Tolerable error is the maximum monetary error that the auditor is prepared to accept in the population and still conclude that audit objective has been achieved is directly related to
|a) Sample size|
b) Audit risk
d) Expected error
The Correct Answer Is:
Tolerable error is a crucial concept in auditing that helps auditors determine the level of errors they can accept in a population without affecting their overall conclusion about the audit objective. It is directly related to the concept of materiality.
Materiality in auditing refers to the significance or importance of an item, transaction, or error in the financial statements. If an error is considered material, it means that it has the potential to influence the decision-making of users relying on the financial statements.
Now, let’s delve into why the correct answer is option (c) Materiality:
Materiality is directly related to tolerable error because it sets the threshold for what the auditor considers as significant in the financial statements. The tolerable error is essentially a quantitative expression of materiality.
The auditor determines a specific monetary amount that they are willing to accept as the maximum error in a population. If the errors found during the audit are below this threshold (tolerable error), the auditor can conclude that the audit objective has been achieved.
Why the other options are not correct:
a) Sample size:
Sample size is an important consideration in auditing as it determines the number of items or transactions that will be examined from the population. The auditor selects a sample to gather evidence about the entire population. A larger sample size generally provides more reliable results.
However, sample size is not directly related to tolerable error. It does not define the maximum monetary error that the auditor is willing to accept in the population.
Instead, sample size is determined based on factors such as the level of assurance required, the expected error rate, and the acceptable level of risk. The auditor may adjust the sample size based on these considerations, but it does not directly impact the tolerable error threshold.
b) Audit risk:
Audit risk is the risk that the auditor may issue an incorrect opinion on the financial statements. It is composed of three components: inherent risk, control risk, and detection risk.
Inherent risk is the risk of material misstatement before considering internal controls, control risk is the risk that a material misstatement will not be prevented or detected by the entity’s internal controls, and detection risk is the risk that the auditor’s procedures will not detect a material misstatement.
While audit risk is a fundamental concept in auditing, it is not directly related to the specific monetary threshold of tolerable error. Audit risk is a broader assessment of the overall risk of making an incorrect conclusion about the financial statements.
It considers various risks and controls in the audit process, but it does not define the maximum allowable error in the population.
d) Expected error:
Expected error refers to the amount of error that the auditor anticipates finding in a population based on their assessment of inherent and control risks. It is used in planning the audit procedures.
The auditor considers factors like the complexity of the transactions, the effectiveness of internal controls, and historical error rates to estimate the expected error.
While expected error is an important consideration in the audit planning process, it is not synonymous with tolerable error. Expected error helps the auditor plan the appropriate level of audit effort and procedures.
It is a forward-looking estimate, whereas tolerable error is a specific threshold set by the auditor based on materiality considerations.
In conclusion, while sample size, audit risk, and expected error are all important aspects of the auditing process, they are not directly related to the concept of tolerable error, which specifically defines the maximum monetary error that the auditor is willing to accept in the population.
Tolerable error is determined based on materiality considerations and serves as a quantitative expression of the level of error that can be tolerated without affecting the auditor’s conclusion about the audit objective.