Audit Strategy, Audit Planning and Audit Programme - Test 3: answer key

Question 1 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. M/s Sharma & Associates is auditing Zenith Manufacturing Pvt Ltd for FY 2026-27. The company manufactures automotive components and has reported profit before tax (PBT) from continuing operations of Rs 48 crore, total revenue of Rs 920 crore, and gross profit of Rs 138 crore. However, PBT has fluctuated significantly over the last three years due to raw material price volatility, ranging from Rs 6 crore to Rs 52 crore. The engagement partner, CA Sharma, initially selects 5% of PBT as the benchmark for materiality for the financial statements as a whole, arriving at Rs 2.4 crore. During the audit, the team discovers that a large government contract expected in the last quarter was cancelled, and management has revised the PBT downward to Rs 22 crore. Additionally, a significant portion of revenue arises from a single customer, and inventory includes specialized components with limited alternative use. CA Sharma is concerned that the initial materiality may no longer be appropriate and considers whether to revise it. The audit manager suggests using total revenue as a more stable benchmark. Meanwhile, the client's CFO argues that materiality should be based on the revised PBT to avoid over-auditing. The team has already performed risk assessment procedures based on the original materiality, and fieldwork is 40% complete. The company also has a bank covenant requiring a minimum current ratio of 1.5, and the current ratio is exactly 1.5. The auditor must decide the appropriate benchmark, whether to revise materiality, and how to document the revision.

In Zenith Manufacturing Pvt Ltd, which benchmark is most appropriate for determining materiality for the financial statements as a whole under SA 320?

1. A normalized PBT based on past results or a more stable benchmark, given the significant volatility in PBT. (correct answer)
2. Total revenue of Rs 920 crore, because it is stable and unaffected by raw material price volatility.
3. Gross profit of Rs 138 crore, because it reflects the core manufacturing performance.
4. PBT of Rs 48 crore, because profit is always the most appropriate benchmark for manufacturing companies.

Answer: A — A normalized PBT based on past results or a more stable benchmark, given the significant volatility in PBT.

Explanation. SA 320 requires the auditor to determine materiality using professional judgment, considering factors such as volatility in earnings. When PBT fluctuates significantly, a normalized PBT or a more stable benchmark such as total revenue or gross profit may be appropriate. Option a ignores volatility, option b is a possible alternative but not automatically the most appropriate, and option c may also be volatile. The auditor must select a benchmark that reflects the entity's circumstances and users' needs.

Where it goes wrong. Students often assume PBT is always the default benchmark, but SA 320 requires consideration of volatility and other factors.

Authority. SA 320

Question 2 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

If CA Sharma revises materiality after learning of the cancelled contract and revised PBT, how should the revision be applied to audit procedures?

1. The revised materiality must be applied retroactively to all procedures already performed, which must be reperformed.
2. The auditor shall revise materiality and apply it to the remaining audit procedures, and may need to perform additional procedures if the revised amount is lower. (correct answer)
3. Materiality cannot be revised after fieldwork has begun, so the original amount must continue to be used.
4. The revised materiality applies only to the auditor's report and not to the performance of audit procedures.

Answer: B — The auditor shall revise materiality and apply it to the remaining audit procedures, and may need to perform additional procedures if the revised amount is lower.

Explanation. SA 320 requires the auditor to revise materiality as the audit progresses if there is a change in circumstances or new information. The revised materiality is applied to the remaining audit procedures, and the auditor may need to perform additional procedures to obtain sufficient appropriate audit evidence. Retroactive reperformance of all procedures is not required, but additional procedures may be necessary. Materiality is not frozen once fieldwork begins.

Where it goes wrong. Students may think revision requires reperforming all procedures or is prohibited after fieldwork starts; SA 320 requires revision and application to remaining procedures with additional work if needed.

Authority. SA 320

Question 3 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

What documentation is required under SA 320 regarding materiality for Zenith Manufacturing Pvt Ltd?

1. Only the final materiality amount used in the auditor's report.
2. Only the benchmark percentage and the examined financial statements.
3. The materiality for the financial statements as a whole, performance materiality, and any revision thereof, including the basis for the determination. (correct answer)
4. The client's written approval of the materiality amount selected by the auditor.

Answer: C — The materiality for the financial statements as a whole, performance materiality, and any revision thereof, including the basis for the determination.

