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Flashcards in Chapter 4 Deck (33):

Information is considered material if it

affects a user's decision-making process. This may be due to factors other than the magnitude of misstatements.


information that exceeds an auditor's preliminary materiality assessment

Quantitatively material


an amount less than materiality, which is set to reduce the likelihood that a misstatement in a particular class of transactions, account balances, or disclosures, in aggregate, do not exceed materiality for the financial statements as a whole

Performance materiality


information that is relevant when some areas of the financial statements are expected to influence the economic decisions made by users of the financial statements

Specific materiality


strategy that sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan

Audit strategy


strategy used when the auditor does not plan to rely on the client's controls and increases the reliance on detailed substantive procedures that involve intensive testing of year-end account balances and transactions from throughout the year

Substantive audit strategy


strategy used when the auditor obtains a detailed understanding of their client's system of internal controls and plans to rely on that system to identify, prevent, and detect material misstatements

Combined audit strategy


measurements, agreed to beforehand, that can be quantified and reflect the success factors of an organization

Key performance indicators (KPIs)


the ability of a company to earn a profit



market price per share to earnings per share

Price-earnings (PE) ratio


profit to weighted average ordinary shares issued

Earnings per share (EPS)


the ability of a company to pay its debts when they fall due



an evaluation of financial information by studying plausible relationships among both financial and non-financial data

Analytical procedures


detailed testing of controls and substantive testing of transactions and accounts

Execution stage


Analytical procedures are conducted at the planning stage of the audit to:

• highlight unusual fluctuations in accounts
• aid in the identification of risk
• enhance the understanding of a client
• identify the accounts at risk of material misstatement
• reduce audit risk by concentrating audit effort where the risk of material misstatement is greatest.


_______ are made between account balances for the current year and the previous year and for the current year and the budget.

Simple comparisons


a comparison of account balances over time

Trend analysis


a comparison of account balances to a single line item

Common-size analysis


conducted by an auditor to assess the relationship between various financial statement account balances. An auditor will calculate profitability, liquidity, and solvency ratios.

Ratio analysis


reflect a company's ability to generate earnings and ultimately the cash flow required to pay debts, meet other obligations, and fund future expansion.

Profitability ratios


gross profit to net sales

Gross profit margin


reflect a company's ability to meet its short-term debt obligations. If a company is unable to pay its debts when they fall due, the company may lose key employees, suppliers may refuse to supply goods, and lenders may recall funds borrowed.

Liquidity ratios


In conducting analytical procedures, the following information sources are generally considered to be reliable:

• information generated by an accounting system that has effective internal controls
• information generated by an independent reputable external source
• audited information
• information generated using consistent accounting methods
• information from a source internal to the client that has proven to be accurate in the past (for example, information used to prepare budgets).


A predominantly substantive audit strategy:

means that the auditor will gain the minimum necessary knowledge of the client's system of internal controls.


A combined audit strategy:

requires the auditor to conduct extensive control testing.


Profitability ratios are used to assess performance and:

companies will be interested in trends in the ratios.


Common uses of analytical procedures include:

risk identification during the audit planning stage.
estimation of account balances during the audit execution stage.
overall assessment of the financial statements at the final review stage of the audit.


An auditor is interested in the client's inventory turnover ratio because it helps the auditor understand:

if the client is as competitive and has as high a turnover as the industry average.


Analytical procedures:

must take into account seasonal variation in the client's business.


An auditor will identify accounts and related assertions at risk of material misstatement:

in order to plan the audit to focus on those accounts.


For an audit, the auditor can control:

detection risk.


An example of an item that is material is:

a theft of $100.
an undisclosed lawsuit for $1 million.
an undisclosed related party.


Testing controls means that:

the auditor can plan to reduce their reliance on detailed substantive testing of transactions and account balances.