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Summary: Chapter 9 Materiality and Risk September 23, 2009 Materiality major consideration in determining the appropriate audit

it report to issue 1. Set Preliminary Judgment about Materiality-the maximum amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users. The lower the $ amount of preliminary judgment, the more evidence required. Factors affecting preliminary materiality judgment Materiality is a relative rather than an absolute concept Bases are needed for evaluating materiality Qualitative factors certain types of misstatements

2. Allocate preliminary judgment about Materiality to segments is necessary because auditors accumulate evidence by segments rather than for the financial statements as a whole. It helps to decide the appropriate audit evidence to accumulate. Tolerable misstatement: materiality allocated to any given account balance. 3. Estimate misstatement and compare with preliminary judgment 2 types of misstatements: Known misstatements auditor can determine the amount of misstatement in the account Likely misstatements o Misstatement from differences between managements and the auditors judgment about estimates of account balance

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o Projection of misstatement based on the auditors test of sample from population. Risk difficult to measure and require careful consideration before the auditor can respond. Auditor use audit risk model to identify the potential for misstatements in the overall financial statements and specific account balances, classes of transactions, and disclosures. Type of risks Planned detection risk - risk that auditor evidence for a segment will fail to detect misstatements exceeding tolerable misstatement. It determines the amount of substantive evidence that the auditor plans to accumulate. Inherent risk measure the auditors assessment of the likelihood that there are material misstatement in a segment before considering the of internal control. Control risk measures whether misstatement exceeding a tolerable amount in segment will be prevented or detected on a timely basis by the clients internal control. Acceptable audit risk / audit assurance measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and unqualified opinion has been issued. Assessing acceptable audit risk Engagement risk is the risk that the auditor will differ harm after the audit is finished, even though the audit report was correct. Factors affecting audit risk o The degree to which external users rely on the statements o The likelihood that a client will have financial difficulties after the audit report is issued.

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o The auditors evaluation of managements integrity. Assessing inherent risk inherent risk affects the amount of evidence that the auditor needs to accumulate, the assignment of staff and the review of auditor documentation. Factors affecting inherent risk o Nature of the clients business o Results of previous audits o Initial VS repeat engagement o Related parties o Nonroutine transactions o Judgment required to correctly record account balance and transactions o Makeup of the population o Factors related to fraudulent financial reporting and misappropriation of assets Relationship of risks to evidence and factors influencing risks auditors respond to risk preliminary by changing the extent of testing and types of audit procedures, including incorporating unpredictability in the audit procedures used. In addition to modifying audit evidence, there are 2 other ways that auditors can change the audit to respond risks. 1. The engagement may require more experienced staff 2. The engagement will be reviewed more carefully than usual.

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