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Chapter 03
Risk Assessment and Materiality
Multiple Choice Questions
1. Engagement risk is:
A. The risk of issuing an incorrect audit opinion
B. The auditor's risk of loss from events arising in connection with financial statements audited
and reported upon
C. The overall risk of material misstatements
D. The risk of entity financial failure
AACSB: Communications
AICPA BB: Legal
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 1
2. Client (or auditee) risk is
A. The auditor's risk of loss from events arising in connection with financial statements audited
and reported upon
B. The overall risk of material misstatements
C. The risk that audit procedures will fail to detect material misstatements
D. The risk of the entity's financial failure
AACSB: Communications
AICPA BB: Legal
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 2
Learning Objective: 6
3-1
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3. Under Statements on Auditing Standards, which of the following would be classified as an
error?
A. Misappropriation of assets for the benefit of management
B. Misinterpretation by management of facts that existed when the financial statements were
prepared
C. Preparation of records by employees to cover a fraudulent scheme
D. Intentional omission of the recording of a transaction to benefit a third party
AACSB: Ethics
AICPA BB: Legal
AICPA FN: Decision Making
Difficulty: Easy
Learning Objective: 6
4. When assessing the risk of material misstatements, auditors evaluate the reasonableness of
an entity's accounting estimates. An auditor normally is concerned about assumptions that are
A. Susceptible to bias
B. Consistent with prior periods
C. Insensitive to variations
D. Similar to industry guidelines
AACSB: Analytics
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 6
5. Which of the following characteristics most likely would heighten an auditor's concern about
the risk of intentional manipulation of financial statements?
A. Turnover of senior accounting personnel is low
B. Insiders recently purchased additional shares of the entity's stock
C. Management places substantial emphasis on meeting earnings projections
D. The rate of change in the entity's industry is slow
AACSB: Analytics
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 6
3-2
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6. Which of the following is a known misstatement?
A. A management estimate that is outside the range of reasonable outcomes determined by the
auditor
B. A fixed asset being recorded at the incorrect cost
C. A projected misstatement resulting from errors found during sampling
D. Difference in judgment between the auditor and management
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Difficulty: Moderate
Learning Objective: 6
7. Tolerable misstatement is
A. Always the same for errors and fraud
B. Materiality for the balance sheet as a whole
C. Materiality for the income statement as a whole
D. Materiality allocated to a specific account
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Difficulty: Easy
Learning Objective: 11
8. Which of the following would an auditor most likely use in determining the auditor's
planning materiality?
A. The anticipated sample size for planned substantive procedures
B. The entity's annualized interim financial statements
C. The results of the internal control questionnaire
D. The contents of the management representation letter
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 11
Learning Objective: 12
3-3
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9. Which of the following is not a qualitative factor that may affect an auditor's establishment of
materiality?
A. Potential for fraud
B. The company is close to violating loan covenants
C. Firm policy sets materiality at 4% of pretax income
D. A small misstatement would interrupt an earnings trend
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 11
Learning Objective: 12
10. Which of the following is not a concern as to whether a misstatement is qualitatively
material?
