Since 1977
AUDITING THEORY
AT.1809-Materiality and Risks
Concept of Materiality
The auditor is expected to design and conduct an audit
that provides reasonable assurance that material
misstatements will, whether due to fraud or error, be
detected.
The auditor is required to determine materiality for the
financial statements as a whole when establishing the
overall audit strategy, which is part of planning an audit.
In financial reporting, materiality is any information that
may influence user’s economic decisions. On the other
hand, materiality in audit is considered in terms of the
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smallest aggregate level of misstatements that could be
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considered material to any one of the statements that
comprise the financial statements.
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For any given client, materiality is not simply a function of
specific amounts in the financial statements. An auditor
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must understand who the potential users are and the type
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of judgments made by those users when relying on
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financial statements.
Application of Materiality
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Materiality is applied both in planning, performing and
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concluding on the audit. In particular, when:
 Identifying material classes of transactions, account
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balances and disclosures
 Determining the nature, timing and extent of risk
assessment procedures
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 Identifying and assessing the risks of material
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misstatement
 Determining the nature, timing and extent of further
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audit procedures (testing of controls and performing
substantive procedures)
 Evaluating the effect of uncorrected misstatements, if
any, on the financial statements and in forming the
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opinion in our audit report.
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Materiality Levels
The auditor establishes the following levels of materiality in
an audit of financial statements:
a. Materiality for the financial statements as a whole
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b. Materiality for particular classes of transactions,
account balances, or disclosures, if necessary
c. Performance materiality for (a) and (b) above
d. Clearly trivial materiality
Materiality for the Financial Statements as a whole
(a.k.a. Preliminary/Planning Materiality)
The auditor’s determination of materiality is a matter of
professional judgment, and is affected by the auditor’s
perception of the financial information needs of users of
the financial statements. The determination of materiality
is not a mechanical exercise, if fact, there is no specific
methodologies prescribed in the standard. However, a
percentage is often applied to a chosen benchmark as a
starting point to determine materiality. Qualitative
conditions should also be considered in determining
materiality.
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LECTURE NOTES
Benchmarks
Factors that may affect the identification of an appropriate
benchmark include:
 The elements of the financial statements (e.g., assets,
liabilities, equity, revenue, expenses)
 Whether there are items on which the attention of the
users of the particular entity’s FSs tends to be focused
 The nature of the entity, where the entity is in its life
cycle, and the industry and economic environment in
which the entity operates
 The entity’s ownership structure and the way it is
financed
 The relative volatility of the benchmark.
Profit before tax from continuing operations is often used
for profit-oriented entities.
Materiality for Particular Classes of Transactions,
Account Balances, or Disclosures
For certain entities, there may be one or more particular
classes of transactions, account balances, or disclosures
for which misstatements of lesser amounts than
materiality for the financial statements as a whole could
reasonably be expected to influence the economic
decisions of users taken on the basis of the financial
statements.
Factors that may indicate such classes of transactions,
account balances, or disclosures exist include the
following:
 Whether law, regulation or the applicable financial
reporting framework affect users’ expectations
regarding the measurement or disclosure of certain
items (e.g., related party transactions, and the
remuneration of management and those charged with
governance)
 The key disclosures in relation to the industry in which
the entity operates (e.g., research and development
costs for a pharmaceutical company)
 Whether attention is focused on a particular aspect of
the entity’s business that is separately disclosed in the
financial statements (e.g., a newly acquired business).
Performance Materiality (a.k.a. Tolerable
Misstatement)
Performance materiality is the amount or amounts set by
the auditor at less than materiality for the FSs as a whole
to reduce to an appropriately low level the probability that
the aggregate of uncorrected and undetected
misstatements exceeds materiality for the FSs as a whole,
i.e., to provide a cushion, so that if misstatements are
detected, the auditor may nevertheless be able to conclude
with reasonable assurance that the total misstatement in
the FSs does not exceed materiality.
The auditor is required to determine performance
materiality for purposes of:
 assessing the risks of material misstatement; and
 determining the nature, timing, and extent of further
audit procedures.
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If materiality level(s) have been set for particular classes
of transactions, account balances, or disclosures,
performance materiality also refers to amount(s) set at
less than these levels
Clearly trivial materiality
Clearly trivial materiality is the amount below which
misstatements would be clearly trivial and would not need
to be accumulated because such amounts clearly would
not have a material effect on the financial statements.
When there is any uncertainty about whether one or more
items are clearly trivial, the matter is considered not to be
clearly trivial.
Revision of Materiality
Materiality levels are not cast in stone once determined.
These may be adjusted, upward or downward, as
necessary as the audit progresses for example:
 Changes in entity’s circumstances
 New information
 Change in understanding of entity and its operations
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Documentation of Materiality
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The auditor shall document the following:
 Materiality for financial statements as a whole
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 Materiality level(s) for particular items
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 Performance materiality for the above
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 Revisions to the above as the audit progresses
Materiality and Audit Procedures
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The level of materiality has an inverse relationship on audit
procedures. The lower the materiality (performance
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materiality), the more extensive the required audit
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procedures to be able to gain reasonable assurance that
the class of transactions, account balance, or disclosure is
not materiality misstated.
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Identifying Material Classes of Transactions, Account
Balances and Disclosures
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The auditor, after determining materiality and gaining
sufficient understanding of the entity and its environment
including internal control, identifies material classes of
