F INANCIAL C ONTROL C HAPTER 7 B ASIC A UDITING C ONCEPTS Text Book: Auditing “An Assertions Approach” Donald H. Taylor, G. William Glezen Samar Gad

T HE SECTIONS OF AN AUDIT 1. The audit is planned 2. The internal control is studied and tested 3. Substantive tests are performed 4. The audit report is issued Samar Gad

W HAT ’ S MATERIALITY ? Materiality : the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement Samar Gad

M ATERIALITY CONSIDERATIONS Quantitative factors Net income Net income before taxes Revenue Total assets Current assets Stockholders’ equity Qualitative factor The probability that illegal payments might occur The probability that fraud might occur Provisions in a client’s loan agreement with a bank requiring that certain financial statement ratios be maintained at minimum levels An interruption in a trend in earnings Samar Gad

M ATERIALITY, AUDIT EFFORT AND AUDIT RISK Larger materiality borders (Materiality), associated with less audit effort and higher audit risk. By selecting narrower materiality borders, the more audit effort will be extended, and less exposure to audit risk. Samar Gad

W HAT ’ S A UDIT RISK ? Audit Risk : The risk that the auditor may unknowingly fail to appropriately modify an opinion on financial statements that are materially misstated Samar Gad

T YPES OF RISKS Audit risk Detection risk Inherent risk Control risk Samar Gad

T YPES OF RISK Inherent Risk : The susceptibility of an account or transaction to error. Control Risk : The risk that the control system will fail to prevent or detect a material error. Control system designed by management based on cost/benefit considerations. All systems have an inherent level of error occurrence. Auditor attempts to estimate inherent error level so appropriate audit procedures can be performed. Detection Risk : The risk that substantive procedures will fail to detect a material misstatement. It contains two types of risks (sampling risk and non sampling risk) Samar Gad

A CCEPTABLE AUDIT RISK The level of audit risk the auditor is willing to accept. It is usually set at minimum level. When AAR increases, audit effort decreases and audit risk increases. Samar Gad

A UDIT RISK MODEL DR= AAR/ (IR x CR) -ve relation between (IR and CR) and DR -ve relation between (IR and CR) and AAR +ve relation between AAR and DR Samar Gad

R ELATIONSHIPS Type of riskChangeEvidence Inherent risk↑↑ Control risk↑↑ As evidence increases, detection risk decreases Samar Gad

S AMPLING What is sampling? It is testing less than 100% of the population Types of sampling: Statistical Non-statitical Samar Gad

E ND OF CHAPTER 7 Samar Gad