dpa 3043(auditing)-chapter 6:materiality and risk

hanimnorzababa, politeknikmelaka 20-21

februari2012 1

Topic 6AUDITING

COURSE LEARNING OUTCOMES (CLO)Upon completion of this course, students should be able to :

Definition a misstatement or omission of financial information either individually or in the aggregate that may influence or affect the decision made by the users of the financial statements. In other words, information is material if its omission or misstatements could influence the economic decision of users of financial statements

Factors affecting preliminary judgement about materialitymateriality is a relative rather than an absolute conceptbases are needed for evaluating materialityqualitative factors will affect materiality decisionsexpected dissemination (various types of users) of the financial statementsthe level of acceptable audit risk

ASSESSMENT OF AUDIT RISK AND MATERIALITYThe assessment of audit risk and materiality is a matter of the auditor’s professional judgements

hanimnorzababa, politeknikmelaka

20-21 februari2012 2

MATERIALITYan item is material if its non-disclosure, misstatement or omission would be likely to change the view given by the accounts. Whether an item is material or not, the auditor will consider:

Its absolute sizeIts nature – does it affect the SOCI or SFP? Are there specific disclosure requirements?Its relative size – relative to the accounts as a whole, to the balance of which it form a part, to corresponding amounts in other periods



7.2.1 Define the meaning of audit riskThe risk that the auditor gives an inappropriate opinion when the financial statements are materiality misstated. In other words, the risk that the auditor delivers an incorrect audit opinion – an opinion which states that the accounts present a true and fair view while in reality they do not.

The auditor plans his work so that the level of audit risk is acceptably low which will depends upon the auditor’s perception of the likelihood of material errors.



ACCEPTABLE AUDIT RISK (AUDIT RISK)is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion can be issuedAn example : acceptable audit risk of 2% is the same as acceptable audit assurance of 98%

FACTORS OF UNCERTAINTY IN AUDIT PERFORMANCEnature of an audit testinherent limitations of an auditinherent limitations of the effectiveness of client’s internal control system

COMPONENTS OF AUDIT RISKinherent riskcontrol riskdetection risk



The risk that the accounts may contain misstatements



INHERENT RISK CONTROL RISK DETECTION RISK

risk derived from the characteristics of the enterprise and of its environment

the risk that internal controls will not prevent or detect material errors

the risk that the auditor may fail to detect misstatements

INHERENT RISKThe risk related to the characteristics of the business that may cause material misstatement in financial statements

Several factors use in assessing inherent risksNature of client’s businessIntegrity of managementClient motivationClient’s knowledge of accounting standardsResult of previous auditSusceptibility to defalcationNature of client’s inventory and technological development



EXAMPLE

external factor such as technological development might make a particular product obsolete, thereby causing inventory to be more susceptible to overstatement

inherent risk will be high if no internal control system and inherent risk will be lower if internal control system exists.



CONTROL RISKThe risk that the client’s system of internal control will not prevent or detect material errors or misstatements in the account balance or class of transactions

The control risk may exist due to the inherent limitation of internal control system and inadequacy of the segregation of duties such as human error, faulty judgement, teaming & lading

Control risk will be higher if internal control system is not effective and control risk will be lower if internal control risk is effective



DETECTION RISKThe risk that any remaining material misstatement after assessing inherent and control risks will not be detected by the auditor

The risk that the auditor’s substantive procedures and review of financial statements will not detect material errors or misstatements

The auditor has to decide on the nature, extent, timing and cost of the audit in the determination of the level of detection risk.

Detection risk will be higher if the auditors are not competent and due care and detection risk will be lower if the auditors are competent and exercise due care


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IR - no internal ctrl HIGH hv internal ctrl LOW

CR - ineffective HIGH effective LOW

DR - not competent HIGH competent & due care LOW

Example :

AR = IR x CR x DRVery low High High ?

AR = IR x CR x DR ? High Low

Moderate


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Example :

AR = IR x CR x DR5% 40% 50% ?

DR = AR / (IR x CR) = 5% / ( 40% x 50%) = 5% / 20% = 25%

Differentiate between AUDIT RISK and BUSINESS RISK


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audit risk business riskRelates mainly to the internal and external audit efforts to achieve its objectives

Resulting from significant conditions, events, circumstances, actions or inactions that could adversely affect an entity’s ability to achieve its objective and execute its strategies

Unable provide effective, timely and efficient assurance and consulting support to management and the board.

Form the setting of inappropriate objectives and strategies

Traditionally, audit risk has been seen as strictly the risk of incorrect audit conclusions.

Risk of poor management planning & decision making


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The relationship between audit materiality and audit risk

dpa 3043(auditing)-chapter 6:materiality and risk

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