Rodelyn C.

Amores Operation Audit Elective

BSA 3A

1. Criticize the following statement: "Throughout this audit, for all purposes, we will
define a 'material amount' as P500,000."
Answers: A set misstatement amount, like P500,000, can be a big deal for a small company but
not for a large one. Using just one number for materiality doesn't work because it doesn't
consider the company's size. Auditing rules say materiality needs to be judged based on the
specifics of each audit, including both the size and type of misstatement.

2. Suggest some factors that might cause an audit engagement to exceed the original
time estimate. Would the extra time be charged to the client?
Answer: Weak internal controls significantly increase the time required for an audit. Because
these controls are designed to prevent or detect misstatements, their weakness forces auditors
to rely more heavily on substantive testing. This means auditors must perform more extensive
testing of transactions and balances, often requiring larger sample sizes and more
time-consuming procedures like confirmations with external parties. The increased scrutiny and
investigation associated with weak controls further adds to the audit duration, as auditors must
thoroughly examine complex transactions and potentially uncover deeper organizational issues.
The overall audit strategy shifts towards a more substantive approach when controls are weak,
inherently demanding more time and resources. Furthermore, communication with management
regarding control deficiencies and their documentation consumes additional time. In short, weak
internal controls create a cascading effect, extending the audit timeline across all phases, from
planning and testing to communication and reporting, as auditors must dedicate more effort to
obtain sufficient evidence to support their opinion.

3. What problems are created for a CPA firm when audit staff members under report the
amount of the time spent in performing specific audit procedures?
Answer: Budgeting/Pricing Errors: Skews future job cost estimates, leading to potential
underbidding or lost bids.
Inaccurate Performance Reviews: Misrepresents staff efficiency, hindering development and
masking real issues.
Billing/Client Problems: Can result in underbilling or damaged client relationships if
discovered.
Insufficient Audit Work: Increases the risk of missed misstatements and potential legal issues.
Compliance Risks: Leads to poor documentation and potential regulatory sanctions.
Staff Morale/Ethics: Creates stress and ethical dilemmas, impacting morale and retention.
Hidden Inefficiencies: Prevents the firm from identifying and fixing process problems.
False Profitability: Distorts the firm's financial picture, leading to bad management decisions.
4. The overall audit strategy, the audit plan, and the time budget are three important
working papers prepared early in an audit. What functions do these working papers serve
in the auditors' compliance with generally accepted auditing standards? Discuss.
Answer: These three documents—the overall audit strategy, the audit plan, and the time
budget—are essential for a successful and compliant audit. The overall strategy sets the broad
scope and direction, ensuring the audit focuses on key areas. The audit plan details the specific
steps to be taken, linking them to assessed risks and ensuring sufficient evidence is gathered.
The time budget helps manage the audit's progress and resources, keeping it on track.
Collectively, these documents demonstrate proper planning and supervision, are directly tied to
risk assessment, guide the gathering of audit evidence, provide crucial documentation, and
support internal quality control, all of which are critical for complying with auditing standards.

5. When planning an audit, the auditors should assess the levels of risk and materiality for the
engagement. Explain how the auditors' judgments about these two factors affect the auditors'
planned audit procedures.
Answer: Materiality

●​ Lower Threshold: More audit work (larger samples, more detailed testing, lower
detection risk).
●​ Higher Threshold: Less audit work.

Risk of Material Misstatement (RMM):

●​ Higher RMM: More audit work (more extensive testing, more persuasive evidence,
earlier testing, greater skepticism).
●​ Lower RMM: Less audit work (but some testing is always required).

Risk and Materiality Combined:

●​ High RMM + Low Materiality: Most audit work.

●​ Low RMM + High Materiality: Least audit work (within acceptable limits).

6. Define the following terms: (a) performance materiality, (b) tolerable misstatement, (c)
clearly trivial.
Answer: (a) Performance Materiality:

Performance materiality is an amount set by the auditor at less than materiality for the financial
statements as a whole. It represents the amount the auditor is willing to accept for
misstatements in particular accounts or transactions. Essentially, it's a buffer. Auditors use
performance materiality to reduce the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the financial statements as a whole.1 It allows
for some wiggle room in individual accounts, recognizing that some misstatements are bound to
slip through the audit net.

