materiality and risk l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Materiality and Risk PowerPoint Presentation
Download Presentation
Materiality and Risk

Loading in 2 Seconds...

play fullscreen
1 / 48

Materiality and Risk - PowerPoint PPT Presentation


  • 142 Views
  • Uploaded on

Materiality and Risk. Chapter 9. Learning Objective 1. Apply the concept of materiality to the audit. Materiality. The auditor’s responsibility is to determine whether financial statements are materially misstated. If there is a material misstatement,

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Materiality and Risk' - fabrizio


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
learning objective 1
Learning Objective 1

Apply the concept of

materiality to the audit.

materiality
Materiality

The auditor’s responsibility is to

determine whether financial

statements are materially misstated.

If there is a material misstatement,

the auditor will bring it to the client’s

attention so that a correction can be made.

steps in applying materiality
Steps in ApplyingMateriality

Step

1

Set preliminary

judgment about

materiality.

Planning

extent

of tests

Step

2

Allocate preliminary

judgment about

materiality

to segments.

steps in applying materiality5
Steps in ApplyingMateriality

Step

3

Estimate total

misstatement in segment.

Step

4

Estimate the

combined misstatement.

Evaluating

results

Step

5

Compare combined

estimate with judgment

about materiality.

learning objective 2
Learning Objective 2

Make a preliminary judgment

about what amounts to

consider material.

set preliminary judgment
Set Preliminary Judgment

Ideally, auditors decide early in the audit

the combined amount of misstatements

of the financial statements that would

be considered material.

This preliminary judgment is the maximum

amount by which the auditor believes the

statements could be misstated and still not

affect the decisions of reasonable users.

factors affecting judgment
Factors Affecting Judgment

Materiality is a relative rather

than an absolute concept.

Bases are needed for

evaluating materiality.

Qualitative factors also

affect materiality.

learning objective 3
Learning Objective 3

Allocate preliminary materiality

to segments of the audit

during planning.

allocate preliminary judgment about materiality to segments
Allocate Preliminary Judgment About Materiality to Segments

This is necessary because evidence is

accumulated by segments rather than

for the financial statements as a whole.

Most practitioners allocate materiality

to balance sheet accounts.

SAS 39 (AU 350)

learning objective 4
Learning Objective 4

Use materiality to evaluate

audit findings.

estimated total misstatement example
Estimated TotalMisstatement 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

example of estimate for sampling error
Example of Estimatefor Sampling Error

Tolerable Direct Sampling

AccountMisstatementProjectionErrorTotal

Cash $ 4,000 $ 0 $ N/A $ 0

Accounts receivable 20,000 12,000 6,000* 18,000

Inventory 36,000 31,500 15,750* 47,250

Total estimated

misstatement amount $43,500 $16,800 $60,300

Preliminary judgment

about materiality $50,000

*estimate for sampling error is 50%

learning objective 5
Learning Objective 5

Define risk in auditing.

slide15
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.

risk and evidence
Risk and Evidence

Auditors gain an understanding of the

client’s business and industry and

assess client business risk.

Auditors use the audit risk model to further

identify the potential for misstatements

and where they are most likely to occur.

example of differing evidence among cycles
Example of DifferingEvidence Among Cycles

Sales and

Collection

Cycle

Acquisition

and Payment

Cycle

Payroll and

Personnel

Cycle

A

Inherent

risk

medium

high

low

B

Control

risk

medium

low

low

C

Acceptable

audit risk

low

low

low

D

Planned

detection risk

medium

medium

high

example of differing evidence among cycles18
Example of DifferingEvidence Among Cycles

Inventory and

Warehousing

Cycle

Capital Acquisition

and Repayment

Cycle

A

Inherent

risk

high

low

B

Control

risk

high

medium

C

Acceptable

audit risk

low

low

D

Planned

detection risk

low

medium

learning objective 6
Learning Objective 6

Describe the audit risk

model and its components.

audit risk model for planning
Audit Risk Modelfor Planning

PDR = AAR ÷ (IR × CR)

Where

PDR = Planned detection risk

AAR = Acceptable audit risk

IR = Inherent risk

CR = Control risk

learning objective 7
Learning Objective 7

Consider the impact of risk

on acceptable audit risk.

impact of engagement risk on acceptable audit risk
Impact of Engagement Riskon Acceptable Audit Risk

Auditors decide engagement risk and use

that risk to modify acceptable audit risk.