Explanation. SA 320 requires the auditor to document the materiality for the financial statements as a whole, performance materiality, and any revision thereof, including the basis for the determination. The documentation should include the factors considered in selecting the benchmark and the reasons for any revision. Client approval is not required, and documenting only the final amount or percentage is insufficient.

Where it goes wrong. Students may think only the final amount needs to be documented; SA 320 requires documentation of the basis and any revisions.

Authority. SA 320

Question 4 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

The client's CFO argues that materiality should be based solely on the revised PBT of Rs 22 crore to avoid over-auditing. How should CA Sharma respond under SA 320?

1. The auditor must always accept management's proposed benchmark if it reduces audit work.
2. The auditor is required to use PBT as the benchmark in all circumstances regardless of volatility.
3. Materiality must be based on the highest possible benchmark to ensure audit efficiency.
4. The auditor should consider management's view but retains responsibility for determining materiality based on professional judgment. (correct answer)

Answer: D — The auditor should consider management's view but retains responsibility for determining materiality based on professional judgment.

Explanation. SA 320 states that determining materiality involves the exercise of professional judgment and is affected by the auditor's perception of the financial information needs of users. The auditor may consider management's views but retains responsibility for the determination. Accepting management's view solely to reduce audit work is inappropriate, and there is no requirement to always use PBT or the highest benchmark.

Where it goes wrong. Students may think management's preference determines materiality; the auditor's professional judgment and users' needs govern the selection.

Authority. SA 320

Question 5 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. M/s V. Raman & LLP is auditing Alpha Infotech Ltd, a listed company providing cloud services. Total revenue is Rs 1,200 crore, PBT is Rs 90 crore, and total equity is Rs 400 crore. The engagement partner, CA Raman, determines materiality for the financial statements as a whole at 1% of total revenue, i.e., Rs 12 crore, considering revenue as the most appropriate benchmark due to the company's growth phase and volatile profit margins. Performance materiality is set at 75% of overall materiality, i.e., Rs 9 crore, to reduce to an appropriately low level the probability that uncorrected and undetected misstatements exceed overall materiality. The audit plan includes testing revenue contracts, unbilled receivables, and capitalized software costs. Midway through the audit, CA Raman identifies a material misstatement of Rs 4 crore in revenue recognition from a barter transaction and concludes that the risk of further misstatements is higher than initially assessed. He considers revising performance materiality downward to 60% of overall materiality. The client's CFO objects, arguing that materiality should not be changed once audit procedures have begun. The audit committee asks how materiality was determined and why revenue was chosen over PBT. CA Raman must decide whether to revise performance materiality, how to apply the revised amount to remaining procedures, and what documentation is required. The audit is 50% complete, and the report is due in six weeks. The company also has a proposed overseas acquisition that may affect future revenue streams.

In Alpha Infotech Ltd, CA Raman sets performance materiality at 75% of overall materiality. What is the primary purpose of performance materiality under SA 320?

1. To reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. (correct answer)
2. To determine the precise amount of misstatement that can be ignored without further investigation.
3. To replace overall materiality for all audit procedures, including the evaluation of uncorrected misstatements.
4. To set a threshold below which all misstatements are automatically considered material.

Answer: A — To reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.

Explanation. SA 320 defines performance materiality as the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. It does not replace overall materiality for evaluating uncorrected misstatements, nor does it set a threshold below which misstatements are automatically material.

Where it goes wrong. Students often confuse performance materiality with overall materiality or think it defines a trivial threshold; its purpose is to provide a buffer for aggregate undetected misstatements.

Authority. SA 320

Question 6 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

CA Raman considers revising performance materiality downward to 60% of overall materiality after identifying the Rs 4 crore barter misstatement. Is this permissible under SA 320?

1. No, performance materiality cannot be revised once audit procedures have begun.
2. Yes, the auditor shall revise performance materiality if the risk of material misstatement increases or new information indicates a need for revision. (correct answer)
3. No, performance materiality is fixed at the planning stage and can only be changed with the audit committee's approval.
4. Yes, but only if the overall materiality is also increased by the same proportion.

Answer: B — Yes, the auditor shall revise performance materiality if the risk of material misstatement increases or new information indicates a need for revision.

Explanation. SA 320 requires the auditor to revise performance materiality if, during the audit, the auditor becomes aware of information that would have caused the auditor to have determined a different amount initially, such as an increase in the risk of material misstatement. The revision applies to remaining procedures. Overall materiality does not need to be increased; audit committee approval is not required.