(b) Tolerable Misstatement:

Tolerable misstatement is the maximum misstatement in a specific account balance or class of

transactions that the auditor is willing to accept without modifying their opinion. It's applied to
individual accounts or transaction classes. It's related to performance materiality, but it's applied
at the individual account level. The aggregate of all tolerable misstatements should generally
not exceed performance materiality.

(c) Clearly Trivial:

A clearly trivial matter is a misstatement or a group of misstatements that are so small that they
are clearly inconsequential, whether considered individually or in the aggregate and whether
judged by any criteria of size, nature, or circumstance. These misstatements are so insignificant
that they wouldn't influence the decisions of financial statement users. Auditors don't need to
correct clearly trivial matters, even if they are technically misstatements. They are, in essence,
"immaterial" without much further analysis.

7. Define the term misstatement and describe characteristics that would make a
misstatement Material.
Answers: A misstatement is a difference between what's reported in financial statements and
what should be there under accounting standards. It can be an omission, inclusion, incorrect
amount, improper disclosure, or inappropriate accounting principle. A misstatement is material if
it could influence a user's decisions. Materiality depends on the size (quantitative), nature
(qualitative), and circumstances. Even small misstatements can be material if they relate to
fraud, related parties, illegal acts, or affect trends or compliance. Context matters too; a
misstatement in a struggling company might be more material.

8. The audit report provides reasonable assurance that the financial statements are free
from material misstatements. The auditor is put in a difficult situation because materiality
is defines from a user's viewpoint, but the auditor must assess materiality in planning the
audit to ensure that sufficient audit work is performed to detect material misstatements.
a. Three major dimensions of materiality are (1) the peso magnitude of item, (2) the
nature
b. Once the auditor develops an assessment of materiality, can it change during the
course of the audit? Explain. If it does change, what is the implication of a change for
audit work that has already been completed? Explain.

Answer:
●​ Materiality: A crucial audit concept, defined from the user's perspective, but must be
considered by auditors throughout the audit process.
 ●​ Dimensions of Materiality: Includes the peso amount (quantitative), the nature of the
item (qualitative), and the surrounding circumstances.
●​ Changing Materiality: An auditor's assessment of materiality can change during the
audit due to new information, changes in the business, or changes in accounting
standards. This can require additional audit work.
●​ Inherent Risk: The risk of misstatement before considering internal controls. It must be
assessed before evaluating internal controls.
●​ Importance of Inherent Risk Assessment: Helps auditors understand vulnerable
areas, tailor control evaluations to the specific risks, and determine the acceptable level
of detection risk.

Implications of a Change in Materiality:

If the auditor's assessment of materiality changes, it can have significant implications for the
audit work already performed. If the materiality threshold is lowered (meaning smaller
misstatements are now considered material), the auditor may need to:

●​ Perform Additional Procedures: The auditor might need to increase the sample size or
perform more extensive testing to obtain sufficient appropriate audit evidence to address
the lower materiality threshold.
●​ Reassess the Risk of Material Misstatement: The change in materiality might indicate
a higher risk of material misstatement than initially assessed, requiring the auditor to
modify their overall audit strategy.
●​ Consider the Impact on the Audit Opinion: If the auditor concludes that the financial
statements are materially misstated, they will need to issue a qualified or adverse
opinion

9. How inherent risks of material misstatements related to internal controls? Why is it

important to assess inherent risks of material misstatement prior to evaluating the
quality of an organization's internal controls?
Answer:
Inherent Risk First: Always assess the risk of misstatement before looking at controls. This is
called "inherent risk."
Why Inherent Risk Matters:

●​ Know the Threats: Helps you understand where misstatements are most likely to
happen.
●​ Focus on Key Controls: Lets you concentrate on the most important controls.
●​ Plan the Rest of the Audit: Helps determine how much other audit work is needed.
10. Explain how concepts of audit risk and materiality are related. Must an auditor make a
decision on materiality in order to determine the appropriate level of audit risk?
Answer: Audit risk is the possibility an auditor will issue an incorrect opinion on financial
statements, while materiality is the level at which a misstatement becomes significant to users.
Materiality influences the assessment of audit risk because the auditor must first determine what
constitutes a material misstatement before evaluating the risk of not detecting one. Incorrectly
setting materiality, whether too high or too low, directly affects the auditor's judgment of audit
risk.

