1. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 9 - 1 Materiality and Risk Chapter 9

2. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 2 Materiality It is a major consideration in determining the appropriate audit report to issue.

3. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 3 Materiality The auditor’s responsibility is to determine whether financial statements are materially misstated. If there is a material misstatement, the auditor will bring it to the client’s attention so that a correction can be made.

4. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 4 Steps in Applying Materiality Planning extent of tests Step 1 Set preliminary judgment about materiality Step 2 Allocate preliminary judgment about materiality to segments

5. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 5 Steps in Applying Materiality Evaluating results Step 3 Estimate total misstatement in segment Step 4 Estimate the combined misstatement Compare combined estimate with judgment about materiality Step 5

6. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 6 Set Preliminary Judgment About Materiality This preliminary judgment is the maximum amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users. Auditors decide early in the audit the combined amount of misstatements of the financial statements that would be considered material.

7. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 7 Factors Affecting Judgment Materiality is a relative rather than an absolute concept. Bases are needed for evaluating materiality. Qualitative factors also affect materiality.

8. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 8 Guidelines Guidelines Accounting and auditing standards do not provide specific materiality guidelines to practitioners. Professional judgment is to be used at all times in setting and applying materiality guidelines.

9. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 9 Risk Auditors accept some level of risk in performing the audit. An effective auditor recognizes that risks exist, are difficult to measure, and require careful thought to respond. Responding to risks properly is critical to achieving a high-quality audit.

10. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 10 Risk and Evidence Auditors gain an understanding of the client’s business and industry and assess client business risk. Auditors use the audit risk model to further identify the potential for misstatements and where they are most likely to occur.

11. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 11 Factors Affecting Acceptable Audit Risk  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 auditor’s evaluation of management’s integrity

12. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 12 Factors Affecting Inherent Risk  Nature of the client’s business  Results of previous audits  Initial versus repeat engagement  Related parties  Nonroutine transactions  Judgment required to correctly record account balances and transactions  Makeup of the population  Factors related to fraudulent financial reporting  Factors related to misappropriation of assets

13. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyr 9 - 13 Relationship of Factors Influencing Risks to Risks and Risks to Planned Evidence  The engagement may require more experienced staff  The engagement will be reviewed more carefully than usual  Auditors can change the audit torespond to risks

14. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 9 - 14 End of Chapter 9