Which of the following is the most important qualitative factor that auditors should consider when making materiality judgments?
Audit Risk and Materiality in Conducting an Audit: Auditing Interpretations of Section 312A
1. The Meaning of the Term Misstatement Show
.01Question—Section 312A, Audit Risk and Materiality in Conducting an Audit, paragraph .04, states that financial statements would be considered materially misstated if "they contain misstatements whose effect, individually or in the aggregate, is important enough to cause them not to be presented fairly, in all material respects, in conformity with generally accepted accounting principles." Section 312A.04 also states that misstatements can result from errors or fraud. The term misstatement is used throughout generally accepted auditing standards; however, this term is not defined. What is the meaning of the term misstatement? .02Interpretation—In the absence of materiality considerations, a misstatement causes the financial statements not to be in conformity with generally accepted accounting principles. fn 1 A misstatement may consist of any of the following:
.03Misstatements may be of two types: known and likely. Section 312A.35 refers to known misstatements as "the amount of
misstatements specifically identified." For example, the failure to accrue an unpaid invoice for goods received or services rendered prior to the end of the period presented would be a known misstatement. Section 312A.35 refers to likely misstatements as "the auditor's best estimate of the total misstatements in the account balances or classes of transactions…." Likely misstatements may be identified when an auditor performs analytical or sampling procedures. For example, if an auditor applies
sampling procedures to a certain class of transactions that identify a known misstatement in the items sampled, the auditor will then determine the likely misstatement by projecting the known difference identified in the sample to the total population tested. With regard to analytical procedures, section 312A.35 states, in part—
.04Likely misstatements also are associated
with accounting estimates. Section 312A.36 states, in part—
[Issue Date: December, 2000.] 2. Evaluating Differences in Estimates .05Question—Section 312A.36 states, in part—
With respect to an estimate, what should the auditor consider in determining the amount of the likely misstatements to be aggregated? .06Interpretation—In determining the amount of the likely misstatements to be aggregated, the auditor considers the "closest reasonable estimate" which may be a range of acceptable amounts or a point estimate, if that is a better estimate than any other amount. .07In some cases the auditor may use a method that produces a range of acceptable amounts to determine the reasonableness of amounts recorded. For example, the auditor's analysis of specific problem accounts receivable and recent trends in bad-debt write-offs as a percent of sales may cause the auditor to conclude that the allowance for doubtful accounts should be between $130,000 and $160,000. If management's recorded estimate falls within that range, the auditor ordinarily would conclude that the recorded amount is reasonable and no difference would be aggregated. If management's recorded estimate falls outside the auditor's range of acceptable amounts, the difference between the recorded amount and the amount at the closest end of the auditor's range would be aggregated as a misstatement. For example, if management has recorded $110,000 as the allowance, the amount by which the recorded estimate falls outside the range ($20,000) is aggregated as a misstatement. .08In other cases the auditor may determine that a point estimate is a better estimate than any other amount. In those situations, the auditor would use that amount to determine the reasonableness of the recorded amount. The auditor would compare the point estimate to the amount recorded by the client and include any difference in the aggregation of misstatements. fn 2 .09Section 312A.36 indicates that the auditor should be alert to the possibility that management's recorded estimates are clustered at either end of the auditor's range of acceptable amounts, indicating a possible bias on the part of management. Section 312A.36 states, in part—
In these circumstances, the auditor should reconsider whether other recorded estimates reflect a similar bias and should perform additional audit procedures that address those estimates. In addition, the auditor should be alert to the possibility that management's recorded estimates were clustered at one end of the range of acceptable amounts in the preceding year and clustered at the other end of the range of acceptable amounts in the current year, thus indicating the possibility that management is using swings in accounting estimates to offset higher or lower than expected earnings. If the auditor believes that such circumstances exist, the auditor should consider whether these matters should be communicated to the entity's audit committee, as described in section 380, Communication With Audit Committees, paragraphs .08 and .11. [Issue Date: December, 2000.] 3. Quantitative Measures of Materiality in Evaluating Audit Findings .10Question—Section 312A, Audit Risk and Materiality in Conducting an Audit, provides guidance to the auditor on evaluating the effect of misstatements on the financial statements under audit. Section 312A.10 states, in part—
Section 312A.34 further describes the auditor's evaluation of the quantitative aspects of materiality. It states, in part—