A. The misstatement hides a failure to meet analysts' expectations
B. The misstatement is less than 5% of pretax income
C. The misstatement increases management's compensation
D. The misstatement changes a small amount of profit to a small reported loss
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 11
Learning Objective: 12
11. Auditors can eliminate engagement risk
A. Under no circumstances
B. By establishing policies for client acceptance and continuance
C. By lowering audit risk
D. By lowering materiality
AACSB: Communications
AICPA BB: Legal
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 1
3-4
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12. The achieved (actual) level of audit risk
A. Can always be accurately assessed by the auditor
B. Should be greater than or equal to acceptable audit risk
C. Can never be known with certainty
D. Is the same for all audit clients
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 1
13. An auditor knows that an audit client operates in an industry in which common stock is
valued based on the price-earnings ratio soon will have an initial public offering. All of the
following are true except:
A. Materiality should be reduced
B. Risk of material misstatement should increase
C. Fraud risk should increase
D. Audit risk should increase
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 11
Learning Objective: 2
Learning Objective: 3
Learning Objective: 6
14. The risk that an auditor will conclude, based on substantive procedures, that a material error
does not exist in an account balance when, in fact, such error does exist is referred to as
A. Sampling risk
B. Detection risk
C. Nonsampling risk
D. Inherent risk
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
Learning Objective: 6
3-5
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15. The risk of material misstatement differs from detection risk in that it
A. Arises from the misapplication of auditing procedures
B. May be assessed in either quantitative or nonquantitative terms
C. Exists independently of the financial statement audit
D. Can be changed at the auditor's discretion
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
16. All of the following are inherent risk factors that are pervasive to the financial statements
except
A. Highly complex significant transactions
B. Non-routine transactions
C. Classes of transactions are not processed systematically
D. Supplies inventory is difficult to count
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
17. When an auditor increases the assessed level of risk of material misstatement because
certain control procedures were determined to be ineffective, the auditor would most likely
increase the
A. Extent of tests of controls
B. Level of detection risk
C. Extent of tests of details
D. Level of inherent risk
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
3-6
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18. On the basis of audit evidence gathered and evaluated, an auditor decides to increase the
assessed level of risk of material misstatement from that originally planned. To achieve an
overall audit risk level that is substantially the same as the planned audit risk level, the auditor
would
A. Decrease substantive procedureing
B. Decrease detection risk
C. Increase detection risk
D. Increase materiality levels
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
19. The risk of material misstatement includes which of the following:
A. Detection risk
B. Audit risk
C. Inherent risk
D. Nonsampling risk
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 2
20. An auditor learns that a client employee in control of inventory gets divorced and is
responsible for paying a large amount of child support. All of the following for the audit of
inventory likely are true except:
A. Fraud risk increases
B. The risk of misappropriation of assets increases
C. Risk of material misstatement increases
D. Detection risk increases
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
Learning Objective: 6
3-7
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21. Which of the following audit risk components may be assessed in nonquantitative
terms?
A. A Above
B. B Above
C. C Above
D. D Above
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
22. When an entity moves into a significant new line of business, all of the following increase
except
A. Client risk
B. Acceptable audit risk
C. Risk of material misstatement
D. Entity business risk
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 5
3-8
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23. Which of the following procedures should not be used to obtain an understanding of the
entity and its environment?
A. Observe entity operations
B. Reperform entity processes
C. Verify proper valuation of inventory subject to technological obsolescence
D. Review prior year's audit documentation
AACSB: Communications
AICPA BB: Industry
AICPA FN: Decision Making
Difficulty: Moderate
Learning Objective: 5
24. Which of the following is not an important consideration in an auditor's evaluation of an
entity's business risk?
A. The specific business risks an entity faces that may result in financial statement errors and
fraud
B. Business risk factors that impact the ability of the entity to be profitable and survive
C. Audit standards include many entity business risk factors that identify circumstances that
increase the likelihood of material misstatements
D. Audit standards require the auditor to evaluate the entity's business risk in order to provide
suggestions to improve the entity's profitability
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 5
25. Which of the following relatively small misstatements most likely would have a material
effect on an entity's financial statements?
A. An illegal payment to a foreign official that was not recorded
B. A piece of obsolete office equipment that was not retired
C. A petty cash fund disbursement that was not properly authorized
D. An uncollectible account receivable that was not written off
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 5
Learning Objective: 6
3-9
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26. The main source of detection risk is:
A. Unstable audit environment
B. Poor client controls
C. A non-representative sample
D. Inherent risk assessed too high
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 6
27. In general, material frauds perpetrated by which of the following are most difficult to
detect?
A. Internal auditor
B. Keypunch operator
C. Cashier
D. Controller
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 6
28. Which of the following circumstances most likely would cause an auditor to believe that
material misstatements may exist in an entity's financial statements?