11. Brainstorming is a group discussion designed to encourage auditors to creatively

assess client risks, particularly those relevant to fraud.
a. When dose brainstorming typically occur?
b. Who attends the brainstorming session? Who leads it?
c. Besides encouraging auditors to creatively assess client risks, what other purpose
does brainstorming serve?
d. What are the guidelines that should be followed during a brainstorming session to
maximize effectiveness?
e. What are the typical steps in the brainstorming process?

Answer:
a. When does brainstorming typically occur?
It happens at the start of the audit.
b. Who attends and leads it?
The audit team attends, and the lead auditor or manager leads it.
c. What is the purpose of brainstorming?
It helps auditors identify potential risks and fraud.
d. Guidelines for brainstorming?
Encourage open sharing of ideas.
Avoid judgment during idea generation.
Involve everyone in the team.
e. Steps in brainstorming?
Prepare by gathering information.
Generate ideas.
Discuss risks.
Plan actions.
Follow-up during the audit.
Multiple Choice Questions
1. The concept of materiality will be least important to the CPA in determining the
a. scope of the audit of specific accounts.
b. specific transactions that should be reviewed.
c. effects of audit exceptions upon the opinion.
d. effects of the CPA's direct financial interest in a client upon his or her independence

2. Edison Corporation has a few large accounts receivable that total P1,400,000. Victor Corporation
has a great number of small accounts receivable that also total P1,400,000. The importance of a
misstatement in any one account is therefore greater for Edison than for Victor. This is an example
of the auditor's concept of
a. Materiality
b. Comparative analysis
c. Reasonable assurance
d. Relative risk

3. Which of the following elements ultimately determines the specific auditing procedures that are
necessary in the circumstances to afford a reasonable basis for an opinion?
a. Auditor judgment
b. Materiality
c. Inherent risk
d. Reasonable assurance

4. 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 PFRS, whereas other matters are not important.
b. An auditor considers materiality for planning purposes in terms of the largest 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.

5. Inherent risk and control risk differ from planned detection risk in that they
a. arise from the misapplication of auditing procedures.
b. may be assessed in wither quantitative or nonquantitative terms.
c. exist independently of the financial statement audit.
d. can be changed at the auditor's discretion.
​
6. In considering materiality for planning purposes, an auditor believes that misstatements
aggregating P10,000 would have a material effect on an entity's income statement but that
misstatements would have to aggregate P20,000 to materially affect the balance sheet. Ordinarily,
it would be appropriate to design auditing procedures that would be expected to detect
misstatements that aggregate.
a. P10,000
b. P15,000
c. P20,000
d. P30,000

7. In planning and performing an audit, auditors are concerned about risk factors for two distinct
types of fraud: fraudulent financial reporting and misappropriation of assets. Which of the
following is the risk factor for misappropriation of assets?
a. Generous performance-based compensation systems.
b. Management preoccupation with increased financial performance.
c. An unreliable accounting system.
d. Strained relationships between management and the auditors.

8. Which portion of an audit is least likely to be completed before the balance sheet date?
a. Test of controls
b. Issuance of an engagement letter
c. Substantive procedures
d. Assessment of control risk

9. Which of the following should the auditors obtain from the predecessor auditors before
accepting an audit engagement?
a. Analysis of balance sheet accounts.
b. Analysis of income statement accounts.
c. All matters of continuing accounting significance.
d. Facts that might bear in the integrity of management.

10. Which of the following items would typically not be included in an audit program?
a. A list of audit procedures to be performed.
b. An indication of who performed the procedure.
c. A work paper heading.
d. All of the above would typically be included in an audit program.

11. Which of the following statements describes a purpose of an audit program?

a. An audit program is used to specific the procedures to be performed in obtaining audit
evidence.
b. An audit program is used to record the completion of each audit step.
c. An audit program is useful for monitoring the progress of the audit.
d. All f the above statements describe the purpose of an audit program.

