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Materiality and Risk

Chapter 9

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Topic Outlines

Materiality
Set preliminary judgement about materiality
Allocate preliminary judgement about materiality to
segment (tolerance misstatement)
Estimate misstatement and compare with
preliminary judgement
Types of risk
Assessing acceptable audit risk
Assessing inherent risk
Relationship of risk and evidence and factors
influencing risks

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Materiality

Major consideration in determining


the appropriate audit report
What is meant by the term material?
(ISA320)

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Materiality
Auditors responsibility = determine whether
financial statements are materially misstated.

Auditor will bring material misstatements to the


clients attention so corrections can be made.

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Set Preliminary Judgment About


Materiality

Auditors set materiality thresholds early in the


engagement.

Thresholds represent the maximum statements


that could be misstated and still not affect
users decisions.
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Factors Affecting Judgment


Materiality is a relative rather
than an absolute concept.
Bases are needed for
evaluating materiality.
Qualitative factors also
affect materiality.

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Guidelines
Accounting and auditing standards do not
provide specific materiality guidelines.

Professional judgment is used to set and


apply materiality guidelines.

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Allocate Preliminary Judgment About


Materiality to Segments
Evidence is accumulated by segments
rather than for the financial statements
as a whole.

Most practitioners allocate materiality


to balance sheet accounts.

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Estimated Total Misstatement and


Preliminary Judgment

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Risk
Auditors accept some level of
risk in performing the audit.

Risks exist, are difficult to


measure, and require careful
thought in response.

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Risk and Evidence


Auditors need to understand the clients
business and assess business risk.

The audit risk model helps identify the


potential and likelihood of misstatements.

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Audit Risk Model for Planning


PDR = AAR (IR CR)
where:

PDR = Planned detection risk


AAR = Acceptable audit risk
IR

= Inherent risk

CR

= Control risk

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Audit Risk Model Components


Planned
Detection
Risk

Inherent
Risk

Control
Risk

Acceptable
Audit
Risk

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Engagement Risk

The risk that the auditor or CA firm will suffer


harm because of a client relationship, even
though the audit report rendered for the
client was correct.

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Impact of Engagement Risk on


Acceptable Audit Risk
Auditors decide engagement risk and use
that risk to modify acceptable audit risk.

Engagement risk closely relates to client


business risk.

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Factors Affecting Acceptable Audit


Risk
The degree to which external users
rely on the statements
The likelihood that a client will have
financial difficulties after the
audit report is issued
The auditors evaluation of
managements integrity
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Factors Affecting Inherent Risk

Nature of Clients
Business

Companys operation
Non-routine transactions
Makeup of the population
Related parties

Audit Experience
Prior audit results
Initial vs. repeat engagement
Audit judgment required to
correctly record balances and
transactions

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Relationship of Factors Influencing


Risks to Risks and Risks to Planned
Evidence
- The engagement may require more
experienced staff
- The engagement will be reviewed more
carefully than usual

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Audit Risk for Segments


Both control risk and inherent risk are
typically set for each cycle, each
account, and often even each audit
objective, not for the overall audit.

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Risk and Evidence

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Tutorial Week 10
Homework:
9-35 : Hashim Energy Corporation (3rd edition; page 267)

THANK YOU

The best revenge is massive success.

-Frank Sinatra-

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