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transactions, account balances and disclosures from the
entity trial balance, list of accounts and notes to financial
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statements.
By identifying these items, the auditor focuses the audit
only on what is deemed material, thereby reduces its work
on what is determined not to be material.
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The auditor applies its professional judgment and should
consider both the account’s nature and amount,
quantitatively and qualitatively, in deciding whether an
account is material or not. Quantitative consideration may
involve comparison of an account’s amount with the
materiality previously determined. If an account’s amount
exceeds materiality, this may be considered material.
However, there are accounts that may not be
quantitatively material but may deemed material
qualitatively, such as those accounts involving accounting
estimates (e.g., allowance for doubtful accounts,
retirement obligations, etc.) or suspicious account
(miscellaneous accounts, related party transactions).
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Types of Risk
The four critical components of risk that will affect the
audit approach and audit outcome are:
1. Business Risk – the risk that affects the operations and
potential outcomes of the entity’s organizational
activities.
2. Financial Reporting Risk – the risk that relates to the
recording of transactions and the presentation of
financial data in an entity’s financial statements.
3. Audit Risk/Audit Engagement Risk – the risk that the
auditor may provide an unqualified opinion on financial
statements that are materially misstated.
4. Other Audit Engagement Risk – the risk auditors
encounter by being associated with a particular client:
loss of reputation, inability of the client to pay the
auditor, or financial loss because management is not
honest and inhibits the audit process.
Audit Risk and The Audit Risk Model
Audit risk is the risk (likelihood) that the auditor gives an
inappropriate audit opinion when the FSs are materially
misstated. Audit risk is a function of the risks of material
misstatement and detection risk [AR = f(ROMM x DR)].
Risks of Material Misstatement (ROMM)
The ROMM refers to the likelihood that the financial
statements are materiality misstated prior to the audit.
The ROMM may exist at two levels:
 The overall financial statement level; and
 The assertion level for classes of transactions, account
balances, and disclosures.
ROMM at the overall FSs level refer to risks of material
misstatement that relate pervasively to the FSs as a whole
and potentially affect many assertions.
ROMM at the assertion level are assessed in order to
determine the nature, timing, and extent of further audit
procedures (test of controls and substantive procedures)
necessary to obtain sufficient appropriate audit evidence.
The risks of material misstatement at the assertion level
consist of two components: inherent risk and control risk.
Therefore, at the assertion level, audit risk can be
expressed through this model AR = f(IR x CR x DR).
Inherent risk and control risk (if the auditor does not
intend to rely on the entity’s internal control, hence control
risk will be assessed as high) can be assessed through
risks assessment procedures. Control risk can also be
assessed by performing test of controls, i.e., if the auditor
intends to rely on effectiveness of the entity’s internal
control. In this case control is may be assessed as low if
the control are found effective, otherwise, it would still be
assessed as high. After assessing the levels of ROMM, the
auditor determines the acceptable level of detection risk.
Control Risk
Control risk is the risk that a misstatement that could
occur in an assertion about a class of transaction, account
balance or disclosure and that could be material, either
individually or when aggregated with other misstatements,
will not be prevented, or detected and corrected, on a
timely basis by the entity’s internal control.
Control risk is a function of the effectiveness of the design,
implementation and maintenance of internal control.
However, internal control, no matter how well designed
and operated, can only reduce, but not eliminate, risks of
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material misstatement in the financial statements, because
of the inherent limitations of internal control. Accordingly,
some control risk will always exist.
Inherent risk
Inherent risk is the susceptibility of an assertion about a
class of transaction, account balance or disclosure to a
misstatement that could be material, either individually or
when aggregated with other misstatements, before
consideration of any related controls (i.e., assuming that
there were no related internal controls.)
Inherent risk is higher for some assertions and related
classes of transactions, account balances, and disclosures
than for others. For example, it may be higher for complex
calculations or for accounts consisting of amounts derived
from accounting estimates that are subject to significant
estimation uncertainty. External circumstances giving rise
to business risks may also influence inherent risk. For
example, technological developments might make a
particular product obsolete, thereby causing inventory to
be more susceptible to overstatement.
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Inherent risk and control risk are the entity’s risks; they
exist independently of the audit of the financial
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statements. Normally, the auditor combines the
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assessment of inherent risk and control risk known as the
environment risk or combined risk assessment.
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Detection Risk
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Detection risk is the risk that the procedures performed by
the auditor to reduce audit risk to an acceptably low level
will not detect a misstatement that exists and that could
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be material, either individually or when aggregated with
other misstatements.
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For a given level of audit risk, the acceptable level of
detection risk bears an inverse relationship to the assessed
risks of material misstatement at the assertion level. The
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higher the assessed level of risk of material misstatement,
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the lower the detection risk the auditor sets, and vice
versa.
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Detection risk relates to the nature, timing, and extent of
the auditor’s procedures that are determined by the
auditor to reduce audit risk to an acceptably low level. It is
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therefore a function of the effectiveness of an audit
procedure and of its application by the auditor.
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Therefore, from the given relationship above, detection
risk cannot be set to zero (given that there is always risk
of material misstatement). This is also because of many
factors in audit such as sampling risk (remember, the
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Concept and Application of Materiality
1. In audit of financial statements, it is considered in
terms of the smallest aggregate level of misstatements
that could be considered material to any one of the
statements that comprise the financial statements,
while in financial reporting, it provides a threshold or
cutoff point rather than being a primary qualitative
characteristic which information must have if it is to be
useful
a. Materiality
b. Reliability
c. Relevance
d. Misstatement
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auditor does not examine the entire transactions and
account balances) and human error.
Limitations of Audit Risk Model
The audit risk model has the following limitations:
 Inherent risk is difficult to formally assess.
 Audit risk is judgmentally determined.
