Task 2: Materiality and audit risk model
a. Identify three factors specific to MPI that could affect the preliminary assessment of inherent risk. For each factor, indicate whether it is at the account level or the financial statement level. For all factors affecting a specific account, indicate the account and assertion affected.
b. Based on MPI’s preliminary financial information for December 31, 2013, calculate a preliminary materiality. Describe the users of the financial statements and explain your reasoning for the quantitative measure selected.
c. Based on the preliminary determination of audit risk and your assessment of the risk of material misstatement, calculate the planned detection risk for the audit of the revenue and collections cycle. Show your work.
d. Prepare a short analysis of each of the following independent what-if situations for the audit manager. Consider each situation independently, varying only the factors stated in each situation and holding all other factors constant. When determining the effect of various changes on the detection risk, calculate the new detection risk and explain whether the detection risk varies directly, inversely, or independently of the factor that has changed.
i. After further study of the client’s operations, you decide that the inherent risk of a material error is 45%. What effect would this have on the calculated detection risk?
ii. You decide to test key internal controls and find that the control risk is 25%. What effect would this have on the calculated detection risk?
e. What effect does a decrease in the detection risk you are prepared to take have on the nature of the audit work performed? What effect does it have on the extent of audit work performed? What effect does it have on the timing of audit work performed?
f. Assume that you decide to decrease the amount of misstatement considered material by $20,000. What effect will this decrease in the amount considered material have on the detection risk? A change in the amount considered material is not an explicit component of the audit risk model. How then (if at all) does a change in the amount considered material result in a change in the detection risk if there is no change in the audit risk and no change in the client’s operations or controls?
