SAS No. 24 Materiality and Audit Risks

Status

Issued by Auditing Standards Committee in Taiwan on 13 April, 1993.

Summary

Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. The concept of materiality recognizes that some matters, either individually or in the aggregate, are important for fair presentation of financial statements in conformity with generally accepted accounting principles, while other matters are not important. The auditor's responsibility is to plan and perform the audit to obtain reasonable assurance that material misstatements, whether caused by errors or fraud, are detected.

At the account balance, class of transactions, relevant assertion, or disclosure level, audit risk (AR) consists of (a) the risk (consisting of inherent risk and control risk) that the relevant assertions related to balances, classes, or disclosures contain misstatements (whether caused by error or fraud) that could be material to the financial statements when aggregated with misstatements in other relevant assertions related to balances, classes, or disclosures and (b) the risk (detection risk) that the auditor will not detect such misstatements.

Inherent riskp(IR) is the susceptibility of a relevant assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming that there are no related controls. The risk of such misstatement is greater for some assertions and related account balances, classes of transactions, and disclosures than for others.

Control risk (CR) is the risk that a misstatement that could occur in a relevant assertion and that could be material, either individually or when aggregated with other misstatements, yet will not be prevented or detected on a timely basis by the entity's internal control. That risk is a function of the effectiveness of the design and operation of internal control in achieving the entity's objectives relevant to preparation of the entity's financial statements. Some control risk will always exist because of the inherent limitations of internal control. 　

Detection risk (DR) is the risk that the auditor will not detect a misstatement that exists in a relevant assertion that could be material, either individually or when aggregated with other misstatements. Detection risk is a function of the effectiveness of an audit procedure and of its application by the auditor. Detection risk can be disaggregated into additional components of tests of details risk (TD) and substantive analytical procedures risk (AP).

Detection risk relates to the substantive audit procedures and is managed by the auditor's response to risk of material misstatement. For a given level of audit risk, detection risk should bear an inverse relationship to the risk of material misstatement at the relevant assertion level. The greater the risk of material misstatement, the less the detection risk that can be accepted by the auditor.

The auditor should determine a materiality level for the financial statements taken as a whole when establishing the overall audit strategy for the audit. Determining a materiality level for the financial statements taken as a whole helps guide the auditor's judgments in identifying and assessing the risks of material misstatements and in planning the nature, timing, and extent of further audit procedures. 　　 　

In evaluating whether the financial statements are presented fairly, in all material respects, in conformity with generally accepted accounting principles, the auditor must consider the effects, both individually and in the aggregate, of misstatements (known and likely) that are not corrected by the entity. In making this evaluation, in relation to particular classes of transactions, account balances, and disclosures, the auditor should consider the size and nature of the misstatements and the particular circumstances of their occurrence, and determine the effect of such misstatements on the financial statements taken as a whole.

The consideration and aggregation of misstatements should include likely misstatements (the auditor's best estimate of the total misstatements in the account balances or classes of transactions that he or she has examined), not just known misstatements (the amount of misstatements specifically identified). Misstatements should be aggregated in a way that enables the auditor to consider whether, in relation to individual amounts, subtotals, or totals in the financial statements, they materially misstate the financial statements taken as a whole.　

Before considering the aggregate effect of identified uncorrected misstatements, the auditor should consider each misstatement separately to evaluate: a. Its effect in relation to the relevant individual classes of transactions, account balances, or disclosures, including whether materiality levels for particular items of lesser amounts than the materiality level for the financial statements taken as a whole have been exceeded. b. Whether, in considering the effect of the individual misstatement on the financial statements taken as a whole, it is appropriate to offset misstatements. c. The effect of misstatements related to prior periods. In prior periods, misstatements may not have been corrected by the entity because they did not cause the financial statements for those periods to be materially misstated. Those misstatements might also affect the current period's financial statements. 　 　

The risk of material misstatement of the financial statements is generally greater when account balances and classes of transactions are subject to estimation rather than precise measurement because of the inherent subjectivity in estimating future events. 　 　

There are quantitative and qualitative materiality considerations. As a result of the interaction of quantitative and qualitative considerations in materiality judgments, misstatements of relatively small amounts that come to the auditor's attention could have a material effect on the financial statements. The auditor must evaluate whether the financial statements taken as a whole are free of material misstatement. In making this evaluation, the auditor should consider both the evaluation of the uncorrected (known and likely) misstatements and the qualitative considerations.　

When concluding as to whether the effect of misstatements, individually or in the aggregate, is material, an auditor should consider the nature and amount of the misstatements in relation to the nature and amount of items in the financial statements under audit.

If the auditor believes that the financial statements taken as a whole are materially misstated, the auditor should request management to make the necessary corrections. If management refuses to make the corrections, the auditor must determine the implications for the auditor's report.　 　 　

If the auditor concludes that the effects of uncorrected misstatements, individually or in the aggregate, do not cause the financial statements to be materially misstated, they could still be materially misstated because of further misstatements remaining undetected. As the aggregate misstatements approach materiality, the risk that the financial statements may be materially misstated also increases; consequently, the auditor should also consider the effect of undetected misstatements in concluding whether the financial statements are fairly stated. 　

The auditor can reduce audit risk by modifying the nature, timing, and extent of planned audit procedures in performing the audit. If the auditor believes that such risk is unacceptably high, the auditor should perform additional audit procedures or satisfy himself or herself that the entity has adjusted the financial statements to reduce audit risk to an appropriate low level.

Effective date

This Statement is effective for audit of financial statements with fiscal years ending on or after 31 December, 1993.