AUDIT RISK AND MATERIALITY

Definition Audit Risk

risk that the auditor gives an inappropriate opinion when financial statement are materially misstated

Auditor's response to risk assessment

Acceptable Audit Risk (ARR)

measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified and unqualified opinion had been issued

  1. determine audit procedures that necessary based on the risk assessment
  1. evaluate whether sufficient audit evidence was obtained and if risk assessments were appropriate
  1. assess risk of material misstatement

if low risk need to design and perform normal procedures

if high risk need to design and perform extended procedures

  1. issue audit report

Audit Risk Model

Inherent risk is risk of material misstatement occur ignoring internal control system

control risk is risk that internal control systems will not prevent or detect and correct the error of material misstatement

IR X CR X DR = Audit Risk

detection risk is risk that auditor's substantive testing will not detect misstatement

Factors that cause uncertainty

inherent limitation of the effectiveness of client's internal control systems

drawing of audit conclusion based on audit evidence that mostly persuasive than conclusive

nature of audit test

Inherent risk

relate to the characteristics of the business

inherent risk high if auditor conclude that there is a high likelihood of misstatement and ignore internal controls

internal controls is ignored in setting inherent risk as they considered separately in audit risk model as control risk

Level of inherent risk

at financial statement level or entity level

at the account balance and transaction level

nature of the client's business, size and number of location of the company

the management have experience, integrity and attitude of directors and management

unusual pressure on management

factors affecting the industry such as economy, legislation, regulations and accounting practices

without previous assignment, inherent risk normally high in first engagement

greater likelihood of misstatement exist in related party transactions as both parties are not independent parties

transactions that unusual to client are more likely to be incorrectly recorded due to lack of experience

misstatement found in previous audit have a high likelihood of occurring again this year due to some company is slow in making changes

many accounts required judgement

other factors to be considered as quality of accounting systems and susceptibility of assets to loss or misappropriation