Where it goes wrong. Students may think performance materiality is fixed at planning; SA 320 requires revision when new information affects the risk assessment.

Authority. SA 320

Question 7 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

What factors should CA Raman consider in determining whether revenue is a more appropriate benchmark than PBT for Alpha Infotech Ltd?

1. Only the size of the company and the industry in which it operates.
2. The audit fee and the time available to complete the audit.
3. The volatility of earnings, the stage of the entity's life cycle, and the needs of users of the financial statements. (correct answer)
4. The client's preference and the tax rate applicable to the company.

Answer: C — The volatility of earnings, the stage of the entity's life cycle, and the needs of users of the financial statements.

Explanation. SA 320 requires the auditor to consider factors such as the elements of the financial statements, whether there are items on which users' attention is focused, the nature of the entity and its industry, the ownership structure, and the volatility of the benchmark. For a growth-phase company with volatile profits, revenue may be a more stable and appropriate benchmark. Audit fee, client preference, and tax rate are not appropriate determinants.

Where it goes wrong. Students may rely on client preference or convenience; SA 320 requires consideration of users' needs and the entity's circumstances.

Authority. SA 320

Question 8 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

The CFO argues that materiality should not be changed once audit procedures have begun. How should CA Raman respond?

1. Agree, because revising materiality would require reperforming all audit procedures from the beginning.
2. Agree, because materiality is a contractual term agreed with the client at the start of the engagement.
3. Disagree, but revision is only permitted if the misstatement is greater than overall materiality.
4. Disagree, because SA 320 requires revision of materiality if new information or changed circumstances indicate a different amount is appropriate. (correct answer)

Answer: D — Disagree, because SA 320 requires revision of materiality if new information or changed circumstances indicate a different amount is appropriate.

Explanation. SA 320 requires the auditor to revise materiality if, during the audit, the auditor becomes aware of information that would have caused the auditor to have determined a different amount initially. Materiality is not a contractual term fixed with the client, and revision does not necessarily require reperforming all procedures from the start. The trigger is new information, not the size of a single misstatement relative to overall materiality.

Where it goes wrong. Students may think materiality is fixed at planning or requires client consent; SA 320 mandates revision based on new information.

Authority. SA 320

Question 9 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. Which of the following correctly describes the concept of materiality under SA 320?

Which of the following correctly describes the concept of materiality under SA 320?

1. The maximum amount of misstatement that can exist without affecting the economic decisions of users of the financial statements. (correct answer)
2. A fixed percentage of total assets applied uniformly to all audits.
3. A threshold determined solely by management and approved by the auditor.
4. The amount of audit evidence required to support the auditor's opinion.

Answer: A — The maximum amount of misstatement that can exist without affecting the economic decisions of users of the financial statements.

Explanation. SA 320 states that misstatements are considered material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. Materiality is not a fixed percentage for all audits, is not determined solely by management, and is not a measure of audit evidence.

Where it goes wrong. Students often think materiality is a fixed percentage or a management decision; SA 320 defines it in terms of users' economic decisions and requires professional judgment.

Authority. SA 320

Question 10 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

Scenario. When determining materiality for the financial statements as a whole, which of the following is least appropriate for the auditor to consider?

When determining materiality for the financial statements as a whole, which of the following is least appropriate for the auditor to consider?

1. The volatility of the benchmark selected over prior periods.
2. The auditor's own fee and profitability of the audit engagement. (correct answer)
3. The needs of users of the financial statements and the nature of the entity.
4. The stage of the entity's life cycle and the industry in which it operates.

Answer: B — The auditor's own fee and profitability of the audit engagement.

Explanation. SA 320 requires the auditor to consider factors such as the elements of the financial statements, the needs of users, the nature of the entity, the industry, the ownership structure, and the volatility of the benchmark. The auditor's fee and the profitability of the engagement are not relevant to determining materiality and could create a conflict of interest.

Where it goes wrong. Students may think commercial factors are relevant; SA 320 focuses on users' needs and the entity's circumstances, not the auditor's fee.

Authority. SA 320

Question 11 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. Which of the following statements about performance materiality is correct under SA 320?

Which of the following statements about performance materiality is correct under SA 320?

