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Risk
Chapter 9
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 1
Apply the concept of
materiality to the audit.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Materiality
The auditors responsibility is to
determine whether financial
statements are materially misstated.
If there is a material misstatement,
the auditor will bring it to the clients
attention so that a correction can be made.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
9-3
Steps in Applying
Materiality
Step
1
Set preliminary
judgment about
materiality.
Allocate preliminary
Step
judgment about
2
materiality
to segments.
Planning
extent
of tests
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Steps in Applying
Materiality
Step
Estimate total
3 misstatement in segment.
Step
Estimate the
4 combined misstatement.
Evaluating
results
Compare combined
Step
estimate with judgment
5
about materiality.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
9-5
Learning Objective 2
Make a preliminary judgment
about what amounts to
consider material.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 3
Allocate preliminary materiality
to segments of the audit
during planning.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 4
Use materiality to evaluate
audit findings.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Estimated Total
Misstatement Example
Net misstatement of the sample
Total sampled
Total recorded population value
Direct projection estimate of misstatement
$3,500 $50,000 $450,000 = $31,500
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Example of Estimate
for Sampling Error
Tolerable
Direct Sampling
Misstatement Projection Error
Total
$ 4,000
$
0 $ N/A
$
0
20,000
12,000
6,000* 18,000
36,000
31,500
15,750* 47,250
Account
Cash
Accounts receivable
Inventory
Total estimated
misstatement amount
Preliminary judgment
about materiality
$50,000
*estimate for sampling error is 50%
$43,500
$16,800
$60,300
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 5
Define risk in auditing.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Risk
Auditors accept some level of risk
in performing the audit.
An effective auditor recognizes that
risks exist, are difficult to measure,
and require careful thought to respond.
Responding to risks properly is critical
to achieving a high-quality audit.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Example of Differing
Evidence Among Cycles
A
B
C
D
Inherent
risk
Control
risk
Acceptable
audit risk
Planned
detection risk
Sales and
Collection
Cycle
Acquisition
and Payment
Cycle
Payroll and
Personnel
Cycle
medium
high
low
medium
low
low
low
low
low
medium
medium
high
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Example of Differing
Evidence Among Cycles
A
B
C
D
Inherent
risk
Control
risk
Acceptable
audit risk
Planned
detection risk
Inventory and
Warehousing
Cycle
Capital Acquisition
and Repayment
Cycle
high
low
high
medium
low
low
low
medium
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 6
Describe the audit risk
model and its components.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 7
Consider the impact of risk
on acceptable audit risk.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Factors Affecting
Acceptable Audit Risk
The degree of which external users
rely on the statements
The likelihood that a client will have
financial difficulties after the
audit report is issued
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Factors Affecting
Acceptable Audit Risk
The auditors evaluation of
managements integrity
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Likelihood
of financial
difficulties
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Learning Objective 8
Consider the impact of several
factors on the assessment
of inherent risk.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 9
Consider information
gathered to assess the
likelihood of fraud.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Responding to the
Risk of Fraud
Design and perform audit procedures
to address identified fraud risk.
Change the overall conduct of the audit
to respond to identified fraud risk.
Perform procedures to address the risk
of management override of controls.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 10
Discuss the relationship
of risks to audit evidence.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Factors
Influencing
Risks
Inherent
risk
Planned
detection
risk
Planned
audit
evidence
Control risk
D = Direct relationship; I = Inverse relationship
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Measurement Limitations
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Relationships of Risk
to Evidence
Acceptable
Audit
Situation Risk
1
High
2
Low
3
Low
4
Medium
5
High
Planned
Inherent Control Detection
Risk
Risk
Risk
Low
Low
High
Low
Low
Medium
High
High
Low
Medium Medium Medium
Low
Medium Medium
Amount of
Evidence
Required
Low
Medium
High
Medium
Medium
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 11
Discuss how materiality and risk
are related and integrated into
the audit process.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Tolerable Misstatements,
Risk, and Planned Evidence
Acceptable
audit risk
Inherent
risk
Control
risk
D
I
Planned
detection risk
I
D
I
Planned
audit evidence
D
Tolerable
misstatement
D = Direct relationship; I = Inverse relationship
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Revising Risks
and Evidence
The audit risk model is primarily a
planning model and is therefore of
limited use in evaluating results.
Great care must be used in revising
the risk factors when the actual results
are not as favorable as planned.
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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End of Chapter 9
2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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