 The model treats each risk component as separate and
independent when in fact the components are not
independent.
 Audit technology is not so precisely developed that
each component of the model can be accurately
assessed.
Because of these limitations, many auditors use the audit
risk model as a functional one, rather than mathematical
model
Risks of Material Misstatements, Detection Risk and
Audit Procedures
The higher the assessed level of risk of material
misstatement, the lower the detection risk the auditor
sets, and vice versa. The lower the detection risk, the
more rigorous (nature, timing and extent) the substantive
audit procedures should be performed, and vice versa.
In summary:
Substantive Assessed level of Assessed level of
Audit procedures ROMM is high ROMM is low
Nature More effective Less effective
Timing At year end At interim dates
Extent More extensive Less extensive
Audit Risk and Materiality
There is an inverse relationship between materiality and
the level of audit risk, i.e., the higher the materiality, the
lower the audit risk, and vice versa. The auditor takes the
inverse relationship between materiality and audit risk into
account when determining the nature, timing and extent of
audit procedures.
Materiality and Audit Evidence
Materiality and audit evidence are inversely related. The
lower the level of materiality the auditor determines, the
more audit evidence must be obtained (and vice versa) in
order to gain more confidence (assurance) that the item is
not materiality misstated.
- done -
MULTIPLE CHOICE
2. In considering materiality for planning purposes, an
auditor believes that misstatements aggregating
P100,000 would have a material effect on an entity’s
income statement, but that misstatements would have
to aggregate P200,000 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. P100,000
b. P150,000
c. P200,000
d. P300,000
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3. The preliminary judgment about materiality is the
_________ amount by which the auditor believes the
statements could be misstated and still not affect the
decisions of reasonable users.
a. Minimum
b. Maximum
c. Mean average
d. Median average
4. Auditors are _____ to decide on the combined amount
of misstatements in the financial statements that they
would consider material early in the audit.
a. Permitted
b. Required
c. Not allowed
d. Strongly encouraged
5. Financial reporting frameworks often discuss the
concept of materiality in the context of the preparation
and presentation of financial statements. Although
financial reporting frameworks may discuss materiality
in different terms, they generally explain that
a. Misstatements, including omissions, are considered
to be material if they, individually or in the
aggregate, could reasonably be expected to
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influence the economic decisions of users taken on
the basis of the financial statements
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b. Judgments about materiality are made in the light
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of surrounding circumstances, and are affected by
the size or nature of a misstatement, or a
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combination of both
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c. Judgments about matters that are material to
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users of the financial statements are based on a
consideration of the common financial information
needs of users as a group. The possible effect of
misstatements on specific individual users, whose
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needs may vary widely, is not considered.
d. All of the above
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6. Only the amount of misstatements need to be
considered in assessing materiality.
Both the amount and nature of misstatements need to
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be considered in assessing materiality.
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a. True, True c. False, False
b. False, True d. True, False
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FSs Level Materiality
7. Which of the following is not true about materiality
judgment?
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a. The auditor’s consideration of materiality is
influenced by the auditor’s perception of the needs
(importance) of users of financial statements.
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b. The auditor considers materiality only in relation to
classes of transactions, account balances, and
disclosures.
c. Materiality judgments make sure that the auditor
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gathers sufficient evidential matter to obtain
reasonable assurance about whether the financial
statements are free of material misstatement.
d. Materiality decisions differ from one audit client to
another.
8. Determining a materiality level for the financial
statements as a whole requires the exercise of
professional judgment. A percentage is often applied to
a chosen benchmark as a starting point in that
determination. Factors that may affect the
identification of an appropriate benchmark include the
following:
a. The elements of the financial statements (e.g.,
assets, liabilities, equity, income, expenses)
b. Whether there are items on which the attention of
the users of the particular entity’s financial
statements tends to be focused (e.g., for the
purpose of evaluating financial performance users
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may tend to focus on profit, revenue or net
assets);
c. The nature of the entity, where the entity is at in
its life cycle, and the industry and economic
environment in which the entity operates;
d. All of the above
9. Which of the following would an auditor most likely use
in determining the auditor’s preliminary judgment
about materiality?
a. The anticipated sample size of the planned
substantive tests
b. The entity’s annual financial statements
c. The results of the internal control questionnaire
d. The contents of the management representation
letter
10. Which of the following is least likely to be appropriate
as the basis for determining the preliminary judgment
about materiality in the audit of financial statements?
a. Net income before taxes
b. Current assets
c. Owners’ equity
d. Inventory
11. Why do auditors establish a preliminary judgment
about materiality?
a. To determine the appropriate level of audit
experience required for the work.
b. So that the client can know what records to make
available to the auditor.
c. To plan the appropriate audit evidence to
accumulate and develop an overall audit
strategy.
d. To finalize the assessment of control risk.
Performance Materiality/Tolerable Misstatement
12. Materiality should be considered by the auditor when
a. Determining the nature, timing and extent of
auditor’s further procedures
b. Identifying and assessing the risks of material
misstatements
c. Both a and b
d. Neither a nor b
13. When auditors allocate the preliminary judgment about
materiality to account balances, the materiality
allocated to any given account balance is referred to
as:
a. The materiality range
b. The error range
c. Tolerable materiality
d. Tolerable misstatement
14. Auditors commonly allocate materiality to balance
sheet accounts rather than income statement accounts
because most income statement misstatements have
a(n) _____ effect on the balance sheet.
a. Reduced
b. Equal
c. Undetermined
d. Increased
Revision and Documentation of Materiality
15. The materiality level for the financial statements as a
whole (or the materiality level for a particular class of
transactions, account balance or disclosure, if
applicable) may need to be revised (adjusted either
downward or upward) as a result of the following
a. a change in circumstances that occurred during the
audit
b. new information
c. a change in the auditor’s understanding of the
entity and its operations as a result of performing
further audit procedures.
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d. all of the above c. Detection risk.

