A2 M7 - Materiality (notes)

Question 1

Which of the following statements is not correct about materiality?

A.Option A.
An auditor considers materiality for the financial statements as a whole in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements.

B.Option B.
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.

C.Option C.
The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important.

D.Option D.
Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments.

Answer 1

Choice “A” is correct. Materiality levels include an overall level for each statement; however, because the statements are interrelated, and for reasons of efficiency, the auditor ordinarily considers materiality for planning purposes in terms of the smallest aggregate level of misstatements that could be considered material to any one of the financial statements.

Choice “B” is incorrect. The auditor’s consideration of materiality is influenced by his or her perception of the needs of a reasonable person relying on the financial statements.

Choice “C” is incorrect. The concept of materiality recognizes that some matters, either individually or in the aggregate, are important for the fair presentation of financial statements in conformity with GAAP, while other matters are not important.

Choice “D” is incorrect. Materiality judgments are made in light of the surrounding circumstances and necessarily involve both quantitative and qualitative considerations.

Question 2

Which of the following statements is correct concerning materiality in a financial statement audit?

A.Option A.
Analytical procedures performed during an audit’s review stage usually decrease materiality levels.

B.Option B.
If the materiality amount used in evaluating audit findings increases from the amount used in planning, the auditor should apply additional substantive tests.

C.Option C.
The auditor’s materiality judgments generally involve quantitative, but not qualitative, considerations.

D.Option D.
Materiality levels are generally considered in terms of the smallest aggregate level of misstatement that could be considered material to any one of the financial statements.

Answer 2

Choice “D” is correct. Because the financial statements are interrelated, materiality levels are generally considered in terms of the smallest level of misstatement that could be material to any one of the financial statements.

Choice “A” is incorrect. Analytical procedures are performed during an audit’s review stage to evaluate the overall financial statement presentation and to assess the conclusions reached. They generally would not result in a change in materiality levels.

Choice “B” is incorrect. If the materiality amount used in evaluating audit findings increases from the amount used in planning, the auditor should consider whether the audit plan needs to be modified. Typically, an increase in materiality levels would result in a decrease in audit risk, which would result in less substantive testing, not more.

Choice “C” is incorrect. Qualitative considerations may lead to situations in which misstatements that do not exceed materiality limits are still likely to influence the economic decisions of users. In such cases, an otherwise immaterial misstatement is deemed to be material.

Question 3

While planning the audit strategy for the current audit, the auditor establishes the materiality for the client’s financial statements taken as a whole. Which of the following is incorrect regarding the process in which the auditor actually determines the level of materiality for the financial statements taken as a whole?

A.Option A.
The auditor uses his or her professional judgment when assessing materiality.

B.Option B.
Materiality is based on the smallest level of misstatement for any one financial statement.

C.Option C.
Both quantitative and qualitative factors are considered.

D.Option D.
No specific dollar amount of materiality threshold is required to be established.

Answer 3

Choice “D” is correct. This represents an incorrect statement. When assessing the materiality level for the financial statements taken as a whole, the auditor needs to determine an actual materiality threshold amount for the client’s audit.

Choice “A” is incorrect. This represents an accurate statement as the auditor must apply his or her professional judgment when establishing materiality levels for the financial statements taken as a whole.

Choice “B” is incorrect. This is an accurate statement because the auditor would determine the smallest level of misstatement that may be material for any one of the client’s financial statements.

Choice “C” is incorrect. This is an accurate statement as the auditor would use both qualitative and quantitative factors when determining the level of materiality for the financial statements taken as a whole.

Question 4

As part of developing an audit strategy for an existing client, the auditor may determine a materiality level for all the following, with the exception of:

A.Option A.
Transaction cycles with misstatements in the prior year’s audit.

B.Option B.
Certain classes of transactions.

C.Option C.
Financial statements as a whole.

D.Option D.
Performance materiality.

