Chapter 7_Student(1).pdf - Chapter 7 Planning the Audit Identifying and Responding to the Risks of Material Misstatement ACCT 640 PRINCIPLES OF AUDITING

Chapter 7_Student(1).pdf - Chapter 7 Planning the Audit...

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1 Chapter 7: Planning the Audit: Identifying and Responding to the Risks of Material Misstatement ACCT 640: PRINCIPLES OF AUDITING Materiality
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2 Materiality SFAC #2 defines materiality: “The omission or misstatement of an item in a financial report is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.” To estimate, must answer 4 questions: Who are the users? What types of decisions will be made? Which variables/bases are most important to the users? What magnitude is considered material? Required by SAS 107, PCAOB AS 12 Materiality 4 Materiality judgments: Are a matter of professional judgment Depend on the needs of a reasonable person relying on the information Involve both quantitative and qualitative considerations Auditors make materiality judgments for purposes of: Audit planning and Evidence evaluation after audit procedures are completed Materiality judgments provide a basis for: Determining the nature and extent of risk assessment procedures Identifying and assessing the risks of material misstatement Determining the tests of controls and substantive audit procedures to perform
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3 Materiality Levels 5 1. Overall materiality Also known as planning materiality Used in determining whether the financial statements overall are materially correct 2. Performance materiality Also known as tolerable error Used for determining significant accounts, significant locations, and audit procedures for those accounts and locations 3. Posting materiality Signifies the misstatements identified throughout the audit that will be considered at the end of the audit in determining whether the financial statements overall are materially correct Materiality Steps in developing materiality 1. Set preliminary judgment about materiality 2. Set performance materiality for segments/cycles/accounts 3. Estimate total misstatements in segment 4. Estimate the combined misstatement 5. Compare combined estimate with materiality Plann Evaluating
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4 Materiality Step 1: Set overall materiality (preliminary judgment) Preliminary judgment about materiality Combined amount of misstatements that would be material Can change during audit if necessary (revised judgment) Must be documented in audit files Standards do not provide specific guidelines, but firms typically do Must be assessed both from quantitative and qualitative perspective Typical Materiality Judgments 8
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5 Materiality Step 1: Set overall materiality (preliminary judgment) Common quantitative bases to calculate materiality:
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  • Spring '14
  • JaredM.Hamburg

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