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AUDIT RISK AND MATERIALITY - Coggle Diagram
AUDIT RISK AND MATERIALITY
Relationship of materiality and audit risk
inverse relationship between materiality and audit risk
the lower the materiality level, the higher the audit risk and vice versa
Definition of materiality
magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement
information is material when the misstatements could influence the economic decisions of users taken on the basis of FS
Steps in applying materiality
determine tolerable misstatement
estimate likely misstatements and compare totals to the preliminary judgment about materiality
establish a preliminary judgment about materiality
Concepts of materiality
if material misstatement exist, auditor should bring the matter to the client attention to take action to rectify such misstatements in order to give a true and fair view opinion
criteria used in distinguishing between unimportant and important matters
FS may contain misstatement but no too large until can change decision
sources of material misstatements are errors and fraud
materiality is an auditor preliminary estimates of the smallest amount of misstatement that that could be material to client of FS
it is relative concept rather than absolute
bases are needed for evaluating materiality
Factors affecting materiality
quantitative amount may be adjusted lower for qualitative factors such as
control weaknesses
management turnover
first year engagement
high fraud risk
quantitative base for materiality is a percentage 3% to 5% of
income before taxes
gross profit
total revenues
total assets
qualitative factors
small amounts could be material if bad consequences arise from contractual obligations
misstatement that are immaterial may be material if it affect a trend in earning
amount involved fraud is more important than error
misstatement that are immaterial but still need to disclose to comply disclosure requirement
Professional Judgement
policies to be applied is combined total of misstatement exceed 10% is material and less than 5% is immaterial due to absence of qualitative factors.
5% and 10% must be measured in relation to to the appropriate base
used at all times in setting and applying guideline
recommendation for select appropriate base
income statement
balance sheet