Engagement risk closely relates to

client business risk.

factors affecting acceptable audit risk
Factors AffectingAcceptable 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

factors affecting acceptable audit risk24
Factors AffectingAcceptable Audit Risk

The auditor’s evaluation of

management’s integrity

making the acceptable audit risk decision
Making the AcceptableAudit Risk Decision

Factors

Methods to Assess Risk

External users

reliance on

financial

statements

  • Examine financial statements.
  • Read minutes of the board.
  • Examine form 10K.
  • Discuss financing plans
  • with management.
making the acceptable audit risk decision26
Making the AcceptableAudit Risk Decision

Factors

Methods to Assess Risk

Likelihood

of financial

difficulties

  • Analyze financial statements for difficulties using ratios.
  • Examine inflows and outflows of cash flow statements.

Management

integrity

  • See Chapter 8 for client acceptance and continuance.
learning objective 8
Learning Objective 8

Consider the impact of several

factors on the assessment

of inherent risk.

major factors when assessing inherent risk
Major Factors WhenAssessing Inherent Risk
  • Nature of the client’s business
  • Results of previous audits
  • Initial versus repeat engagement
  • Related parties
  • Nonroutine transactions
  • Judgment – correctly record account
  • balances and transactions
  • Makeup of the population
learning objective 9
Learning Objective 9

Consider information

gathered to assess the

likelihood of fraud.

assessing risks of fraud
Assessing Risks of Fraud

Three conditions are generally present.

1. Incentives/Pressures

2. Opportunities

3. Attitudes/Rationalization

examples of risks factors for fraudulent reporting
Examples of Risks Factorsfor Fraudulent Reporting

1. Incentives/Pressures

Financial stability or profitability is threatened by

economic, industry, or entity operating conditions.

Excessive pressure exists for management

to meet debt requirements.

Personal net worth is materially threatened.

examples of risks factors for fraudulent reporting32
Examples of Risks Factorsfor Fraudulent Reporting

2. Opportunities

There are significant accounting estimates

that are difficult to verify.

There is ineffective oversight over

financial reporting.

High turnover or ineffective accounting internal

audit, or information technology staff exists.

examples of risks factors for fraudulent reporting33
Examples of Risks Factorsfor Fraudulent Reporting

3. Attitudes/Rationalization

Inappropriate or inefficient communication

and support of the entity’s values is evident.

A history of violations of laws is known.

Management has a practice of making overly

aggressive or unrealistic forecasts.

responding to the risk of fraud
Responding to theRisk 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.

learning objective 10
Learning Objective 10

Discuss the relationship

of risks to audit evidence.

relationship of risk factors risk and evidence
Relationship of Risk Factors,Risk, and Evidence

Acceptable audit risk

D

D

I

Factors

Influencing

Risks

Inherent

risk

Planned

detection

risk

Planned

audit

evidence

I

I

I

D

Control risk

D = Direct relationship; I = Inverse relationship

changing the audit in response to risk
Changing the Audit in Response to Risk

The engagement may require

more experienced staff.

The engagement will be reviewed

more carefully than usual.

audit risk for segments
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.

relating risk of fraud to risk model components
Relating Risk of Fraud toRisk Model Components

The risk of fraud can be assessed

for the entire audit or by cycle,

account, and objective.

Specific response could include

revising assessments of acceptable

audit risk, inherent risk, and control risk.

tolerable misstatement risks and balance related objectives
Tolerable Misstatement, Risks,and Balance-related Objectives

It is common to assess inherent and control

risk for each balance-related audit objective.

It is not common to allocate

materiality to objectives.

measurement limitations
Measurement Limitations

One major limitation in the application

of the audit risk model is the difficulty

of measuring the components of the model.

relationships of risk to evidence
Relationships of Riskto Evidence

Acceptable Planned Amount of

Audit Inherent Control Detection Evidence

Situation Risk Risk Risk Risk Required

1 High Low Low High Low

2 Low Low Low Medium Medium

3 Low High High Low High

4 Medium Medium Medium Medium Medium

5 High Low Medium Medium Medium

tests of details of balances evidence planning worksheet
Tests of Details of Balances Evidence Planning Worksheet

Auditors develop various types of worksheets to

aid in relating the considerations affecting audit

evidence to the appropriate evidence to accumulate.

learning objective 11
Learning Objective 11

Discuss how materiality and risk

are related and integrated into

the audit process.

tolerable misstatements risk and planned evidence
Tolerable Misstatements,Risk, and Planned Evidence

Acceptable

audit risk

D

D

I

Inherent

risk

Planned

detection risk

Planned

audit evidence

I

I

I

D

I

Control

risk

Tolerable

misstatement

D = Direct relationship; I = Inverse relationship

audit risk model for evaluating results
Audit Risk Model for Evaluating Results

AcAR = IR × CR × AcDR

Where

AcAR = Achieved audit risk

AcDR = Achieved detection risk

IR = Inherent risk

CR = Control risk

revising risks and evidence
Revising Risksand Evidence

The audit risk model is primarily a

planningmodel 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.