The concept of risk and materiality in Planning Phase of the Audit Process

Planning the audit process and planning procedures for the audit process and identifying the accounting systems, policies and procedures in force within the organization, the risks of the audit process and the relative importance

Amer Ibrahim - • External audit and audit

Planning the audit process : -

Ø the importance of planning the review process.

Reach adequate confirmation of the financial statements at the lowest possible cost and avoid misunderstandings with the client

Ø the most important procedures for planning the audit process.

1.Contact the previous reviewer.

2.Collect information about the entity under review and understand the nature of its activity.

• Identify the organizational structure of the facility

• Identify the nature of the activity, drivers, customers and suppliers

• Number of employees, wage and salary policies

• The company's future goals

1.Identify the accounting systems, policies and procedures in force within the facility.

• Identify the applied accounting system

• Custom on documentary courses

• Identify accounting policies that may be unique to the industry.

Follow the most important procedures for planning the review process: -

1.Evaluation of internal control systems and internal audit department reports.

2Analytical review.

• View the company's estimated budgets and compare them with the financial statements

• Compare current financial statements with previous years

1.Identify risks.

2.Assess materiality for audit purposes.

3.Determine the work team and the size of the expertise that must be available.

Risks of the audit process :-

The concept of risk in external audit is the degree of non-confirmation by the auditor about the fairness of the financial statements when carrying out the audit process, or in other words, the possibility of expressing an incorrect opinion in the financial statements under review, due to the auditor's failure to discover material errors that may be found in those statements in which he expresses his opinion.

Audit Process Risks :-

Natural ( inherent Risks )

Acceptable risk

Control Risk

Risk of Planned Discovery

1 – Natural hazard : -

It is the auditor's estimate of the expectations of misrepresentation in the financial statements before taking into account the impact of internal control

Factors affecting the assessment of natural hazard : -

• Secretariat of the administration This factor would affect the natural hazard at the level of all departments of the facility

• The nature of the customer's work (type of activity) Example: The obsolescence of inventory in the activity of electronics trade represents a significant risk compared to inventory in the activity of iron and steel

•Results of the previous review process ... High probability of falling into the same misrepresentations discovered in the previous review since it is often difficult for management to address these distortions

• The results of the new review versus the repeated review ... The auditor gains experience as a result of repeating the client's audit process, which allows him to identify the natural hazard with great accuracy – so the auditor when performing the audit process in F estimates a relatively high natural risk.

• Deceptive financial report... The deceptive report aims to deceive users of financial statements (such as concealing a judicial expense by the administration itself that may affect the credit position of external parties, bank balances).

• Embezzlement of assets ... This embezzlement is often committed by employees (such as embezzlement of cash before it is recognized or embezzlement in exchange for excessive recognition of expenses) and such embezzlement is detrimental to both users of the financial statements and shareholders because the company's assets are no longer in their possession.

Risk of admissible revision :-

It is the extent to which the auditor wants to allow material distortions after the end of the audit process

Before we address the factors affecting the assessment of this risk - the auditor must study what is known as (contracting risk), which is the risk that the audit facility can be exposed to in the event of accepting the contract with a specific client.

Example: The possibility of the client declaring bankruptcy after the issuance of the financial statements - despite their validity - may expose the audit entity to litigation by users of the financial statements even if the auditor has exercised professional care in the audit process.

Factors affecting the assessment of acceptable audit risk: -

• The degree of dependence of external users on the financial statements. this factor is inversely related to the risk of an acceptable audit – the more the external user relies on the financial statements, the reduction of the risk of an acceptable audit was desirable.

• The possibility of financial difficulties for the client after the issuance of the audit report ... Example: Some business owners who are exposed to large losses may resort to accusing the auditor of negligence in his work in order to question the validity of the financial statements, and here the auditor must reduce his estimate of the risk of the audit that can be accepted.

• The extent of the honesty of the administration and here the auditor must reduce the risk of the review can be accepted in case of doubt in the honesty and integrity of the administration and examples of the lack of integrity of the administration (accusing one of its members in criminal cases previously, managing disputes with previous auditors, high turnover of employees of the Internal Audit Department)

• Through the previous factors, the auditor can estimate the risk of the review that can be accepted, which depends largely on the judgment, personal assessment and the extent of the auditor's experience in reading the factors previously referred to.

