Ch 9 Solution

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Chapter 9 - Materiality and Risk

← Multiple Choice Questions From CPA Examinations

9-22a.(4)b.(4)

9-23a.(1)b.(1)c.(1)

9-24a.(2)b.(3)c.(1)

9-25a.The justification for a lower preliminary judgment about materiality for overstatements is directly related to legal liability and audit risk. Most auditors believe they have a greater legal and professional responsibility to discover overstatements of owners' equity than understatements because users are likely to be more critical of overstatements. That does not imply there is no responsibility for understatements. b.There are two reasons for permitting the sum of tolerable misstatements to exceed overall materiality. First, it is unlikely that all accounts will be misstated by the full amount of tolerable misstatement. Second, some accounts are likely to be overstated while others are likely to be understated, resulting in net misstatement that is likely to be less than overall materiality. c.This results because of the estimate of sampling error for each account. For example, the likely estimate of accounts receivable is an understatement of $7,500 + or - a sampling error of $11,500. You would be most concerned about understatement for accounts receivable because the estimated understatement of $19,000 exceeds the tolerable misstatement of $18,000 for that account. d.You would be most concerned about understatement amounts since the total estimated understatement amount ($30,000) exceeds the preliminary judgment about materiality for understatements ($20,000). You would be most concerned about accounts receivable given that the total misstatement for that account exceeds tolerable misstatement for understatement.

e.

1.This may occur because total tolerable misstatement was allowed to exceed the preliminary judgment (see Part b for explanation). 2.The auditor must determine whether the actual total overstatement amount actually exceeds the preliminary judgment by performing expanded audit tests or by requiring the client to make an adjustment for estimated misstatements.

9-26a.The profession has not established clear-cut guidelines as to the appropriate preliminary estimates of materiality. These are matters of the auditor's professional judgment. To illustrate, the application of the illustrative materiality guidelines shown in Figure 9-2 (page 235), are used for the problem. Other guidelines may be equally acceptable.

|STATEMENT COMPONENT |PERCENT GUIDELINES |DOLLAR RANGE | | | |(IN MILLIONS) | |Earnings from continuing | | | |operations before taxes |5 - 10% |$20.9 - $ 41.8 | |Current assets |5 - 10% |$112.7 - $225.4 | |Current liabilities |5 - 10% |$ 60.7 - $121.5 | |Total assets |3 - 6% |$115.8 - $231.6 |

b.The allocation to the individual accounts is not shown. The difficulty of the allocation is far more important than the actual allocation. There are several ways the allocation could be done. The most likely way would be to allocate only on the basis of the balance sheet rather than the income statement. Even then the allocation could vary significantly. One way would be to allocate the same amount to each of the balance sheet accounts on the consolidated statement of financial position. Using a materiality limit of $21,000,000 before taxes (because it is the most restrictive) and the same dollar allocation to each account excluding retained...
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