Accounts Receivable and Acceptable Audit Risk

1. Explain why decisions about acceptable audit risk, inherent risk, the preliminary judgement about materiality, and performance materiality should be made early in the audit during the planning phase. The purpose of assessing risks early is to help auditor plan the audit by deciding which parts of the audit to emphasize and the extent of testing. It helps auditors to understand the nature, timing, extent of the accounts, therefore plan a right procedure and the appropriate evidence to accumulate

2. Explain how the levels of acceptable audit risk and materiality you selected in this assignment might affect the remainder of the audit. Specifically, what effect would lower levels of acceptable audit risk and materiality have on the audit compared to the levels you selected? The levels of acceptable audit risk decide how much evidence to gather during the audit. Lower levels of acceptable audit risk means less tolerant of the misstatement, and therefore more substantive tests will need to be done. A low acceptable audit risk requires a high level of audit assurance, but more time, labor and cost are required.For the accounts are high risky, such as those with relatively large size and easy to have errors, a low level of materiality will lead to a over audit. Auditors will collect more evidence than needed to audit the accounts. For the accounts that are expensive to gathering evidence, such behavior will increase the audit cost.

3. In requirement (f) of this assignment, you established performance materiality for each of several balance sheet accounts. Explain/justify how you chose your performance materiality amounts for each of the following accounts:(a) accounts receivable, (b) allowance for bad debts, (c) accounts payable. (a) Accounts Receivable is relatively risky by nature, and the amount is large. It is easy to manipulate and costly to get confirmation, so the level of materiality should be set higher. As for Oceanview, the size and materiality of the accounts of Cash and Accounts Receivable are similar, so we apply the performance materiality level of Cash to Accounts Receivable. (b) ADA account is as risky as Accounts Receivable , however the size is considerably lower and easy to be recalculated. So we set a low level of materiality for ADA account.