RSM426

Critical Thinking, Analysis and

Decision Making
Week 3 – Assurance Topics
Technical Knowledge
• Risk Analysis /Assertions
• Approach
• Materiality
• Audit Procedures
Risk

Risk of material Overall financial

misstatement statement level

AR = IR × CR × DR
Determined separately for Assess by assertion for each account
each engagement; balance, class of transaction, or
fixed at acceptably low aspect of presentation and disclosure
level
Approach
• Combined approach
• Substantive approach
Materiality - Users
• Materiality is a user-based concept
• Before calculating materiality, it is important to identify the users
of the financial statements and identify their objectives
• What types of decisions will they be making?
• This identification of key users will help the auditor form the basis
for calculating materiality
Materiality - Basis
• CAS320
• Consider:
• Elements of the financial statements (assets, liabilities, equity,
income, expenses
• Whether there are items on which the users tend to focus
• Past history with audits
• The nature of the entity and the industry
• The entity’s ownership structure and the way it is financed
• The relative volatility of the benchmark

• DO NOT MENTION RISK!!!!

Materiality - Basis
• Common percentages that are appropriate are:
• 3 – 7% of net income before taxes (normalized)
• .5 – 5% of gross profit
• .5 – 1% of total assets
• .5 – 5% of shareholders’ equity
• .5 – 1% of revenue
• .5 – 3% of expenses (non-profits)

• DO NOT MENTION RISK!!!!

Performance Materiality

• MENTION RISK!!!!
Procedures
• For each procedure you need:
• Risk for the financial statements
• Accounts and assertions impacted
• Procedure to perform
• Nature
• Timing
• Extent
Scenario #1
You are engaged to conduct the audit of the
December financial statements of Polylex Realty Inc.
Polylex rents apartments to executives — often for
long-term stays. Many of the rentals are for six to 12
months and are prepaid by the executive’s employer
for the period. At year end, there was a material
balance of deferred revenue related to prepaid rental
apartments showing on the balance sheet.
Scenario #1 - Solution
Risk: Polylex may record unearned rent revenue as
revenue earned.

Account and assertions: Revenue (occurrence)

Procedure: Obtain a sample of rental contracts. •

Recalculate revenue that has been earned based on
months passed in the current year. • Compare to the
amount recorded in the general ledger.
Scenario #2
You are engaged in the year-end audit of Raintree
Distribution Inc. Raintree sells magazines to newsstands
and other retailers with a one-month right of return. For
example, a retailer can return magazines that are sold
in December to Raintree for a full refund until the end
of January of the next year. Raintree’s year end is
December 31. On average, the amount of returns is
considered material.
Scenario #2 - Solution
Risk:

Account and assertions:

Procedure: