RISK ASSESSMENT

The Risk-Based Audit Process

Phase 1 RISK ASSESSMENT
➢ Continue or stop a relationship with an
A. Preliminary engagement activities to decide whether existing client
to accept or continue an Audit Engagement ➢ Self-evaluation of the auditor's capabilities
B. Planning the Audit for overall Strategy and Audit Plan and competence
Development ➢ Integrity and auditability of the client's
C. Risk Assessment Procedures to identify and assess financial statements
risk of material misstatement through understanding ➢ Primary Objective: To minimize the likelihood
the entity. of being associated with a client whose
management lacks integrity.
Preliminary Engagement Activities
Preliminary Engagement Activities
• Perform procedures required by PSA 220 "Quality
Control of an Audit of Financial Statements Vital Considerations before preparing the Audit
regarding the continuance of the client relationship Plan
and the specific audit engagement
• The auditor maintains the necessary
• Evaluate compliance with ethical requirements,
independence
including independence are required by PSA 220
(Redrafted) • Ability to serve the client properly competence
• Establish an understanding of the terms of to perform the engagement.
engagement as required by PSA 210 "Agreeing the
There are no issues with management integrity
terms of Audit Engagements
that may affect the auditor's willingness to
continue the engagement.
General Principles Regarding the Independent
• There is no misunderstanding with the client as
Audit of Financial Statements (PSA 200)
to the terms of the engagement.
1. The auditor should comply with relevant ethical
➢ In accepting new clients, the auditor
requirements.
should consider the following:
2. The auditor should conduct the audit in accordance ➢ Competence to perform the audit
with the PSA. ➢ Capacity and Capability of Resources and
Time to perform the audit
3. The auditor should exercise professional
➢ Consideration of the Integrity of the
judgement in planning and performing an audit
client
4. The auditor should obtain sufficient appropriate ➢ Compliance to ethical requirements
audit evidence to reduce audit risk.
5. The auditor should plan and perform the audit
Client Acceptance & Continuance
with an attitude of professional skepticism.
Decisions to Make:
Preliminary Engagement Activities
Accept or Deny New Client >Continue or Cease
Purposes of Preliminary Activities
the Audit of Existing Client
• Assists the auditor in identifying and evaluating
The profession heavily relies on the trust and
events or circumstance adversely affecting
confidence given by the public.
planning and performing the audit engagement
• To reduce audit risk to an acceptably low level Due care must always be exercised to ensure that
the firm avoids or minimizes associating with
clients whose management lacks integrity.
Preliminary Engagement Activities
➢ Investigation of client's integrity through: Communication with
This phase will require a decision from the auditor:
previous auditor (called predecessor auditor)
➢ Accept or deny a new client ➢ Reading published articles Inquiry to appropriate parties
➢ Inquiry to appropriate parties
Prior to accepting new clients, the CPA should:
• Investigate the history of the prospective client
• Establish identities and reputation of the
directors, officers, and major stockholders
• Obtain management's permission to inquire on
third parties
Decisions should involve more than just a
consideration of management's integrity
Strict client acceptance/continuance guidelines
should be established to screen out:
❖ clients that are in financial and/or
organizational difficulty
❖ clients that constitute a disproportionate
percentage of the firm's total practice
disreputable clients
❖ clients that offer unreasonably low fee for
the auditor's services
Matters to be discussed with the previous auditor
(predecessor auditor)
➢ Understanding as to the reason for change in
➢ Information of the integrity of the
management auditor
➢ Disagreement between previous auditor and
management as to accounting principles,
auditing matters, et.al.
Note:
The auditor should seek permission of the client
prior to communicating with the predecessor
auditor.