What factors should the auditor consider in assessing the quantitative impact of identified misstatements? .11Interpretation—The quantitative evaluation of identified misstatements is a matter of professional judgment and should reflect a measure of materiality that is based on the element or elements of the financial statements that, in the auditor's judgment, are expected to affect the judgment of a reasonable person who will rely on the financial statements, considering the nature of the reporting entity. For example, it is generally recognized that after-tax income from continuing operations is, in most circumstances, the measure of greatest significance to the financial statement users of entities whose debt or equity securities are publicly traded. Depending on the entity's particular circumstances, other elements of the financial statements that may be useful in making a quantitative assessment of the materiality of identified misstatements include current assets, net working capital, total assets, total revenues, gross profit, total equity, and cash flows from operations. In all instances, the element or elements selected should reflect, in the auditor's judgment, the measures most likely to be considered important by the financial statement users. .12Question—An entity's after-tax income or loss from continuing operations may be nominal or may fluctuate widely from year to year due to the inclusion in the results of operations of significant, unusual, or infrequently occurring income or expense items. What other quantitative measures could be considered if after-tax income or loss from continuing operations is nominal or fluctuates widely from period to period? .13Interpretation—In certain circumstances, a quantitative measure of materiality based on after-tax income from continuing operations may not be appropriate. The auditor may identify another element or elements that are appropriate in the circumstances or may compute an amount of current-year after-tax income from continuing operations adjusted to exclude unusual or infrequently occurring items of income or expense. fn 3 .14The selection of an alternate element or elements for use in assessing a quantitative measure of materiality is a matter of the auditor's professional judgment. In choosing an alternate element or elements, the auditor should evaluate the perceived needs of the financial statement users, the particular circumstances that caused the abnormal results for the current year, the likelihood of their recurrence, and any other matters that, in the auditor's judgment, may be relevant to a quantitative assessment of materiality. [Issue Date: December, 2000.] 4. Considering the Qualitative Characteristics of Misstatements .15Question—Section 312A, Audit Risk and Materiality in Conducting an Audit, paragraph .34, states,
in part—
What qualitative factors should the auditor consider in assessing whether misstatements are material? .16Interpretation—Section 312A.10 states that the auditor's consideration of materiality is a matter of professional judgment and is influenced by his or her perception of the needs of a reasonable
person. Section 312A.11 states—
Section 508, Reports on Audited Financial Statements, paragraph .36, states that the significance of an item to a particular entity (for example, inventories to a manufacturing company), the pervasiveness of the misstatement (such as whether it affects the amounts and presentation of numerous financial statement items), and the effect of the misstatement on the financial statements taken as a whole are all factors to be considered in making a judgment regarding materiality. Section 312A.10 also makes reference to the discussion of materiality in Financial Accounting Standards Board Statement of Financial Accounting Concepts No. 2, Qualitative Characteristics of Accounting Information. FASB Concepts Statement No. 2, paragraphs 123 through 132, includes a discussion about matters that might affect a materiality judgment. .17The auditor considers relevant qualitative factors in his or her qualitative considerations. Qualitative factors the auditor may consider relevant to his or her consideration include the following:
[Issue Date: December, 2000.] Which of the following is a qualitative factor we consider when establishing materiality?Qualitative factors to consider in the auditor's evaluation of the materiality of uncorrected misstatements, if relevant, include the following: The potential effect of the misstatement on trends, especially trends in profitability. A misstatement that changes a loss into income or vice versa.
Which of the following is a qualitative factor affecting the materiality of an audit?Answer: Qualitative factors that affect an auditor's materiality judgment include: Amounts involving fraud. Amounts involving fraud are usually considered more important than unintentional errors of equal dollar amounts because fraud reflects on the honesty and reliability of the management or other personnel involved.
What are the factors that should be considered in a materiality determination?How do auditors determine materiality? To establish a level of materiality, auditors rely on rules of thumb and professional judgment. They also consider the amount and type of misstatement. The materiality threshold is typically stated as a general percentage of a specific financial statement line item.
What are the qualitative and quantitative factors of determining materiality?Quantitative consideration is simply about the relative size of the items in the financial statements. On the other hand, qualitative factors usually include the nature of information, the circumstance and possible cumulative effects of error or omission of such information.
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