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1、9-1 Chapter 9 Materiality and Risk This is an essential chapter because both materiality and risk are critical to the audit process and somewhat difficult to understand.The material in the chapter is closely tied to the risk assessment auditing standards.We consider risk a more essential topic than
2、materiality,but both are important.The following are emphasized in this chapter:Chapter opening vignette Set preliminary judgment about materiality Determine performance materiality(allocate preliminary judgment about materiality to segments)Estimate misstatement and compare with preliminary judgmen
3、t Audit risk model Planned detection risk Acceptable audit risk Inherent risk and control risk Relating the risk of fraud to the audit risk model Discussion of the audit risk model Chapter Opening Vignette “Explain to Me One More Time that You Did a Good Job,but the Company Went Broke”This vignette
4、dramatizes the positions of investors and auditors in three famous situations.The three situations are:Enron,WorldCom,and Adelphia.Many of the investors in these companies were retirees or retirement funds.Although the risks may have seemed low on these investments,they were actually high.Unqualifie
5、d audit opinions were issued by the auditors in all years prior to massive failure in which the investors suffered huge losses.The overriding messages of the case are that,(1)real people invest real money in client companies and rely greatly on the auditors to protect them,and(2)auditors must grasp
6、the real nature of the risks their clients present and deal with them effectively.Set Preliminary Judgment About Materiality(page 249)Before discussing setting materiality,we refer to Figure 8-1(page 208)to help integrate materiality as one factor affecting audit planning.Next we cover the steps in
7、applying materiality as shown in Figure 9-1 on page 249,with emphasis on the first step.(See Figures 8-1 and 9-1;shown on Slides 8-6 and 9-7)9-2 Next we discuss how setting a preliminary judgment about materiality affects audit evidence.Problems 9-26 and 9-28 part a.,are useful to discuss overall ma
8、teriality.Either problem should bring out the essential points in setting a preliminary estimate.Determine Performance Materiality(Allocate Preliminary Judgment about Materiality to Segments)(page 252)Studying this topic is conceptually fairly easy,but difficult to demonstrate.Figure 9-3(page 253)sh
9、ould be helpful to illustrate the methodology and logic.Review Question 9-8 and Problem 9-27 both show students how this is done.An important point to bring out is that the allocation is always arbitrary,and regardless of how it is done,the final audit results of all audit areas combined will have t
10、o support the auditors opinion.It is important to explain why the total of performance materiality exceeds the preliminary judgment about planning materiality.(See Figure 9-3)Part a.of Case 9-37 can be used to give students practice in setting the preliminary judgment about materiality for the finan
11、cial statements as a whole and determining performance materiality for segments of the audit.Estimate Misstatement and Compare with Preliminary Judgment(page 255)We spend little time doing this,but believe it is essential to show students how the results of audit tests tie back to materiality.We fin
12、d a brief discussion using Problem 9-26 is sufficient.We return to the discussion of materiality when covering audit sampling for detailed tests of balances in Chapter 17 and completing the audit in Chapter 24.Table 9-1 on page 256 is useful to discuss sampling error.(See Table 9-1;shown on Slide 9-
13、17)Audit Risk Model(page 257)We consider the audit risk model one of the most important concepts in auditing.We refer to it throughout the course.We go over the logic of its use and discuss the model when the auditor is determining planned detection risk.We briefly introduce each element of the audi
14、t risk model.(See OH-9-1;also shown on Slide 9-22)It is important for students to be able to relate the audit risk model to the understanding of the clients business and industry studied in Ch.8.Figure 9-4 on page 258 can be used for this purpose.(See Figure 9-4;shown on Slide 9-23)9-3 Planned Detec
15、tion Risk(page 259)Students often have difficulty with detection risk.We find the key is for students to relate it to components of the financial statements,distinguish between achieved and planned detection risk,and remember that it is the inverse of evidence.The use of Table 9-4 on page 269 and OH
16、-9-2 is helpful to discuss planned detection risk.(See Table 9-4;shown on Slide 9-40)(See OH-9-2)It is also useful to relate achieved level of assurance to segments.OH-9-3 is useful to do that.(See OH-9-3)Assessing Acceptable Audit Risk(page 261)This material is the beginning of the general area of“
17、risk assessment.”The auditor who is to be effective and efficient must recognize certain risks and modify evidence accordingly.We find students have difficulty understanding the concept of audit risk.We go through a several-step process.Relate the concept of acceptable audit risk to information risk
18、 as it was discussed in Chapter 1.If auditors demand zero audit risk what does it mean?(They are willing to be insurers or guarantors.)What audit risk level do you believe auditors achieve in practice for publicly held companies?Students tend to say 5%because of their knowledge of statistics.That is
19、 an ideal time to explain the difference between audit risk and confidence level.You might give them a level of assurance such as 7%and then explain what it means.Why cant the level of audit risk be quantified as a specific number?Should auditors have different acceptable audit risk for different co
20、mpanies?If so,how can it be justified from an individual firm and a social point of view?What factors affect acceptable audit risk?What is the relationship between auditors legal liability and acceptable audit risk?How does acceptable audit risk affect evidence accumulation?What is the relationship