d. Both A and C.
16. Under which of the following conditions would you
consider lowering individual item materiality 23. Which of the following statements is not true regarding
thresholds. audit risk assessment?
a. Study of the business and industry, together with a. The auditor studies the business and industry and
the application of analytical procedures, reveals applies analytical procedures as a basis for
that the client has enjoyed a surge in sales and assessing inherent risk.
gross profit during an industry downturn. b. When control risk and inherent risk are high, the
b. Application of analytical procedures shows that the auditor increases detection risk to maintain overall
client's gross profit rate is significantly below last audit risk at the desired level.
year and also is materially lower than the industry c. The auditor studies and evaluates internal control
average. policies and procedures for assessing control risk.
c. Study of internal controls within the revenue cycle d. The auditor designs substantive audit procedures
reveal material weaknesses. to reduce detection risk to an acceptable level.
d. Study of internal controls within the payroll cycle
24. Which of the following audit risk components may be
confirm the auditor's belief that few errors have
assessed in nonquantitative terms?
occurred.
Control risk Detection risk Inherent risk
17. Auditing standards _____ that the basis used to a. Yes Yes Yes
determine the preliminary judgment about materiality b. No Yes Yes
be documented in the audit files. c. Yes Yes No
a. Permit d. Yes No Yes
b. Do not allow
25. Assume that control risk = 0.70, inherent risk = 0.80,
c. Require

