Audit Simulation

ema192

Hi,
I have Unit 17 audit simulation tomorrow,

We have been told to look at Potential, Material and Tolerable Errors allowed within the audit.

I have never studied auditing before i am a not sure what these exactly mean or are referring to could anyone give me some examples or try to explain it in layman's terms for me please :-)

Many Thanks
Emma

Rinske

Hi Emma,

If I remember correct it's about this:

Potential, I assume this is the expected error. Aka the auditor who has done the audit for a few years at the same company, might start to expect a certain level of errors in the books of a company, based on previous years.

Material error is the level of error that the auditor will set. If it's below this level, (depending heavily on the errors as well of course) this will be acceptable. Anything above this is considered material and might need a correction in the year end statements.
However this can be for the total of all errors and it can also be each error separately. The auditor will always consider both options.

Tolerable errors is the level of errors that is allowed to be found during the audit, without the auditors considering it material enough to change the year end statements.

However, there are a lot of people better in explaining these things, so hopefully you get a bit more useful comment soon!

Thanks,
Rinske

Steve Collings

Hi,

Potential Error
These can also be referred to as 'projected errors'. Consider a sales invoice test. The value of the invoices tested was $35,000 out of total sales of $100,000. We divided our population into two as follows:

(a) We tested all material items. These amounted to $20,000 and included an error of $1,000. Since we have tested all material items these errors will not be reproduced in the population which has not been tested and the likely error from this source is limited to $1,000.

(b) We tested a number of other invoices amounting to $15,000 and found an error of $500. The error in the sample could be reproduced in the population. In this case the population and sample are limited to the non-material items. The projected (potential) error by extrapolation will be the error discovered ($500) multiplied by the poplation ($80,000) divided by the sample ($15,000) i.e. $2,667.

The total projected (potential) error is therefore $1,000 plus $2,667 = $3,667. Since the actual errors discovered will probably be adjusted the likely error in the accounts is projected error ($3,667) less adjustments ($1,500) = $2,167.

BUT if we had not split the population like we had done above into two distinct elements, the projected error would be found by extrapolating over the total population and would have been error discovered ($1,500) x population ($100,000) / Sample ($35,000) = $4,286.

Material Error
This would be an error(s) found which is above tolerable error. A material error can be an error in isolation, or a combination of immaterial errors which become material errors when they are aggregated.

Tolerable Error
Is the error which the auditor is willing to accept and still conclude that the financial statements are free from material misstatements. This is also known as the 'materiality level'.

Hope that helps. Sorry for the long-winded explanation about projected/potential errors but I find illustrating this sort of error helps aid understanding.

Regards

Steve

Steve Collings

Sorry, just noticed your simulation was in fact today! Hopefully it will benefit future students.

Kind regards
Steve

ema192

Thankyou for your replies!

I took the simulation today, Rinske i did find your reply helpful thanks, thanfully the simulation only had one question regarding error levels and i did understand enough to answer it fully :-).
Hopefully auditing is done with now

Thanks again

Emma