Materiality and Risk

1
Materiality and Risk

• Chapter 4

2
Homework

• Read Pacioli article handout.
• Review summary of the Sarbanes-Oxley Act of 2002
  on the AICPA Website.
• Memorize the unqualified audit report.
• Know the 10 generally accepted auditing standards.

3
Materiality

• Definition
• Important, essential, or pertinent important
  enough to affect the outcome of a legal case.
  (Webster)
• Judgment criteria
• Absolute size
• Relative Size
• Nature of the item or issue (cause or location)
• Circumstances (use of information)
• Uncertainty
• Cumulative effects

4
Application of Materiality

• Planning Materiality
• For scheduling the work and assigning staff
• Allocation of Materiality among accounts
• top-down vs bottoms-up
• Final Materiality Threshhold for the Engagement
• For determining the opinion to be issues
• May be different from planning materiality

5
Risk

• Audit Risk
• The risk that an auditor will render an
  inappropriate opinion.
• Inherent Risk
• The susceptibility to misstatements
• Control Risk
• Probability that material misstatements will not
  be prevented/corrected by the internal controls.
• Detection Risk
• Probability that the audit will fail to detect
  material misstatements.

6
Risk

• Audit Risk Model
• AR IR x CR x DR
• The model is not mathematically correct because
  IR, CR, and DR are not independent. The model
  does illustrate basic relationships. Calculations
  on page 88 should not be used.

7
Audit Planning

• Client acceptance and retention
• Preliminary risk assessment
• Preliminary analytical procedures (ch 5)
• Audit program
• Assignment of staff

8
General Audit Procedures

• Recalculation of Clients Figures
• Physical Observation of Tangible Assets
• Confirmation with Independent Parties
• Verbal Inquiry of Knowledgeable Individuals
• Examination of Documents
• Scanning for Unusual Items and Events
• Analytical Procedures

9
Analytical Procedures

• Vertical Analysis
• Horizontal Analysis
• Ratio Analysis
• Comparison With Expectations
• budgets and forecasts
• anticipated results
• normal relationships

10
Auditing in an Electronic Environment

• Virtually all clients will have a computerized
  accounting system.
• Principles remain unchanged.
• Application of principles may be different.
• Internal controls are more important due to lack
  of paper trail.