If the client disagrees to the planned
communication, the auditor should
communicate. (In accordance with the basic
principle of Confidentiality in Professional Ethics)
Preliminary Engagement Activities
• The auditor is not obliged to accept new clients
The auditor is not obliged to conte servicing existing
clients if:
❖ Relationships had deteriorated
❖ Management’s integrity has become
doubtful
Auditors should assess if they can complete the
audit in accordance with the Philippine Standard on
Auditing based on International Standard on
Auditing
The CPA must determine:
conditions that would prevent performing an
independent audit of the client competence and
capability of partners and staff to conduct an audit
Preliminary Engagement Activities
The CPA firm shall establish the following pre-
conditions:
Acceptability of Financial Reporting Framework to
be applied in the Financial Statements
• Management acknowledges and understands its
responsibilities:
• Preparation of financial statements in accordance
with applicable financial reporting framework
• Establishment of internal control system
• Provide auditors with access to all information
relevant to the financial statement, additional
information needed in the engagement,
unrestricted access to personnel ingathering
evidences
ACCEPTABLE FINANCIAL REPORTING
FRAMEWORK
The Financial Reporting Framework adopted by
management and, where appropriate, those
charged with governance in the preparation of
the financial report that is acceptable in view of
the nature of the entity and the objective of the
financial report, or that is required by law or
regulation
Reporting Framework
IFRS/PERS
➢ Full IFRS
➢ IFRS for SMES
not
➢ NIRC and Revenue Regulation
Cash Basis (IPSAS)
Bank - BSP Circulars and Relevant Laws
Government-NGAS
The CPA and the Management or Those Charged
with Governance should confer and agree to the
appropriate terms of the audit as recorded in the
audit engagement letter
Summary:
Before accepting new client:
Assess competence to perform the
engagement and capabilities, time, and
resources
Determine compliance with the relevant
ethical requirements
Consider the integrity of the client
Obtain information that concludes client's
lack of integrity
Acceptance and Continuance of Relationships and
Specific Engagements
A. Does the firm has the:
• Competence
• Capability
• Time
• Resources
• Personnel
B. Comply with Ethical Requirements and identify
threats (continuity)
C. Consider the integrity of the client
• identify the business
• Reputation of the owners
• Nature of operation
D. Investigate from other sources
E. Reason for the selection
F. Potential conflicts to exist in the continuity of
relationship
Policies and Procedures on Auditor Withdrawal
Policies and procedures on withdrawal from an
engagement and the client relationship shall include
the following:
a. Discussing with the appropriate level of the
client's management and those charged with its
governance regarding the appropriate action that
the firm might take based on the relevant facts and
circumstances
b. If the firm determines that it is appropriate to
withdraw, discussing with the appropriate level of the
client's management and those charged with its
governance withdrawal from the engagement or from
both the engagement and the client relationship, and
the reasons for the withdrawal
Preliminary Engagement Activities
Recurring Audit:
• Assess whether terms of the audit should be
revised
• Assess whether there is need to remind
management of the existing terms
• Do not agree to change the terms where there
is no reasonable justification for doing so
• If disagreements persist, withdraw from the
engagement legally
The interest of the public must always be at the
utmost importance
Following factors make appropriate revisions
of the terms of the engagement
• Client misunderstands the objective and scope
of the audit
• Any revised or special terms of the engagement
• Recent change of management, governance,
or ownership
• Significant change in ownership
• Significant change in nature or size of the
client's business
• Change in legal or regulatory requirements
• Change in financial reporting framework for
preparation of financial statements
• Change in other reporting requirements
If the terms of audit engagement are changed,
auditor and management shall agree on and
record the new terms of the engagement in an
engagement letter or other suitable form of
written agreement
Code of Ethics for Professional Accountants in
the Philippines
• Revised Code of Ethics for Professional
Accountants in the Philippines
(effective June 4, 2014)
• Amended: PRBOA Res. No. 263
effective April 6, 2016
• Based on the IESBA
Code Developed by the International
Ethics Standards Board for Accountants
(IESBA) of the IFAC
• This supersedes the Revised Code of
Ethics for Professional Accountants in
the Philippines (effective June 30, 2008)
The provisions of the Philippine Code are
mandatory in nature and are applicable to
professional services performed in the
Philippines.
All CPAs are expected to comply with the
ethical requirements of the Philippine Code
and other subsequent pronouncements to
be adopted and approved by the IFAC.
A professional accountant's responsibility is
not limited to satisfy the needs of an
individual client
Responsibility to serve the Public
The role of the independent accountant is to ensure
that information is fair to all parties and not biased
to benefit one group at the expense of another.
Public accountants must maintain a high degree of
independence from their clients if we are to remain
credible to the community.
Public's Expectation:
The public's knowledge that members of the
accounting profession adheres to such code
provides a set of expectation about the quality of
service the CPA provide.
