Luận văn xác lập mức trọng yếu và rủi ro kiểm toán (Tiếng Anh)

Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Contents
List of tables.................................................................................................. B
List of charts ................................................................................................. B
List of Appendices ........................................................................................ B
Introduction .................................................................................................... 1
Chapter 1. Literature review on assessing materiality and audit risk in
planning stage of the financial statements audit ..................................................... 2
1.1. Audit risk ........................................................................................ 2
1.1.1. Definition and components of audit risk ................................... 2
1.1.2. Assessing acceptable audit risk and audit risk components ...... 4
1.2. Materiality assessment .................................................................. 10
1.2.1. Definition and characteristics of materiality ........................... 10
1.2.2. Process of assessing materiality .............................................. 14
1.2.3. Relationship between materiality and audit risk ..................... 18
Chapter 2. Assessing audit risk and materiality at planning stage of the
financial statements audit conducted by Auditing and Accounting Limited
Liability Company ................................................................................................ 19
2.1. Overview about Auditing and Accounting Limited Liability
Company ...................................................................................................... 19
2.1.1. Historical development of Auditing and Accounting Limited
Liability Company ........................................................................................ 19
2.1.2. AAC Missions of Auditing and Accounting Limited Liability
Company
................................................................................................. 19
2.1.3. Types of services provided by Auditing and Accounting Limited
Liability Company ........................................................................................ 20
2.1.4. Management organization structure and human resources in

AAC Auditing and Accounting Limited Liability Company ....................... 23
2.1.5. Overview of the process of the financial statement audit
conducted by Auditing and Accounting Limited Liability Company .......... 25
2.2. Preliminary assessment audit risk and materiality conducted by
AAC Auditing and Accounting Limited Liability Company ........................... 27
2.2.1. Assessing the audit risk ........................................................... 28
2.2.2. Assessing materiality............................................................... 40
Chapter 3. Comments and solutions to improve the assessment of audit risk
and materiality performed by Auditing and Accounting Limited Liability
Company
................................................................................................. 43
3.1. Comments on the assessment of audit risk and materiality
performed by AAC ........................................................................................... 43
3.1.1. Positive points ......................................................................... 43
3.1.2. Limitations............................................................................... 44
3.2. Some solutions for improving the assessment of audit risk and
materiality conducted by AAC ......................................................................... 45
3.2.1. Solutions for the audit risk assessment ................................... 45
3.2.2. Solutions for the materiality assessment ................................. 51
Student: Huynh Thi Bich Ha

A


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Conclusion ................................................................................................... 53
References .................................................................................................... 54

List of tables
Table 1: The matrix to assessing detection risk ............................................. 9
Table 2: The guideline of VACPA for determine materiality: .................... 15
Table 3: Example for using multiple benchmarks ....................................... 15
Table 4: The ratio of engagement risk ......................................................... 16
Table 5: Balance Sheet accounts with significant changes ......................... 32
Table 6: Income Statement accounts with significant changes ................... 33
Table 7: Conclusion about internal control system of client ....................... 37
Table 8: Conclusion of the auditor about control risk on cycle ................... 39
Table 9: Risk matrix .................................................................................... 39
Table 10: Setting the materiality of ABC .................................................... 42
Table 11: Questionnaire to assess the inherent risk on the whole financial
statements ............................................................................................................. 45
Table 12: Conclusion inherent risk at ABC ................................................. 46
Table 13: Questionnaire to assess inherent risk at account level ................ 47
Table 14: The scorecard for the risk assessment of each internal control
components ........................................................................................................... 48
Table 15: Conclusion about co risk on the whole financial statements....... 48
Table 16: Assessing control risk of revenue following each assertion........ 50
Table 17: Planned detection risk on each assertions for revenue ................ 51
Table 18: The ratio to assess the performance materiality .......................... 51

List of charts
Chart 1: Steps in applying materiality ......................................................... 14
Chart 2: The structure of AAC .................................................................... 24

List of Appendices
Appendix 1: Understanding client and operating environment
Appendix 2: Preliminary analysis of financial statements

Appendix 3: Risk assessment of preliminary analysis procedures
Appendix 4: Assessment of the internal control system of the client
Appendix 5: Purchase, payable and payment cycle
Appendix 6: Sales, receivables and collection cycle

Student: Huynh Thi Bich Ha

B


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Introduction
In the trend of integration with the world economy and the continuous
development of the market economy, business activities and financial situation of
enterprises are the concern of state agencies, investors, employees and especially
business owners. So the need for transparency of financial information becomes
more and more important. In the face of that trend, auditing firms further
demonstrated their roles. In auditing, the financial statement audit is the traditional
service and accounts for a large proportion of the revenue of the audit firms. In
order to improve the quality of the financial statement audits, audit firms are now
paying attention to the work carried out in an audit. Assessing a materiality and
audit risk in the planning stage is an extremely important step to help auditing
firms develop an audit plan that contributes to quality improvement as well as the
effectiveness of the audit. However, in practice, the assessment of the materiality
and audit risk in the planning stage of the companies still have many incomplete
points. Understanding the important of assessing the materiality and audit risk and
during my internship at AAC Auditing and Accounting Limited Liability

Company, I have the opportunity to learn and compare between theory and
practice. Therefore, I chose the topic: "Assessing audit risk and materiality in
the audit planning stage performed by AAC Auditing and Accounting
Company" to as the topic for my graduation thesis.
Research content of the project consists of 3 main parts:
Chapter 1: Literature review on assessing materiality and audit risk in
planning stage of the financial statement audit
Chapter 2: Preliminarily assessing materiality and audit risk conducted by
AAC Auditing and Accounting Limited Liability Company
Chapter 3: Comments and solutions to improve the assessment of materiality
and audit risk conducted by Auditing and Accounting Limited Liability Company

Student: Huynh Thi Bich Ha

1


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Chapter 1.
Literature review on assessing materiality and
audit risk in planning stage of the financial statements audit
1.1. Audit risk
1.1.1. Definition and components of audit risk
1.1.1.1.
Definition of audit risk
According to Vietnam Standards of Auditing No. 400 – Assessing risk and
internal control, the audit risk is defined:

“Audit risk is the risk that the auditor and auditing company make
inappropriate opinion when the audited financial statements have material
misstatements.”
Audit risk includes three parts: inherent risk, control risk and detection risk.
In fact, the audit risk usually occurs in the direction: the financial statements have
material misstatements but the auditor make unqualified opinion with financial
statements as a whole. In this case, this opinion is inappropriate about the financial
statements. It means that the auditor agrees with material misstatements. With such
an argument, audit risk is defined as the probability of occurrence of material
misstatements on the financial statements that the auditor does not detect.
Audit risk always exists due to factors such as the auditor’s ability and
capability, limited time and cost of auditing, sampling techniques in audit and
fraud detection more difficult than errors.
The users of information of course only accept low risk, which requires the
auditor to work in the effort to achieve an acceptable level of audit risk. Acceptable
audit risk is a measure of how willing the auditor accepts that the financial
statements may be materially misstated after the audit is completed and an
unqualified opinion has been issued. When the auditor decides on a lower
acceptable audit risk, it means that the auditor wants to be more certain that
financial statements are not materially misstated (Arens, 2012).
The level of audit risk is high or low that determines the amount of audit
work required to be carried out. Therefore, it is necessary to analyses insight into
the components of the audit risk and consider the impact of these components to
the amount of audit work as well as the appropriate procedures. In this relationship,
the audit risk and the auditing costs have a negative relationship.
1.1.1.2.
Components of audit risk
In order to learn and assess the factors effect to the audit risk, they divide into
three components, include inherent risk, control risk and detection risk.
1.1.1.2.1.

Inherent risk
According Arens (2012), inherent risk measures the auditor’s assessment of
the likelihood that there are material misstatements due to error or fraud in a
segment before considering the effectiveness of internal control.

Student: Huynh Thi Bich Ha

2


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Thus, inherent risk is the probability of the existence material misstatements
on the financial statements due to the potential problems in business, in business
environment or in the nature of accounts. This is an objective factor, belonging to
the nature of an entity, the control activities.
Inherent risk is generally considered to be higher where a high degree of
judgment and estimation is involved or where transactions of the entity are highly
complexity. In addition to increasing audit evidence for a higher inherent risk in a
given audit area, the auditor commonly assign more experienced staff to that area
and review the completed audit test more thoroughly. (Arens, 2012)
1.1.1.2.2.
Control risk
According to VSA No. 400, the control risk is defined: Control risk is the
risk that material misstatements will occur in a particular transactions, accounts on
financial statements when separately or aggregated, the accounting system and
internal control system are not able to prevent or detect and repair timely.
As control risk is the probability of occurrence of material misstatements on

the financial statements that the internal control system does not detect and prevent
timely, control risk always exists due to inherent constraints of internal control
system:
- The scope of the internal control system is limited by the issue of costs.
Because the managers always require for the cost of the test to be effective, it
means that the cost must be less than the loss due to misstatement and fraud.
- Most of inspection measures focus on the commonly misstatements, so
difficultly detect the unusual misstatements.
- Operations and examination may be disabled due to collusion with staff or
outside parties.
- Control procedures may no longer be appropriate because the actual
conditions have changed.
In summary, the effective internal control system will minimize misstatement
and fraud but cannot completely eliminate the potential violations. The auditor
only bases on the internal control to reduce the workload but cannot completely
base on this system. Therefore, the auditor also conduct the test while the internal
control system is very effective.
1.1.1.2.3.
Detection risk
According to VSA No. 400, “The detection risk is the risk that material
misstatements will occur in each transaction or account on the financial statements
when it is calculated separately or in aggregate that the auditing process, auditor
and audit firm fail to detect.”
In other words, planned detection risk is the risk that audit evidence for a
segment will fail to detect misstatements exceeding tolerable misstatement.
Student: Huynh Thi Bich Ha

3

Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Planned detection risk determines the amount of substantive evidence that the
auditor plans to accumulate. If the planned detection risk is reduced, the auditor
needs to accumulate more evidence to achieve the reduced planned risk (Arens,
2012).
1.1.2. Assessing acceptable audit risk and audit risk components
1.1.2.1.
Assessing acceptable audit risk
According to Arens (2012), as you know, a reasonably low acceptable audit
risk is always desirable, but in some circumstances an even lower risk is needed
because of engagement risk factors. Research points to several factors affecting
acceptable audit risk as follows:
- The degree to which external users rely on the statements: when external
users place heavy reliance on the financial statements, it is appropriate to decrease
acceptable audit risk. Several factors are good indicators of the degree to which
statements are relied on by external users such as client’s size, distribution of
ownership and nature & amount of liabilities.
- The likelihood that a client will have financial difficulties after the audited
financial statements is issued: If the client is forced to file for bankruptcy or
suffered a significant loss after completion of the audit, the auditor faces a greater
chance of being required to defend the quality of the audit than if the client were
under no financial strain. In this situations in which the auditor believes the chance
of financial failure or loss is high and a corresponding increase, acceptable audit
risk should be reduced.
- The auditor’s evaluation of management’s integrity: if a client has
questionable integrity, the auditor is likely to assess a lower acceptable audit risk.
To assess acceptable audit risk, the auditor must assess each of the factors

affecting acceptable audit risk. Then, the auditor assess the acceptable audit risk at
high, medium or low.
1.1.2.2.
Assessing audit risk components
1.1.2.2.1.
Assessing inherent risk
According to Arens (2012), the auditor must assess the factors that make up
the risk and modify audit evidence to take them into consideration. The auditor
should consider several major factors when assessing inherent risk:
- Nature of the client’s business: Business characteristics of client such as
technology process, capital structure, dependent entity, geographic scope.
Seasonal operation, etc., affect the level of inherent risk of the client. For example,
some enterprises have backward technology processes, the ability to present the
cost of inventories as finished products may not be in accordance with prudent
principles. Moreover, an enterprise with many dependent units or operating on
wide area is capable of updating and synthesizing data with many errors.

Student: Huynh Thi Bich Ha

4


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

- Results of previous audits: The risk assessment on each account balance or
type of transaction may be based on the results of previous audits. If the account
balance in the previous year has many differences, in this year inherent risk of this
account will be assessed very high. Because some misstatements of the previous

year cannot be overcome.
- Related parties: Transactions between parent and subsidiary companies,
and those between management and the corporate entity, are examples of relatedparty transactions actions as defined by accounting standards. Because these
transactions do not occur between two independent parties a greater likelihood
exists that they might be misstated, causing an increase in inherent risk
- Non-routine transactions: Transactions that are unusual for a client are more
likely to be incorrect recorded than routine transactions because the client often
lacks experience recording them.
- Judgment required to correctly record account balances and transactions:
Account balances and transactions which related to accounting estimation such as
provision, depreciation of fixed assets, allocating, expense accruals, etc. usually
conduct on the basic of subjective judgment of the manager and the operator, so it
is more likely to contain inherent risk on these accounts. Therefore, the auditor
should assess the high level of inherent risk for this accounts to enhance
misstatements detection.
- Factors related to misappropriation of assets: some assets sensitive to fraud
such as cash, gold, gemstone, the compact assets and easy to transport and great
value are easy to steal. Therefore, the auditor should determine the high level of
inherent risk for the balance of these accounts.
- Personnel characteristics of Board of Directors: The auditor should consider
the integrity, qualifications and experience of the Board of Directors as well as
changing in the composition of the management board in the accounting period. In
this, the auditor should pay attention to the role and characteristics of the highest
leader, because this is a person who has the power to make the majority of the
company’s policies and has a major impact on the most of the company’s
operations. If the company is led by a person who is dishonest and fraudulent; or
if the company regularly changes personnel in the Board of Directors, the auditor
must assess the inherent risk at high level.
- Personnel characteristics of accounting department: The qualifications and
experiences of the chief accountants and main accounting staffs is directly related

to the process of gathering, the processing and providing information on the
financial statements.
- The pressure of the Board of Directors and the chief accountant: The auditor
should consider and assess that the Board of Directors and the chief accountant
have been pressured to disclose the false financial statements. For example, the
enterprise, which has suffered loss continuously and is unable to pay its debt, is
Student: Huynh Thi Bich Ha

5


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

not allowed to continue lending to traditional banks. Therefore, it is expected to
issue bonds to raise capital. With this pressure, the enterprise may disclose the false
financial statements about revenue, expense, profit or loss and solvency of debt.
- Outside factors: Economic fluctuations, competition, changes in the buying
and selling markets also affect the inherent risk of the enterprise. A company
operating in a fierce competitive environment, losing market share, the auditor
must assess the very high level of inherent risk to set up reasonable audit
procedures.
The auditor must evaluate the information affecting inherent risk and decide
on an appropriate inherent risk level for each cycle, account, and many items, for
each audit objectives. The auditor does not create nor control the inherent risk, but
only assesses them based on a number of sources such as the audited result of
previous years, customer economic policies, etc… Inherent risk assessment is
usually initiated by considering what the auditor knows about the business and the
nature of the client company. If the auditor does not explain the assessment about

the nature of the client company, they may not identify and determine the
important risk area.
Based on that, the auditor usually uses the following procedures to assess the
inherent risk of the client:
- Interview: Conducting interviews on the basic of well-formed questions for
the management and staff involved to collect the necessary information for the
assessing the inherent risk. Questions are set to collect the information about the
characteristics of business, the personnel of the Board of Directors and accounting
department, the unusual pressure of Board of Directors and chief accountant, the
accounting policies and changing of policies and so on.
- Observation: The observation of the actual situation, process and business
will help the auditor have the necessary knowledge in assessing inherent risk.
- Preliminary analysis the financial statements and review other related
document: The auditor analyzes preliminary the financial statements in
combination with the business plan indicators to gain an overview of the financial
situation and business trends of the client company. At the same time, the auditor
also considers other relevant documents such as internal financial regulations,
meeting minutes, tax inspection, etc. to forecast the inherent risk of the client
company.
The auditor begin their assessments of inherent risk during the planning
phase and update the assessments throughout the audit.
1.1.2.2.2.
Assessing control risk
Because control risk arises from the internal control system, the components
of the internal control system are also the factors affect the control risk. Therefore,

Student: Huynh Thi Bich Ha

6

Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

to assess the control risk the auditor must base on the knowledge about the internal
control system. According Arens (2012), the factors affect the control risk:
- Control environment: The control environment consist of the actions,
policies, and procedures that reflect the overall attitudes of top management,
directors, and owners of an entity about internal control and its importance to the
entity.
- Risk assessment for financial statements is management’s identification and
analysis of risk relevant to the preparation of financial statements in conformity
with appropriate accounting standards. Management’s risk assessment differs from
but is closely related to the auditor’s risk assessment. While management assesses
risks as a part of designing and operating internal controls to minimize errors and
fraud, auditor assess risks to decide the evidence needed in the audit.
- Control activities: Control activities are policies and procedures, in addition
to those included in the other four control components that help ensure that
necessary actions are taken to address risks to the achievement the entity’s
objectives. There are potential many such control activities in any entity, including
both manual and automated controls.
- Information and communication: the purpose of an entity’s accounting
information and communication system is to initiate, record, process, and report
the entity’s transactions and to maintain accountability for the related assets. An
accounting information and communication system has several subcomponents,
typically made up of classes of transactions such as sales, sales return, cash receipt,
acquisitions, and so on. To understand the design of the accounting information
system, the auditor should determine the major classes of transactions of the entity,
how those transactions are initiated and recorded, what accounting records exist

and their nature, how the system captures other events that are significant to the
financial statements, and the nature and details of the financial statements process
followed, including procedures to enter transactions and adjustments in the general
ledger.
- Monitoring: Monitoring activities deal with ongoing or periodic assessment
of the quality of internal control by management to determine that controls are
operating as intended and that they modified as appropriate for changes in
conditions.
The auditor does not create and also control the control risk, the auditor only
may assess internal control system strong or weak and determine the level of
control risk (low, medium or high).
Based on that, the auditor usually uses the following procedures to assess the
control risk of the client:
- Control environment: The auditor interviews the management and staff
to understand the factors of control environment such as the integrity and
ethical values of the organization; competence commitment; the

Student: Huynh Thi Bich Ha

7


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

organizational structure and assignment of authority and responsibilities;
and so on. In addition, the auditor also associates with the observation and
examination of documents.
- Risk assessment: The auditor needs to interview the management to

understand the content and the results of risk assessment process.
Understanding the client’s risk assessment can help the auditor to assess
the risk of material misstatement. The auditor must use professional
judgment to determine whether the client's risk assessment process is
appropriate or not.
- Control activities: The auditor interviews the management and staff about
the control activities applied. Then, the auditor must observe and examine
the documents to determine whether these activities have been effectively
implemented.
- Information and communication: By conducting interviews accountants
in combination with examining documents, the auditor will gain an
understanding of the information system relating to the preparation and
presentation of financial statements.
- Monitoring: Interviewing management to find out how the board
conducts an assessment of the effectiveness of the internal control
activities.
The auditor may assess the high level of control risk in the following case:
- The internal control system is not sufficient and effective
- The auditor does not have sufficient basic to assess the appropriateness,
completeness and efficiency of internal control system.
The auditor may assess the low level of control risk in the following case:
- The auditor is qualified and has plans to carry out tests of control to confirm
the risk assessment.
- The auditor has sufficient evidence and basic to conclude the effective
internal control system. That system has ability to prevent, detect and handle in
time the fraud, errors in the enterprise.
This assessment on control risk will affect the timing, content and scope of
the audit methodology.
1.1.2.2.3.
Assessing planned detection risk

The detection risk is usually affected by the following factors:
- Sampling risk: The auditor make the sample which does not represent the
audited entity so the auditor’s conclusions are based on sample results different
from the overall actual results.

Student: Huynh Thi Bich Ha

8


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

- Non-sampling risk:
+ The scope of the audit: If the scope of the audit is broad, the probability of
detecting frauds and errors increases. It means that the possibility of not detecting
fraud, errors decreases, so the risk of detection decreases and vice versa.
+ The auditing methods: If the auditing methods are more scientific,
appropriate and effective, the ability to detect frauds and errors increase. It means
that the frauds and errors which are not detected decrease, so the detection risk
decrease and vice versa.
+ The qualification, experience and ability of judge of the auditor: the auditor
has a high level of expertise, has a lot of experience and ability to judge well, it is
easy to detect many frauds and errors, therefore the detection risk will decrease
and vice versa. Determining the scope of the audit and selecting the audit method
depends on the qualifications, experience and the ability to judge of the auditor.
Base on the assessment of inherent risk and control risk associated with
acceptable audit risk, the auditor will adjust the planned detection risk so that the
audit risk is acceptable. Planned detection risk can be determined qualitatively and

quantitatively based on audit risk model:
𝐴𝑅 = 𝐼𝑅 𝑥 𝐶𝑅 𝑥 𝐷𝑅
 The qualitative model:
Based on the auditor’s assessment of inherent risk and control risk, the
detection risk level is determined according to the matrix as follows:
Table 1: The matrix to assessing detection risk
Assessing control risk of auditors
High
Average
Low
Min
Low
Medium
High
Assessing
Low
Medium
High
inherent risk of
Medium
auditors
Medium
High
Max
Low
Each type of inherent risk and control risk is divided into three levels:
Detection risk

High – Average – Low
The detection risk is divided into 5 levels:

Max – High – Average – Low – Min
The matrix illustrating the relationship between the types of risks usually is
expected by the auditor in the audit planning stage. However, if the auditor has
evidences to adjust the inherent risk and control risk, the detection risk will be
adjusted by the auditor.

