CHAPTER 7 : MATERIALITY & AUDIT RISK

SHARIFAH NUR AFIZA BT SYED AHMAD MUSTAFAH (10 DAT 11 F 2013) NORFAZIRA BT KASIM (10 DAT 11 F 2014) NUR ADIBAH BT ALIAS (10 DAT 11 F 2023) ADZRUL AINI BT ZAHARI (10 DAT 11 F 2026) NORSHAHIDA BT MOHD AZRUL JOON (10 DAT 11 F 2052) MUHAMMAD IZZAT AMIR BIN MOHD RAHIMI (10 DAT 11 F 2097)

7.0 MATERIALITY AND AUDIT RISK

7.1 Know the audit materiality

7.1.1 Define the meaning of audit materiality 7.1.2 Determine the level of audit materiality 7.1.3 Discuss the impact of audit materiality to audit work

DEFINITION OF AUDIT MATERIALITY

Materiality can be defined as a misstatement in the financial statement of such magnitude that it : By its omission or misstatement Will affect the decision of a reasonable user

of the statement

LEVEL OF AUDIT MATERIALITY

a) Amount are immaterial

Where a misstatement in the financial statement exist but it is unlikely to affect the decision of a reasonable user, it is consider to be immaterial. An unqualified opinion is therefore appropriate.

b) Amount are material but not pervasive

This second level of materiality exist when a misstatement in the financial statement would affect a user’s decision but the overall statement still present a true and fair view, and therefore usefull.

c) Amount are so material and pervasive

That the overall truth and fairness of the financial statement is in question the highest level of materiality exist when the user are likely to make incorrect decisions if they real rely on the overall financial statement

IMPACT OF AUDIT MATERIALITY Indicate that auditors considers the factors of materiality when evaluating the materiality of a quantitatively immaterial misstatement. Auditors fail to consider audit risk in the materiality decision. The materiality decisions of the auditors were not affected by whether the company had a high audit risk or a low audit risk. The amount of auditor experience may have an impact on the decision. More experienced auditors were more likely to require

an audit adjustment for a factor of quantitative misstatement than were less experienced auditors.

7.2 Know the audit risk

7.2.1 Define the meaning of audit risk 7.2.2 Determine types of audit risk as below a) Inherent Risk b) Control Risk c) Detection Risk 7.2.3 Diferrentiate between audit risk and business risk

DEFINITION OF AUDIT RISK

Audit risk is the risk that auditors may express an inappropriate auditors opinion, such as issuing an unqualified audit opinion when the financial statement contain material misstatement

TYPES OF AUDIT RISK

Inherent Risk (IR)

Detection Risk (DR)

Current Risk (CR)

INHERENT RISK Susceptibility of an assertion to material misstatement assuming no related internal controls. The auditor should consider several major factor when assessing inherent risk :

a) Nature of the client’s Business b) Results Of Precious Audits c) Initial versus repeat engagement d) Related parties e) Non-routine transaction f) Judgement required to correctly record account balanced and transaction g) Makeup of the population

CONTROL RISK Risk of misstatement not being detected by system of internal control There are two basic phases to an auditor’s evaluation on control risk :

a) Obtain an understanding of internal control. This phase applies to all audits. b) Test the internal controls for effectiveness. This phase only applies when the auditor chooses to assess control risk at below the maximum

PLANNED DETECTION RISK

Risk of misstatement not being detected by the auditor Planned detection risk will change if the auditor change the other factor If planned detection risk is reduced, the auditor need to accumulate more evidence to achieve the reduce planned risk

DIFFERENT BETWEEN AUDIT RISK AND BUSINESS RISK

Audit

Risk

Audit risk relates mainly to the internal and external audit effort to achives its objective. That is provide effectives, timely and efficient assurance and consulting support to management and board

Business

Risk

Business risk related mainly to an

organization’s goals and objective. It is essentially the potential cost incurred if the business does not achieve its strategic plans

7.3 Understand the relationship between audit materiality and audit risk

7.3.1 Distinguish the stages of audit materiality to be considered in the audit process 7.3.2 Identify the level of audit risk

THE STAGE OF AUDIT MATERIALITY

Materiality should be considered by auditors when planning and evaluating the results of an audit . No authoritative guidance is provides on factors that should be considered when establishing materiality for planning or evaluating purposes During the planning phase of an audit, auditors establish materiality to determine the nature, timing, and extent of audit procedures to perform Auditors commonly establish a quantitative amount for materiality during the planning phase This quantitative amount will be referred to as “ planning materiality “ as it can change if audit circumstances changes

THE LEVEL OF AUDIT RISK It is not posibble to quantity the audit risk achieved in an audit. The idea of a reasonable level of audit risk is subjective and determine by judgement. In some circumstances, very low audit essential for both users and the auditor When user place heavy reliance on the financial difficulty When the auditor has more legal liabilty exposure

BUSINESS RISK

1) Accounting risk

2) Credit risk

3) Management risk

4) Physical security risk

5) Risk relating to automated (IT)

procedures

6) Risks relating to electronic commerce

ACCOUNTING RISK

- the risk that accounting standards, interpretation of the standards or accounting treatments may be applied incorrectly.

- it is a matter of opinion of how best to account for and reflect the transactions in accordance with its substance rather than the form.

CREDIT RISK

- The risk of counter parties defaulting, is controlled by the application of credit approval, limits and monitoring procedures.

- credit risk could be minimized and monitored by strictly limiting the company’s associations to business partners with high credit worthiness.

- trade receivables should be monitored on an ongoing basis via the company’s management reporting procedures.

MANAGEMENT RISK

- the risk that the auditor not detecting a material misstatement resulting from management fraud or irregularity is greater than for employee fraud.

- level of management may also be in a position to override control procedures designed to prevent similar frauds by other employees.

PHYSICAL SECURITY RISK

- cover areas such as protection of people, products, processes and properties.

- risk related to physical security could not be overlooked as lossess suffered from this risk could be material to the business.

RISKS RELATING TO AUTOMATED (IT) PROCEDURES

- The use of manual or automated elements in internal control affects the manner in which transactions are initiated, recorded, processed and reported.

- IT also poses specific risks to a company’s internal control, such as unauthorized access to data, unauthorized changes to data in master files and to systems or programs, and inappropriate manual intervention.

RISKS RELATING TO ELECTRONIC COMMERCE

- Businesses are involved in electronic commerce (e-commerce), the risks exposures are even higher in terms of interaction with unknown third parties over the internet and the risk of corruption of the systems by viruses and worms.