Materiality and risk 9 EXPLAIN TO ME ONE MORE TIME THAT YOU DID A GOOD JOB. BUT THE COMPANY WENT BROKE @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. 9 Materiality and Risk EXPLAIN TO ME ONE MORE TIME THAT YOU DID A GOOD JOB, BUT THE COMPANY WENT BROKE
USER FOCUS Materiality is defined in terms of financial statement users Therefore no hard and fast rules Need to consider multiple users and multiple bases Arens, Loebbecke: Aua @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. USER FOCUS Materiality is defined in terms of financial statement users Therefore no hard and fast rules Need to consider multiple users and multiple bases
Materiality Audits provide reasonable assurance that the financial statements are free of material misstatements @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Audits provide reasonable assurance that the financial statements are free of material misstatements
FIGURE 9-1 Steps in Applying materiality Set Step preliminary Planning extent of tests judgment about materiality Estimate Step total misstatement Allocate In segment Step preliminary Perform Dement about materiality tests Estimate to segments Step the combined misstatement Evaluating results Compare combine BS line items or cycles Step estimate with preliminary or Mat- TE or TM revised judgment Arens, Loebbecke; Auditing, 8/E about materiality @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. FIGURE 9 - 1 Steps in Applying Materiality Estimate total misstatement in segment Step 3 Estimate the combined misstatement Step 4 Compare combined estimate with preliminary or revised judgment about materiality Step 5 Set preliminary judgment about materiality Step 1 Allocate preliminary judgment about materiality to segments Step 2 Planning extent of tests Evaluating results BS line items or cycles Mat – TE or TM Perform tests
SET PRELIMINARY JUDGMENT ABOUT MATERIALITY Factors Affecting Judgment Base X (function of client Percentage (function of audit risk ●●●●●●●●●0●● Preliminary estimate of materiality @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. SET PRELIMINARY JUDGMENT ABOUT MATERIALITY Base X (function of client) Percentage (function of audit risk) = Preliminary estimate of materiality Factors Affecting Judgment
Typically 5-10% for net income, lower percentage for larger bases such as assets or revenues High risk Low o Low Risk High (less evidence; less assurance) @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Typically 5 - 10% for net income, lower percentage for larger bases such as assets or revenues High Risk Low % Low Risk High % (less evidence; less assurance)
Materiality/ Evidence Relation Increase in materiality L ess evidence required Arens, Loebbecke; Auditing, 8/E @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Materiality / Evidence Relation Increase in materiality Less evidence required
Factors Affecting Tolerable Misstatement Large versus Small Allocation of Materiality Small balance Large balance Few Errors Expected Many Errors Expected Costly to test Inexpensive to Test Not testable with ap Testable with AP Arens, Loebbecke: Aua @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Factors Affecting Tolerable Misstatement Large versus Small Allocation of Materiality Small Balance Large Balance Few Errors Expected Many Errors Expected Costly to test Inexpensive to Test Not testable with AP Testable with AP
Options when Projected Errors Exceed Materiality Record an adjustment Usually limited to actual errors Perform more testing Better error estimate Lower sampling risk Qualify opinion Arens, Loebbecke: Aua @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Options When Projected Errors Exceed Materiality • Record an adjustment - Usually limited to actual errors • Perform more testing - Better error estimate - Lower sampling risk • Qualify opinion
mesofRisks Planned detection risk Inherent risk Control risk Acceptable Audit Risk @2000 Prentice hall.Inc
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. • Planned Detection Risk • Inherent Risk • Control Risk • Acceptable Audit Risk