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Assessing Materiality and Risk Simulation Essay

Certain accounts, such as cash, long term debt and short term borrowings, and intangibles, are audited 100% because they are very important to the audit process and/or industry, or simply because they are easily verifiable. Unlike auditing inventory, accounts receivable, accounts payable, capital assets; which can be time-consuming to audit fully, auditing 100% of cash or long term debt is fairly easy (e.g. by obtaining cash and debt confirmations from banks).

“According to the financial accounting standards board, materiality symbolized the importance of something forgotten or a misstatement of an entry in an economic report that, the encircling assets make it believable that the awareness of a sensible individual depending on the facts would have been replaced, altered by the involvement or repair of an article” (Boynton, Johnson). All in all when an auditor create an agreeable materiality level that discover both the quantity (amount) and the (quality) nature of misstatements needed to be examined. The auditor will also with given time will assign materiality to everything that is sampled, this way no report is omitted or avoids a looked.

Audit risk is the possibility of a material misstatement, remaining undetected even after the audit is completed and as a result the audit statement fails to provide true and fair view of the company financial statements. Of the three components of audit risk, only detection risk is a result of failure on the part of the auditor to notice a misstatement.

As noted above, audit risk is a function of inherent risk, control risk and detection risk. Inherent risk and control risk make up the risk of material misstatement.

RMM = IR x CR

AR = RMM x DR

If we assume that the auditor does not have impact on control risk (control risk is usually assessed as High, unless test of controls is performed) and no impact on inherent risk, the auditor needs to manipulate detection risk to reduce the level of audit risk. The higher the risk of material misstatement, the more thorough substantive procedures the auditor needs to apply to support the account balance.


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