risk of an error occurring regardless of controls.

What is control risk?

The risk that errors won't be prevented or detected by the company's internal controls.

What is detection risk?

The risk that the auditor will miss a material misstatement.

What is the significance of adjusting materiality thresholds?

To ensure accurate representation of financial statements post-audit.

What impact does lower net income have on materiality threshold?

It necessitates a lower materiality threshold and possibly additional audit procedures.

What is expected loss in risk management?

The probability of incurring loss multiplied by the outcome of that loss.

What result leads to a revision of materiality thresholds?

Detecting significant errors that impact the benchmark for materiality.

What does it mean when auditors say there's a 'risk of material misstatement'?

There's a possibility that errors exist in the financial statements due to inherent and control risks.

What ensures that effective risk assessment is conducted?

Systematic evaluation of both inherent and control risks.

What should be done when the materiality threshold is reduced?

Auditors need to evaluate all accounts against the new threshold.

What happens if an error occurs and goes undetected before auditing?

It will lead to audit failure if not caught.

How does the magnitude of financial statement impact materiality assessments?

It determines the level of significance users attach to each item.

What is the relationship between risk of material misstatement and audit planning?

Risk assessment informs the audit planning process.

Why do auditors control detection risk?

To reduce the likelihood of missing material errors in financial statements.

What is the nature of the audit risk model?

It combines inherent risk, control risk, and detection risk.

What approach do auditors take to ensure compliance with revised materiality thresholds?

Adjust procedures and confirm all relevant misstatements are identified.

Why is it important to communicate findings to the audit committee?

To inform them of material misstatements regardless of significance.

What can happen at the end of the audit if misstatement aggregates exceed thresholds?

Auditors must begin rectifying misstatements.

How can planning errors impact the audit?

They may lead to increased scrutiny or additional work if not corrected.

What is the acceptable audit risk?

The level of audit risk an auditor is willing to accept in a particular engagement.

What is an example of a benchmark used in determining materiality?

Net income or total assets.

What do auditors assess to determine control risk?

The effectiveness of the client’s internal control environment.

What does a decrease in net income suggest for audit planning?

The need to reassess materiality and potential adjustments.

What is the consequence of an audit failing to report significant misstatements?

Users of the financial statements could make poor decisions based on inaccurate information.

How are materiality and audit efficiency related?

Identifying thresholds helps auditors focus only on significant misstatements.

What critical aspect does risk assessment influence in an audit?

The overall strategy and execution of the audit process.

What is the collective impact of misstatements below performance materiality?

They typically do not require correction unless they aggregate above the threshold.

Why is understanding qualitative factors in materiality crucial for auditors?

It helps auditors determine which misstatements are worth examining.

What is a potential outcome of not adjusting materiality during an audit?

Financial statements may not be reliable or useful to users.