1. Performance materiality is always set at 50% of overall materiality.
2. Performance materiality is used to evaluate the final uncorrected misstatements in the financial statements.
3. Performance materiality is an amount or amounts set at less than overall materiality to reduce the probability that aggregate uncorrected and undetected misstatements exceed overall materiality. (correct answer)
4. Performance materiality must be identical to the materiality level used for the auditor's report.

Answer: C — Performance materiality is an amount or amounts set at less than overall materiality to reduce the probability that aggregate uncorrected and undetected misstatements exceed overall materiality.

Explanation. SA 320 defines performance materiality as the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. It is not a fixed percentage, and it is not used to evaluate final uncorrected misstatements; overall materiality is used for that purpose.

Where it goes wrong. Students may confuse performance materiality with overall materiality or think it is a fixed 50%; SA 320 requires professional judgment and it is always less than overall materiality.

Authority. SA 320

Question 12 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

Scenario. Which benchmark is generally most appropriate for an entity whose profit before tax is highly volatile due to external factors?

Which benchmark is generally most appropriate for an entity whose profit before tax is highly volatile due to external factors?

1. Profit before tax, because it directly reflects the entity's performance.
2. Gross profit, because it captures the core trading margin.
3. Total equity, because it represents the shareholders' stake.
4. Total revenue, because it is less affected by volatility and reflects the scale of operations. (correct answer)

Answer: D — Total revenue, because it is less affected by volatility and reflects the scale of operations.

Explanation. SA 320 requires the auditor to select a benchmark that is appropriate in the circumstances. When PBT is highly volatile due to external factors, a more stable benchmark such as total revenue may be more appropriate. PBT, gross profit, and equity may also be volatile or not representative of users' needs. The auditor should consider the nature of the entity and the users' focus.

Where it goes wrong. Students often default to PBT; SA 320 requires considering volatility and selecting a more stable benchmark when appropriate.

Authority. SA 320

Question 13 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. During the audit of Suryodaya Sugar Mills Ltd, the auditor discovers that a misstatement of Rs 1.5 crore exists in inventory, while overall materiality is Rs 2 crore. Which of the following is correct?

During the audit of Suryodaya Sugar Mills Ltd, the auditor discovers that a misstatement of Rs 1.5 crore exists in inventory, while overall materiality is Rs 2 crore. Which of the following is correct?

1. The misstatement may be evaluated along with other uncorrected misstatements to determine if the aggregate exceeds overall materiality. (correct answer)
2. The misstatement must be considered material because it exceeds performance materiality.
3. The misstatement must be reported to the audit committee irrespective of its amount.
4. The misstatement must be corrected before the audit can continue.

Answer: A — The misstatement may be evaluated along with other uncorrected misstatements to determine if the aggregate exceeds overall materiality.

Explanation. SA 320 requires the auditor to evaluate the aggregate of uncorrected misstatements against overall materiality. Individual misstatements below overall materiality may still be material when aggregated with other misstatements. Performance materiality is used for designing procedures, not for evaluating final uncorrected misstatements. Reporting to the audit committee is required for material misstatements, but not automatically for every misstatement.

Where it goes wrong. Students may think any misstatement above performance materiality is automatically material; SA 320 requires evaluating the aggregate against overall materiality.

Authority. SA 320

Question 14 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

Scenario. Under SA 320, when should the auditor revise materiality?

Under SA 320, when should the auditor revise materiality?

1. Only at the completion stage of the audit when final figures are available.
2. When the auditor becomes aware of information that would have caused a different materiality determination initially. (correct answer)
3. Only if the client requests a revision in writing.
4. Never, because materiality is determined at the planning stage and remains fixed.

Answer: B — When the auditor becomes aware of information that would have caused a different materiality determination initially.

Explanation. SA 320 requires the auditor to revise materiality if, during the audit, the auditor becomes aware of information that would have caused the auditor to have determined a different amount initially. Revision is not limited to the completion stage, does not require a client request, and materiality is not fixed at planning if circumstances change.

Where it goes wrong. Students may think materiality is only a planning decision; SA 320 requires ongoing consideration and revision when new information arises.

Authority. SA 320

Question 15 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. Which of the following is not required to be documented under SA 320?

Which of the following is not required to be documented under SA 320?

1. Materiality for the financial statements as a whole.
2. Performance materiality and any revision thereof.
3. The auditor's assessment of the client's management integrity. (correct answer)
4. The basis for the determination of materiality, including the benchmark and percentage applied.

