Applying materiality in audit process

>Planning

. Preliminary judgement:about the maximum amount of financial statements that can be misstated without affecting users’ decision and this will be based on both quantitative (for example, profit, total assets, total revenue) and qualitative (legal or contractual obligations, earnings trend) factors.

.Allocating to account balances: in terms of the tolerable misstatements.

>Evaluating findings: factors to consider include as follows:

.Impacts of certain events affecting the entity’s operations.

.Size and nature of the misstatement.

.Information needs of users of financial statements.

>The auditor’s assessment of materiality, related to classes of transactions, account balances and disclosures helps the auditor to decide the items to be examined and the appropriate audit procedures can be selected to reduce audit risk to an acceptably low level.

Audit risks - this refers to the risk of expressing inappropriate audit opinion.

>Assessing level of audit risk - which depends on

.engagement risk

.degree of reliance placed by financial statements users - client’s size, ownership distribution, liabilities.

.likelihood of client having financial difficulties - client's liquidity, profitability, financing and operations.

.Questionable management integrity - inquiries and investigation by governmental and regulatory bodies, conflicting interest, etc

>Components of audit risks

.Detection risk - audit procedures performed cannot reduce audit risk to an acceptable level and cannot detect material misstatements.

.Risks of material misstatements - This comprises inherent risks and control risk, which depends on the following:

.External environment, including economic, market, regulatory and IT.

.Client’s operations and strategies, including organisational structure, product and market, liquidity, internal controls, IT and other required skills, business strategy.

.Financial reporting issues - including issues of: off-balance-sheet financing, nature of transactions, related parties, uncertainties and measurement problems.

>Audit risk model - Audit risk model helps auditor to plan and perform an efficient and effective audit because this model indicates that there is an inverse relationship between

.control risk and detection risk.

.inherent risk and detection risk.

.detection risk and volume of audit evidence required.