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and audit risk = 0.05. If a material misstatement

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d. Strongly encourage
occurred and was not corrected by the auditee’s

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Relationships to Materiality internal controls, what is the risk that the

materiality, then the auditor will:

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18. If an auditor establishes a relatively high level for misstatement would not be detected by the audit
procedures?

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a. accumulate more evidence than if a lower level had a. 0.02
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been set. b. 0.07
b. accumulate less evidence than if a lower level had c. 0.09
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been set. d. 0.50

c. accumulate approximately the same evidence as
26. Which of the following best describes the relationship
would be the case were materiality lower.
between IR, CR, and DR?
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d. accumulate an undetermined amount of evidence.

a. DR does not vary from one assertion to another.
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19. Which of the following statements concerning b. IR, CR, and DR vary from assertion to assertion.
materiality thresholds is incorrect? c. IR and CR do not vary from assertion to assertion,
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a. Aggregate materiality thresholds are a function of but DR does vary from assertion to assertion.
the auditor's preliminary judgments concerning d. When IR increases, DR decreases.
audit risk.
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27. Which of the following statements is not true?

b. In general, the more misstatements the auditor
a. Inherent risk is inversely related to detection risk.
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expects, the higher should be the aggregate

b. Inherent risk is inversely related to evidence.
materiality threshold.
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c. Inherent risk is the susceptibility of the financial

c. The smallest aggregate level of errors or fraud that
statements to material error, assuming no internal
could be considered material to any one of the
controls.
financial statements is referred to as a "materiality
d. Inherent risk is the auditor’s assessment of the
threshold."
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likelihood that errors exceeding a tolerable amount

d. Materiality thresholds may change between the
exist in a segment before considering the
planning and review stages of the audit. These
effectiveness of internal controls.
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changes may be due to quantitative and/or

qualitative factors. 28. Inherent risk is often low for an account such as:
a. inventory.
20. Why should the auditor plan more work on individual
b. marketable securities.
accounts as lower acceptable levels of both audit risk
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c. cash.
and materiality are established?
d. accounts receivable.
a. To find smaller errors.
b. To find larger errors. 29. Audit risk consists of inherent risk, control risk, and
c. To increase the tolerable error in the accounts. detection risk. Which of the following statements is
d. To decrease the risk of overreliance. true?
a. Cash is more susceptible to theft than an inventory
Risks of coal because it has a greater inherent risk.
21. In the audit risk model, which of the risk components b. The risk that material misstatement will not be
can be assessed by the auditor? prevented or detected on a timely basis by internal
a. Inherent risk. control can be reduced to zero by effective
b. Control risk. controls.
c. Detection risk. c. Detection risk is a function of the efficiency of an
d. Both A and B. auditing procedure.
d. The existing levels of inherent risk, control risk,
22. In the audit risk model, its risk components are either
and detection risk can be changed at the discretion
determined, assessed, or manipulated. Which of the
of the auditor.
following risks are controllable by the auditor?
a. Audit risk. 30. Inherent risk and control risk differ from detection risk
b. Control risk. in that inherent risk and control risk
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a. arise from the misapplication of auditing internal control systems.

