1 Chapter 9 Materiality and Audit Risk

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3 Under which auditing approach(es) are auditors required to obtain an understanding of the internal controls? Gordon

4 Which section of the Auditing Standards requires auditors to obtain an understanding of the internal controls? Katina

5 Why are auditors always required to obtain and understanding of the internal controls? Lauren

6 we are always required to obtain an understanding of the Internal Control to identify & assess the RoMM risks of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels through understanding the entity and its environment, including the entity's internal control, thereby to provide a basis for designing and implementing responses to the assessed RoMM. planning phase

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8 Under what audit approach(es) are auditors required to obtain sufficient appropriate audit evidence? Huyen

9 Which section of the Auditing Standards requires auditors to obtain sufficient appropriate evidence? Julissa

10.04 The objective of the auditor is to design and perform audit procedures that enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor's opinion. AU-C 500 Audit Evidence

11 How do we obtain audit evidence? Marc

12 What is the definition of audit risk? Somer

13 Audit risk. The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

14 What is the definition of Materiality? Jena

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16 Performance Materiality tolerable error tolerable misstatement The allocation of the preliminary judgment about materiality to segments (account balances or classes of transactions)

17 Xiaodan Describe a Significant Class of Transactions ? Describe a Transaction Cycle?

18 Class of Transactions Accounts receivablexxx.xx Salesxxx.xx Revenue & Collection Cycle Accounts receivablexxx.xx Salesxxx.xx Cashxxx.xx Accounts receivablexxx.xx

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20 Audit Risk Model

21 What are the elements of the “Audit Risk Model”? Nicole

22 the Audit Risk Model AAR = IR * CR * PDR page 128 Materiality and Risk

23 the Audit Risk Model AAR = IR * CR * PDR Risk of Material Misstatement RoMM = combines IR * CR Materiality and Risk Page 128

24 Audit Risk Model

25 Which Component(s) of Audit Risk do you think the auditor might be able to reduce? Which Component(s) of Audit Risk do you think the auditor would be unable to reduce? Ricardo

26 environmental clientauditor

27 Obtain engagement Understand the client AU-C 315 Analytical procedures Understand the internal controls Risk assessment Testing AU-C 500 Tests of controls (transactions) Substantive tests of transactions Substantive Analytical procedures Substantive tests of details of balances Reporting AU-C 700

28 Describe the relationship between Control Risk and the planned level of Detection Risk? The mathematical relationship Ian

29 Audit Risk Model What type of audit procedures will we perform to obtain appropriate evidence that controls are effective?

30 Audit Risk Model What type of audit procedures will we perform to obtain appropriate evidence to reduce Detection Risk to a low level?

31 Audit Risk Model What type of audit procedures will we perform to obtain appropriate evidence if Planned Detection Risk is high?

32 What is the definition of Control Risk Chen

33 Control risk. The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.

34 What is the definition of Planned Detection Risk Jonathan de

35 Planned Detection risk. The risk that the audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement.

36 Detection risk. The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

37 Alyssa If we assess CR = Low, what does that tell us about the level of PDR …. ? If we assess CR = High, what does that tell us about the level of PDR …. ?

38 If we assess CR = Max, what does that imply about the effectiveness of the Internal Controls? Iris

39 If we assess CR = Low, what does that imply about the effectiveness of the Internal Controls? Ciara

40 Katie If we assess Control Risk as Low, what type of evidence would our audit procedures need to generate?

41 Dillon If PDR = High, what does that imply about Control Risk …. ? If PDR = Low, what does that imply about Control Risk …. ?

42 preliminary Control Risk assessment significant classes of Transactions occurcomplete accuracy classifycutoff Credit sales Low Max Cash receiptsLow Payroll Low MaxLowMax Cash Disburse Low Purchasing Low

43 when we assess Control Risk less than Max Control activity Test of Control Proc Results Of ToC Occur Low Complete Low Accuracy Low Classification Low Cutoff Max Max Credit Sales Transactions

44 High Risk Areas and Transactions

45 1. Related Party Transactions 2. Non Routine Transactions 3. Judgement -Actg Estimates 4. Complex Transactions

46 1. Related Party Transactions high risk

47 Related Party Transactions high risk - page 86 & 135 One of the parties is in a position to exert significant influence over another party Related parties can structure transactions to conceal problems in the financial statements

48 2. Non Routine Transactions high risk

49 3. Judgement -Actg Estimates

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51 Auditing accounting estimates high risk p. 135 (judgment required) Keep track of differences

52 Auditing accounting estimates With estimates, there often is no right answer Keep track of differences between the estimate and what auditor finds reasonable Evaluate differences taken together

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54 4. Complex Transactions high risk page 77 - ENRON

55 Stephanie In your statistics class, why does a larger sample increase your level of confidence? How does evidence reduce risk?

56 Sample $ 50,000 Population 450,000

57 Accounts Receivable Project Sample Results Tolerable Misstatement 1.Known misstatement 2.Projection of sample results to the population 3.Allowance for sampling risk Estimates –Difference between auditor’s estimate –Book Value (management’s estimate Page $ 3,500 $ 3,500*(450,000/50,000) = $31,500 $ 15,750 $ 47,250

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61 Please describe Professional Skepticism ? Jon

62 An attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence.

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68 Given the definition of Audit Risk what is the relationship between Materiality and Audit Risk? ???

69 Evaluation of Sample Results Critical Value= μ + Z β * S x /√n 2, *1, / √ 44= 2, We are unable to conclude that Accounts Receivable is not materially overstated because the sample mean of $2, is less than the $2, critical value.

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