Answer: C — The auditor's assessment of the client's management integrity.

Explanation. SA 320 requires documentation of materiality for the financial statements as a whole, performance materiality, and any revision thereof, including the basis for the determination. The auditor's assessment of management integrity is a matter for client acceptance and continuance under SQC 1 and SA 220, not a specific documentation requirement under SA 320 for materiality.

Where it goes wrong. Students may think all planning decisions must be documented under SA 320; the standard specifically requires documentation of materiality and performance materiality, not management integrity.

Authority. SA 220; SA 320; SQC 1

Question 16 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

Scenario. M/s Sharma & Associates is auditing Zenith Manufacturing Pvt Ltd for FY 2026-27. The company manufactures automotive components and has reported profit before tax (PBT) from continuing operations of Rs 48 crore, total revenue of Rs 920 crore, and gross profit of Rs 138 crore. However, PBT has fluctuated significantly over the last three years due to raw material price volatility, ranging from Rs 6 crore to Rs 52 crore. The engagement partner, CA Sharma, initially selects 5% of PBT as the benchmark for materiality for the financial statements as a whole, arriving at Rs 2.4 crore. During the audit, the team discovers that a large government contract expected in the last quarter was cancelled, and management has revised the PBT downward to Rs 22 crore. Additionally, a significant portion of revenue arises from a single customer, and inventory includes specialized components with limited alternative use. CA Sharma is concerned that the initial materiality may no longer be appropriate and considers whether to revise it. The audit manager suggests using total revenue as a more stable benchmark. Meanwhile, the client's CFO argues that materiality should be based on the revised PBT to avoid over-auditing. The team has already performed risk assessment procedures based on the original materiality, and fieldwork is 40% complete. The company also has a bank covenant requiring a minimum current ratio of 1.5, and the current ratio is exactly 1.5. The auditor must decide the appropriate benchmark, whether to revise materiality, and how to document the revision.

CA Sharma initially used 5% of PBT (Rs 48 crore) to arrive at materiality of Rs 2.4 crore. After the PBT revision to Rs 22 crore, if he continues to use 5% of PBT, what is the revised materiality?

1. Rs 2.4 crore, because materiality cannot be revised.
2. Rs 2.2 crore, because 10% of revised PBT is the standard.
3. Rs 4.8 crore, because the percentage must be doubled.
4. Rs 1.1 crore, which may require additional audit procedures. (correct answer)

Answer: D — Rs 1.1 crore, which may require additional audit procedures.

Explanation. 5% of revised PBT of Rs 22 crore is Rs 1.1 crore. Under SA 320, if materiality is revised downward, the auditor must apply the revised amount to remaining procedures and may need to perform additional procedures to obtain sufficient appropriate audit evidence. Materiality is not frozen, and the percentage is not doubled or changed to 10% without justification.

Where it goes wrong. Students may calculate the revised amount incorrectly or assume materiality cannot be revised; SA 320 requires revision and application to remaining procedures.

Authority. SA 320

Question 17 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. M/s V. Raman & LLP is auditing Alpha Infotech Ltd, a listed company providing cloud services. Total revenue is Rs 1,200 crore, PBT is Rs 90 crore, and total equity is Rs 400 crore. The engagement partner, CA Raman, determines materiality for the financial statements as a whole at 1% of total revenue, i.e., Rs 12 crore, considering revenue as the most appropriate benchmark due to the company's growth phase and volatile profit margins. Performance materiality is set at 75% of overall materiality, i.e., Rs 9 crore, to reduce to an appropriately low level the probability that uncorrected and undetected misstatements exceed overall materiality. The audit plan includes testing revenue contracts, unbilled receivables, and capitalized software costs. Midway through the audit, CA Raman identifies a material misstatement of Rs 4 crore in revenue recognition from a barter transaction and concludes that the risk of further misstatements is higher than initially assessed. He considers revising performance materiality downward to 60% of overall materiality. The client's CFO objects, arguing that materiality should not be changed once audit procedures have begun. The audit committee asks how materiality was determined and why revenue was chosen over PBT. CA Raman must decide whether to revise performance materiality, how to apply the revised amount to remaining procedures, and what documentation is required. The audit is 50% complete, and the report is due in six weeks. The company also has a proposed overseas acquisition that may affect future revenue streams.