Many segments of society are dependent for
decision-making on information for which they have
no control
They rely on professional accountants in assessing
the reliability of this information
An accountant who is Objectivity (Sec. 120)
A professional accountant shall not allow bias,
conflict of interest or undue influence of others to
override professional or business judgments.
• Independent and neutral
• A professional with code of ethics
• A member of profession with systematic
theory
Important Note !!!
This does not connote inappropriate
abandonment of the client
We serve both the public and client with the
public at the utmost importance.
The conceptual framework approach (also
known as the "threats and safeguards"
approach) provides a system for identifying
and evaluating threats to compliance with
ethical standards and determining whether
safeguards would eliminate threats or
reduce them to an acceptable level
Situation
Fundamental Principle
Threat
Safeguard
FUNDAMENTAL PRINCIPLES
Section 100.5
A professional accountant shall comply
with the following fundamental principles:
*Objectivity
*Professional Competence and Due Care
*Confidentiality
*Professional Behavior
Integrity (Sec. 110.1)
To be straightforward and honest in all
professional and business relationships
Integrity also implies fair dealing and
truthfulness
A professional accountant shall not
knowingly be associated with reports,
returns, communications or other
information which:
Contains a materially false or misleading
statement
Contains statements or information
furnished recklessly
Omits or obscures information required
to be included where such omission or
obscurity would be misleading
Objectivity (Sec. 120)
A professional accountant shall not allow
bias, conflict of interest or undue influence of
others to override professional or business
judgments.
Independence
❖Taking an unbiased viewpoint in the
performance of the examination and in the
preparation of the report.
❖ Refers to the independence of the auditor
from parties that may have a financial interest
in the business being audited.
State of mind
Auditor's own opinion of his own
independence
The state of mind that permits the provision
of an opinion without being affected by
influences that compromise professional
judgment, allowing an individual to act with
integrity, and exercise objectivity and
professional skepticism.
Two phases Independence in Appearance
• The avoidance of facts and circumstances
that are so significant that a reasonable and
informed third party would be likely to
conclude, weighing all the specific facts and
circumstance, that a firm's, or a member of
the audit or assurance team's integrity,
objectivity or professional skepticism has
been compromised
Professional Competence and Due Care
(Sec.130.1)
• To maintain professional knowledge and
skill at the level required to ensure that a
client or employer receives competent
professional service based on current
developments in practice, legislation and
techniques.
To act diligently in accordance with applicable
technical and professional standards
Competent professional service requires the
exercise of sound judgment in applying
professional knowledge and skill
Professional competence may be divided into
two separate phases:
• Attainment of professional competence
• Maintenance of professional competence
Due Care
Diligence covers the responsibility to act in
accordance with the requirements of an
assignment, carefully, thoroughly and on a
timely basis
Professional accountants to take steps to
ensure all members of the audit team have
appropriate training and supervision
Communicate to clients, employers, or other
users of the professional services aware of
limitations inherent in the services
Confidentiality (Sec. 140)
To respect the confidentiality of information
acquired as a result of professional and
business relationships and, therefore, not
disclose any such information to third parties
without proper and specific authority, unless
there is a legal or professional right or duty to
disclose, nor use the information for the
personal advantage of the professional
accountant or third parties
Maintain confidentiality-
In a social environment particularly to a close
business associate or immediate family
members
Of information disclosed by a prospective
client or employer
Within the firm or employing organization
Even after the end of relationships with a
client or employers
By staff members who shall respect the
professional accountant's duty of confidentiality
Confidentiality
Instances when disclosure is allowed: *Upon the
order of competent court Professional right or
duty to disclose
Professional Behavior (Sec. 150)
• Comply with relevant laws and regulations
Avoid actions that discredits the profession
• Make exaggerated claims about services
• Make damaging references or comparisons
with others
In marketing and promotions, professional
accountants shall not bring the profession in
disrepute
Professional accountants shall not make
*exaggerated claims for the services they are
able to offer, qualification they possess, or
experience they have gained disparaging
references or unsubstantial comparisons to the
work of others.
Threats to compliance with the fundamental
principles
Threats to Fundamental Principles
Obstructions that auditors may face or expect to face
while carrying requirements of engagements which
could compromise a professional accountant's
compliance with the fundamental principles.