A. Accounts receivable confirmation requests yield significantly fewer responses than expected
B. Audit trails of computer-generated transactions exist only for a short time
C. The chief financial officer does not sign the management representation letter until the last
day of the auditor's fieldwork
D. Management consults with other accountants about significant accounting matters
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
3-10
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29. The primary responsibility for preventing fraud in an organization lies with
A. The audit committee of the board of directors
B. The internal audit staff
C. The external auditor
D. The organization's management
AACSB: Communications
AICPA BB: Industry
AICPA FN: Decision Making
Difficulty: Moderate
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
30. Which of the following is not a misstatement of the financial statements?
A. The client uses different inventory accounting methods for internal and external reporting
B. A departure from GAAP
C. The footnote for pensions is omitted
D. A clerk incorrectly based the allowance for doubtful accounts on 31% of sales as opposed to
13% of sales as determined by the controller
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Decision Making
Difficulty: Moderate
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
31. Which of the following does not represent an opportunity to commit fraud?
A. Significant related party transactions
B. The auditor's relationship with management is strained
C. Management is dominated by a single person
D. The financial statements included highly subjective estimates
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
3-11
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32. The auditor can respond to an increased risk of fraud by doing all of the following except
A. Increasing professional skepticism
B. Assigning more experienced personnel to the audit
C. Increasing acceptable audit risk
D. Taking steps to obtain more reliable evidence
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
33. An auditor discovers a likely fraud during an audit but concludes that the effect of the fraud
is not sufficiently material to affect the audit opinion. The auditor should
A. Disclose the fraud to the appropriate level of the client's management
B. Disclose the fraud to appropriate authorities external to the client
C. Discuss with the client the additional audit procedures that will be needed to identify the
exact amount of the fraud
D. Modify the audit program to include tests specifically designed to identify the fraud and its
impact on the financial statements
AACSB: Communications
AICPA BB: Critical Thinking
AICPA FN: Decision Making
Difficulty: Moderate
Learning Objective: 7
Learning Objective: 8
34. Which of the following is the most important qualitative factor that auditors should consider
when making materiality judgments?
A. A misstatement exceeded five percent of net income
B. The auditor also provides consulting services to the audit client
C. The misstatement will cause the client to fail to meet an earnings forecast
D. The audit committee is not well educated about the accounting principle in question
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 12
3-12
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35. The acceptable level of detection risk is inversely related to the
A. Assurance provided by substantive procedures
B. Risk of misapplying auditing procedures
C. Planning materiality
D. Risk of failing to discover material misstatements
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 2
Learning Objective: 3
36. As the acceptable level of detection risk decreases, an auditor may change the
A. Timing of substantive procedures by performing them at an interim date rather than at
year-end
B. Nature of substantive procedures from less effective to more effective procedures
C. Timing of tests of controls by performing them at several dates rather than at one time
D. Assessed level of risk of material misstatement to a higher amount
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 2
Learning Objective: 3
37. As the acceptable level of detection risk decreases, the assurance directly provided from
A. Substantive procedures should increase
B. Substantive procedures should decrease
C. Tests of controls should increase
D. Tests of controls should decrease
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 2
Learning Objective: 3
3-13
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38. As the acceptable level of detection risk increases, an auditor may change the
A. Assessed level of risk of material misstatement from below the maximum to the maximum
level
B. Assurance provided by tests of controls by using a larger sample size than planned
C. Timing of substantive procedures from year-end to an interim date
D. Nature of substantive procedures from less effective to more effective procedures
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 2
Learning Objective: 3
39. Increased fraud risk could also result in all of the following except
A. Lower detection risk
B. Higher inherent risk
C. Lower control risk
D. Higher client risk
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 2
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
40. The objectives of the engagement partner's communication with the audit team include
A. Turning the audit team against management
B. Complying with SEC rules
C. Complying with FASB rules
D. Emphasizing the importance of professional skepticism
AACSB: Communications
AICPA BB: Resource Management
AICPA FN: Decision Making
Difficulty: Hard
Learning Objective: 6
3-14
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41. The auditor is most likely to presume that a high risk of a fraud exists if
A. The entity is a multinational company that does business in numerous foreign countries
B. The entity does business with several related parties
C. Inadequate segregation of duties places an employee in a position to perpetrate and conceal
theft
D. Inadequate employee training results in lengthy EDP exception reports each month
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
42. Which of the following factors most likely would heighten an auditor's concern about the
risk of fraudulent financial reporting?