procedures
b. may be assessed in either quantitative or
nonquantitative terms
c. exist independently of the financial statement audit
d. can be changed at the auditor’s discretion
31. Which of the following is an incorrect statement?
a. Detection risk cannot be changed at the auditor’s
discretion
b. Detection risk bears an inverse relationship to
inherent and control risks
c. The greater the inherent and control risks the
auditor believes exists, the less detection risk that
can be accepted
d. The auditor might separate or combined
assessments of inherent risk and control risk
32. When discussing control risk (CR) and the audit risk
model, which of the following is false?
a. CR is a measure of the auditor’s assessment of the
likelihood that misstatements will not be prevented
or detected by internal control.
b. If the auditor concludes that internal control is
completely ineffective to prevent or detect errors,
c. The risk that an auditor's substantive procedures
will not detect a misstatement that exists in an
account balance or class of transactions that could
be material, individually or when aggregated with
misstatements in other balances or classes.
d. The susceptibility of an account balance or class of
transactions to misstatement that could be
material, individually or when aggregated with
misstatements in other balances of classes,
assuming that there were no related internal
controls.
34. Which is a primary limitation of the audit risk model?
a. The audit risk model does not adequately consider
external forces on the client organization.
b. Components of audit risk are treated as
independent variables even though many
interdependencies exist between them.
c. The audit technology achieves approximate
precision outside of a mathematical model.
d. Control risk must be adjusted at the hands of the
auditor, not by an arbitrary estimation.
35. Which of the following statements is true with regard

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he/she would assign a low value (e.g., 0%) to CR. to the relationship among audit risk, audit evidence,
c. The relationship between control risk and detection and materiality?

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risk is inverse. eH w a. The lower the inherent risk and control risk, the
d. The relationship between control risk and evidence lower the aggregate materiality threshold.
needed to support account balances is direct. b. Under conditions of high inherent and control risk,

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the auditor should place more emphasis on
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33. Detection risk is
obtaining external evidence and should reduce
a. The risk that the auditor gives an inappropriate
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reliance on internal evidence.

audit opinion when the financial statements are
c. Where inherent risk is high and control risk is low,
materially misstated.
the auditor may safely ignore inherent risk.
b. The risk that a misstatement, that could occur in
d. Aggregate materiality thresholds should not
an account balance or class of transactions and
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change under conditions of changing risk levels.

that could be material individually or when
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aggregated with misstatements in other balances

- now do the DIY drill -
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or classes, will not be prevented or detected and

corrected on a timely basis by the accounting and
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DO-IT-YOURSELF (DIY) DRILL

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1. The probability of an auditor's procedures leading to detailed review

the conclusion that a material error does not exist in
4. Materiality is:
an account balance when, in fact, such error does exist
a. Addressed within a practitioner’s audit and other
is referred to as
assurance reports
a. Prevention risk.
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b. Expressed only in terms of pesos

b. Inherent risk.
c. Measured using guidelines established by PICPA
c. Control risk.
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d. Not applicable to assurance engagements

d. Detection risk.
5. Materiality thresholds for accounting errors should be
2. When discussing control risk (CR) and the audit risk established for each financial statement element.
model, which of the following is false? However, they
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a. CR is a measure of the auditor’s assessment of the a. Must require correction of accounting errors in the
likelihood that misstatements will not be prevented subsequent year’s records.
or detected by internal control. b. Lead to rejection of financial statements found with
b. If the auditor concludes that internal control is unrecorded accounting records.
completely ineffective to prevent or detect errors, c. Tend to hamper objectivity of auditor’s judgment
he/she would assign a low value (e.g., 0%) to CR. concerning severity of errors.
c. The relationship between control risk and detection d. Must be established prior to execution of audit
risk is inverse. procedures.
d. The relationship between control risk and evidence
needed to support account balances is direct. 6. Since materiality is relative, it is necessary to have
bases for establishing whether misstatements are
3. Materiality is least important to an external auditor in material. Normally, the most common base for
determining the: deciding materiality is:
a. Effect on independence of his direct financial a. Net income before taxes
interest in the client b. Net working capital
b. Extent of his audit of certain accounts c. Net income after taxes
c. Effects of exceptions upon his opinion in the audit d. Total assets
report
d. Specific transactions which should require a

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 EXCEL PROFESSIONAL SERVICES, INC.