Student: Huynh Thi Bich Ha

9


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

 The quantitative method:
Beside the qualitative method, the auditor also uses the specific percentage,
called the quantitative risk assessment method. In this model, the relationship
between the audit risk and its components is shown as follows:
𝑃𝐷𝑅 =

𝐴𝐴𝑅
𝐼𝑅 𝑥 𝐶𝑅

Where:
AAR: accepted audit risk
IR: inherent risk
CR: control risk
PDR: planned detection risk
However, this is not the purely mathematical formula, but rather a model

used to assist the auditor in judging and determining the acceptable level of
tolerable misstatements as a basic for designing the audit procedures and
conducting the audit.
The process of this model is as follows:
Step 1: Establishing an acceptable level of audit risk for each audit contract.
This level is applied on all accounts or important transactions.
Step 2: Assessing the inherent risk for the financial statements as a whole and
for the account balances and important types of transactions.
Step 3: Assessing the control risk for each account or important type of
transactions.
Step 4: Based on the audit risk, inherent risk, and control risk are assessed to
determine the acceptable detection risk. Then, the auditor bases on this to
determine content, time and substantive test scope.
1.2. Materiality assessment
1.2.1. Definition and characteristics of materiality
1.2.1.1.
Definition of materiality
According to Vietnamese Standards of Auditing No. 320 – Materiality in
auditing:
“Materiality is the term used to express the importance of the information (the
accounting data) in the financial statement. Information which is considered
material, means that the lack of information or inaccuracy of information would
affect the decisions of the user of the financial statement.”
Materiality depends on the importance and the nature of the information or
errors that are assessed in a certain situation. Materiality is a threshold, a point of
Student: Huynh Thi Bich Ha

10

Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

division rather than the content of information required. The materiality must be
considered both quantitatively and qualitatively.
When planning, auditor must determine materiality level acceptable to the
standard for detecting the quantitative material misstatements. However, in order
to assess misstatements that are material, auditors must consider both the
quantitative and qualitative aspects of misstatements. For example: Not comply
with the current accounting system may be considered a material misstatement on
the financial statements that lead the users understanding wrong the nature of
issues.
The common definition of materiality as it applies to accounting and therefore
to audit reporting is as follow: A misstatement in financial statements can be
considered material if knowledge of the misstatement will affect a decision of a
reasonable user of the financial statements (Arens, 2012).
In other words, the materiality in the relationship with the content of audit, is
general concept that defines the scale and importance of the basic content of the
audit which affect the correctness of assessing object and using this information
for making decisions. On the perspective of the user information, a simple way,
materiality is an important information and should be presented if it is likely to
affect user decisions.
Understanding simply in the audit, materiality is a level that if a misstatement
is below that level, it shall be considered as non-material misstatement and may be
omitted during the audit process, in contract, a misstatement is over that level, it
shall be considered as material misstatement, this makes the users misunderstand
the situation of the client and make incorrect decisions.
1.2.1.2.
Characteristics of materiality

1.2.1.2.1.
The size of materiality
This factors is expressed in the size or scale of transactions, accounts for the
object audited. If a transaction or an account of violation is so large that it
determines the nature of the object, the transaction or account is considered
material. In contract, the scale of misstatement is not large enough to change the
perception of object, that the transaction or account is not considered material.
The size of material cannot be consider an absolute number, because a certain
transaction or account, which may be material to a small company but not material
to a large company. Therefore, the material in terms of scale should be in relation
to the whole audited entity. It means that should consider the ratio of a transaction
or an account to a calculate base, depending on the characteristics of each client
such as: total assets, total equity, total revenue or profit before tax.
Determining the materiality to aspect scale is not easy, so to be able to
identify the correct content in this respect, we need to understand the following
basic principles:

Student: Huynh Thi Bich Ha

11


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

- Firstly, the material scale must be determined. It means that assessing
materiality base on certain object such as financial statements, all accounting
documents, and actual financial situation, or types of business lines of the client
company such as product, agriculture, service, bank, insurance, and so on. Because

each business line has distinctive features therefore the material scale is different.
- Secondly, the size of transactions or accounts is a relative rather than an
absolute concept. It is a ratio of size of transactions or accounts to calculate base
such as total assets, revenue, profitable before tax.
- Finally, the material scale bases on object and purpose of audit.
1.2.1.2.2.
Nature of materiality
The nature of materiality is reflected in the importance or nature of
transactions or accounts (Arens, 2012).
Commonly, amounts involving fraud are usually considered more important
than unintentional errors of equal amounts because fraud reflects on the honesty
and reliability of the management or other personnel involved. Besides, there are
many cases that the amount of money is low difference, however, the nature of
difference affects material to whole of financial statements and the decisions of
users. So this is a material misstatement. Some illustrations:
 Transactions and accounts have fraud or potential fraudulent:
- Illegal bidding, contracting, and trading transactions because there may be
a collusion between parties to benefit the individual.
- Liquidating of assets transactions: there is the possibility of connecting the
liquidator and the buyer while the assessing is still in use.
- Cash transactions: these transactions occur regularly. Cash is compact and
easy to embezzle, so it is easy to cheat.
- Buying, selling and payment transactions: client firms and customer or
suppliers may conclude to report incorrect financial situation.
- Unusual transactions: These transactions rarely occur but they affect
directly to financial statements.
- The benefit distribution transactions: Transactions related benefit always
constant high levels of fraud because everyone wants to benefit themselves.
- The lefting outside deliberately the books transactions: All transactions
must be recorded into books, if the client company deliberately dropped out of the

books, this is an expression of fraud.
- Transactions occur at the end of the accounting period: commonly, at the
end of accounting period, in order to have satisfied financial statements or adjust

Student: Huynh Thi Bich Ha

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Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

some difference, accountant usually change in record. Therefore, transactions
which occur at the end of the accounting period have high level of fraud.
- Accounts or documents repaired: Because these repairs may aberrant
financial information, affect financial statements.
- Violating accounting principles transactions: because it affects honest and
faith of the management and related individual.
 Transactions or accounts have material misstatements as weakness
competence and prudence of the accountant, include:
- Transactions or accounts have difference from previous year.
- Transactions or accounts have repeated misstatements: although repeated
misstatements have small size, these raises a great suspicion about capacity of
accountant as well as the problem of poor management. Moreover, total all small
misstatement may be a material misstatement which affect financial statements.
- Misstatements affect profit.
- Transactions or accounts relate to other transactions or accounts.
- An incorrect description of the accounting policy of the client company may
cause the user to misrepresent the nature of the information.

