CH4 : Materiality and Audit Risk

Question 1

What is materiality ?

Answer 1

• Any misstatements including omissions are considered material if they could individually or in aggregate influence the economic decisions of the users taken on the basis of the F.S.
• It is the auditor’s professional judgement to determine the materiality level

Question 2

What is planning materiality ?

Answer 2

-The materiality level set during the planning stage of the audit.

Question 3

Items material by nature are :

Answer 3

• Director’s remuneration
• Related party transaction
• any items that can turn a profit into loss

Question 4

What are related party transactions ?

Answer 4

- A related party transaction is where the entity shares a transaction with the following :
# A subsidiary or parent
# An associate
# with an entity where common control is shared
# key mgmt. personnel

Question 5

Materiality benchmark for revenue :

Answer 5

1/2 % - 1%

Question 6

Materiality benchmark for profit before tax :

Answer 6

5% -10 %

Question 7

Materiality benchmark for total assets :

Answer 7

1%-2%

Question 8

issue with planning materiality

Answer 8

• This level of materiality is set during the planning stage using forecasted F.S profit, revenue and total assets. Hence, the final F.S profit, revenue and total assets could be significantly different and could vary from the forecasted F.S figures.
• Thus, as new evidence is obtained the planning materiality should be revised and the reasons and justifications for revising those changes must be documented.

Question 9

What is performance materiality and its purpose ?

Answer 9

• Performance materiality is set at a lower level than overall materiality.
• It is used to test individual accounts, balances, disclosures and transactions
• Its aim is to reduce risk of total errors in individual accounts, balances, disclosures and transactions in total should not exceed the overall materiality.

Question 10

What to document about materiality?

Answer 10

• Performance materiality
• Materiality for the F.S
• How was materiality determined
• Was materiality reviewed on a periodic basis ?
• Was materiality revised , if yes then what is the revised materiality ?

Question 11

Audit risk

Answer 11

• Risk of issuing the wrong audit opinion

- A.R = ( I.R * C.R) * D.R

Question 12

Inherent risk

Answer 12

• The risk that arises when an entity fails to comply with accounting standards while preparing the F.S.
• The susceptibility of an account or a transaction that contains a misstatement either individually or in aggregate before considering any related controls.

Question 13

Control risk

Answer 13

• Risk of entity’s internal controls failing to prevent, detect and correct any material misstatements in the F.S

Question 14

Detection risk

Answer 14

• Under the control of the auditor.
• Risk of performing insufficient audit procedures to reduce the audit risk to an acceptably low level , resulting in the auditor being unable to detect any misstatement which exists and could be material either individually or in aggregate with other misstatements.

Question 15

Types of risks which lead to detection risk

Answer 15

# Sampling risk
# Non-sampling risk

Question 16

Sampling risk

Answer 16

• Risk arising from the sample selected by the auditor where samples are not representative of the population.

Question 17

Non-sampling risk

Answer 17

-Any risk arising that but it is not because of sample selection.

Question 18

Why non-sampling risk arises ?

Answer 18

• If it’s a new client then there is high risk as team is unfamiliar with the entity and its nature of operations.
• It’s a time pressurised audit
• Incompetent and less experienced team members
• Lack of industry knowledge

Question 19

ROMM for client

Answer 19

When I.R goes UP and C.R goes UP and D.R goes DOWN then materiality benchmark is low.

Question 20

Analytical review

Answer 20

-Evaluation of financial information by analysing the relationship between the financial and non-financial information and identifying any significant fluctuations and inconsistencies and investigating them

Question 21

When is analytical review not suitable ?

Answer 21

• If it’s the first year of business
• Business is under liquidation.
• Significant change in the nature and size of the business
• Significant one-off transactions such as a business has been acquired or merged with another entity.
• Application of new financial reporting framework

Question 22

Suitability of analytical review

Answer 22

# When data is reliable: the internal control system is strong so the data produced is reliable to use.
# It can be used on the whole F.S and not suitable to use on individual accounts, balances and disclosures : not good fo accuracy
# It is suitable to us if the acceptable variation between figures is below the overall materiality. but if the variation is above overall materiality then ned to carry ou further more procedures.

Question 23

Fraud

Answer 23

An intentional act using deception to gain an unjust and illegal advantage.

Question 24

Kinds of fraud

Answer 24

# Misappropriation of assets
# financial reporting framework fraud

Question 25

Misappropriation of assets

Answer 25

# This includes theft of the company's assets and property.
#Use of company's assets for personal use without seeking company's permission

Question 26

Financial reporting framework fraud

Answer 26

Involves manipulation of figures to overstate assets and income and understate liabilities and expenses.

Question 27

Responsibilities of mgmt. in relation to fraud

Answer 27

# To be aware of the potential for fraud
# To incorporate the potential for fraud in corporate governance and internal controls
# if req. to have an audit committee, have the audit committee review whether procedures work effectively from a fraud viewpoint.
# Implement an effective system of internal controls

Question 28

Responsibilities of external auditors in relation to fraud

Answer 28

# Discuss the risk of fraud with TCWG, mgmt. and internal audit dept.
# Report any suspicions of fraud to TCWG or 3rd parties like regulators
# Maintain always an attitude of professional scepticism.
#Plan, design and perform work to prevent and detect any material fraud.

obtain reasonable assurance that F.S is free from material misstatement.

Question 29

Responsibilities of mgmt. in relation to laws and regulations

Answer 29

# Ensure the entity is aware of all relevant laws and regulations.
# Ensure that the entity has controls in place for compliance with laws and regulations.

Question 30

Responsibilities of external auditors in relation to law and regulations

Answer 30

# Understand all rules and regulations affecting the client's business.
#Discuss the risk of non-compliance with the law with TCWG, mgmt. and internal audit dept.
#Plan, design and perform procedures to detect non-compliance
#Report non-compliance to TCWG or 3rd parties.
#Inspect correspondence from lawyers

Question 31

What to do if audit risk is high ?

Answer 31

• Assign more skilled and experienced team members to the risky areas of the audit.
• Increase Y/E testing.
• Increase sample size
• Emphasise more substantive procedures
• Increase supervision levels