AUDIT APPROACH

AND
CONCEPT OF MATERIALITY

wawat sutanto
 COVERAGE:

• AUDIT OBJECTIVES
• BASIC CONCEPTS
• RISK BASED AUDIT
APPROACH
• AUDIT PROCESS/
METHODOLOGY
• CONCEPT OF
MATERIALITY
AUDIT OBJECTIVES

• TO OBTAIN SUFFICIENT
APPROPRIATE EVIDENCE:
 TO PROVIDE ADEQUATE
ASSURANCE THAT THE FINANCIAL
STATEMENTS ARE FREE FROM
MATERIAL MISSTATEMENT
• TO ENABLE THE AUDITORS TO
EXPRESS AN OPINION :
 WHETHER THE FINANCIAL
STATEMENTS ARE PREPARED IN
ALL MATERIAL RESPECT, IN
ACCORDANCE WITH GENERALLY
ACCEPTED ACCOUNTING
PRINCIPLES
BASIC CONCEPTS

• MATERIALITY

• AUDIT RISK

• THE FINANCIAL
STATEMENTS AS A
COMBINATION OF
ASSERTIONS BY
MANAGEMENT
 MATERIALITY

“MAGNITUTE OR NATURE OF
A MISSTATEMENT THAT, IN
/-?
+ ? THE LIGHT OF THE
SURROUNDING
CIRCUMSTANCES, MAKES IT
PROBABLE TO CHANGE OR
INFLUENCE THE JUDGEMENT
OF THE USER OF THE
FINANCIAL STATEMENTS”
ONLY MATERIAL MISSTATEMENTS AND UNCERTAINTIES
WILL AFFECT OUR AUDIT OPINION
AUDIT RISK

RISK THAT THE AUDITOR

MAY UNKNOWINGLY
FAIL TO MODIFY OPINION
APPROPRIATELY ON THE
FINANCIAL STATEMENTS
THAT ARE MATERIALLY
MISSTATED
COMBINATION OF ASSERTIONS

PRESENTATION BY
MANAGEMENT THAT THE
FINANCIAL STATEMENTS ARE
FAIRLY PRESENT FINANCIAL
POSITION AND RESULT OF
OPERATION

– E.G COMPLETENESS, EXISTENCE,

OWNERSHIP, ACCURACY,
VALUATION, PRESENTATION, ETC
RISK BASED AUDIT APPROACH

AUDIT
RISK

RISK OF
MATERIAL
DETECTION
MISSTATEMENT RISK

INHERENT CONTROL
RISK RISK

CONTROL CONTROL
PROCEDURE
ENVIRONMENT
RISK
AUDIT PROCESS/METHODOLOGY

• PLANNING AND DESIGN

AUDIT STRATEGY

• EXECUTE THE AUDIT

• COMPLETING THE AUDIT

PLANNING AND DESIGN
AUDIT STRATEGY

 AGREE TERMS OF ENGAGEMENT

 UNDERSTANDING THE BUSINESS
 UNDERSTANDING THE ACCOUNTING
SYSTEM & EVALUATE INTERNAL
CONTROL
 RISK ASSESSMENT
 DETERMINE PLANNING MATERIALITY
 PERFORM PRELIMINARY ANALYTICAL
REVIEW
 DETERMINE AREAS OF AUDIT
SIGNIFICANCE
 DESIGN AUDIT STRATEGY ( NATURE
AND EXTENT OF AUDIT PROCEDURES)
AGREE TERM OF ENGAGEMENT

