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Lecture 5

Auditing 300- Lecture 5- Chp 10, materiality & audit evidence

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Abhi Singh

Lecture 5: Chapter 10- Materiality and audit evidence 10.1 Materiality [Definition]Materiality: information which, if omitted, misstated or not disclosed, has the potential to adversely affect decisions about the allocation of scarce resources made by users of the financial report or the discharge or accountability by the management, including the governing body of the entity. (Involves both judgements about amount (qty) and nature (quality) of the misstatements). Quantitative guidelines relate dollar amount of error to financial statements under examination. (AASB 1031- guidelines to determine materiality). Base: Materiality Threshold (%) Profit before tax 5-10 Turnover 0.5-1 Gross profit 2-5 Total Assets 0.5-1 Equity 1-3 N.B. misstatements up to this level is known as tolerable error.[Definition] Risk that auditor gives wrong opinion due to material misstatement (inverse relationship) If low materiality (HIGH RISK)- won’t perform in depth procedures If high materiality (LOW RISK) Qualitative considerations qualitative effect can be considered only as quantitative evidence becomes available: -significance of the misstatement to the particular entity -the pervasiveness of the misstatement -effect of misstatement on the financial report as a whole 10.2 Audit strategies If control risk = HIGH, detection (audit) risk must be made LOW – therefore use predominately substantive procedure (90% substantive & 10% test of controls) If control risk= LOW, detection (audit) risk will be HIGH- therefore can use test of controls (10% substantive & 90% test of controls) ________________________ [Definition] substantive procedures: provides evidence to support the amounts recorded in financial statements. (Source documents) COSTLY - test of details: -substantive tests of transactions -substantive tests of account balances -substantive tests of disclosures - and/or analytical procedures (less costly) Lecture 5: Chapter 10- Materiality and audit evidence [Definition] test of controls: (aka test of controls)-audit procedure that relies on internal controls to support the use of a reduced level of substantive procedures. CHEAP. -designed to verify that control procedures are actually operating as laid down. 10.3 Audit Evidence [Definition] Audit evidence: information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based -consists of: -information contained in the accounting records underlying the financial report -books of original entry (journals) -General & subsidiary ledgers -related accounting manuals -informal and memorandum records, such as worksheets, calculations & reconciliations -other information -documents (cheques, invoices & contracts) -confirmations & other written representations -information from enquiry, observations, inspection and physical examination -other information obtained/developed by the auditor Auditing standards applying to evidence Sufficiency of audit evidence Appropriateness of audit Reasonable basis evidence -materiality &risk -Relevance: -professional judgement -high materiality needs -for auditor’s objectives follow auditing more evidence -Reliability: standards -economic factors -timeliness -professional scepticism -obtain in reasonable -objectivity achieving appropriate time & cost balance between -size & characteristics of the distrusting population management and -number of items that placing complete trust constitute the total in the integrity of -number of samples management (chp 13) Types of corroborating information [Definition]Corroborating information: strengthen/supports other evidence Analytical information as a substantive test  Comparisons of current period entity data, such as total revenues or returns Lecture 5: Chapter 10- Materiality and audit evidence on assets, with expected values. Debtor/supplier Confirmations  Direct written responses made by knowledgeable third parties to specific requests for factual information Positive confirmation: require response Negative confirmation: only require response if disagree with figure If cannot get positive/negative confirmation, can instead examine evidence of subsequent cash receipts and examining sales & shipping documents. Documentary Evidence  Documents (printed and electronic) relati
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