Auditing and assurance services 14e by arens chapter 09

Materiality and Risk
Chapter 9
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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Learning Objective 1
Apply the concept of materiality to the audit.

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Materiality
Major consideration in determining
the appropriate audit report
Referenced in audit report’s scope
paragraph
What is meant by the term “material”?

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Materiality
Auditor’s responsibility = determine whether

financial statements are materially misstated.

Auditor will bring material misstatements to the
client’s attention so corrections can be made.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Steps in Applying Materiality

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Learning Objective 2
Make a preliminary judgment about what
amounts to consider material.

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Set Preliminary Judgment About
Materiality
Auditors set materiality thresholds early in the
engagement.

Thresholds represent the maximum statements
that could be misstated and still not affect
users decisions.
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Factors Affecting Judgment
Materiality is a relative rather
than an absolute concept.
Bases are needed for
evaluating materiality.
Qualitative factors also
affect materiality.

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Qualitative Factors
Considerations that may render material a
quantitatively small misstatement include:
Loan covenants

Changing trend

Management compensation

Financial statements users

Conceals an illegal act

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Guidelines
Accounting and auditing standards do not
provide specific materiality guidelines.

Professional judgment is used to set and
apply materiality guidelines.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Learning Objective 3
Allocate preliminary materiality to segments
of the audit during planning.

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Allocate Preliminary Judgment
About Materiality to Segments
Evidence is accumulated by segments
rather than for the financial statements
as a whole.
Most practitioners allocate materiality
to balance sheet accounts.


SAS 107 (AU 312)

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Learning Objective 4
Use materiality to evaluate audit findings.

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Known and Likely Misstatements
Auditor can determine the misstated
amount in an account (“Known”)
Two types of “Likely” misstatements:

Judgmental differences


Projections of misstatements from
audit samples

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Estimated Total Misstatement
and Preliminary Judgment

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Estimated Total Misstatement
and Preliminary Judgment
Estimated
Net misstatements in Sample ($3,500)
× Total recorded
=
Misstatement
Total sampled ($50,000)
population value
($31,500)
($450,000)

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Learning Objective 5
Define risk in auditing.

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Risk
Auditors accept some level of
risk in performing the audit.
Risks exist, are difficult to
measure, and require careful
thought in response.
Proper risk response is critical
to achieving a high-quality audit.
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Risk and Evidence
Auditors need to understand the client’s
business and assess business risk.

The audit risk model helps identify the

potential and likelihood of misstatements.

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Audit Risk Model for Planning
PDR = AAR ÷ (IR × CR)
where:

PDR = Planned detection risk
AAR = Acceptable audit risk
IR = Inherent risk
CR = Control risk

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Audit Risk Model for Planning

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Illustration of Differing Evidence
Among Cycles

Sales and
collection
cycle

Acquisition Payroll and
and payment personnel
cycle
cycle

A

Inherent
risk

Medium

High

Low

B

Control
risk

Medium

Low

Low

C

Acceptable
audit risk

Low

Low

Low

D

Planned
Medium
detection risk

Medium

High

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Illustration of Differing Evidence
Among Cycles
Inventory and

warehousing
cycle

Capital acquisition
and repayment
cycle

A

Inherent
risk

High

Low

B

Control
risk

High

Medium

C

Acceptable
audit risk

Low

Low

D

Planned
Low
detection risk

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Medium
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Learning Objective 6
Describe the audit risk model and
its components.

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Audit Risk Model Components
Planned
Detection
Risk

Inherent
Risk

Control
Risk

Acceptable
Audit
Risk

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