Welcome To

Presentation
 Presentation On
The Case Study
Related to
Materiality and Risk
Presented By Group 15
 Overview of the problem no. 25
While evaluating audit results for current assets in the
audit of Quicky Plumbing Co. the preliminary judgment
about materiality for overstatements is set at $12500 and for
understatements it is set at $20000. the preliminary and
actual statements are shown below:

Tolerable Misstatements Estimate of Total Misstatements

 Solution:
Justification for a lower preliminary
25.a judgment about materiality for
overstatements

Directly related to legal liability

1 and audit risk.

Users are likely to be more critical

2 of overstatements.
 Reasons for permitting the sum of
25.b tolerable misstatements to exceed overall
materiality

It is unlikely that all accounts will be

misstated by the full amount of tolerable
misstatement.

Some accounts are likely to be

overstated while others are likely
to be understated.
 Three of the estimates of total
25.c misstatements have both an
overstatements and an understatements,
because of,

Sampling error for each

account
25.d For the existence of material
overstatements or understatements, I
would be more concerned about:

Understatement amounts

The account receivables

25.e.1 Why the estimates of total misstatements
exceeds the preliminary judgment of
materiality?
Total tolerable misstatement was allowed to
exceed the preliminary judgment

25.e.2 What the auditor should do?

Determining whether the actual total

overstatements exceed the preliminary
judgment
 OVERVIEW OF CASE NO. 30

Several situations are given which deal with the

use of Audit Risk Model. It can be stated as
follows:
PDR = AAR/ IR * CR
Where,
PDR = Planned Detection Risk
AAR = Acceptable Audit Risk
IR = Inherent Risk
CR =Control Risk
30.a.1 Auditor is likely to set both inherent and
control risk at 100% because of:

1. Lack of prior information

2. Chance of a material misstatement

3. Ineffectiveness of internal controls

30.a.2 Acceptable audit risk and planned detection
risk will be identical. Using the formula:

PDR = AAR / (IR x CR)

If IR and CR equal to 1, then PDR = AAR

30.a.3 Effect of PDR on evidence
accumulation

Planned detection risk is a measure of the

risk that audit evidence for a segment will
fail to detect misstatements exceeding a
tolerable amount. PDR depends on three
factors - AAR,IR and CR.

If PDR is lower, the auditor must

accumulate more audit evidence than if PDR
is higher.
 Reasons behind setting IR and CR at a
30.b.1
higher level

1. Year of auditing is not enough

Mangers and employees are

2. not Trustworthy

3. Auditor’s Lack of knowledge

30.b.2 Calculation of PDR

Using the formula of Audit Risk Model,

planned detection risk is equal to 20%

[PDR = .05 / (.5 x .5) = .2].

30.b.3 Effect of PDR

For part 2 where PDR is 20%,the evidence

accumulation will be larger than when the PDR is
smaller like 5% because auditor will accumulate
evidence until the PDR comes down to 5%.
30.c.1 Circumstances for such conclusions

AAR can be set high because:

1 relatively good financial condition

2 few users of financial statements.

IR should be set low because:

Good results in No higher expectations of

prior Years misstatements.
CR should be set low because:

1 effective internal controls in the past

continued expectation of good controls

2 in the current year.

30.c.2 Calculation of PDR

PDR = .05 / (.2 x .2) = 1.25.

Planned detection risk is equal to more than

100% in this case
 How much evidence should be
30.c.3
accumulated?

No evidence would be necessary in this case,

because there is a planned detection risk of more
than 100%.

the effectiveness of
internal controls.

the immateriality of
repairs and
maintenance