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CHAPTER 8

CHAPTER 8. MATERIALITY AND RISK. MATERIALITY. THE MAGNITUDE OF AN OMISSION OR MISSTATEMENT…THAT MAKES IT PROBABLE THAT THE JUDGMENT OF A REASONABLE PERSON WOULD BE CHANGED OR INFLUENCED BY THE ITEM. PRELIMINARY JUDGMENT ABOUT MATERIALITY. PROFESSIONAL JUDGMENT

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CHAPTER 8

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  1. CHAPTER 8 MATERIALITY AND RISK

  2. MATERIALITY • THE MAGNITUDE OF AN OMISSION OR MISSTATEMENT…THAT MAKES IT PROBABLE THAT THE JUDGMENT OF A REASONABLE PERSON WOULD BE CHANGED OR INFLUENCED BY THE ITEM.

  3. PRELIMINARY JUDGMENT ABOUT MATERIALITY • PROFESSIONAL JUDGMENT • AMOUNT OF MISSTATEMENT PRESENT AND NOT INFLUENCE USERS • PLANNING DECISION • APPROPRIATE LEVEL OF EVIDENCE • HIGHER MATERIALITY, LOWER EVIDENCE • FACTORS AFFECTING JUDGMENT • RELATIVE RATHER THAN ABSOLUTE • BASES FOR COMPARISON • QUALITATIVE FACTORS

  4. ALLOCATE PLANNING MATERIALITY TO SEGMENTS • EVIDENCE IS ACCUMULATED BY SEGMENT • AMOUNT IF EVIDENCE IS INVERSLY RELATED TO MATERIALITY • TOLERABLE MISSTATEMENT • NO ONE WAY TO ALLOCATE • MATERIALITY REVISED DURING AUDIT

  5. ESTIMATE MISSTATEMENT • RESULTS OF AUDIT PROJECTED TO ACCOUNT BALANCE • PROJECTION • STATISTICAL OR NONSTATISTICAL • DIRECT PROJECTION • ALLOWANCE FOR SAMPLING RISK • ESTIMATE OF COMBINED MISSTATEMENT • COMPARE WITH MATERIALITY • EXPAND AUDIT WORK OR ACCEPT RESULT

  6. RISK • UNCERTAINTY IN THE AUDIT FUNCTION • COMPETENCE OF EVIDENCE • STRENGTH OF INTERNAL CONTROLS • FAIRNESS OF FINANCIAL STATEMENTS

  7. AUDIT RISK MODEL • AR = IR * CR * DR • AR = AUDIT RISK • RISK THAT AUDITOR REACHES THE WRONG CONCLUSION • IR = INHERENT RISK • RISK THAT MATERIAL MISSTATEMENTS OCCUR BECAUSE OF NATURE OF ITEM AUDITED • CR = CONTROL RISK • RISK THAT CLIENT’S INTERNAL CONTROLS WILL NOT PREVENT OR DETECT MISSTATEMENT • DR = DETECTION RISK • RISK THAT AUDIT PROCEDURES WILL BE INEFFECTIVE

  8. PLANNED DETECTION RISK • MEASURE OF RISK THAT AUDITOR’S PROCEDURES WILL NOT FIND MATERIAL MISSTATEMENTS THAT EXIST IN FINANCIAL STATEMENTS • ACCEPTABLE AUDIT RISK • RISK THAT AUDITOR IS WILLING TO ACCEPT THAT AUDIT OPINION WILL BE INCORRECT • RELIANCE OF USERS ON F/S • LIKELIHOOD OF FINANCIAL DIFFICULTIES • MANAGEMENT INTEGRITY

  9. ASSESSMENT OF INHERENT RISK • EXPECTATION OF MATERIAL MISSTATEMENTS BEFORE INTERNAL CONTROLS • FACTORS • NATURE OF BUSINESS • FRAUD • RESULTS OF PREVIOUS AUDITS • INITIAL ENGAGEMENT • RELATED PARTIES • NONROUTINE TRANSACTIONS • JUDGMENT IN PROPER ACCOUNTING • SUSCEPTABILITY TO ASSET MISAPPROPRIATION • MAKEUP OF POPULATION

  10. OTHER MATERIALITY AND RISK CONSIDERATIONS • AUDIT RISK MODEL APPLIED TO SEGMENTS • CONTROL RISK AND INHERENT RISK SET • EACH CYCLE • EACH ACCOUNT BALANCE • EACH AUDIT OBJECTIVE • AUDIT RISK USUSALLY SET FOR WHOLE

  11. MEASUREMENT PROBLEMS AND MODEL • DIFFICULT TO QUANTIFY RISKS ACCURATELY AS %-AGES • MOST AUDITORS USE SUBJECTIVE MEASURES LIKE “LOW” • RELATION OF EVIDENCE TO RISK IS SUBJECTIVE ALSO • CONCERN ABOUT OVER- OR UNDER-AUDITING

  12. RELATIONSHIP OF RISK AND MATERIALITY • RISK IS UNCERTAINTY • MATERIALITY IS SIZE • RISK OF MATERIAL MISSTATEMENT • RISK THAT MISSTATEMENT OF CERTAIN SIZE EXISTS IN ITEM BEING AUDITED • AS MATERIALITY DECREASES, RISK INCREASES • RISK MODEL IS PRIMARILY A PLANNING TOOL • IMPORTANT RELATIONSHIP IS RISK - EVIDENCE

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