A. Inability to generate cash flows from operations while reporting substantial earnings growth
B. Management's lack of interest in increasing the entity's earnings trend
C. Large amounts of liquid assets that are easily converted into cash
D. Inability to borrow necessary capital without granting debt covenants
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 6
Learning Objective: 7
Learning Objective: 8
3-15
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43. A properly planned and performed audit may fail to detect a material misstatement resulting
from fraud because
A. Audit procedures that are effective for detecting an error may be ineffective for fraud that is
concealed through collusion
B. An audit is planned and performed to provide reasonable assurance of detecting material
misstatements caused by errors but not by fraud
C. The factors considered in assessing control risk indicated an increased risk of error but only
a low risk of fraud in the financial statements
D. The auditor did not consider factors influencing audit risk for account balances that have
effects pervasive to the financial statements taken as a whole
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 4
Learning Objective: 6
44. Which of the following is correct concerning SAS No. 99's requirements concerning auditor
communications about fraud?
A. Fraud that involves senior management should be reported directly by the auditor to the
audit committee regardless of the amount involved
B. Fraud with a material effect on the financial statements should be reported directly by the
auditor to the Securities and Exchange Commission
C. Any requirement to disclose fraud outside the entity is the responsibility of management and
not that of the auditor
D. The professional standards provide no requirements related to the communication of fraud,
but the auditor should use professional judgment in determining communication
responsibilities
AACSB: Communications
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 10
3-16
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45. Which of the following underly(ies) the application of generally accepted auditing
standards, particularly the standards of fieldwork and reporting?
A. The elements of materiality and audit risk
B. The element of internal control
C. The element of corroborating evidence
D. The element of reasonable assurance
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Decision Making
Difficulty: Hard
Learning Objective: 11
46. Which of the following statements is not correct about materiality?
A. The concept of materiality recognizes that some matters are important for fair presentation
of financial statements in conformity with GAAP, while other matters are not important
B. An auditor considers materiality for the aggregate level of misstatements that could be
material to any one of the financial statements
C. Materiality judgments are made in light of surrounding circumstances and necessarily
involve both quantitative and qualitative judgments
D. An auditor's consideration of materiality is influenced by the auditor's perception of the
needs of a reasonable person who will rely on the financial statements
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 11
Learning Objective: 12
3-17
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Short Answer Questions
47. What is the difference between audit risk and engagement risk?
Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion
on financial statements that are materially misstated. It can be directly controlled by the scope
of the auditor's test procedures. Engagement risk, on the other hand is the auditor's exposure to
loss or injury to professional practice from litigation, adverse publicity or other events arising in
connection with financial statements audited and reported on. It cannot be directly controlled by
the auditor, but some control can be exercised through the careful acceptance and continuance
of clients.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 1
48. You are teaching a class of new hires at your international accounting firm. Explain the
audit risk model using a mathematical formula.
AR = RMM X DR
AR = Audit risk
RMM = Risk of material misstatement
DR = Detection risk
Audit risk consists of
1) The risk that the balance or class and related assertions contain misstatements that could be
material to the financial statements when aggregated with misstatements in other balances or
classes. These risks exist independently of the audit.
2) The risk that the auditor will not detect such misstatements (detection risk). This risk can be
controlled by the auditor through the scope of the audit procedures performed.
AACSB: Communications
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 2
Learning Objective: 3
3-18
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49. Stacey, the partner in charge of the audit of RIF Enterprises, sets the planned level of audit
risk for the audit of accounts payable at .06. The risk of material misstatement is assessed at .65.
What is the detection risk for this audit and what is the significance determining that risk.
Substituting the values into the audit risk model, the detection risk is around 9%.
DR = AR / (RMM)
DR = .06/ .65
DR = 9.2%
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 2
Learning Objective: 3
50. Your classmate asserts, "Accountants shouldn't need to take business courses besides
accounting, because they are only interested in the financial statements of a company." Defend
or refute this statement.
The classmate is misguided. Auditors need to develop a deep understanding of business. Most
business concepts and risks have the potential to affect the financial statements either
immediately or in the long run. In addition, a thorough understanding of business risks
increases the likelihood of identifying material misstatements in the financial statements.