The assessment and issuance of the audit opinion depends on the transactions
or accounts related to the nature of the client company. Therefore, material
definition set out the requirement to define the audit content with the principle of
not ignoring transactions or accounts of large size and importance, reflecting the
nature of the object. So that, auditors must consider both size and nature of
problem, and then auditors make reasonable decisions about material, assure
purpose and quality of audit.
In auditing financial statements, examining all documents and transactions
of client firm is impossible because if they do so, the workload will be too large
and costly. If auditors check 100 percent of documents and transactions, they
cannot detect all misstatement due to the limited qualifications as well as the
deliberate concealment of managers.
According VSA, in planning the audit, the auditor makes judgments about
the size of misstatements that will be considered material. These judgments
provide a basis for:
- Determining the nature and extent of risk assessment procedures;
- Identifying and assessing the risks of material misstatement; and
- Determining the nature, timing, and extent of further audit procedures.

Student: Huynh Thi Bich Ha

13


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

1.2.2. Process of assessing materiality
In the planning stage, the auditor should determine materiality for financial

statements as a whole and materiality for accounts. Commonly, the auditor follow
three closely related steps in applying materiality as following chart
Chart 1: Steps in applying materiality
Determine preliminary judgment about materiality
Determine performance materiality for entire financial statement
Allocate performance materiality to segments
1.2.2.1.
Overall materiality assessment (PM)
The primary purpose for setting overall materiality when planning the audit
is that it is used to identify performance materiality and a clearly trivial threshold
for accumulating misstatements (IAAE, 2012)
Firstly, to determining the overall materiality, the auditor should choose the
appropriate benchmarks. According VSA 320, there are many factors to consider
when choosing the benchmarks. These include the nature of entity, the industry of
entity or the particular accounts in the financial statements.
Some examples of benchmarks which the auditor can use:
-

Revenue
Profit before tax
Total assets
Total equity

Secondly, the auditor should determine a level of this benchmark (usually a
percentage).
Finally, the auditor should justifying the choices for example explaining the
judgment.
In order to determine the materiality, the auditor may choose one of two
follow methods:
Method 1: The use of a benchmark.

The table below is a guideline of VACPA for determining materiality for
whole of financial statements.

Student: Huynh Thi Bich Ha

14


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Table 2: The guideline of VACPA for determine materiality:
Benchmark
Percentage
Profit before tax
5% - 10%
Revenue
0,5% - 3%
Total assets
2%
Total equity
2%
Revenue might be appropriate for an entity which does not stable profit, but
revenue is stable and revenue is an important factors to assess efficiency.
Though not common, total assets might be appropriate for an entity which
likely to go bankrupt, with a large accumulated loss compared to its equity. The
user of financial statements may be more concerned about solvency, the use of
total assets is reasonable.
Total equity might be an appropriate benchmark to use for a star-up company

which has little revenue or profits.
The truth is one size does not fit all. The auditor need to use their professional
judgment to determine an appropriate benchmark and the chosen benchmark needs
to the justifiable, with the rationale clearly documented (IAAE, 2012)
Method 2: The use of multiple benchmarks.
Using this method, the auditor use multiple benchmarks with respectively
rate, and then determining materiality by choosing the largest, the smallest or the
average. For example:
Table 3: Example for using multiple benchmarks
Benchmark
Total assets
Net revenue
Profit before tax

Amount of money on
financial statements
(million VND)
25.000
15.000
2.500

Amount of
Percentage
money
(million VND)
2%
500
1%
150
10%

250

Overall materiality may be chose from:
The smallest: 150 (million VND)
The largest: 500 (million VND)
The average: 300 (million VND)
Commonly, in order to assure the prudent principles, the auditor usually uses
the smallest or the average, rarely uses the largest.

Student: Huynh Thi Bich Ha

15


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

1.2.2.1.1.
Performance materiality (MP)
Performance materiality is the “working materiality”. It sets a numerical level
which helps guide auditors to do enough work to support their audit opinion. It
recognizes that if auditors simply applied the overall materiality throughout the
planning and conducting stages they would be taking an undue risk that material
misstatements were not detected by their audit work.
Broadly it serves two functions:
- To reduce the engagement risk (the risk that the aggregate of uncorrected
and undetected misstatements individually below materiality will exceed
materiality for the financial statements as a whole) to an acceptable level;
- To provide a safety net against the risk of undetected misstatements.

Performance materiality must be set at a percentage of the overall materiality
so as to allow us a margin or buffer for the possible undetected misstatements that
may occur during the engagement. We use a sliding scale of % based upon an
estimate of the engagement risk associated with the client.
Table 4: The ratio of engagement risk
Engagement Risk
Low
Low to Medium
Medium
Medium to High
High
90%
85%
80%
75%
70%
1.2.2.1.2.
Tolerable misstatement (TM)
When auditors allocate the performance materiality to account balances, the
materiality allocated to any given account balance is referred as tolerable
misstatement.
It is necessary to allocate the performance materiality to each account
because the auditor needs to accumulate enough evidence of the account rather
than the whole financial statements. If the auditor allocates the performance
materiality for each account, it will help them determine the appropriate audit
evidence (Arens, 2012).
Materiality for each account is also known as the omitted error for that
account. The auditor allocates the performance materiality to the accounts on the
Balance Sheet and the Income Statement. However, Balance Sheet and the Income
Statement items are related to each other. Most of the deviation of the items on the

Income Statement affect the accounts on the Balance Sheet (because, according to
the double-entry principle, all transactions involved in the Income Statement are
related to the accounts on the Balance Sheet). So it is not necessary to allocate the
performance materiality to the accounts on the Income Statement (Arens, 2012).
The auditor faces three major difficulties in allocating materiality to balance
sheet accounts:
-

Auditor expects certain accounts to have more misstatements than others
Student: Huynh Thi Bich Ha

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Graduation thesis

-

Academic Advisor: Pham Hoai Huong, Ph.D

Both overstatements and understatements must be considered
Relative audit costs affect the allocation
There are 2 methods to allocate the performance materiality to the segments.