Threats to compliance with the fundamental
principles
• Self-interest threats
• Self-review threats
• Advocacy threats
• Familiarity threats
• Intimidation threats
SELF-INTEREST THREATS
May occur as a result of the financial or other
interests of a professional accountant or of an
immediate family
When an auditor or any immediate or close family
member of the auditor is involved in the entity which
might cause the auditor to violate multiple ethical
requirements
SELF-REVIEW THREATS
May occur when a previous judgement needs to be
re- evaluated by the same professional accountant
responsible for that judgement
When the auditor is asked to report on or examine
his own assessment, opinion, judgement or work and
thus he is basically self-reviewing his work
Examples:
• The auditor has previously established the
internal control
• system of the audit client
• The auditor is providing payroll services to the
audit client
• The auditor designed the IT system of his
audit client
ADVOCACY THREATS
When a professional accountant promotes a position
or opinion of a client to the point that subsequent
objectivity may be compromised.
Other advocacy situations
• Auditor serving as corporate secretary
• Auditor is promoting the stock offerings of
the client
• Auditor is acting as advocate in behalf of the
client
• Providing assurance and non-assurance to
client
• Performing tax services
• Representing client in resolution of tax
dispute
• Performing litigation support services
• Authorization of transaction for client
• Preparation of the client's bank reconciliation
statement
Preparation and posting of journal entries for
the client
FAMILIARITY THREATS
Due to a long or close relationship with a client or
employer, a professional accountant will be too
sympathetic to their interests or too accepting of
their work
The auditor and the CEO of the entity are brods
in Kappa Kappal Muks Mamau fraternity
During the engagement, the auditor fills gasoline
for his car full tank for free in the gas station
owned by the entity
More actual illustrations
• Member of team with immediate member in
the client's business
• Member of the team with family as
employee of the firm
• Officer of client (former team member)
exerting influence over subject matter of
engagement
• Accepting gifts or preferential treatment
from client
• Senior officer of the firm with long
association with client
• Family with personal relationship with client
Audit engagement for a long time
• Providing security services to client Team
member becomes employed with client
• Officer of the firm is town mate, classmate,
fraternity brod of the client
INTIMIDATION THREATS
A professional accountant will be deterred
from acting objectively because of actual or
perceived pressures including attempts to
exercise undue influence over the
professional accountant
More intimidating situations
• The firm is threatened with dismissal from
client
• Cancellation of possible non-assurance
services over adverse report
• Pressure to reduce the extent of work to
reduce Fees
 • No endorsement to client's friends due to
disagreement
• Family or personal relationship with client
Fees from client represent a large proportion
of total revenue.
• Actual or threatened litigation business
relationship dominant personality attempting
to influence the decision team member with
running feud with client
Safeguards
Sec. 100.13
Actions or other measures that may eliminate
threats or reduce them to an acceptable level
Broad categories:
Created by the profession, legislation, or
regulation
In the work environment
• Engagement-specific safeguards
• Firm-wide safeguards
Within the client system
Audit Engagement Letter
• A written agreement that describes the
business relationship to be entered into by a
client and a company.
• The letter details the scope of the agreement,
its terms, and costs.
• The purpose of an engagement letter is to set
expectations on both sides of the agreement
Audit Engagement Letter
• Objective and Scope of the Audit of the
Financial Statements
• Responsibilities of the Auditor
• Responsibilities of the management
• Identification of the applicable financial
reporting framework for the preparation of
the financial statements
• Reference to the expected form and content
of any reports to from its expected form and
content be issued by the auditor
• Consideration of circumstances in which a
report may differ from its expected form and
content
Responsibilities of Management
• Prepare and present the financial statements
in accordance with the applicable financial
reporting framework
• Design, implement and maintain internal
control system relevant to the preparation
and presentation of FS.
• To provide the auditors with unrestricted
access to all information, records and
documents relevant to the financial
statements
On Recurring Audits
the Auditor shall assess whether circumstances
require the terms of the audit engagement to be
revised and whether there is a need to remind
the entity of the existing terms of the audit
engagement.
