Write short notes on: Materiality and Audit Risk

Auditing and Assurance Revision Questions and Answers

As per NSA 320 ” Audit Materiality”, The auditor should consider materiality and its relationship with audit risk when conducting an audit. According to it, information is material if its misstatement (i.e. omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of item, judge in the particular circumstances of its misstatement. Thus, materiality provides a threshold or cut off point rather than being a primary qualitative characteristic, which the information must have if it is to be useful. It stresses that the assessment of what is material is matter of professional judgment.

The audit should be planned so that audit risk is kept at an acceptable low level. After the auditor has assessed the inherent and control risks, he should consider the level of detection risk that he is prepared to accept and based upon his judgment, select appropriate substantive audit procedures. If the auditor does not perform any substantive procedures, detection risk, that is the risk that the auditor will fail to detect a misstatement, will be high. The auditor reduces detection risk performing substantive

procedures the more extensive the procedures will also affect the detection risk than reliance on internal data, as will procedures have carried out closure to year-end.

The auditor’s assessment of audit risk may change during the course of an audit. For example, in planning the audit, the auditor may believe that he has low inherent and control risk based on his assessment of the probability of errors occurring and, on his review, and testing of the system of internal control. After performing audit procedures, however, the auditor may conclude that his earlier assessment was too low. In this case he will have to carry out additional audit procedures in order to reduce the level of detection risk and achieve audit risk at the level originally planned.

b. Auditing in Depth. (4 Marks December 2005)
Auditing in Depth is a system of audit, which involves tracing a transaction through its various stages form origin to conclusion examining at each stage to an appropriate extent the vouchers, records and authorities relating to that stage and observing the incidence of internal check and delegated authority.
Thus, if a particular purchase invoice is subjected to audit in depth, the auditor will examine the original requisition slip, the purchase order, the tenders against which the purchase order was made, the good receipt note, stores inspection report, the quality control report and entries in the bin card and store ledger.
Thus, while auditing in depth, the auditor reviews all the accounting and operational aspects of the transaction form the origin to the end. This enables him to have an overall view and evaluate the procedures through selected transactions.
c. Audit planning & materiality (5 Marks December 2007)
Materiality is an important consideration for an auditor to evaluate whether the financial statements reflects a true or fair view or not. Auditor should plan his audit based on audit materiality and its relationship with audit risk while conducting an audit. When planning the audit, the auditor should consider what would make the financial information materially mis-stated. Auditors assessment of materiality and audit risk may be different at the time of initially planning of the audit as against at the time of evaluating the results of audit procedures.

d. Audit Working Papers. (4 Marks December 2005)
NSA 230 “Documentations”, states that the audit working papers were written records kept the auditor of the evidence gathered during the course of an audit, the methods and procedures followed and the conclusions reached. These papers generally include his examination and provide support for his audit report. It also includes a summary of all significant matters identified, which may require the

exercise of judgment together with auditor‟s conclusions thereon. Thus, the auditor is required to documents maters, which are important in providing evidence that the audit was carried out in accordance with the basic principles. The documentation for the purpose refers to the performance of an audit.
NSA 230 also requires that the auditor should adopt reasonable procedures for custody and confidentiality of his working papers and should retain them for a period of time sufficient to meet the needs of his practice and satisfy and pertinent legal or professional requirements of record retention.
The audit working papers demonstrate the extent of audit work carried out and whom as well as carried forward matters for the future. The maintenance of such working papers facilitates in conducting each year‟s audit and provide a basis of the auditor. In fact, there can be circumstances when legal suit is brought against the auditor and to ascertain whether or not the exercised “reasonable care and skill” while discharging his duties would be evident form working paper only. Thus, it is imperative for an auditor to carefully preserve the audit working papers. Moreover, they would also provide the evidence of work performed to support the auditor‟s opinion.

e. Testing of the Internal Control System.

The auditor in forming his opinion on financial information/ statements needs reasonable assurance that transactions should be properly authorized and recorded in the accounting, records and that transactions have not been omitted. Internal controls, even though if fairly simple, may contribute to the reasonable assurance the auditor seeks. The auditor’s objective in studying and evaluating internal controls is to establish the reliance he can place thereon in determining the nature, timing and extent of his substantive audit procedures.

The auditor should acquaint himself with the important features of the business carried on the concern, the nature of activities and the system followed in the entire process of manufacturing, trading and administration; such knowledge will give the auditor an awareness of the physical realities behind the book entries and records, which he examines. He should also find out the basis on which the control and procedures are laid down the management. This knowledge he can always obtain having discussion with the various managers of organization. He should also look at the company’s procedures, manuals, study organizations flow charts to ascertain the character, scope and efficiency of the control system. Sometimes, manuals and charts are not available or very little information available. In that case, the auditor should contact the right officers and employee to get the desired information. He can use one of the following to obtain correct and necessary information.

a) Narrative record
b) Check list
c) Questionnaire
d) Flow Chart

All these assessment techniques will help the auditor to understand and evaluate the internal control system in the correct perspective.

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