2. 1 Chapter 9 Materiality and Audit Risk

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4. 3 Under which auditing approach(es) are auditors required to obtain an understanding of the internal controls? Giselle

5. 4 Which section of the Auditing Standards requires auditors to obtain an understanding of the internal controls? Elizabeth W

6. 5 Why are auditors always required to obtain and understanding of the internal controls? Eric

7. 6.03 The objective of the auditor is to identify and assess the 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 providing a basis for designing and implementing responses to the assessed risks of material misstatement. AU-C 315 Understanding the Entity & Its Environment & Assessing RoMM

8. 7 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

9. 8 Analytical Procedures during the planning phase understand the client’s industry and business to identify potential misstatements attention directing design audit procedures that reduce the risk we might fail to detect a material misstatement page 94

10. 9 AICPA December 2006 109 Statement on Auditing Standards Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement

11. 10 Under what audit approach(es) are auditors required to obtain sufficient appropriate audit evidence? Ellen

12. 11 Which section of the Auditing Standards requires auditors to obtain sufficient appropriate evidence? Dev

13. 12.04 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

14. 13 How do we obtain audit evidence? Jennifer

15. 14 What is the definition of audit risk? Brenda

16. 15 Audit risk. The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.

17. 16 What is the definition of Materiality? Ryan M

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19. 18 Performance Materiality tolerable error tolerable misstatement The allocation of the preliminary judgment about materiality to segments (account balances or classes of transactions)

20. 19 Michael Describe a Significant Class of Transactions ? Describe a Transaction Cycle?

21. 20 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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23. 22 Audit Risk Model

24. 23 What are the elements of the “Audit Risk Model”? Steffan

25. 24 the Audit Risk Model AAR = IR * CR * PDR page 128 Materiality and Risk

26. 25 the Audit Risk Model AAR = IR * CR * PDR Risk of Material Misstatement RoMM = combines IR * CR Materiality and Risk Page 128

27. 26 Audit Risk Model

28. 27 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? Elizabeth

29. 28 environmental clientauditor

30. 29 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

31. 30 Describe the relationship between Control Risk and the planned level of Detection Risk? The mathematical relationship Suiting

32. 31 Audit Risk Model What type of audit procedures will we perform to obtain appropriate evidence that controls are effective?

33. 32 Audit Risk Model What type of audit procedures will we perform to obtain appropriate evidence to reduce Detection Risk to a low level?

34. 33 Audit Risk Model What type of audit procedures will we perform to obtain appropriate evidence if Planned Detection Risk is high?

35. 34 What is the definition of Control Risk Steve

36. 35 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.

37. 36 What is the definition of Planned Detection Risk Catherine

38. 37 Planned Detection risk. The risk that the audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement.

39. 38 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.

40. 39 Brian 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 …. ?

41. 40 If we assess CR = Max, what does that imply about the effectiveness of the Internal Controls? Alejandro

42. 41 If we assess CR = Low, what does that imply about the effectiveness of the Internal Controls? Sandra

43. 42 Polina If we assess Control Risk as Low, what type of evidence would be appropriate for our audit procedures need to generate?

44. 43 Chesley If PDR = High, what does that imply about Control Risk …. ? If PDR = Low, what does that imply about Control Risk …. ?

45. 44 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

46. 45 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

47. 46 High Risk Areas and Transactions

48. 47 1. Related Party Transactions 2. Non Routine Transactions 3. Judgement -Actg Estimates 4. Complex Transactions

49. 48 1. Related Party Transactions high risk

50. 49 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

51. 50 2. Non Routine Transactions high risk

52. 51 3. Judgement -Actg Estimates

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54. 53 Auditing accounting estimates high risk p. 135 (judgment required) Keep track of differences (page 360)

55. 54 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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57. 56 4. Complex Transactions high risk page 77 - ENRON

58. 57 Katherine In your statistics class, why does a larger sample increase your level of confidence? How does evidence reduce risk?

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60. 59 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 125-126 $ 3,500 $ 3,500*(450,000/50,000) = $31,500 $ 15,750 $ 47,250

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64. 63 Please describe Professional Skepticism ? Tracy

65. 64 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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71. 70 Given the definition of Audit Risk what is the relationship between Materiality and Audit Risk? ???

72. 71 Evaluation of Sample Results Critical Value= μ + Z β * S x /√n 2,295.47 + 1.04 *1,390.09 / √ 44= 2,513.42 We are unable to conclude that Accounts Receivable is not materially overstated because the sample mean of $2,425.56 is less than the $2,513.42 critical value.

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