The auditor shall not agree to the change in the
terms of the audit engagement where there is no
reasonable justification for doing so
If the auditor is unable to agree to a change in
terms of the audit engagement and is not
permitted by management to continue the
original audit engagement, the auditor shall:
➢ Withdraw from the audit engagement where
withdrawal is possible under applicable law or
regulation
➢ Determine whether there is any obligation,
either contractual or otherwise, to report the
circumstances to other parties, such as those
charged with governance, owners or regulators
If the terms of audit engagement are changed,
auditor and management shall agree on and
record the new terms of the engagement in an
engagement letter or other suitable form of
written agreement.
Following are appropriate revisions of the
terms of the engagement
➢ Client misunderstands the objective and
scope of the audit
➢ Any revised or special terms of the
engagement Recent change of
management, governance, or ownership
➢ Significant change in ownership
Significant change in nature or size of the
client's business Change in legal or
regulatory requirements
➢ Change in financial reporting framework
for preparation of financial statements
➢ Change in other reporting requirements
Figure 9-1 shows an illustration of an Audit
Engagement Letter
Audit Planning
PHASE 1-B
PLANNING THE AUDIT TO DEVELOP AN
OVERALL AUDIT STRATEGY AND AUDIT
PLAN
Start of Planning?
"As the client has been obtained and the
engagement letter signed by both parties
(auditor and client), the planning process
intensifies...." (Cabrera)
Start of Planning Activities
Even before the client is obtained and the
engagement letter is signed by both parties
(auditor and client), planning activities
should be initiated by the auditor.....
PSA 300 "Planning an Audit of Financial
Statements"
Sep 211-nhte-cup
▸ Establishes standards and provides
guidance on the considerations and activities
applicable to planning and audit of financial
statements.
It states that the auditor should plan the
audit so that the engagement will be
performed in an effective manner
Audit Planning
Definitions:
• Audit Planning involves the
establishment of the overall audit
strategy for the engagement and
developing an audit plan, in order to
reduce audit risk to an acceptably
low level
• (Cabrera) Audit Planning means
establishment of the overall audit
strategy for the engagement and
developing an audit plan to reduce
audit risk to an acceptably low level
• (Mark Eranes Ng) Audit Planning
means developing a general audit
strategy and a detailed approach for
the expected conduct of the audit
(Salosagcol, Tiu, Hermosilla)
PLANNING THE AUDIT
Auditing is:
• A systematic process of objectively
obtaining and evaluating evidence
• Regarding assertions about economic
actions and events
• To ascertain the degree of
correspondence
• Between these assertions and
established criteria
• And communicating the results to
interested users.
(American Accounting Association)
Systematic Process
Auditing consists of:
➢ Structured, logical, and
organized series of steps and
procedures
➢ A series of sequential step at
independent Auditors follow
➢ To ensure that the audit is
conducted in:
• Organized
• Effective
• Efficient manner
SYSTEMATIC PROCESS INVOLVES COMPLETE
PLANNING
Features in Audit Planning:
• Establish overall audit strategy for
the engagement and audit plan to
reduce risk.
• Team members benefit from
experience and insight
• Nature and extent of activities will
vary according to size and complexity
of the entity
• Continuous and iterative, not
discrete
• Enhance effectiveness and efficiency
of the planning process
• Timing of planning activities and
procedures needing completion prior
to considering other procedures.
Benefits of Audit Planning
• Helps ensure that appropriate
attention is devoted to important
areas of the audit
• Aids identify potential problems
and resolving them on a timely
basis
• Ensures proper organization,
engagement and performance in
an effective efficient
• Assists in proper manner, ation,
and of the work of the team
• Allows the work to be completed
expeditiously
• Helps coordinate the work by
other auditors and other parties
Other Activities in Audit Planning
Modifying (Updating) the overall audit
Strategy and the audit plan as necessary
during the audit
➢ Unexpected events
➢ Changes in conditions Audit
evidence obtained from audit
➢ Procedures
Two Levels of Planning
Overall Audit Strategy
• Scope
• Objectives and Timing
• Materiality
• Key aspects of focus.
• Staffing needs, selection, &
supervision
• Approach to Audit
Detailed Audit Plan
• Understanding the entity and its
environment (PSA 315)
• Auditor's response to assessed risk
(PSA 330) (risk-based audit)
• Other planned audit procedures for
compliance to PSA (various PSA)
AUDIT STRATEGY
PSA 300 par 6
* Requires that the audito esblishes the overall
strategy for the audit.
