Risk & Materiality

[Acid]

Hi

Whats the relationship between Risk and Materiality ? Can anyone explain with an example?

Thanks

Acid

[Vanessa]

According to ISA 320, there is an inverse relationship between materiality and the level of audit risk. This is because if the auditor gathers the same amount of audit evidence and does not modify the audit strategy, and decreases / increases the materiality level, the audit risks increases / decreases.

Example

Peter, an auditor of Peer Ltd, finds that he should reduce the materiality level for sales transactions from $500,000 to $200,000, and accordingly should gather more audit evidence. However, in practice, he does not gather the further audit evidence required. As a result, the audit risk to Peter increases, as previously errors of a value beyond $500,000 were material but presently errors within the value range of $200,000 to $500,000 are also material.

For further details please refer Page C3.2 of F8 book.

[Acid]

Hi

I would like to add something about the inverse relationship between risk and materiality to make it more clear to our members :

In general terms, the greater the risk of error, the more evidence the auditor will require in order to conclude that the financial statements give a true and fair view.

At the planning stage, the auditor will set a materiality threshold. This threshold will affect things like sample sizes. the higher the materiality threshold, the lower the sample size required.

So - if the auditor thinks the risk is high he/she will want to do more work, ie increase sample sizes etc. To do this, the materialty threshold will be set low.


I hope this will make the relationship much clear!

Regards

Acid