Answer 4

Choice “A” is correct. While developing an audit strategy, the auditor determines the level of materiality for the client’s financial statements as a whole, performance materiality, and if necessary, for certain account balances, transactions, and disclosures. A separate materiality level would not be established for specific transaction cycles that contained misstatements in the prior year’s audit.

Choice “B” is incorrect. There are certain situations in which one or more classes of transactions may have materiality levels that are set lower than the financial statements as a whole.

Choice “C” is incorrect. It is important for the auditor to establish a materiality level for the client’s financial statements as a whole.

Choice “D” is incorrect. The auditor determines performance materiality in order to assess the risk of material misstatement and to determine the extent, nature, and timing of audit procedures. The materiality level is set lower than the materiality level for the financial statements as a whole.

Question 5

Which one of the below statements best describes the concept of materiality?

A.Option A.
Information that meets strict quantitative thresholds.

B.Option B.
Information that directly impacts the income statement.

C.Option C.
Information that is not likely to influence the decisions of a reasonable investor.

D.Option D.
Information that is likely to be viewed by a reasonable investor as altering the mix of available information.

Answer 5

Choice “D” is correct. According to the U.S. Supreme Court, information is material if there is a substantial likelihood that the information would be viewed by a reasonable investor as having significantly altered the total mix of available information.

Choice “A” is incorrect. Materiality is not determined by the use of strict quantitative thresholds. The determination of materiality may differ from client to client. Materiality must be determined using both quantitative and qualitative factors.

Choice “B” is incorrect. Information can be material if it influences the user’s reasonable judgments about any of the financial statements.

Choice “C” is incorrect. Information is material if it is likely to influence the judgments of a reasonable investor.

Question 6

Which of the following would an auditor most likely use in determining the auditor’s preliminary judgment about materiality?

A.Option A.
The results of the initial assessment of control risk.

B.Option B.
The entity’s financial statements of the prior year.

C.Option C.
The assertions that are embodied in the financial statements.

D.Option D.
The anticipated sample size for planned substantive tests.

Answer 6

Choice “B” is correct. The auditor would most likely use the entity’s financial statements of the prior year in the preliminary determination of materiality. The prior year financial statements would be a good starting point in estimating the current year’s expected results, especially for a continuing client.

Choice “A” is incorrect. The assessment of control risk affects the design of audit procedures but is not relevant in determining materiality.

Choice “C” is incorrect. Management assertions embodied in the financial statements have little relationship to materiality.

Choice “D” is incorrect. The anticipated sample size for planned substantive tests is set after the preliminary materiality level is determined.

Question 7

Which of the following statements is correct with regard to the consideration of materiality when an auditor is planning and performing a financial statement audit of an issuer?

A.Option A.
An auditor should determine a tolerable misstatement threshold at the overall financial statement level, but not at the account or disclosure level.

B.Option B.
An auditor does not need to express materiality as a specified, quantitative amount.

C.Option C.
When determining a tolerable misstatement threshold, an auditor should take into account the amount of misstatements that were accumulated in prior periods.

D.Option D.
When the reevaluation of materiality results in a significantly lower amount than initially established, an auditor would generally not modify audit procedures.

Answer 7

Choice “C” is correct. Determining the tolerable misstatement is a matter of the auditor’s professional judgment. The identification of misstatements in the prior-period audit may result in the auditor needing to reduce the tolerable misstatement to reduce the probability that the aggregate uncorrected and undetected misstatements exceed the materiality for the financial statements to an acceptably low level.

Choice “A” is incorrect. In certain circumstances, it is necessary for the auditor to reduce the tolerable misstatement for certain classes of transactions, balances, or disclosures if the auditor determines that misstatements of a lesser amount than the overall financial statement materiality would influence the judgment of a reasonable financial statement user.

Choice “B” is incorrect. Although both qualitative and quantitative factors impact the assessment of materiality, it must always be expressed as a specific quantitative amount.

Choice “D” is incorrect. It is the responsibility of the auditor to consider whether the audit plan and the nature, timing, and extent of auditing procedures need to be revised when the revised assessment of materiality is significantly different.