7. Which of the following elements of the audit risk model a. Balance sheet only.
is most likely to be the same across a range of audits b. Income statement only.
performed by a professional accounting firm? c. Income statement and balance sheet.
a. Audit risk d. Statement of cash flows.
b. Control risk
c. Detection risk 15. Engagement risk has been defined as the risk of
d. Inherent risk potential losses that are incurred by the auditor in
being associated with a particular client. Which of the
8. Which of the following statements is not correct?
following factors are not associated with increased
a. Materiality is a relative rather than an absolute
engagement risk for the auditor?
concept.
a. Management with questionable integrity.
b. The most important base used as the criterion for
b. A failed company.
deciding materiality is total assets.
c. Materially misstated financial statements.
c. Qualitative factors as well as quantitative factors
d. All of these factors increase engagement risk.
affect materiality.
d. Given equal amounts, frauds are usually 16. In implementing the audit risk model, which of the
considered more important than errors. following is not a limitation of the model that makes its
implementation difficult?
9. The preliminary judgment about materiality and the
a. Inherent risk is difficult to formally assess.
amount of audit evidence accumulated are _____
b. Audit risk is objectively determined.
related.
c. The model treats each risk component as separate
a. Directly
and independent.
b. Indirectly
d. Audit technology is not precisely developed in
c. Not
assessing each component.
d. Inversely

m
er as
17. Residual risk is defined as
10. Which of the following statements is correct concerning
a. susceptibility of a transaction or accounting

co
the concept of materiality?
eH w adjustment to be recorded in error, or for the
a. Materiality is determined by reference to PICPA
transaction not to be recorded in the absence of
guidelines
internal controls.

o.
b. Materiality depends only on the peso amounts of
b. the risk that the client’s internal controls system
rs e
an item relative to other items in the financial
will fail to prevent or detect a misstatement.
statements
ou urc

c. the risk left in an account balance after application

c. Materiality depends on the nature of an item rather
of internal controls.
than the peso amount
d. risk that the audit procedures will fail to detect a
d. Materiality is a matter of professional judgment
material misstatement.
o

11. In determining audit risk, the auditor decides how

18. Madison Corporation has a few large accounts
aC s

much risk will be taken on by the firm. Which of the

receivable that total P1,000,000. Nass Corporation
following is correct regarding this decision by the
vi re

has a greater number of small accounts receivable that

auditor?
also total P1,000,000. The importance of an error in
a. The auditor may decide to intentionally render an
any one account is, therefore, greater for Madison than
inappropriate opinion.
y

for Nass. This is an example of the auditor’s concept

b. The auditor may decide not to take the audit
of
ed d

engagement.
a. Materiality
c. The auditor may decide to accept audit risk at
ar stu

b. Comparative analysis
100%.
c. Relative risk
d. The auditor may decide that engagement risk is an
d. Reasonable assurance
appropriate measure of audit risk.
19. Regardless of how the preliminary judgment about
is

12. Auditors frequently refer to the terms audit assurance,

overall assurance, and level of assurance to refer to materiality is allocated, the auditor must be confident
________. that total combined misstatements in all accounts are:
Th

a. detection risk a. Less than the preliminary judgment.

b. audit report risk b. Equal to the preliminary judgment.
c. acceptable audit risk c. More than the preliminary judgment.
d. inherent risk d. Less than or equal to the preliminary judgment.
sh

13. Inherent risk is _______ related to detection risk and 20. What is the primary difference between financial
_______ related to the amount of audit evidence. reporting risk and audit risk?
a. directly, inversely a. The application of accounting principles.
b. directly, directly b. Responsibilities of the respective parties involved.
c. inversely, inversely c. Demands of users of financial statements.
d. inversely, directly d. Risks of being sued by third parties.
14. Auditors generally allocate the preliminary judgment
about materiality to the:  - end of AT.1809 - 

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