Method 1: allocating performance materiality for each account follow value
of each account
After setting the initial materiality for the overall financial statements, the
auditor allocates this level to each account, each segment and each indicator on the
financial statements to form the materiality for each account, each segment or each
indicator. The materiality used for allocation to each account is the performance

materiality MP (Performance materiality by a certain percentage compared to
overall materiality). The auditor allocates a materiality for each account at the
performance materiality to ensure the prudence principle that all misstatements are
detected by the auditor and misstatements not detected by the auditor that do not
exceed the defined overall materiality (PM).
The materiality allocated to each account are usually performed on the
following principle bases:
+ Based on the policy of allocating the overall materiality to each account on
the financial statements
+ Inherent risk and control risk which are assessed by the auditor for each
account. If the inherent risk and control risk is assessed as high for a particular
account, this account will be allocated a low tolerable misstatement and vice versa.
+ The auditor’s experience of the misstatements and frauds in respect of such
accounts.
+ The audit cost for each account. If the account requires evidence collection
to be more costly then the tolerable misstatements are more than and vice versa.
The advantages of this method helps the auditor selects the objects in detail
and selects the appropriate test methods. After testing, the materiality for each
account is the basic to collating the misstatements of the account to form a
conclusion on this account. However, this method also has the disadvantage that
the importance allocation depends on the subjectivity of the auditor.
Method 2: Using the performance materiality for all accounts on the
financial statements
Following this method, the auditor does not allocate the materiality for each
account, the auditor only use a general materiality for all accounts on financial
statements. This materiality is different between auditing companies.
MP= (50% - 75%) x PM

Student: Huynh Thi Bich Ha

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Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

The disadvantages of this method is that the materiality is applied for all
accounts; therefore, all accounts, regardless of their balance or nature differences,
are applied a general materiality for the whole audit.
1.2.3. Relationship between materiality and audit risk
Materiality and audit risk are closely related, determining the materiality is
very important for the evaluation of the audit risk. If materiality increases, the audit
risk will decrease. It means that, the auditor increases the value, when the auditor
increases the value of errors can be ignored, then the possibility of material
deviations will decrease and the audit risk will obviously decrease. In contract, if
the tolerance level is reduced, the audit risk will increase.
Besides that, the auditor should consider factors that may cause material
misstatement on the financial statements. There is not consistent rule or principle
in establishing materiality, therefore, the auditor must use the knowledge as well
as the professional judgment to perform this assignment. Considering the
possibility of material misstatements in the accounts as well as the specific
transactions will help the auditor to zone the areas to be considered, design the
content, timing and scope of auditing procedures so that the financial statements
risk are material misstated will be reduced to an acceptable level as well as
maintaining a balance between auditing costs and quality.
Applying the materiality and audit risk concepts in the audit process is an
important issue. However, in order to make good use of these issues to improve
the effectiveness and efficiency of the audit, the requirements: The auditor and
auditing firm must have a methodology to establish a materiality and a risk

assessment process that is effective and appropriate for different customers.

Student: Huynh Thi Bich Ha

18


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

Chapter 2.
Assessing audit risk and materiality at
planning stage of the financial statements audit conducted by
Auditing and Accounting Limited Liability Company
2.1. Overview about Auditing and Accounting Limited Liability Company
2.1.1. Historical development of Auditing and Accounting Limited Liability
Company

AAC previously named Auditing and Accounting Company attached to the
Ministry of Finance, incorporated in 1993, and restructured in 1995, is one of the
earliest audit firms established and operating in Vietnam.
AAC is a member of Prime Global, based in the United States, with more
than 300 independent accounting firms operating in 90 countries around the world.
AAC provides a full range of professional services, such as auditing, accounting,
finance and investment advisory, tax advisory, training and staffing services…
AAC was nominated by Ministry of Industry and Trade to be one of the top
five audit firms in Vietnam and awarded with honorable prize Top Trade
Services”. AAC was nominated by the Voice of Vietnam, Ministry of Industry and
Trade, Ministry of Information and Communication, Ministry of Culture, Sports

and Tourism,…and awarded with the “Typical Vietnamese Enterprises” Golden
Cup; Vietnam Association of Securities Business (VASB), Vietnam Securities
Magazine (State Securities Committee), Credit Information Center of State Bank
of Vietnam conferred the title “Prestigious Audit Organization for Listed
Companies”.
2.1.2. AAC Missions of Auditing and Accounting Limited Liability Company
AAC operates under the motto “Quality in every single service” and well
observes the principles of independence, integrity and confidentiality in our
rendered services. Our operational objective is to assist our clients and
stakeholders in protecting their legal rights and interests; providing earnest
information and optimal solutions for business management and corporate
governance.
The company’s strategic vision is to become a leading professional service
provider in Vietnam. With the professionally capable and devoted leadership team,
AAC pledges efforts to bring our clients the true value of each service the company
renders. AAC is taking steady steps in the development of a prestigious and quality
brand name in order to meet the clients’ trust and expectation their service
engagement with AAC. Moreover, AAC place great attention in creating an ideal

Student: Huynh Thi Bich Ha

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Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

working place and modern corporate culture that deserve the first choice of wellqualified and ethical professionals in their pursuit of career and talent
development.