• UNDERSTAND CLIENT’S NEEDS

AND REQUIREMENTS

• OBJECTIVES OF THE
ENGAGEMENT

• AGREE THE NATURE AND TIMING

OF OUR REPORT

• PROCEDURES FOR ACCEPTANCE

UNDERSTANDING THE BUSINESS

• BUSINESS AND INDUSTRY

CONDITION
• COMPETITIVE SITUATION
• LONG TERM STRATEGIC
OBJECTIVES
• CRITICAL SUCCESS FACTOR
• ENVIRONMENTAL,
TECHNOLOGY, LEGAL
• ACCOUNTING PRACTICES
• FINANCIAL CONDITION
• OPERATING, PRODUCTION,
SALES
UNDERSTANDING THE ACCOUNTING SYSTEM
AND EVALUATE INTERNAL CONTROL
• ACCOUNTING INFORMATION
SYSTEM
• ACCOUNTING CYCLE AND
MAJOR TRANSACTION STREAM
• MANAGEMENT INFORMATION
SYSTEM
• CONTROL PROCEDURES WITHIN
ACCOUNTING SYSTEM
• COMPUTER SYSTEM
• PREPARING THE FINANCIAL
STATEMENTS
• WALK-THROUGH & CAATs
RISK ASSESSMENT

• ASSESS INHERENT RISK

 MANAGEMENT CHARACTERISTICS
 ENGAGEMENT CHARACTERISTICS
 OPERATING AND INDUSTRY
CHARACTERISTICS

• ASSESS CONTROL ENVIRONMENT

 BUSINESS STRATEGY
 INFORMATION SYSTEMS
 SUPERVISORY PROCEDURES
 PERSONNEL POLICIES &
PROCEDURES

• CONSIDERATION OF FRAUD
 RESPONSIBILITY TO DETECT FRAUD
CONSIDERATION OF FRAUD

• THE RISK THAT FRAUD CAN

OCCUR AND REMAIN
UNDETECTED

• THE RISK THAT A PARTICULAR

TYPE OF FRAUD COULD CAUSE
THE FINANCIAL STATEMENTS TO
BE MATERIALLY MISSTATED

• THE RELATIVE EFFECTIVENESS

OF VARIOUS AUDIT PROCEDURES
 PLANNING MATERIALITY

• PRELIMINARY JUDGMENT
Stocks ABOUT WHAT WOULD BE
MATERIAL MISSTATEMENT

Interest Rates
PRELIMINARY ANALYTICAL REVIEW

• IDENTIFY FINANCIAL STATEMENT

AMOUNTS WHICH ARE NOT IN
ACCORDANCE WITH OUR BROAD
EXPECTATIONS AND WHICH
MIGHT THEREFORE BE
MATERIALLY MISSTATED
• ANALYSE INFORMATION USED BY
MANAGEMENT TO CONTROL
BUSINESS
 ACTUAL RESULT TO BUDGET
 CURRENT YEAR RESULT &
FINANCIAL POSITION WITH PRIOR
YEAR
 KEY FINANCIAL AND OPERATING
RATIOS
DETERMINE AREAS OF AUDIT SIGNIFICANCE

• DECIDE WHETHER EACH FINANCIAL

AREA IS SIGNIFICANT OR
INSIGNIFICANT FROM AN AUDIT
PERSPECTIVE
• QUANTITATIVE AND QUALITATIVE
FACTORS OF:
 PLANNING MATERIALITY
 RISK ASSESSMENT
 EVIDENCE OF COMPLETENESS THAT THE
RECORDED AMOUNT IS NOT UNDERSTATED
 PROFESSIONAL OR LEGISLATIVE
REQUIREMENTS (MANDATORY
PROCEDURES)

NO FURTHER AUDIT PROCEDURES NEED TO BE PERFORMED TO THE

INSIGNIFICANT FINANCIAL STATEMENTS AREAS
 DESIGN AUDIT STRATEGY

• DECIDE THE MOST EFFECTIVE

AND EFFICIENT COMBINATION
?
? OF AUDIT PROCEDURES
FROM:

– TEST OF CONTROL
– SUBSTANTIVE
PROCEDURES
– PLAN LOGISTICS
– DOCUMENT PLANNED
AUDIT APPROACH
DESIGN AUDIT STRATEGY
Control
Inherent Risk RISK Environment
PROFILE Strengths

OPTIMUM
COMBINATION

Test of Substantive Other

Controls Analytical Substantive
Procedures Procedures
 DESIGN AUDIT STRATEGY- CHOOSING THE
OPTIMUM COMBINATION OF PROCEDURES