This overall audit strategets scope, tining and
direction of the audit and gues the development
of the more detailed audit plan.
THE AUDIT STRATEGY
• An abstract idea that occurs in the
brainstorming stage of the audit planning
process
• Main ideas of the auditor on how to plan
and conduct the audit and set the scope,
timing, and direction of the audit
• This guides the development of the more
detailed audit plan
The process of establishing the audit strategy
should involve:
➢ Identifying the characteristic of the
engagement that defines the scope
➢ Ascertaining the reporting objectives of the
engagement to plan the timing of the audit
and the nature of the communication
required
➢ Considering the Important factors that
will determine the focus and direction of
the engagement team efforts Considering
the results of preliminary and relevance
of knowledge gained by the engagements
performed
➢ Ascertaining the nature, timing and
extent of resources necessary to perform
the engagement
Overall Audit Strategy
Identifying the characteristic of the
Engagement that defines the scope
• Financial Reporting Framework
• Industry specific reporting requirements
• Locations of the components of the
entity
Ascertaining the reporting objectives of the
engagement to plan the timing of the audit and
the nature of the communication required
• Deadline for interim and final reporting
• Key dates and organizations of meeting
with management and those charged
with governance to discuss the nature
and extent of audit work
• Discussion with management regarding
thed communication on the status of
audit work
AUDIT STRATEGY
Other Benefits of Audit Strategy:
• Resources to deploy for specific areas Amount
of resources to be allocated in specific areas
• When the resources are to be deployed How
such resources are managed, directed and
supervised
The Best Audit Strategy:
The approach that results in the most efficient
audit, that is, an effective audit performed at the
least possible cost.
Audit strategy normally identifies and sets after
the audit objective but before or at the same
time as the audit plan is performed. Managing
the time frame of the audit assignment is also
part of the audit strategy.
The right audit strategy could lead to minimizing
auditor risks, meeting audit deadlines, and using
audit resources efficiently
The auditor will have to make sure that the audit
assignment is not only complete within the time
required by its client, but they have to make sure
that there is sufficient time to ensure that the
maximum audit quality is maintained
Examples of Audit Strategy
Auditors will:
➢ use risks-based audit approach
➢ apply a top-down approach to conduct
audit assignments
➢ audit of new clients and they decided not to
rely on the internal control financial
statements by deciding not to test of
control. Go to a substantive test.
➢ Income Tax season, audit the classes of
transactions then account balances.
The Audit Plan
❖ Formalizes the audit strategy and is more
detailed than the Audit Strategy
❖ It includes the nature, timing, and extent of
audit procedures to be performed
❖ The purpose is to obtain sufficient appropriate
audit evidence
An Audit Plan is a detailed plan that professionals
create before performing an audit on a company or
organization.
This plan includes information about the standards
the auditors aim to uphold while performing the
audit
The Audit Plan
• Includes the specific procedures and policies
that the auditors are to use to complete the
audit.
• Contains information about:
o the scope of the audit
o the name and other defining information
about the company in question
o the time frame over which the audit occurs
Typical Audit Plan
▪ Description of the client company
-Structure
-Nature of business
-Organization
▪ Audit objectives (tax filing, for end users)
▪ Description of the nature and extent of other
services such as tax returns
▪ Required governmental reports of the audit
work
▪ Work to be done by the client's employer
▪ Assignment of audit staff
▪ Target completion dates
▪ Preliminary evaluation and judgement about
materiality level
▪ Any special problems to be resolved during
the engagement
▪ Conditions that may require revision in
materiality
Matters of Importance
Difference between audit strategy and audit plan
• An AUDIT STRATEGY is about implementing a
program for
tackling the audit, and the AUDIT PLAN is about
how you will use this strategy to tackle the audit.
• AN AUDIT PLAN is more detailed than the AUDIT
STRATEGY and includes the nature, timing, and
extent of audit procedures to be performed to
obtain sufficient evidence to
reduce the audit risk at an acceptable low level.
