MATERIALITY AND RISK

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CHAPTER 8

• MATERIALITY AND RISK

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MATERIALITY

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

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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

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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

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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

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RISK

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

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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 CLIENTS INTERNAL CONTROLS WILL NOT
  PREVENT OR DETECT MISSTATEMENT
• DR DETECTION RISK
• RISK THAT AUDIT PROCEDURES WILL BE INEFFECTIVE

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• PLANNED DETECTION RISK
• MEASURE OF RISK THAT AUDITORS 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

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• 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

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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

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• 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

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• 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