Question 8

An auditor of an issuer should determine the amount of tolerable misstatement for assessing risks of material misstatement at which of the following levels?

A.Option A.
Total revenue

B.Option B.
Account

C.Option C.
Total assets

D.Option D.
Financial statements as a whole

Answer 8

Choice “B” is correct. Tolerable misstatement should be determined at the account level to properly assess risks of material misstatement for a particular population or sampling procedure.

Choice “A” is incorrect. Total revenue is too broad a level for determining tolerable misstatement, as it would not allow for proper risk assessment of an individual population.

Choice “C” is incorrect. Total assets is too broad a level for determining tolerable misstatement, as it would not allow for proper risk assessment of an individual population.

Choice “D” is incorrect. Financial statements as a whole is too broad a level for determining tolerable misstatement, as it would not allow for proper risk assessment of an individual population.

Question 9

Tracy, senior accountant at JFM CPA Firm, is determining the performance materiality for her client in Year 2. Tracy expects that there will be a high likelihood of uncorrected and undetected misstatements.

JFM CPA Firm’s materiality guidelines advise the auditor to set performance materiality in the range of 50 percent to 70 percent of overall materiality based on the likelihood of misstatement. Tracy has calculated overall materiality at $140,000.

Tracy will most likely set performance materiality closest to:

A.Option A.
$98,000

B.Option B.
$70,000

C.Option C.
$140,000

D.Option D.
$168,000

Answer 9

Choice “B” is correct. $140,000 (overall materiality) × 0.5 (lower range provided in audit firm guidance) = $70,000. Tracy believes that there is a high likelihood of uncorrected and undetected misstatements. Therefore, Tracy most likely will use a percentage closer to the lower end of the range provided in firm guidance. Generally, if there is a high likelihood of misstatements then the auditor sets materiality at a lower amount, which results in the auditor looking closer at audit evidence.

Choice “A” is incorrect. This calculation uses the higher range provided in guidance. Generally, the lower range of materiality is used when there is a high likelihood of uncorrected and undetected misstatements, and a higher percentage will be used when there is a low likelihood of uncorrected and undetected misstatements.

Choice “C” is incorrect. Performance materiality should be set at an amount less than the materiality for the financial statements as a whole.

Choice “D” is incorrect. Performance materiality should not be higher than overall materiality.

Question 10

Answer 10

Question 11

Answer 11

Question 12

Answer 12

Question 13

If new information becomes available that could require a reevaluation of the quantitative level of materiality applied during an audit of an issuer, then the auditor should:

A.Option A.
Raise or lower the materiality level as appropriate to the situation.

B.Option B.
Not change the materiality level once it has been established.

C.Option C.
Lower the materiality level, but not raise it.

D.Option D.
Raise the materiality level, but not lower it.

Answer 13

Choice “A” is correct. If new information becomes available that could require a reevaluation of the quantitative level of materiality applied during an audit of an issuer, then the auditor should raise or lower the materiality level as appropriate to the situation.

Choice “B” is incorrect. An auditor is allowed to change the materiality level. For example, an auditor is likely to revise materiality, if materiality levels were originally based on estimated or preliminary financial statements that differ significantly from actual amounts.

Choice “C” is incorrect. An auditor is allowed to raise or lower the materiality level.

Choice “D” is incorrect. An auditor is allowed to raise or lower the materiality level.

Question 14

According to PCAOB standards, when would a company be least likely to reevaluate established materiality levels or tolerable misstatements?

A.Option A.
There is a substantial likelihood that misstatements of amounts less than the materiality level established for the financial statements as a whole would influence the judgment of a reasonable investor.

B.Option B.
Changes that occurred after the materiality levels were originally set are likely to affect investor’s perceptions about the company’s financial statements.

C.Option C.
The client has stated that it will not be able to respond to the auditor’s request for evidence within the prescribed timeframe.

D.Option D.
Materiality levels and tolerable misstatement were originally based on estimated or preliminary financial statement amounts that differ significantly from actual amounts.

