What is the relationship between materiality and audit risk and how audit risk can be reduced to an acceptable level?

Auditing and Assurance Revision Questions and Answers

Answer
According to NSA 320 on Audit materiality, there is an inverse relationship between materiality and degree of audit risk. Higher the materiality level, lower the audit risk and vice-versa. The risk that a particular account balance or class of transaction would be mis-stated an extremely large amount might be very low. But the risk that it could be mis-stated an extremely small amount might be very high. The auditor considers this inverse relationship when he determines the nature, timing and extent of his audit procedures. If after planning for specific audit procedures, he concludes that acceptable materiality level is lower, audit risk is increased. The auditor should try to reduce the audit risk to an acceptable level by: –

i. Reducing the assessed degree of control risk carrying out extended or additional test of control. or

ii. Reducing detection risk modifying the nature, timing and extent of his substantive procedures.

iii. During the audit the auditor may seek to obtain, in conjunction with the client or independently, audit evidence in the form of reports, opinions, valuations, and statements of an expert.

Examples are:
 Valuations of certain types of assets, for example, land and buildings, plant and machinery, works of art, and precious stones.
 Determination of quantities or physical condition of assets, for example, minerals stored in stockpiles, mineral and petroleum reserves, and remaining useful life of plant and machinery.
 Determination of amounts using specialized techniques or methods, for example, an actuarial valuation.
 The measurement of work completed and to be completed on contracts in progress for the purpose of revenue recognition.
 Legal opinions concerning interpretations of agreements, statutes, regulations, notifications circulars, etc.



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