EXERCISE 1

○​ Inventory Increase (57.5%): Potential for obsolete stock. Auditor should analyze
turnover, observe inventory, test valuation, and analyze returns.​

○​ Accounts Payable Increase (68%): Possible cash flow issues. Auditor should
confirm payables, review cash flow projections, and investigate reasons for
increase.​

○​ Employee Turnover Increase (60%): Potential operational problems. Auditor

should review HR policies and assess impact on financial performance.​

○​ Debt-to-Equity Increase (71%): Increased financial risk. Auditor should review

loan agreements and assess debt repayment capacity.​

○​ Days to Collect Increase (33%): Potential collection issues. Auditor should review
credit policies, analyze receivables aging, and assess collectability.​

○​ Interrelationships: Auditor should consider how these areas relate to each other
(e.g., slow inventory turnover impacting cash flow and payables).​

○​ Materiality: Auditor should assess the significance of each change in relation to

the overall financial statements.​

○​ Skepticism: Auditor should maintain a questioning mind, critically evaluating

management explanations and corroborating evidence.​

○​

Interrelationships and Materiality:

The auditor should consider the interrelationships between these risk areas. For example, the
increase in inventory and days to collect could be connected, indicating broader issues with
sales and collections, which could contribute to cash flow problems and the increases in
accounts payable and debt. The auditor must also consider the materiality of each change in
relation to the financial statements as a whole. Even a large percentage change might not be
material if the absolute dollar amount is small.

Professional Skepticism:

The auditor should maintain a questioning mind throughout the audit, critically evaluating
management's explanations and corroborating their representations with sufficient and
appropriate audit evidence. This might involve performing more extensive testing, increasing
sample sizes, or obtaining independent confirmations. The auditor should be alert for
inconsistencies and consider the possibility of fraud. The auditor's overall objective is to obtain
reasonable assurance that the financial statements are free from material misstatement,
whether due to error or fraud.1

EXERCISE 2
Auditors make materiality judgments during the planning phase of the audit in order to be
sure they ultimately gather sufficient evidence during the audit to provide reasonable
assurance that the financial statements are free of material misstatements. The lower the
materiality threshold that an auditor has for an account balance, the more the evidence that
the auditor must collect. Auditors often use quantitative benchmarks such as 1% of total
assets or 5% of net income to determine whether misstatements materially affect the
financial statements, but ultimately it is an auditor's individual professional judgment as to
whether a given misstatement is or is not considered material.

a) Relationship between the level of riskiness of the client and the level of misstatement
considered material

The level of riskiness of a client plays a crucial role in determining the materiality threshold an
auditor sets for an account balance. When a client, like Client A, has weaker controls over
accounts receivable, it increases the risk of misstatement, making the client riskier compared to
Client B, who has stronger controls. As a result, the auditor would lower the materiality threshold
for Client A in order to account for this higher risk. A lower materiality threshold means that
even smaller misstatements are considered significant. Additionally, due to the increased risk of
errors or fraud in Client A’s accounts, the auditor will need to gather more audit evidence to
ensure the financial statements are free of material misstatements. In contrast, for Client B, who
is less risky, the auditor would have a higher materiality threshold and would need to collect less
audit evidence.

b) How might an auditor's individual characteristics affect their professional judgments about
materiality?

An auditor’s individual characteristics, such as experience, professional skepticism, personal

biases, and risk tolerance, can significantly influence their materiality judgments. Experienced
auditors are better able to assess risks and set appropriate materiality thresholds based on their
understanding of the client’s environment. A more skeptical auditor is likely to set a lower
materiality threshold, taking a more cautious approach to detect misstatements and requiring
more evidence to support their conclusions. On the other hand, personal biases might lead an
auditor to set thresholds that are either too lenient or too stringent, depending on their
perceptions of the client or industry. Lastly, an auditor's risk tolerance can also impact
materiality decisions. A more risk-tolerant auditor may set a higher threshold, accepting a higher
chance of overlooking small misstatements, while a risk-averse auditor would set a lower
threshold and require more evidence to reduce the chance of missing material misstatements.

c) Comparison of materiality judgment between a more and less skeptical auditor for Client A

When comparing a more skeptical auditor to a less skeptical one, the differences in their
materiality judgments for Client A are likely to be noticeable. A more skeptical auditor,
concerned about the higher risks due to weaker controls, would likely lower the materiality
threshold for Client A, believing that the potential for misstatements is greater. This auditor
would also require more audit evidence to be gathered in order to be confident that the
financial statements are free of material misstatements. In contrast, a less skeptical auditor
might set a higher materiality threshold for Client A, assuming that the risks are not
significant enough to warrant a conservative approach. This auditor may gather less
evidence, being less concerned about the possibility of misstatements. Ultimately, the more
skeptical auditor would take a more cautious and thorough approach, while the less
skeptical auditor would take a more relaxed stance on materiality and audit evidence.