)Determine the following risks "AR= IR *CR * DR":(Use the 2 tables below to help you determine what risk settings are appropriate. Table 1 gives you RMM- plug that vale into table 2)

• (HINT 1: Determine RMM first, then AR and then back into DR)
• (HINT 2: Use the facts above to determine IR & CR, Use your auditor judgement to determine AR & DR, remember auditors don't want to take too much risk, but also don't want to be in efficient.)
• 3i. Inherent Risk (Look at the notes and see if there is anything risky about this audit client, is it profitable, liabilities vs assets, any lawsuits, significant related party transactions. Think about what we discussed in Chap 3 & 5 about what is low inherent risk and what is high inherent risk.)
• 3i.__________________________________

• 3ii. Control Risk (Look at the information you learned above to gauge information about the company's controls are they working/not working. Read the Internal Controls over Financial Reporting opinion issued by the auditor to see if the company received an unqualified opinion about whether its controls were working, look out for any material weaknesses identified. Think about what we discussed in Chap 3 & 5 about what is low control risk and what is high control risk.)

3ii.__________________________________

• 3iii. RMM (Risk of Material Misstatement): _____________(Should be IR x CR you determined above, see table below for guidance.)

• 3iv. Audit Risk (Should generally be only choices (a), (b), or (c)) (Should be based on if the client is a publicly traded company, how much risk you are willing to take, complexity of the client, size of the company, chance of lawsuits, size of our audit firm, etc.)
• 3iv.__________________________________

• 3v. Detection Risk (Remember you are generally backing into this figure after you figure out inherent risk, control risk, and audit risk.)
  1. Revenue

3v.__________________________________

* Tables are from the PowerPoint slides for Chapter 5.

As it is our first-year auditing a company and starting the audit we need to determine a few things:

Required:

3Bi)What would be a good basis to set materiality (Revenue, Assets, Equity, etc.)? (Think about the definition of materiality, and what would be important to shareholders- do they care about profitability or how many assets the company has acquired.) (Think about if the company is a non-profit, a start-up, oriented towards building up assets, profitable, etc. Use these factors in your explanation.)(Pick 1 letter and & explain why.) [EX: B. Net Income because.......]

1. Net Income
2. Total Assets
3. Total Equity

i.__________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

ii)What percentage (higher percentage or a lower percentage) would you use for the benchmark you selected in Q5 above? (Pick an actual percentage ex: 5% or 1%, or 10%, based on the guidance below.)(EX: 5% of Net Income vs 10% of Net Income)? Explain why?Your choice should be based on the Inherent risk and control risk determined in questions 1-4 above. [Click on one of the boxes below to select your answer, check only one box.]

a. 5 percent of net income before taxes.

b. 10 percent of net income before taxes.

c. percent of total assets.

d. 1 percent of total assets.

e. percent of total revenues.

f. 1 percent of total revenues.

g. 1 percent of total equity.

h. Less than 1 percent of total Equity

iii)What does picking a larger or smaller % for materiality mean to our detection risk? (Example if you picked 10% or 5% does that mean Detection risk is high or low.) (See slides for guidance on how to answer this question.) [Click on one of the boxes below to select your answer, check only one box.]

a. Picked a Larger % for materiality, this means Detection Risk is higher.

b. Picked a Smaller % for materiality, this means Detection Risk is lower.

iv)Using the financial statements and the answers to the questions above calculate materiality for your audit of the company. (Calculate Overall materiality, Tolerable Misstatement (use 75% of overall Materiality), and De minimis Materiality (use 10% of Tolerable Misstatement). (Show your calculation and the number you calculated.)

• EX: Benchmark %(1%) * Assets ($25m)= $250K (Overall Materiality)
• EX:-Tolerable Misstatement = 50% * Overall Materiality [$250K* 50% = $125k]
• EX: De minimis Materiality = 5% of Tolerable Misstatement [$125K * .05 = $6,250 ).
  1. Overall Materiality=_______________________________________________________

1. Tolerable Misstatement=___________________________________________________

1. De minimis Materiality=____________________________________________________

v)Compare the Overall Materiality number you calculated and compare it to both the income statement and Balances Sheet of your company- does the number appear reasonable (not too low or too high). (EX: Overall Materiality is $1M but Total Revenue is $950K, this materiality would probably be too high in relation to the Income Statement, or if the materiality was $1,000 but revenue is $5M this materiality appears to be too low for testing purposes.) [This situation happens when the balance sheet numbers or Income Stmt Numbers are significantly higher than the other statement.]

v.______________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________