Chapter 9

9-1

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Apply the concept of materiality to the

audit.
Make a preliminary judgment about what
amounts to consider material.
Determine performance materiality during
planning.

Use materiality to evaluate audit findings.

Define risk in auditing.
9-2

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Describe the audit risk model and its

components.
Consider the impact of engagement risk on
acceptable audit risk.
Consider the impact of several factors on
the assessment of inherent risk.
Discuss the relationship of risks to audit
evidence.
Discuss how materiality and risk are related
and integrated into the audit process.
9-3

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Apply the concept of materiality to the audit.

9-4

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Major consideration in determining

the appropriate audit report

Referenced in auditors responsibility

section of the audit report
What is meant by the term material?

9-5

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Auditors responsibility = determine whether

financial statements are materially misstated.

Auditor will bring material misstatements to the

clients attention so corrections can be made.

9-6

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9-7

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

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

9-8

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Auditors set materiality thresholds early in the

engagement.

Thresholds represent the maximum amount

that statements could be misstated and still
not affect users decisions.
9-9

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Materiality is a relative rather

than an absolute concept.
Benchmarks are needed for
evaluating materiality.

Qualitative factors also

affect materiality.

9-10

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Considerations that may render material a

quantitatively small misstatement include:
Loan covenants

Changing trend

Management compensation
Financial statement users

9-11

Conceals an illegal act

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Accounting and auditing standards do not

provide specific materiality guidelines.

Professional judgment is used to set and

apply materiality guidelines.

9-12

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3
Determine performance materiality
during planning.

9-13

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Evidence is accumulated by segments

rather than for the financial statements
as a whole.
Most practitioners allocate materiality
to balance sheet accounts.

9-14

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4
Use materiality to evaluate audit findings.

9-15

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Auditor can determine the misstated

amount in an account (Known)
Two types of Likely misstatements:

Judgmental differences

Projections of misstatements from

audit samples

9-16

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9-17

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Estimated
Misstatement
($31,500)

9-18

Net misstatements in Sample ($3,500)

Total recorded
= Total sampled ($50,000)
population value
($450,000)

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

5
Define risk in auditing.

9-19

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

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.

9-20

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Auditors need to understand the clients

business and assess business risk.

The audit risk model helps identify the

potential and likelihood of misstatements.

9-21

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PDR = AAR (IR CR)

where:

PDR = Planned detection risk

AAR = Acceptable audit risk
IR = Inherent risk
CR = Control risk

9-22

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

9-23

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Sales and
collection
cycle

Acquisition Payroll and

and payment personnel
cycle
cycle

Inherent
risk

Medium

High

Low

Control
risk

Medium

Low

Low

Acceptable
audit risk

Low

Low

Low

Planned
Medium
detection risk

Medium

High

9-24

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Inventory and
warehousing
cycle

Capital acquisition
and repayment
cycle

Inherent
risk

High

Low

Control
risk

High

Medium

Acceptable
audit risk

Low

Low

Planned
Low
detection risk

9-25

Medium
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6
Describe the audit risk model and
its components.

9-26

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Planned
Detection
Risk

Inherent
Risk

Control
Risk

Acceptable
Audit
Risk

9-27

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7
Consider the impact of engagement risk
on acceptable audit risk.

9-28

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What is Engagement Risk?

9-29

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Auditors decide engagement risk and use

that risk to modify acceptable audit risk.

Engagement risk closely relates to client

business risk.

9-30

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 The degree to which external users

rely on the statements
The likelihood that a client will have
financial difficulties after the
audit report is issued
The auditors evaluation of
managements integrity

9-31

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9-32

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

8
Consider the impact of several factors on
the assessment of inherent risk.

9-33

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Nature of Clients
Business
Industry practices
Non-routine transactions
Makeup of the population

Audit Experience
Prior audit results
Initial vs. repeat engagement
Audit judgment required to
correctly record balances and
transactions

Culture
Related parties
Factors related to fraudulent
financial reporting
Factors related to
misappropriation of assets
9-34

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9
Discuss the relationship of risks
to audit evidence.

9-35

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Acceptable audit risk

D

Factors
influencing
risks

Inherent
risk

Planned
detection
risk

D
I

Planned
audit
evidence
D

Control risk
9-36

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Auditors can change the audit to respond

to risks

The engagement may require more

experienced staff
The engagement will be reviewed more
carefully than usual

9-37

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Both control risk and inherent risk are

typically set for each cycle, each
account, and often each audit
objective, not for the overall audit.

9-38

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It is common to assess inherent and control

risk for each balance-related audit objective
It is not common to allocate materiality
to objectives

9-39

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9-40

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

One major limitation in the audit risk model is

the difficulty of measuring the components
of the model.

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Known

Unknown

Preliminary
Assessed Level
of Risk

Actual level of
risk achieved
on the audit

+/-

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Auditors develop various types of worksheets

to aid in relating the considerations affecting
audit evidence to the appropriate evidence
to accumulate.

9-42

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10
Discuss how materiality and risk are related
and integrated into the audit process.

9-43

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Acceptable
audit risk
Inherent
risk

D
Planned
detection risk

D
I

Planned
audit evidence

Control
risk
Performance
materiality
D = Direct relationship; I = Inverse relationship
9-44

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The auditor must revise the original

assessment of the appropriate risk.
The auditor should consider the effect
of the revision on evidence requirements,
without the use of the audit risk model.

9-45

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

9-46

Copyright 2014 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright

All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise,
without the prior written permission of the publisher. Printed in the
United States of America.
9-47

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