Guide to Using International Standards on Auditing in - IFAC

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<strong>Guide</strong> <strong>to</strong> <strong>Using</strong> <strong>International</strong> <strong>Standards</strong> on Auditing in the Audits of Small- and Medium-Sized Entities Volume 1—Core Concepts
7.4 Materiality and Audit Risk
Materiality (as discussed above) and audit risk are related, and are considered <strong>to</strong>gether throughout the audit
process.
Audit risk is the possibility that an audi<strong>to</strong>r expresses an inappropriate audit opinion on financial statements
that are materially misstated.
Exhibit 7.4-1
Risks of Material
Misstatement
(RMM)
Detection Risk
Audit Risk Components
The risk that the financial statements are materially misstated prior <strong>to</strong> the start of
any audit work. These risks are considered at the financial statement level (often
pervasive risks, affecting many assertions) and at the assertion level, which relates <strong>to</strong>
classes of transactions, account balances, and disclosures. RMM is a combination of
inherent risk (IR) and control risk (CR), which can be summarized as IR x CR = RMM.
The risk that the audi<strong>to</strong>r fails <strong>to</strong> detect a misstatement that exists in an assertion that
could be material. Detection risk (DR) is addressed through:
• Sound audit planning;
• Performing audit procedures that respond <strong>to</strong> the risks of material misstatement
identified;
• Proper assignment of audit personnel;
• The application of professional skepticism; and
• Supervision and review of the audit work performed.
Detection risk can never be reduced <strong>to</strong> zero, because of the inherent limitations in
the audit procedures carried out, the human judgments (professional) required, and
the nature of the evidence examined.
Audit risk (AR) can therefore be summarized as:
AR = RMM x DR
Materiality and audit risk are considered throughout the audit in:
• Identifying and assessing the risks of material misstatement;
• Determining the nature, timing, and extent of further audit procedures;
• Determining revisions <strong>to</strong> materiality (overall and performance) after becoming aware of new information
during the audit, which would have caused the audi<strong>to</strong>r <strong>to</strong> have determined a different amount (or
amounts) initially; and
• Evaluating the effect of uncorrected misstatements, if any, on the financial statements and in forming
the opinion in the audi<strong>to</strong>r’s report.
<strong>Using</strong> the simple analogy of a high jump in athletics, materiality would be equivalent <strong>to</strong> the height of the
bar the athlete has <strong>to</strong> jump over. Audit risk is equivalent <strong>to</strong> the level of difficulty inherent in the jump at that
particular height (RMM), combined with the additional risk of making a mistake in jump strategy or execution
(detection risk).