Materiality and

Audit Risk

Group 4:
Eka Setyaningsih (141521474)
Natya Nindyagitaya (141521573)

Definition
Materiality is the magnitude of an omission or misstatement of
accounting information that, in the light of surrounding circumstance,
makes it probable that the judgment of a reasonable person relying on
the information would have been changed or influenced by the omission
or misstatement.
Two purposes why auditors make preliminary judgments :
1. To make decisions about the scope of audit procedures.
2. To evaluate whther known misstatements are significant enough to
require the entity to adjust the financial statements, or the auditor will
issue a qulified opinion.

Preliminary Judgments about

Materiality
The auditor makes preliminary judgments about materiality levels
in planning the audit. In planning an audit, the auditor should
asses materiality at the following 2 levels:
The financial statement level
The account balance level

Materiality at the Financial

Statement Level
Financial statement materiality is the minimum aggregate misstatement in a
financial statement that is important enough to prevent the statement from
not being presented fairly in conformity with GAAP.
Each statement could have several levels.
In making a preliminary judgment about materiality, the auditor initially
determines the aggregate (overall) level of materiality for each statement.
Materiality judgements invlove both quantitative and qualitative considerations :
Quantitative Guidelines
Qualitative Considerations

Materiality at the Account

Balance Level
The minimum misstatements that can exist in an account
balance for it to be considered materially misstated.

Tolerable Misstatement

Audit Risk

Audit risk is the risk that the auditor may unknowingly fail to
appropriately modify his or her opinion on financial statements
that are materially misstated

Materiality in An Audit Process

Step 1 Risk Assesssment
- Determine two kinds of materiality
Overall Materiality
Overall Performance
Materiality
Specific Materiality
Specific Performance
Materiality

Financial Statement Level

Account Balance,
Class of Transactions
and Disclosures Level

- Design the procedure of risk assessment

Materiality in An Audit Process

- Identify and assess the risk of material missstatements.
The auditor should perform the following procedures to identify the
risk of material misstatement :
- Make inquiries of management and others within the entity.
- Consider any unusual or unexpected relationships that have
been identified in performing analytical procedures in audit
planning.
- Consider other information obtained while planning the audit.

Materiality in An Audit Process

Step 2 Risk Respond
- Determine the nature, the timing, and the extent of further audit
procedures.
- Rivise the materiality due to any change in circumstances during
the auditing.
Step 3 Reporting
- Evaluate the misstatement that has not been corrected by the
entity.
- Formulate the auditor opinion.

The Audit Risk Model

AR = IR x CR x DR
AR = RMM x DR
Detection risk consists of two components: AP (Analytical
Procedure Risk) and TD (Test of Details)
Analytical procedure risk is the risk that substantive analytical
procedures will fail to detect material misstatemnts in the
financial statements.
Test of details risk is the risk that test of details of transactions
and balances will fail to detect material misstatements in the
financial statements.

Risk Components Matrix

Acceptable levels of test of details risk are inversely related to inherent, control, and analytical
procedures risk assessments.

Assesing the Components of

Audit Risk
1. Develop a knowledgeable perspective about the risk of misstatement in the
Steps Involved
in Using
the Audit Risk Model
financial
statement
a. Assess inherent risk
b. Assess control risk
c. Consider the effects of the risk of fraud on inherent and control risk
assessments
2. Determine an appropriate level for analytical procedure risk
3. Plan tests of details risk to restrict audit risk to an appropriately low level

Assessing Inherent Risk

Inherent risk is the susceptibility of an assertion to a material
misstatement, assuming that there are no controls.
The auditor should consider two types of risks:
1. Risks that have a pervasive effect on the financial statements
and may affect many accounts and assertions
2. Risks that may pertain only to a specific assertion for a
specific account

Identifying Significant Inherent

Risks
1. Assessing inherent risk as maximum or high ro relevant
Auditors responses:
assertions
2. Obtaining evidence about the effectiveness of design of
internal controls related to the assertion
3. Ensuring that evidence about internal controls over
significant inherent risks is obtained during the current audit
period
4. Obtaining significant evidence through tests of details of
transactions and balances

Assessing Control Risk

Control risk is the risk that a material misstatement that could occur in an
assertion will not be prevented or detected on a timely basis by the
entitys internal controls.
It can never be zero because internal controls cannot provide complete
assurance that all material misstatements will be prevented or detected.
Assessing Control Risk
Planned assessed level of control risk based on assumptions about the
effectiveness of the design and operation of the clients internal control
Actual assessed level of control risk based on evidence obtained from
study and evaluation of the clients system of internal control when
performing further audit procedures.

Assessing Detection Risk

Detection risk is the risk that the auditor will not detect a
material misstatement that exists in an assertion.
Decisions about detection risk Combination of analytical
procedures risk and test of details risk which are controlled by
the effectiveness of auditing procedures and their appplication
Assessing Detection Risk
Planned acceptable level of detection risk determined for
each significant assertion using the audit risk model

Relationship between audit risk

and audit evidence
The lower the level of detection risk to be achieved, the greater
the amount of evidence needed

Interrelationships among Materiality,

Detection Risk, and Substantive Audit
Evidence
To reduce detection risk, the auditor must obtain more
persuasive evidence from substantive audit tests while holding
the materiality level constant.
Relationships between the detection risk and the sufficiency and
competency of evidence: detection risk low, more sufficent and
more competent evidence needed.