21、between performance materiality and acceptable audit risk?How does acceptable audit risk affect the components of the audit?This is a good place to discuss why the auditor may want to have different audit risks for different areas because of liens on certain assets or reliance on specific informatio
22、n by certain users.Distinguish between acceptable and achieved audit risk.What does the auditor do if the achieved audit risk is greater than the acceptable level?9-4 It is useful to summarize acceptable audit risk,audit evidence and achieved audit risk by discussion of Review Questions 9-17 and 9-1
23、8.Problem 9-30 is a good one to use for this material.(See also OH-9-3)Inherent Risk and Control Risk(pages 259-260 and 264-266)It is important for students to understand the relationship between these two risks and audit risk.We go through several steps.Compare two situations where everything else
24、is equal.a.The auditors uncovered considerable misstatements in the valuation of inventory in each of two previous years.b.The auditor uncovered no misstatements in the valuation of inventory in each of the two previous years.There is no apparent change in circumstances.In which one would more evide
25、nce likely be accumulated for tests of inventory valuation?Why?What factors affect the likelihood of misstatements,and how should each impact the audit?(Students are asked to identify factors and explain logic for including them.)Distinguish between control risk and inherent risk.Relating Risk of Fr
26、aud to the Audit Risk Model(page 267-268)We review the auditors responsibility for the detection of material misstatements due to fraud introduced in Chapter 6,which includes a responsibility to assess fraud risk.While the responsibility to assess fraud risk is covered extensively in Chapter 11,it i
27、s important for students to relate the fraud risk assessment to the audit risk model.We emphasize that it is difficult in concept and practice to separate fraud risk factors into acceptable audit risk,inherent risk,and control risk.We point out that it is more important for the auditor to assess the
28、 risks and respond to them than it is to identify them as specific components of the audit risk model.This topic will be discussed more extensively in Chapter 11.Discussion of the Audit Risk Model There are several problems to illustrate application of the audit risk model:9-31,9-32,9-33,9-34,and 9-
29、35.Case 9-36 is useful to apply audit risk concepts,either using the audit risk model or discussing the concept without use of the model.Parts b-d of Case 9-37 can also be used to illustrate parts of the audit risk model.If there is adequate time,OH-9-4 provides a good class exercise to summarize th
30、e relation of planning materiality and inherent risk to planned audit evidence.(See OH-9-4)9-5 Using the columnar headings and the major accounts,discuss the contents of each column.The idea is to logically indicate the expected degree of audit effort for each account,relative to other accounts.This
31、 helps the students gain an appreciation of the concept that the purpose of assessing materiality and risk is to allocate audit effort to the accounts that are most likely to contain material misstatements.You can change assumptions about materiality and inherent risk and discuss the effect on audit
32、 effort.Table 9-2(page 259)and Figure 9-5(page 267)are also helpful to summarize the effect of factors in the audit risk model on planned evidence.Figure 9-6(page 270)and Figure 9-7(page 272)are helpful to help explain the relationships among the various risks and planned evidence.(See Table 9-2,Fig
33、ures 9-5,9-6,and 9-7)CHAPTER 9 CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL LEARNING OBJECTIVES REVIEW QUESTIONS MULTIPLE CHOICE QUESTIONS DISCUSSION QUESTIONS AND PROBLEMS CASES 9-1 Apply the concept of materiality to the audit.9-1,9-2,9-3 9-23 9-2 Make a preliminary judgment about w
34、hat amounts to consider material.9-3,9-4,9-5,9-6,9-7,9-10 9-23 9-26,9-28,9-29 9-37 9-3 Determine performance materiality during planning.9-7,9-8,9-9 9-26,9-27,9-28,9-29 9-37 9-4 Use materiality to evaluate audit findings.9-11 9-26,9-28,9-29 9-5 Define risk in auditing.9-6 Describe the audit risk mod
35、el and its components.9-12,9-13,9-14,9-17,9-19 9-24 9-29,9-30,9-32,9-33,9-34,9-35 9-36,9-37 9-7 Consider the impact of engagement risk on acceptable audit risk.9-17,9-18 9-29,9-30,9-31 9-36,9-37,9-38 9-8 Consider the impact of several factors on the assessment of inherent risk.9-14,9-15,9-16 9-24 9-
36、29,9-33 9-36,9-37,9-38 9-9 Discuss the relationship of risks to audit evidence.9-20 9-25 9-32,9-33 9-10 Discuss how materiality and risk are related and integrated into the audit process.9-21,9-22 9-29,9-35 9-6 OH-9-1 AUDIT RISK MODEL PDR=AAR IR x CR Where:AAR=Acceptable Audit Risk IR=Inherent Risk
37、CR=Control Risk PDR=Planned Detection Risk OH-9-2 PLANNED DETECTION RISK Evidence was accumulated such that achieved detection risk for accounts receivable was 14%.WHAT WOULD ACHIEVED DETECTION RISK HAVE BEEN IF(TREAT EACH ONE INDEPENDENTLY):ACHIEVED DETECTION RISK WOULD HAVE BEEN HIGHER LOWER 1.Add
38、itional audit procedures for accounts receivable were performed 2.More accounts receivable had been confirmed 3.The client instructed the auditor not to confirm accounts receivable 4.The auditor contended that confirmations were not reliable due to the nature of the customers 5.Confirmations were se
39、nt at an interim date rather than at year-end What are the answers to 1 through 5 if“Achieved Audit Risk”is substituted for“Achieved Detection Risk?”OH-9-3 ACHIEVED LEVEL OF ASSURANCE FOR PARTS OF THE AUDIT ACHIEVED LEVEL OF ASSURANCE=98.6%FOR ALL SEGMENTS EXCEPT INVENTORY,WHICH IS MATERIAL Question
40、:1.What is the overall achieved level of assurance?2.What should the auditor do?Accounts Receivable 98.6%Inventory 63%Sales 98.6%Accounts Payable 98.6%OH-9-4 RELATIONSHIP OF MATERIALITY AND INHERENT RISK WITH PLANNED AUDIT EVIDENCE ACCOUNTS SIGNIFICANCE OF AMOUNTS INHERENT RISK PLANNED AUDIT EVIDENCE Inventory Petty Cash Accounts Payable Prepaid Insurance Capital Stock Allowance for Uncollectible Accounts What is the effect on planned audit evidence if acceptable audit risk is reduced for the entire audit?