Luke Cason

Dr. Shapeero
Acct. 342-02
Chapter 7 Homework

7.29 – Define the term misstatement and describe characteristics that would make a misstatement
material.
An error, either intentional or unintentional, that exists in a transaction or financial statement account
balance. Characteristics of a misstatement that would be material depends on the audit client, because
what could be material to one client may not be material to another. Materiality is a matter of
professional judgment, depends on the needs of a reasonable person relying on the financial
information, and involve both quantitative and qualitative considerations.

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7.32 – The SEC is concerned that auditors recognize the qualitative aspect of materiality judgments.

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Explain what the qualitative aspect of materiality means. List some factors that would result in a

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quantitatively small misstatement being judged as qualitatively material.

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The qualitative aspect of materiality means that there is a reason for a misstatement, and that reason

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could be intentional or unintentional. It is the auditors’ job to figure out whether or not the
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misstatement was purposely made or not. Some factors that would result in a quantitatively small
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misstatement being judged as qualitatively material would be:
 An item capable of precise measurement or arises form an estimate and, if so, the degree of
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imprecision inherent in the estimate.

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 Masks a change in earnings or other trends

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 Hides a failure to meet analysts’ consensus expectations for the enterprise

 Changes a loss into income or vice versa
 Affects compliance with regulatory requirements
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7.35 – a. Define materiality as used in accounting and auditing, particularly emphasizing the
differences that exist between the FASB and U.S. Supreme Court materiality definitions.
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FASB Materiality – the magnitude of an omission or misstatement of accounting information that, in

light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying
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on the information would have been changed or influenced by the omission or misstatement.
U.S. Supreme Court Materiality – a fact is material if there is a substantial likelihood that the fact would
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have been viewed by the reasonable investor as having significantly altered the total mix of information
made available.
b. Three major dimensions of materiality are the dollar magnitude of the item, the nature of the item
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under consideration, and the perspective of a particular user. Give an example of each.
Dollar magnitude of the item – If misstatements in the income statement total $50,000, which is
considered material for this business.

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 The nature of the item under consideration – If a piece of equipment that is used in the everyday course
of business operations has been stolen is considered material.
Perspective of a particular user – The auditor gives a professional judgment to the business/company
and can deem one item material to a company and the same item not material to a different company.
c. 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.
The assessment of materiality can change during the course of an audit, because sometimes the
performance of materiality is set too high and the auditor might not perform sufficient procedures to
detect material misstatements in the financials. Just like if performance materiality is set too low, the
auditor might perform more substantive testing. Some implications that for a change of audit work that
has already been completed are that the auditor will adjust the performance that has already been
done. For example, if a material amount is set at $150,000 and that is deemed too high, the auditor will
adjust it to $100,000.

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7.36 – Define the terms inherent risks, control risk, audit risk, and detection risk. Refer to exhibit 7.1
and explain how these risks relate to each other.

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Inherent Risk – 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

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misstatements, before consideration of any related controls.
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Control Risk – 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
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internal control.
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Audit Risk – The risk that the auditor expresses an inappropriate audit opinion when the financial
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statements are materially misstated.

Detection Risk – 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 be material, either
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individually or when aggregated with other misstatements.

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All of these risks relate to each other because they all the risks can be avoided if the client controls the
inherent and control risks. That then reduces the audit and detection risks which are controlled by the
auditor.
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7.37 – How are inherent risks of material misstatements related to internal controls? Why is it
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important to assess inherent risks of material misstatement prior to evaluating the quality of an
organization’s internal controls?
Inherent risks of material misstatements are related to internal controls because when there is a high
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inherent risk that is a greater possibility that an account balance is materially misstated, which is can be
caused by a faulty control. It is important to assess inherent risks of material misstatement because the
misstatement could be a simple error and the internal controls can be operating effectively.

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 7.38 – What is the directional relationship between the risk of material misstatement (inherent and
control risk) and both audit risk and detection risk? In other words, if the risk of material
misstatement increases or decreases, how are audit risk and detection risk affected?

If the risk of material misstatement increases then that is directly related to audit and detection risk in
which that they will decrease. This is because if there is a higher level of inherent and control risk it will
be a lot easier to determine a material misstatement. While if the inherent and control risks were lower
it would be more difficult to find a material misstatement, thus audit and detection risk will increase.

7.39 – Explain how the 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?

The concepts of audit risk and materiality are related because if there is a material misstatement found
within the course of the audit, it will determine the outcome of the auditors’ opinion. If there is a
material misstatement found it is likely the auditor will issue an adverse or disclaimer opinion. But if a
material misstatement is not found, then it is likely that an unqualified opinion will be issued. The
auditor must make a decision on materiality because that directly affects the level of audit risk.

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7.40 – Describe factors that would lead the auditor to assess, at a higher level, inherent risk at the

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assertion level.

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Some factors to assess at a higher level inherent risk at the assertion level would be:

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Accounts that are valued from estimates are more likely to be material misstatement
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 The account balance represents an asset that is relatively easily stolen, such as cash

 The account balance is made up of complex transactions

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 The account balance requires a high level of judgment or estimation to value

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 The account balance is subject to adjustments that are not in the ordinary processing routine,
such as year-end adjustments
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