Shared Flashcard Set


Chapter 9
Undergraduate 4

Additional Accounting Flashcards




What is materiality?

-Materiality is the magnitude of omitted or misstated information that probably would have made a difference in the judgment of someone relying on that information (FASB 2).


For each engagement, auditors establish a preliminary judgment about materiality


-is the maximum amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users.


The auditor considers materiality at 2 stages;

   -Planning Stage

   -Opinion Formulation Stage


In planning an audit, the auditor should assess materiality at the following two stages:

   -Financial Statement Level

   -Account Balance Level


-Materialty is a relative rather than an absolute concept

-Bases are needed for evaluating materialty


-A variable percentage based on the greater of Total Assets or Revenue


How does the preliminary judgment about materiality affest the

Volume of audit evidence


-small materiality estimate will result in more evidence

-large materiality estimate will result in less evidence

-strongly influenced by client size

factors affecting the preliminary judgement about materiality

-materiality is strongly influenced by client size

-multiple bases of materiality may be appropriate

-a fraud is considered more material than an error of the same dollar amount.

-small differences from contractual requirements may be material (e.g.,ratios related to debt agreements)

-immaterial amounts may accumulate into a material amount

What is acceptable audit risk

-the risk that the auditor is willing to accept that an unqualified opinion will be issued for statements that are materially misstated.


-lower the acceptable audit risk

      -the greater the certainty the auditor wants to achieve

      -the greater the amount of evidence and costs

What is achieved audit risk

the actual risk that the statements are materially misstated after an unqualified opinion has been issued

How do acceptable and achieved audit risk affect the audit report?

if acheieved is less than acceptable

  -audit report is supported by evidence


if acheieved is greater than acceptable

   -audit report is not supported by evidence

how can an auditor reduce audit risk?

-gather more evidence

-auditors may face more audit risk because of increased business risk auditor should consider:

    -degree to which users rely on the clients FS

    -likelihood client will have financial difficulties after the report has been issued

    -management integrity

audit risk formula

inherent risk * control risk (auditors influence) * detection risk (auditors influence) = audit risk


detection risk= audit risk / (inherent risk * control risk

inherent risk

-the risk that material misstatements exist before considering the client internal control

-some accounts, components, cycles are inherently riskier than other

    -must identify inherently risky areas

    -gather appropriate evidence on these areas

    -risky-cash, inventory, AP

    -less risky- fixed assets, equity



-nature of client’s business

-integrity of management

-client motivation to misstate the financial statements

-results of previous audits

-initial vs. repeat engagements (not familiar w/ clients systems, internal controls, personnel--- must extensively examine beg. balances)

-related parties

-nonroutine transaction (has GAAS been correctly applied)

-judgement required to correctly record transactions

-susceptibility to defalcation (embezzling cash)

-makeup of population(AP ageing of 15 days vs. ageing of 45 days)

control risk

-the risk that material misstatements will not be prevented or detected by internal control

Detection risk

-the risk that material misstatements will not be detected by the auditor


why does detection risk exist?

-the auditor samples (sampling risk)

-the auditor may select ineffective audit procedures

-the auditor may apply procedures ineffectively

-the auditor may incorrectly evaluate the results of procedures


The last 3 reasons are non sampling errors. The risk of their occurrence is non sampling risk

auditors influence on audit risk 

-auditors can only influence control risk and detection risk


-control risk- indirectly- influence management


-detection risk- directly- large sample size, enhanced training

Securities Litigation Reform handout

Private Securities Litigation Reform Act of 1995

-proportionate liability up to 50%, reduce innocent parties from settling meritless claims out of court rather than risk negative exposure.

-requires plaintiffs to pay defendants reasonable attorneys fees and expenses for frivolous and unwarranted suits.

-limits punitive damages.

-places limits on the rights of third parties to sue.

can only be led plaintiff of 5 class actions in 3 yr period.

-encouraged companies to make voluntary disclosures by providing a safe harbor (not liable) for forward looking statements. 


Securities Litigation Uniform Standards Act of 1998

-closed loophole for lawyers to take these cases to state court when federal court band them w/ the 1995 Act

Regina Case

-Sheelen CEO of Regina vacuum, had a marketing background.

-Growing the stock price became an obsession for him



1. created false invoices

2. understated COGS

3. "ship-in-place" sales- recorded customer orders that have yet to be shipped (revenue recognition)

4. in commercials would use an industrial strength suction that was available on model sold to customers

5. was not recording the models that customers have return. left them in revenue



1. compare everything as a % of total assets

2. there were red flags in Reginas net receivable

3. gross margin (netsales/COGS). GM was static while COGS was booming

4. barly spent any $ on R&D and claimed they had so many new models

5. intrest expense should go up relativly in accordance w/ debt


Materiality Handout

-planning materiality-preliminary judgment about materiality levels

-there may be more than one level of materiality relating to the FS

- for planning purposes the auditor should use the smallest aggregate level of misstatments considered to be material to any one of the FS

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