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Auditing
 Quick Recap
Audit Risk
Motives of an Auditor
What is a Misstatement?
Categories of Misstatement
Inherent Risk
Control Risk
Detection Risk
Professional Scepticism
 What is materiality?

 'Misstatements, including omissions, are considered to

be material if they, individually or in the aggregate,
could reasonably be expected to influence the
economic decisions of users taken on the basis of the
financial statements.'
 Significance of materiality

 If the financial statements contain material misstatement

they cannot be deemed to show a true and fair view.
 As a result, the focus of an audit is identifying the
significant risks of material misstatement in the financial
statements and then designing procedures aimed at
identifying and quantifying them.
 How is materiality determined?

 The determination of materiality is a matter of

professional judgment. The auditor must consider:
 Whether the misstatement would affect the economic
decision of the users.
 Both the size and nature of misstatements.
 The information needs of the users as a group.
 Materiality is a subjective matter and should be
considered in light of the client's circumstances.
 Material by size
 ISA 320 recognizes the need to establish a financial
threshold to guide audit planning and procedures. For this
reason the following benchmarks may be used as a starting
point:
 ½ – 1% revenue
 5 – 10% profit before tax
 1 – 2% total assets.
 The above are common benchmarks but different audit firms
may use different benchmarks or different thresholds for each
client.
 Material by nature
 Materiality is not a purely financial concern. Some items may be material by nature.
 Examples of items which are material by nature or material by impact include:
 Misstatements that affect compliance with regulatory requirements.
 Misstatements that affect compliance with debt covenants.
 Misstatements that, when adjusted, would turn a reported profit into a loss for the year.
 Misstatements that, when adjusted, would turn a reported net-asset position into a net-liability
position.
 Transactions with directors, e.g. salary and benefits, personal use of assets, etc.
 Disclosures in the financial statements relating to possible future legal claims or going concern
issues, for example, could influence users' decisions and may be purely narrative. In this case a
numerical calculation is not relevant.
 Performance materiality
 Performance materiality is 'The amount set by the auditor at less
than materiality for the financial statements as a whole to reduce to
an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements exceeds materiality for
the financial statements as a whole.’
 The auditor sets performance materiality at a value lower than
overall materiality, and uses this lower threshold when designing
and performing audit procedures.
 This reduces the risk that the auditor will fail to identify
misstatements that are material when added together.
 Risk assessment procedures

The auditor should perform the following risk assessment procedures:

 Enquiries with management, of appropriate individuals within the
internal audit function, and others within the client entity (e.g. about
external and internal changes the company has experienced)
 Analytical procedures
 Observation (e.g. of control procedures)
 Inspection (e.g. of key strategic documents and procedural manuals)
 Understanding the entity and its environment
 Relevant industry, regulatory and other external factors, including:
 Financial reporting framework
 Legislation and regulations
 Competition
 Economic conditions.
 Nature of the entity, including:
 Nature of products and services
 Ownership and governance structures
 Investment and financing activities
 Key customers and suppliers.
 Entity's selection and application of accounting policies.
 Entity's objectives, strategies and related business risks
 Industry developments
 New products and services
 New accounting requirements
 Current and future financing requirements.
 Measurement and review of the entity's financial performance
 Performance measures and related incentives to commit fraud through
management bias
 Budgets, forecasts and variance analyses and performance reports
 Comparison of performance with competitors
 Consideration of performance related bonuses.
 Internal controls relevant to the audit
 Analytical procedures
Analytical procedures are fundamental to the auditing process.
 The auditor is required to perform analytical procedures as risk
assessment procedures in accordance with ISA 315 in order to:
 Identify aspects of the entity of which the auditor was
unaware.
 Assist in assessing the risks of material misstatement.
 Help identify unusual transactions or events, and
amounts, ratios, and trends that might have audit
implications.
 Help identify risks of material misstatement due to
 Analytical procedures include comparisons of the
entity’s financial information with, for example:
 Comparable information for prior periods.
 Anticipated results of the entity, such as budgets or
forecasts, or expectations of the auditor, such as an
estimation of depreciation.
 Similar industry information, such as a comparison of the
entity’s ratio of sales to accounts receivable with industry
averages or with other entities of comparable size in the same
industry.
 Analytical procedures also include consideration of relationships, for
example:
 Among elements of financial information that would be
expected to conform to a predictable pattern based on the
entity’s experience, such as gross margin percentages.
 Between financial information and relevant non-financial
information, such as payroll costs to number of employees.
 Automated tools and techniques including computer-assisted
auditing techniques and data analytic tools are increasingly
being used to perform this analysis.
Thank You