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,
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Apply the concept of
materiality to the audit.
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.
Make a preliminary judgment
about what amounts to
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.
Materiality is a relative rather
than an absolute concept.
Bases are needed for
Qualitative factors also
Allocate preliminary materiality
to segments of the audit
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)
Use materiality to
evaluate audit findings.
*estimate for sampling error is 50%Estimated Total Misstatement and Preliminary Judgment
Total recorded population value
Direct projection estimate of misstatementEstimated Total Misstatement and Preliminary Judgment
Net misstatements in the sample
$3,500 ÷ $50,000 × $450,000 = $31,500
Define risk in auditing.
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.
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.
Describe the audit risk
model and its components.
PDR = AAR ÷ (IR × CR)
PDR = Planned detection risk
AAR = Acceptable audit risk
IR = Inherent risk
CR = Control risk
Consider the impact of
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.
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 auditor’s evaluation of
Methods used to assess
acceptable audit risk
Consider the impact of several
factors on the assessment
of inherent risk.
Discuss the relationship
of risks to audit evidence.
The engagement may require
more experienced staff.
The engagement will be reviewed
more carefully than usual.
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.
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.
It is common to assess inherent and control
risk for each balance-related audit objective.
It is not common to allocate
materiality to objectives.
One major limitation in the application
of the audit risk model is the difficulty
of measuring the components of the model.
Auditors develop various types of
worksheets to aid in relating the
considerations affecting audit
evidence to the appropriate
evidence to accumulate.
Discuss how materiality and
risk are related and integrated
into the audit process.
D = Direct relationship; I = Inverse relationshipTolerable Misstatements,Risk, and Planned Evidence
AcAR = IR × CR × AcDR
AcAR = Achieved audit risk
IR = Inherent risk
CR = Control risk
AcDR = Achieved detection risk
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.