An auditor seeks to select the best market approach for the materiality threshold. The auditor studies Gutierrez et al.’s (2018) investigation into the effects of the materiality threshold on audit quality and decides that this approach is best practice. The auditor decides to use this approach for the financial report as a whole. As, the audit is high risk, the auditor also decides to set a low level of materiality to appropriately reduce the probability that the aggregate misstatement exceeds the materiality threshold
a) Given this information, calculate what the performance materiality and the overall materiality should be for for the audit ended on 30 June 2022
b) Explain why materiality is considered an important concept in auditing
Question 2: Calculating an audit sample An auditor is planning the process to confirm accounts payable. The total of debit balances in the trial balance of payables is $2.8 million. The total of credit balances in trial balance of payables is $3.2 million. The auditor decides that the tolerable misstatement for this sampling application is 10% of $700 000, the desirable level of assurance is 95% and one error is expected. There are 5000 supplier balances.
a) Given the information disclosed, calculate what the estimated sample size should be for this auditor.
b) Explain why sampling is considered an important concept in auditing.
Question 3: Case study on Revenue You are auditing the revenue for a wholesale company for the year ended on 30 June 2021. In your conversations with management, you find that the customers are less keen to purchase their company’s products and competitors have higher demand for similar products. The managers think that is only temporary, as they are developing new products for release in 2025. Management also explain that they have the best professionals working for them compared with the market. You investigate the average wage and salary conditions of your client and find that they are paying approximately 25% above the wholesale industry average. Last quarter, a number of employees were fired based on sales performance targets. You assessed these targets using experts in wholesale. The conclusion from the experts is that the targets are unreasonable and unachievable due to the low quality of the products. The experts suggest that there is likely to be a significant negative impact on demand in the future for this company if the quality of the products remain at their current level. You discuss the experts’ report with management. Management reply to the feedback by asserting that that their company, their work and their products are the best on the market. Management suggest that the real problem is that cannot find the right customers. In your observations of the sales teams, you find that the current competitive environment in the wholesale market suggests the low level of customer service is leading to a significant increase in customer complaints. The following sale practices are noted: cash sales are registered monthly, sales leaders are very friendly, and one former salesperson is suing the company due to underpayment. One evening you were driving by the client’s premises at night and you decided to drop by to check a particular document. When you arrive, you see a group of people in the sales sales department celebrating. You approach a member of the sales team an inquire why they were celebrating. The response is that CEO was just replaced by a leader of the sales team. Required: Evaluate the audit risk associated with this audit of revenue by identifying any risks concerning the potential for material misstatements in your opinion as an auditor. In your evaluation, suggest actions, activities or procedures that would be necessary to reduce the potential risk of misstatement.
Question 4: Case study on Financial Instruments and Fair Value You are auditing the financial instruments for a financial institution in Australia. While their primary business has been foreign exchange (trading and exchanging in foreign currencies), they have also entered recently (within the last 3 years) into a full range of derivatives, including hedging contracts for foreign exchange currencies and a range of other derivatives including options, swaps and futures contracts (all in relation to foreign exchange). Management engaged external experts to assist in developing the derivative trading strategy, as they have some knowledge, but not extensive knowledge of the risks and processes associated with derivative trading, so they have retained the external experts to assist in regular reviews of derivative policies and practices within the team. The foreign exchange derivatives trading team has good knowledge of the products they sell, and they have sub-divided the team into their focus area: one group focuses on hedging, one group on options and swaps and another on futures. They have been given significant leeway under policy by the company, as management rely on the processes established by the external consultant. Management is aware that there has been a history (especially in international banks} of foreign exchange traders taking ever greater risks and over-exposing their organisations. In your substantive testing, you identify three different types of discrepancies: The settlement amounts for a series of transactions have been entered incorrectly (the effect of this is understate the risk carried to the organization) The contract dates for many derivatives are entered incorrectly. There are some discrepancies with respect to cash received for derivatives sold. Receipts are not issued immediately and physical cash is only deposited once a week. Management have actual little oversight of the team and almost no oversight over actual contracts entered into and exposure. Required: Evaluate the evidence you have obtained in relation to policy and valuation. Identify any risks or ‘red flags’ in relation to the potential for material misstatement that you consider important in your role as an auditor. Suggest what actions you think you would need to undertake based on your evaluation.
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