• EFFECTIVENESS
• EFFICIENCY
– CHOOSE THE MOST EFFECTIVE
COMBINATION PROCEDURES TO OBTAIN
SUFFICIENT RELIABLE EVIDENCE
 DESIGN AUDIT STRATEGY- CHOOSING THE OPTIMUM COMBINATION OF
PROCEDURES

TEST OF TRANSACTION ANALYTICAL DETAILS OF

CLIENT BALANCES

COMPLIANCE SUBSTANTIVE SUBSTANTIVE COMPLIANCE SUBSTANTIVE

STRONG AIS &

STRONG CE Extensive Small Extensive Extensive Small

STRONG AIS &

SUFFICIENT
Medium Extensive Extensive Medium Small
CE

SUFFICIENT
AIS & Medium Small Medium Medium Medium
STRONG CE

SUFFICIENT
AIS & CE N/A Medium Medium N/A Extensive

AIS = Accounting Information System, CE = Control Environment

EXECUTE THE AUDIT
• PERFORM AND EVALUATE
– CONTROL PROCEDURES AND TEST
OF CONTROL

– SUBSTANTIVE PROCEDURES
 ANALYTICAL PROCEDURES
 TEST OF TRANSACTIONS
 DETAILS OF BALANCES

• ENGAGEMENT RESPONSIBILITIES:
REVIEW AND CONSULTATION
• COOPERATION WITH OTHER
AUDITORS
• RELIANCE ON SPECIALIST OR
EXPERT
COMPLETING THE AUDIT

• EVALUATE OVERALL RESULTS OF

AUDIT PROCEDURES

• PERFORM FINAL ANALYTICAL REVIEW

• FORM AN OPINION

• ISSUE AUDIT REPORT

• ISSUE MANAGEMENT LETTER

 CONCEPT OF MATERIALITY

IMMATERIAL AUDIT IMMATERIAL

OBJECTIVE

FINANCIAL STATEMENT
(Free of Material
Misstatement)
 DEFINITION

MATERIALITY:
“MAGNITUTE OR NATURE OF A
MISSTATEMENT THAT, IN THE LIGHT OF
THE SURROUNDING CIRCUMSTANCES,
MAKES IT PROBABLE TO CHANGE OR
INFLUENCE THE JUDGEMENT OF THE
USER OF THE FINANCIAL STATEMENTS”
 NATURE OF MATERIALITY

• VARIES OF EACH CLIENT

• CANNOT BE EXPRESSED AS A GIVEN AMOUNT

OR PERCENTAGE WHICH WILL APPLY TO ALL
ENGAGEMENT

• NOT ONLY THE FUNCTION OF MAGNITUTE OF A

MISSTATEMENT, BUT ALSO THE FUNCTION OF
THE NATURE OF MISSTATEMENT
 MATERIALITY – AUDIT PROCESS

• DETERMINING NATURE, TIMING AND EXTENT OF

AUDIT PROCEDURES

• EVALUATING EVIDENCE FROM AUDIT

PROCEDURES

• FORMING OUR OPINION

 PLANNING MATERIALITY

- PRELIMINARY JUDGMENT ABOUT WHAT WOULD

BE A MATERIAL MISSTATEMENT

- MAJOR FACTOR IN DETERMINING WHICH FINANCIAL

STATEMENTS AREAS ARE SIGNIFICANT FROM AN
AUDIT PERSPECTIVE AND WHICH ARE NOT
 PLANNING MATERIALITY

MATERIALITY IS RELATIVE TO AMOUNTS IN THE FINANCIAL

STATEMENTS RATHER THAN IN ABSOLUTE TERMS

AMOUNTS TO BE CONSIDERED:

-TURNOVER

-PROFIT

-TOTAL ASSETS

-NET ASSETS

-WORKING CAPITAL AND LIQUIDITY

 MATERIALITY

INDICATES THAT A MATERIAL ERROR

COULD EXIST

EVALUATING EVIDENCE

SATISFY OURSELVES THAT

A MISSTATEMENT DOES NOT EXIST
 ULTIMATELY

MATERIALITY IS A MATTER FOR

THE PROFESSIONAL JUDGMENT
OF AUDITORS