Answer 14

Choice “C” is correct. The client’s request for an extension to submit documentation generally would not have an impact on established materiality levels or tolerable misstatements.

Choice “A” is incorrect. If there is a belief that misstatements of an amount below the current materiality level would influence the judgment of a reasonable investor, then by definition, materiality is not at its correct level. Materiality is defined in part by the level at which information begins to influence the judgment of a reasonable person.

Choice “B” is incorrect. If changes have occurred that will likely affect the investor’s perception about the financial information, the materiality level should be revised accordingly.

Choice “D” is incorrect. If materiality levels were based on preliminary or estimated data, they should be revised when the actual amounts are known.

Question 15

When there is a group audit, the group engagement team should make a preliminary assessment of materiality. Which of the following is not an accurate statement of the engagement team’s responsibilities when assessing materiality?

A.Option A.
Ascertain materiality levels for specific classes of transactions, balances, or disclosures for group financial statements for which misstatements of lesser amounts than the group financial statements taken as a whole could influence user’s economic decisions.

B.Option B.
Assess materiality for the group financial statements as a whole, without an assessment of performance materiality.

C.Option C.
Determine component materiality for those components on which the group engagement team will perform an audit.

D.Option D.
Develop a threshold at which anything above would not be considered trivial to the group financial statements.

Answer 15

Choice “B” is correct. The group engagement team should assess the materiality of the group financial statements as a whole as well as performance materiality.

Choices “C”, “A”, and “D” are incorrect as each should be performed by the group engagement team when making a preliminary assessment on a group audit.

Question 16

In order to reduce the risk that the aggregate of undetected misstatements in the group financial statements of a nonissuer exceeds the materiality for the group financial statements as a whole, an auditor should establish a:

A.Option A.
Materiality for the group financial statements that is lower than the component materiality.

B.Option B.
Component materiality that is lower than the materiality for the group financial statements.

C.Option C.
Component materiality that is equal to the materiality for the group financial statements.

D.Option D.
Materiality for the group financial statement that exceeds prior-year materiality for the group financial statements.

Answer 16

Choice “B” is correct. In order to reduce the risk that the aggregate of undetected misstatements in the group financial statements of a nonissuer exceeds the materiality for the group financial statements as a whole, an auditor should establish a component materiality that is lower than the materiality for the group financial statements.

Choice “A” is incorrect. Materiality for the group financial statements should be higher, not lower, than component materiality.

Choice “C” is incorrect. Component materiality should be lower, not equal, to the materiality for the group financial statements.

Choice “D” is incorrect. Materiality should be determined each year and may not necessarily exceed prior-year materiality.

Question 17

An auditor determined materiality for planning purposes before year-end based on a nonissuer entity’s prior-year financial statements. During the audit, the auditor learns that the actual financial results are significantly different from those of the prior year because of a merger. The auditor’s most appropriate response would be to:

A.Option A.
Reassess the risk of material misstatement to determine whether detection risk remains appropriate.

B.Option B.
Revise materiality for the financial statements as a whole.

C.Option C.
Reevaluate the sufficiency of audit procedures performed in the prior-year audit.

D.Option D.
Reperform audit procedures completed before year-end.

Answer 17

Choice “B” is correct. When materiality levels are assessed based upon estimated or preliminary results and those results differ significantly from actual amounts, it is appropriate for the auditor to revise the assessment of established materiality levels.

Choice “A” is incorrect. The assessment of the risk of material misstatement is not impacted by the materiality assessment; however, the auditor may need to amend the nature, timing, and extent of procedures to keep audit risk at an acceptably low level when materiality is revised.

Choice “C” is incorrect. The prior-year assessment of materiality is not impacted by a significant change in actual financial statement amounts in the current year. Therefore, it is not necessary for the auditor to reevaluate the sufficiency of procedures performed in the prior year.

Choice “D” is incorrect. It would not be necessary to reperform audit procedures completed before year-end; however, the auditor should consider whether the nature, timing, and extent of procedures needs to be modified because of the revised assessment of materiality.