2.1.3. Types of services provided by Auditing and Accounting Limited
Liability Company
Being a member of Prime Global, AAC has the conditions to provide
innovative services. Auditing and consulting professionals are trained with
internationally recognized standards of Prime Global. Thus, AAC has the ability
to offer customer quality related services. Our company is expanding business
lines to fulfill customers’ demands in domestic area. Our main lines are as below:
2.1.3.1.
Audit and Assurance Services
Requirements for more financial transparency and information disclosure
place a great deal of challenging pressure on enterprises. The engagement by
trusted auditors with profound knowledge of the industry and strong devotion is
crucial for a company. This is because the audit results are not only for statutory
compliance purposes but also enhancing the quality of accounting and finance
work at the company.
Providing independent audit services has always been the strength of AAC.
Our audit procedures and processes are designed and applied on the basis of a
thorough understanding of business operations and environment of engaged
clients. Besides, with a wide pool of experienced, well-educated auditors,
consultants, AAC is capable of providing practical advice and solutions optimized
for business operations, as well as for the selection and making sound investment
decisions.
AAC is pleased to serve our clients with the following audit services:
- Audit of financial statements;
- Audit of investment finalization accounts;
- Audit of financial statements for tax purposes;
- Operation audit;
- Compliance audit;
- Internal audit;
- Agreed upon procedure review of financial information;

- Other audit-related services.
2.1.3.2.
Tax consulting services
Vietnam’s tax legislation has been in state of constant change in recent years
caused in particularly by the need to align the country with requirements upon
entry to WTO. Several significant reforms have been implemented just recently in

Student: Huynh Thi Bich Ha

20


Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

order to bring tax legislation into line with international tax practices, with the aim
of closing loopholes and also to attract investment. However, Vietnam's tax law
remains complicated, and enforcement can often be unpredictable. Thus,
businesses and investors will need to stay closely in touch not only with tax law
itself, but also with the way in which it is interpreted by the tax authorities. With a
team of well-trained and experienced tax consultants, AAC offer a full range of
tax services, including:
- Full-scale tax advisory package;
- Review and assessment of tax obligations fulfillment;
- Advisory on tax declarations and returns;
- Advisory on application of double taxation avoidance regulations;
- Tax planning and structuring;
- Advisory on tax implications regarding future contracts or financial
decisions;

- Support to update changes in tax policy;
- Other tax – related services.
2.1.3.3.
Accounting and Reporting services
In the process of business management, entrepreneurs need timely, accurate
and reliable information for making business decisions. The information about
financial accounting plays an important role in every single business decision of a
company. It requires that a company must establish and maintain an accounting
apparatus compatible and relevant for generating accurate and useful information.
Vietnamese legal system on accounting and auditing standards is in the
process of gradual improvement and integration to international accounting
practices and conventions. However, due to its particular business environment,
the legal framework and economic institutions, Vietnamese accounting system still
have many distinctive features. Thus, it is not a simple job to stay abreast to
changes in accounting field in Vietnam. In some cases the specific application of
specific, a company needs prompt advice and support to ensure timely financial accounting information suitable and reliable for business decisions.
AAC supports clients with the following professional services:
- Bookkeeping services;
- Advisory on accounting treatment;
- Advisory on preparation of financial statements;
- Conversion of financial statements in accordance with IAS, IFRS;

Student: Huynh Thi Bich Ha

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Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

- Advisory on adoption of accounting methods and improvement of
accounting system;
- Other accounting – related services.
2.1.3.4.
Finance and Investment Advisory Services
AAC takes pride in provision of strategic advice on governance, finance, and
investment matters to businesses. The well-qualified specialists have undertaken
several successful engagements in field of finance and investment, ranging from
corporate privatization to listing procedures, M&A, corporate restructure, design
and implementation of internal control systems…
AAC’s professional services are tailored and rendered on the basis of indepth knowledge of legal framework, technical requirements, and taking into
account prima interest of our clients. This approach enables entrepreneurs,
investors and stakeholders to make appropriate choices, while securing compliance
with legal requirements and fruitful investments
AAC’s advisory services on finance and investment include:
- Advisory on business start-up, corporate governance;
- Advisory on setting up internal financial regime;
- Services of asset valuation, business valuation;
- Review of financial statements prior to M&A;
- Forensic audits;
- Procedural advisory on M&A, business dissolution;
- Other advisory services on finance and investment.
2.1.3.5.
Training and Staffing services
Apart from the conventional services of audit, accounting and advisory, AAC
invests greatly in broadening and diversification of rendering services.
AAC takes pride and advantages of high qualified and experienced staff in
offering value added training services. AAC constantly opts out education and
training courses in fields of accounting, auditing and taxes to regular clients and

other learners.
In addition, AAC is pleased to assist in the selection and testing applicants
for client’s company’s accounting and internal audit divisions.
Services of training and recruitment include:
- Training courses for chief accountant;
- Training courses for internal auditors;
- Updating knowledge on accounting, finance and audit;
Student: Huynh Thi Bich Ha

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Graduation thesis

Academic Advisor: Pham Hoai Huong, Ph.D

- Training courses for accounting practice;
- Training courses on taxes;
- Recruitment assistance and testing accountants, internal auditors;
- Work permit and payroll services;
2.1.4. Management organization structure and human resources in AAC
Auditing and Accounting Limited Liability Company
AAC always regards the staff as the most valuable asset of the company.
AAC undertakes to create great working conditions for all staff and maximum
supports for their pursuits of higher education and career development.
The structure of AAC is as below:

Student: Huynh Thi Bich Ha

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