Therefore, an auditor should be familiar with a client's business environment for numerous
reasons, including evaluating the going concern assertion.
AACSB: Communications
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 5
Learning Objective: 6
3-19
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51. You are the senior on an audit of Two Be Gone, a large publicly held company. The
company recently completed an acquisition of its fifth largest competitor. What risks might this
present? As an auditor, what actions should you take related to this acquisition?
Student answers for the first question will vary. After identifying possible risks, the auditor
should determine which ones may result in material misstatements in the financial statements.
Once those are identified, the auditor should evaluate how those risk may impact financial
reporting and then design the audit to obtain evidence that addresses whether those risk have
adversely impacted financial reporting. If the entity does not respond adequately to business
risks that may affect financial reporting, the auditor will have to expanding audit tests to
determine if any misstatements are present in the related account balances or class of
transactions.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Hard
Learning Objective: 6
Learning Objective: 7
52. Define misstatements arising from fraudulent financial reporting and misstatements arising
from misappropriation of assets in one sentence each.
Misstatements arising from fraudulent financial reporting are intentional misstatements or
omissions of amounts or disclosures in financial statements intended to deceive financial
statement users. Misstatements arising from misappropriation of assets involve the theft of an
entity's assets where the theft causes the financial statements to be misstated.
AACSB: Communications
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 6
3-20
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53. DATRIX, Inc, a Fortune 500 company, has been experiencing poor performance. Industry
analysts have been issuing negative reports and the company's stock price has been steadily
declining. As an auditor, what would concern you about the audit engagement of DATRIX,
Inc.
An auditor should be concerned because of the apparent incentive the management of DATRIX
may have to commit financial statement fraud. For instance, the company's management may
be tempted to change accounting estimates or use other means to falsely increase the company's
book profits. The auditor should exercise professional skepticism in this engagement and
addresses carefully the risk of financial statement fraud.
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Risk Analysis
Difficulty: Moderate
Learning Objective: 6
54. During the course of the audit of FF Financial, you find that some accounting entries have
been altered. You believe this may be the result of management fraud and you have determined
that the effect of this could be material to the financial statements. What are appropriate steps to
take?
In this situation, the auditor should attempt to obtain audit evidence to determine whether
material fraud has occurred and, if so, its effect. The auditor should consider the implications
for other aspects of the audit. If fraud is found in one account, there are chances the auditor will
find fraud in other accounts, as well. The auditor needs to discuss the matter and the approach to
further investigation with an appropriate level of management that is at least one level above
those involved in committing the fraud and with senior managements. If appropriate, the
auditor could suggest that the client consult with legal counsel. If the results of the audit tests
indicate a significant risk of fraud, the auditor should consider withdrawing from the
engagement and communicating the reasons for withdrawal to the audit committee or others
with equivalent authority and responsibility.
AACSB: Communications
AICPA BB: Industry
AICPA FN: Decision Making
Difficulty: Moderate
Learning Objective: 10
Learning Objective: 8
Learning Objective: 9
3-21
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55. Often in an audit, total combined tolerable misstatement is greater than overall materiality.
Why does this make sense?
Answers may vary, but could include:
This makes sense for a number of reasons. First, not all accounts will be misstated by the full
amount of their tolerable misstatement allocation. In addition, audits of the individual accounts
are conducted simultaneously. If accounts were audited sequentially, unadjusted misstatements
observed during testing would count against materiality and theoretically the auditor could
carry the unused portion of materiality to the next account and so forth.
In addition, when control weaknesses or misstatements are identified in an account, the auditors
typically perform additional procedures in that and related, accounts. Thus, the actual testing
will often achieve a much smaller margin for misstatement than planned tolerable
misstatement.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Difficulty: Hard
Learning Objective: 11
Learning Objective: 12
56. Provide some examples of qualitative factors auditors would consider when determining
tolerable misstatement for an account.
Relevant qualitative factors include the size and complexity of the account, the importance of
changes in the account to key performance indicators, debt covenants and meeting published
forecasts or estimates.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Difficulty: Easy
Learning Objective: 12
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