Chapter 9 Instructor's Guide

Chapter 9 Instructor's Guide - Chapter 9 Materiality and...

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Chapter 9 Materiality and Risk This is an essential chapter because both materiality and risk are critical to the audit process and somewhat difficult to understand. The material in the chapter is closely tied to SAS 107 (AU 312). We consider risk a more essential topic than materiality, but both are important. The following are emphasized in this chapter: Chapter opening vignette Set preliminary judgment about materiality Allocate preliminary judgment about materiality to segments (tolerable misstatement) Estimate misstatement and compare with preliminary judgment Audit risk model Planned detection risk Acceptable audit risk Inherent risk and control risk Relating the risk of fraud to the audit risk model Discussion of the audit risk model Chapter Opening Vignette – “Explain to Me One More Time that You Did a Good Job, but the Company Went Broke” This vignette dramatizes the positions of investors and auditors in three famous and presumably low-risk situations. The three situations are: Washington Public Power Supply System ("Whoops"), Bonneville Pacific Corporation, and Orange County, California. The primary investments in all cases were bonds and a large portion of the investors were retirees or retirement funds. Although the risks seemed low on these investments, they were actually high. Unqualified audit opinions were issued by the auditors in all years prior to massive failure in which the investors suffered huge losses. The overriding messages of the case are that, (1) real people invest real money in client companies and rely greatly on the auditors to protect them, and (2) auditors must grasp the real nature of the risks their clients present and deal with them effectively. Set Preliminary Judgment About Materiality (page 249) Before discussing setting materiality, we refer to Figure 8-1 (page 209) to help integrate materiality as one factor affecting audit planning. Next we cover the steps in applying materiality as shown in Figure 9-1 (page 249), with emphasis on the first step. (See Figures 8-1 and 9-1) Next we discuss how setting a preliminary judgment about materiality affects audit evidence. Problems 9-25 and 9-26 a, are useful to discuss overall materiality. Either problem should bring out the essential points in setting a preliminary estimate. 9-1
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Allocate Preliminary Judgment about Materiality to Segments (Tolerable Misstatement) (page 252) Studying this topic is conceptually fairly easy, but difficult to demonstrate. Figure 9-3 (page 254) should be helpful to illustrate the methodology and logic. Review Question 9-8 and Problem 9-25 b both show students how this is done. An important point to bring out is that the allocation is always arbitrary, and regardless of how it is done, the final audit results of all audit areas combined will have to support the auditor's opinion. It is important to explain why the total of tolerable misstatement exceeds the preliminary judgment about planning materiality.
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This note was uploaded on 01/23/2010 for the course ACCOUNTING auditing taught by Professor Pro-abuel-ezz during the Spring '10 term at Cairo University.

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Chapter 9 Instructor's Guide - Chapter 9 Materiality and...

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