CA Raman set performance materiality at Rs 9 crore (75% of Rs 12 crore). If he revises it to 60% of overall materiality, what is the revised performance materiality?

1. Rs 7.2 crore, and the revised amount applies to the remaining audit procedures. (correct answer)
2. Rs 9 crore, because performance materiality cannot be revised.
3. Rs 12 crore, because performance materiality equals overall materiality.
4. Rs 6 crore, because 50% is the mandatory minimum.

Answer: A — Rs 7.2 crore, and the revised amount applies to the remaining audit procedures.

Explanation. 60% of Rs 12 crore is Rs 7.2 crore. SA 320 permits revision of performance materiality when new information indicates a need for revision. The revised performance materiality applies to the remaining audit procedures. Performance materiality can be revised, is always less than overall materiality, and there is no mandatory 50% minimum.

Where it goes wrong. Students may compute incorrectly or think performance materiality is fixed; SA 320 requires revision when circumstances change.

Authority. SA 320

Question 18 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

Scenario. Which of the following correctly describes the relationship between materiality and audit risk under SA 320?

Which of the following correctly describes the relationship between materiality and audit risk under SA 320?

1. There is a direct relationship: higher materiality requires higher audit risk.
2. There is an inverse relationship: higher materiality generally allows lower audit risk. (correct answer)
3. Materiality and audit risk are unrelated concepts under SA 320.
4. Materiality is determined solely by audit risk without considering users' needs.

Answer: B — There is an inverse relationship: higher materiality generally allows lower audit risk.

Explanation. SA 320 indicates that there is an inverse relationship between materiality and the level of audit risk: the higher the materiality level, the lower the audit risk, and vice versa. Materiality and audit risk are related, and materiality is not determined solely by audit risk but also by users' needs and professional judgment.

Where it goes wrong. Students may confuse the inverse relationship or think materiality and audit risk are unrelated; SA 320 highlights their inverse relationship.

Authority. SA 320

Question 19 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · medium

Scenario. An auditor determines overall materiality at Rs 50 lakh and performance materiality at Rs 35 lakh. During the audit, uncorrected misstatements aggregate to Rs 45 lakh. What is the appropriate action under SA 320?

An auditor determines overall materiality at Rs 50 lakh and performance materiality at Rs 35 lakh. During the audit, uncorrected misstatements aggregate to Rs 45 lakh. What is the appropriate action under SA 320?

1. No action is required because the aggregate is below overall materiality.
2. The auditor should revise performance materiality upward to avoid qualifying the report.
3. The auditor should request management to correct the misstatements or consider the effect on the audit opinion if not corrected. (correct answer)
4. The auditor should immediately withdraw from the engagement.

Answer: C — The auditor should request management to correct the misstatements or consider the effect on the audit opinion if not corrected.

Explanation. SA 320 requires the auditor to evaluate whether uncorrected misstatements, individually or in aggregate, are material. Although the aggregate of Rs 45 lakh is below overall materiality of Rs 50 lakh, the auditor should consider the nature and circumstances and may request correction. If not corrected, the auditor considers the effect on the opinion. Revising performance materiality upward to avoid qualification is improper, and withdrawal is not the automatic response.

Where it goes wrong. Students may think any aggregate below overall materiality requires no action; SA 320 requires evaluation of the nature and circumstances and consideration of correction.

Authority. SA 320

Question 20 · 2 marks · Chapter 2: Audit Strategy, Audit Planning and Audit Programme · hard

Scenario. Which of the following is an example of a benchmark that may be appropriate for determining materiality for the financial statements as a whole?

Which of the following is an example of a benchmark that may be appropriate for determining materiality for the financial statements as a whole?

1. The auditor's professional fees.
2. The number of employees in the entity.
3. The client's budgeted profit for the next year.
4. Total revenue, gross profit, or profit before tax, depending on the entity's circumstances. (correct answer)

Answer: D — Total revenue, gross profit, or profit before tax, depending on the entity's circumstances.

Explanation. SA 320 identifies examples of benchmarks that may be appropriate, such as profit before tax, total revenue, gross profit, total expenses, total equity, or net asset value, depending on the entity's circumstances. The auditor's fees, number of employees, and budgeted future profit are not appropriate benchmarks for materiality.

Where it goes wrong. Students may think any financial or non-financial measure can be a benchmark; SA 320 lists benchmarks that reflect the financial statements and users' needs.

Authority. SA 320