Magnitude of An Omission or Misstatement of Accounting Information

Question Description

Materiality deals with 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 on the information would have been changed or influenced by the omission or misstatement”.

In auditing account balances of the client and making judgments as to what has to be adjusted or not, the auditor has to evaluate the materiality of proposed adjustments and the extent to which adjustments will be required of the client. Those proposed adjustments that are not material are below the recognition threshold and by definition don’t require adjustment. Overall planning materiality is determined at the beginning of the audit and then allocated to account balances using various methods.

Auditing standards (ISA 320 Materiality in Planning and Performing an Audit) explain the concept of materiality in the following manner:

Misstatements, including omissions, are considered to be material if they individually or in the aggregate, could reasonably be expected to influence the economic decision of users taken on the basis of the financial statements. Judgments about materiality are made in light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both.

Control environment

One of the elements of an organization’s control system is the “control environment.” Identify at least four factors that the auditor should consider when reviewing the control environment and discuss how the auditor would relate this review to the assessment of control risk.

ANS:

The factors that an auditor should consider when reviewing the control environment would include:

·management’s philosophy and operating style.
·the entity’s organization structure.
·the functioning of the board of directors and its committees.
·methods of assigning authority and responsibility.
·management’s control methods for monitoring and following up on performance, including internal auditing.
·personnel policies and practices.
·external influences such as bank regulatory agencies.

The auditor would examine his or her findings relating to each of the listed factors in determining whether control risk was high, medium or low. For example, if the philosophy of management placed little priority on internal controls the auditor would be concerned about control risk.

Use of audit tools

Jen Staples, is an auditor at King and Sheets, LLP. King and Sheets is engaged to perform an audit of the First national Bank of the Everglades which has very complex systems and technology in place related to its financial accounting and operations. Jen has information systems skills and experience in performing audits in such an environment. Discuss how Jen might use audit tools to perform procedures of FNB of the Everglades.

ANS:

Jen will most likely utilize generalized audit software for the following:

1.To sample the savings and checking account population for confirmations
2.To sample the loan account population for confirmations.
3.To electronically foot the subsidiary ledger of loans receivable.
4.To electronically analyze the loans receivable outstanding for past due accounts in order to evaluate the reserve for loan losses account.
5.To analyze the interest rate field for outliers such as percentages exceeding a certain range.
6.To analyze customer fields for missing data such as tax ID or statement address.
7.To derive statistics such as the average of all savings account balances for analysis.

4.Fraud consideration by auditors

John Beasley is interviewing with public accounting firms to become an auditor. John does not believe that fraud is a “big deal” in client organizations and argues that most individuals in management of companies are “honest people”. He believes that auditors are becoming too cynical.

Describe your response to John’s attitude and discuss the major types of fraud that occur in companies.

ANS:

Audit firms have taken criticism for failing to discover material frauds. Auditors have a greater responsibility to plan the audit to consider and detect fraud. This is accomplished partially by the auditor’s use of professional skepticism. Professional skepticism is not necessarily being cynical, it is performing an audit with a questioning mind.]

 It means that the auditors will obtain persuasive evidence to corroborate management responses to inquiries and to increase the sufficiency of substantive audit evidence. Professional skepticism is exhibited in the auditor’s assumption that honesty in people is not a given. Auditors must not only go beyond the evidence in front of them, they must have the mindset of the possibility of fraud in all financial statement engagements.

It must also be mentioned that John may not be accepted by a public accounting firm because his attitude toward fraud is not rigorous enough for the profession.
John must realize that, quite often, fraud in organizations usually takes place in one of three areas:

Defalcation such as corruption such as bribery or conflicts of interest.
Defalcation such as asset misappropriation such as theft and misuse of assets.
Fraudulent financial reporting such as the overstatement of certain assets and revenues and the understatement of certain liabilities and expenses.

Write 4 of each answers into 4 short essays(i think about less than 100 words per each) that is easy to be memorized ,as simplified as possible. thanks