Question

Question 9  

An amount that is clearly inconsequential relative to overall materiality, when taken individually or in aggregate and whether judged by any criteria of size, nature and circumstances.

a. Must be proposed to the client for adjustment in the financial statements

b. Must be passed along to the audit committee if not adjusted in the financial statements.

c. May be ignored by the auditor.

d. Must be aggregated with other misstatements to determine how it affects materiality.

Question 10  

Included in the auditor’s evaluation of inherent risk is business risk. When business risk is high, the auditor may be concerned about what?

I.	The organization may be unable to operate effectively and profitably.
II.	The organization may lack effective internal controls over financial reporting.
III.	The organization may not have effective monitoring controls.
IV.	The organization may be too risky to accept as an audit client.

Answer 1

Q.No.	Answer:
9)	c. may be ignored by the auditor Explanation: Auditor while setting materiality levels for performing his audit work, decides the overall materiality, performance materiality and further designates an amount as clearly trivial. When auditor designates any amount as clearly trivial or inconsequential, it means that misstatements below that amount can be straightaway ignored based on materiality. No further action needs to be taken with regard to such misstatements. Any number of misstatements of the amount below clearly inconsequential amounts will not lead the overall financial statements to be materially misstated and hence auditor can increase the effectiveness of his audit procedures by designating such an amount. Other options given in the situation seem to be irrelevant with inconsequential amounts.
10)	ii. The organization may lack effective internal controls over financial reporting. Explanation: Generally, an auditor is not concerned about business risk while expressing his opinion on the financial statements. What the auditor is concerned about is Audit Risk. Now, Audit Risk (AR) is defined as a product of Inherent Risk (IR), Control Risk (CR), Detection Risk (DR). Inherent Risk (IR) and Control Risk (CR) taken together is called as Risk of material misstatement. AR = IR * CR * DR AR = Risk of Material Misstatement * Detection Risk As an auditor has to keep his audit risk at an acceptably low level, he will try to counterbalance one high risk with other low risks. If higher business risk leads to higher inherent risk, the auditor would like to lower his overall audit risk by getting confidence that, at least, the entity's control environment is strong and effective, this will lead in lowering the audit risk. If the control environment is also weak, the auditor will have to reduce his detection risk to the lowest level possible. But, in the options provided there is no mention of detection risk, therefore, the answer would be option (ii), which talks about lack of effective control. Other options are irrelevant to reduce audit risk.