Take note:
• Development of audit strategy and audit plans
is not sequential
 • Audit strategy and audit plans should be
updated and changed as necessary during the
course of the audit
RELATIONSHIPS IN AUDIT PLANNING
THE AUDIT STRATEGY
THE AUDIT PLAN
THE AUDIT PROGRAM
THE AUDIT PROCEDURES
Areas for consideration in Audit Strategy
• Characteristics of the engagement that defines
the scope Reporting objectives to plan the timing
and-nature of communications required
• Results of preliminary activities and previous
engagement experience
• Nature, Timing, and extent of available resources
AUDIT STRATEGY
When developing an audit strategy, the auditor
must consider the appropriate levels of materiality
and audit risk
Materiality
Definition
➢ Misstatements, including omissions, are
considered to be material if they,
individually or in the aggregate, could
reasonably be expected to influence the
economic decisions of users taken on the
basis of the financial statements
➢ Judgement about materiality are made in light
of
➢ surrounding circumstances, and are affected by
the size and nature of misstatement, or a
combination of both; and
➢ Judgement about matters that are material to
users of the financial statements are based on a
consideration of the common financial
information needs of users as a group. PSA 320
PAR 2
Materiality
Definition:
❖ Information is material if its omission or
misstatement could influence the economic
decision of users taken on the basis of the
financial statements.
❖ Materiality depends on the size of the item or
error judged in the particular circumstances of
its omission or misstatement.
❖ Thus, materiality provides a threshold or cut-
off point rather than being a primary
qualitative characteristic which information
must have if it is to be useful.
Financial Reporting Standard Council (FRSC)
Concept of Materiality:
The largest amount of misstatement that the
auditor could tolerate
The smallest aggregate amount that could misstate
the financial statement
Materiality therefore relates to:
❖ the significance of transactions
❖ balances and errors contained in the financial
statements.
❖ threshold or cut-off point after which financial
information becomes relevant to the decision
making needs of the users
Overall materiality
• Based on financial statement as a whole
• The highest amount of misstatement
without
• affecting the economic decision of the users
• Financial Statements are interrelated
• Based on the common financial information
needs of the users.
• Percentage is often applied to a chosen
benchmark as starting point
Materiality Benchmarks
• The elements of financial statements
• Items which users tends to be focused
• Life cycle of the entity
• Economic environment which the entity
operates
• Ownership structure and the way it is
financed
Technical Benchmark
Reported income such as profit before tax, total
revenue
• Gross profit and total expense
• Total equity or net asset value
• Total Assets
• Total Revenues
• Profit before tax from continuing operations
(for profit-oriented entities)
Average of three years' net income before taxes
Starting Points
PSA does not require any range of percentages,
based in
actual practice
• Income from continuing operations - 3% to 7%
• Assets - 1% to 3%
Equity-3% to 5%
• Revenues - 1% to 3%
• Less than 5% immaterial & greater than 10%
materiality
 • 1% to 1.5% larger of total assets or revenue
Suggestion: ranges from 5% - 20% of the factor

Specific Materiality
• Lesser amount than the overall materiality
that may be relevant to users
• Refers to sensitive accounts in the financial
statements or disclosures
• Done by allocating the overall materiality
to the respective account balances
• Allows the auditor to determine audit
procedures to each specific accounts
• Allocation is not provided in the standards
and highly subjective

Specific Materiality
• Factors affecting application of specific
materiality:
• Law, regulation or applicable reporting
framework affect user's expectations on
measurement or disclosures on accounts
• Key disclosures in relation to industry it
operates Certain aspect in the business that
is separately disclosed in the financial
statements
• Tolerable misstatement:

Performance Materiality
✓ Definition (PSA 320 par 9)
The amount or amounts set by the auditor at less
than materiality for the financial statements as a
whole to reduce to an appropriately low level the
probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality
for the financial statements as a whole. If
applicable, performance materiality also refers to
the amount set by the auditor at less than the
materiality level or levels for particular classes of
transactions, account balances or disclosures.

Performance Materiality

• Margin of safety or buffer against undetected

misstatement and uncorrected errors
• Consideration of immaterial items on the
aggregate to cause misstatement exceeding
materiality level
• Set at lower amount than the overall materiality
and specific materiality
• To lower audit risk to an appropriately low level