Materiality and Risk Chapter 9 Learning Objective

Transcript:Materiality and Risk Chapter 9 Learning Objective:
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, the auditor will bring it to the client’s attention so that a correction can be made. Steps in Applying Materiality Step 1 Set preliminary judgment about materiality. Step 2 Allocate preliminary judgment about materiality to segments. Planning extent of tests Steps in Applying Materiality Step 3 Estimate total misstatement in segment. Step 4 Estimate the combined misstatement. Evaluating results Compare combined estimate with judgment about materiality. Step 5 Learning Objective 2 Make a preliminary judgment about what amounts to consider material. Set Preliminary Judgment 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. Ideally, auditors decide early in the audit the combined amount of misstatements of the financial statements that would be considered material. 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 Allocate preliminary materiality to segments of the audit during planning. 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 Use materiality to evaluate audit findings. Estimated Total Misstatement Example Net misstatement of the sample $3,500 ÷ $50,000 × $450,000 = $31,500 Total sampled Total recorded population value Direct projection estimate of misstatement × ÷ = Example of Estimate for Sampling Error Tolerable Direct Sampling Account Misstatement Projection Error Total 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 Define risk in auditing. 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 Auditors gain an understanding of the client’s business and industry and assess client business risk. Auditors use the audit risk model