The auditor’s overall objective in considering issues of materiality and risk is to reduce the likelihood of not detecting material misstatements to an acceptable level. Materiality and risk are closely intertwined. When the various authoritative sources speak of audit risk, they are explicitly or implicitly referring to the risk of the presence of material misstatements in the financial statements. Although this course has been organized to treat each of the topics separately, the reader should understand that this treatment is to facilitate exposition and should bear in mind that materiality and risk need to be considered together throughout the audit.

There is increasing recognition of the relevance of materiality and risk to a wider scope of assurance engagements. In its Public Practice Manual, CGA‑Canada has addressed the role of materiality in assurance engagements other than audits, for example review engagements. More will be said regarding this topic throughout the course. To facilitate exposition, the terms “audit,” “auditor,” and so on are generally used in this course; however, the reader should be aware of the applicability of the concepts of risk and materiality to non-audit engagements as well.

The importance of professional judgment in this process is paramount. Even though the auditor may make use of guidelines provided by one or other of the professional accounting bodies to assist in the determination of materiality, the assessment of the different components of audit risk, the translation of materiality and risk assessments into substantive work levels, and the evaluation of misstatements, it is still very much a matter of professional judgment to apply these concepts to a particular client. Throughout the course, examples are given of industry- and firm-specific factors that may influence the materiality decision. Appendix A identifies the checklists and associated guidance provided by CGA‑Canada for the determination of materiality and the assessment of risk.

Since the second edition of Materiality and Risk in Audit and Review Engagements was published in 2005, there have been changes to the standards and guidance provided to the auditor with respect to both materiality and audit risk. The purpose of this revision is to bring the reader up to date on the profession’s current position with respect to both topics.

In May 2004, the CICA issued a major new Exposure Draft dealing with the topics of materiality and audit risk. Effective for audits of companies with fiscal year ends subsequent to December 14, 2010, Canadian auditing standards have become harmonized with those of the International Federation of Accountants (IFAC). The new materiality standard, Canadian Auditing Standard (CAS) 320, Materiality in planning and performing an audit, follows very closely the contents of International Standard on Auditing (ISA) 320, with minor editorial changes as necessary to maintain consistency with current Handbook terminology and to replace references to other ISAs with appropriate Handbook references.

This course is comprised of three modules. The modules correspond to the three main Canadian Auditing Standards dealing with Materiality and Risk in an audit. At the end of each module are review questions and solutions intended to highlight some of the key aspects of each module. Also, there are two online quizzes at the end of the material to test your understanding of the concepts. The contents of the modules are as follows:

Module 1: begins with a working definition of materiality, discusses the steps involved in determining appropriate planning materiality for the audit, and describes the application of the concept of materiality during the performance and conclusion of the audit.

Module 2: covers the topics of audit risk and the risks of material misstatement. It discusses how the auditor assesses audit risk, defined as the risk of material misstatement at the financial statement level and/or at the level of the individual balance or transaction level.

Module 3: takes the assessed level of audit risk and the risks of material misstatement as a starting point and discusses the auditor’s appropriate responses, at both the macro level and the micro level, to the assessed level of audit risk.

Module 1: Materiality
The role of materiality
The determination of materiality
Materiality and review engagements
Determination and documentation of materiality — An example
Review questions
Review solutions

Module 2: Audit risk and the risks of material misstatement
Introduction
Audit risk
Risk and review engagements
Documentation of the assessment of audit risk
Assessing the risk of material misstatement
Review questions
Review solutions

Module 3: The auditor’s responses to assessed risks
At the financial statement level
At the assertion level for classes of transactions, account balances, and disclosures
Application to test of controls
Application to substantive testing
Interpretation of “low,” “moderate,” and “high”
Evaluating the sufficiency of audit evidence obtained
Detection risk and review engagements
Review questions
Review solutions

Quiz 1

Quiz 2

Illustration 1 — Evaluating misstatements
Illustration 2 — Evaluating misstatements – Adjustments

Appendix A — Canadian Hardware Sales Ltd. and select PPM forms
Appendix B — Select PPM forms

Glossary

Craig Emby, PhD, CA, is a Professor of Accounting in the Beedie School of Business at Simon Fraser University where he has taught auditing for more than 20 years. Prior to that, he was a member of the chartered accounting firm of Peat Marwick Mitchell & Co. in Vancouver.

Craig has been associated with CGA‑Canada for a number of years, as a National Examiner and course author. He was one of the original co-authors of the CGA‑Canada PACE Resource Materials. He is also author of another course in this Auditing Series, Analytical Procedures: A Guide for Practitioners.