The following are examples of some of the means by which the risk of an admissible review can be assessed.

Dependence of external users on financial statements: -

1.Examination of the previous financial statements and their notes

2.View the minutes of the Board of Directors meetings to learn about the company's future plans

3.Discuss the expected funding plans with the management.

Possibility of financial difficulties: -

4.Using financial ratios and analytical review to identify the extent of financial difficulties that the company may be exposed to.

5.Examine the nature of cash inflows and outflows by examining previous cash flow statements to determine the company's sources of funding and expenditures.

Secretariat of the Department:

6.Examination of previous audit reports

7.Contact previous reviewers

8.Identify the client's goals from the review process through discussions with the client

9.Identify potential users of financial statements and the purpose of their use

Risk of censorship : -

It is the auditor's estimate of the effectiveness of internal control systems in preventing or detecting distortions in the financial statements

The risk of planned discovery : -

It is a measure of the auditor's failure to determine the size of the evidence to detect any distortions that actually exist and is inversely proportional to the size of the evidence planned to be collected.

The estimate of this risk depends on the first three risks previously presented ... That is, by estimating the three previous risks, the auditor can measure the risk of planned discovery and thus the amount of evidence that can be collected - through the following audit risk model:

(Acceptable risk)

(risk of planned discovery) = -------------------------------------

(natural hazard) × (control risk)

Materiality :-

The concept of materiality :

It is the amount of omission or misrepresentation in the accounting statements contained in the financial statements - which can lead to an impact on the judgment of the appropriate individual who relies on these data in making his decisions.

1. Omissions omissions and unintentional error

1. Misrepresentation Deliberate manipulation to conceal data or prove misleading data to the decision-maker

The auditor should determine the relative importance early for two reasons:

1. Determining the scope of the relative importance of errors and distortions early allows the auditor not to accept any errors or distortions outside this scope ... One of the proofs of the audit is that the auditor is interested from the outset in important mistakes.

2. Once the scope of materiality is determined, relatively insignificant values are also challenged... This allows the auditor to focus on important aspects with high efficiency and at the lowest cost.

3. He should identify answers to two questions that are important for materiality.

4. Important regarding whom?

5. Important in relation to what?

So, the reviewer should be interested.

1- Intended users of the financial statements

2- For distortions that may influence the decisions of users of these lists

Criterion for determining the scope of materiality : -

In general, there are no uniform criteria for judging the relative importance in the audit, as there is in practical life a general criterion is that the presence of 10% error in any item of the financial statements is a relatively important error, while the error less than 5% is considered relatively unimportant unless it turns out during the audit process otherwise.... Errors ranging from 5% to 10% should be judged during the audit process and according to the needs of users of the financial statements.

Effect of materiality in the audit report :-

Audit Report :

1. It is the last step in the review process.

2. It is the report that expresses the findings of the auditor.

3. Therefore, the auditor is responsible for issuing an incorrect audit report.

4. It is important for users of financial statements because it is considered confirmation of the correctness of the financial statements.

Types of audit reports : -

• Clean Audit Report

It is a report issued in the case of proper preparation of financial statements

• Unrestricted report

It is a clean audit report, but the auditor believes that it is necessary to add additional information in a separate paragraph

• Restricted report

It is a report issued when the auditor believes that the financial statements have been properly drafted but not followed the accepted accounting principles - the term (except ...) is used

• Reverse report

It is a report that the auditor writes when he considers that the financial statements are incorrect and misleading.

• Non-opinion report

It is issued in the absence of the requirement of independence for the auditor, regardless of the soundness of the financial statements. (Independence: i.e., the independence of the auditor's opinion from parties that have an interest in the results published in the financial statements)

The difference between the relative importance and the risk of review : -

The relative importance of the review:

It is the amount or size of the omission or distortion in the accounting information that affects the opinion of the moderate person who relies on this information .... (Linked to the financial statements)

As for the risk of revision:

It is the possibility of making a mistake during the review process ... In the sense that some significant misrepresentations affecting the financial statements may not be discovered, although the audit process has been planned and performed appropriately in accordance with the auditing standards ... (Risk associated with the performance of the auditor)

The relationship between risk and materiality : -

Risk and materiality are closely related concepts that cannot be separated at the planning stage of the audit process. Due to their direct impact on the size of the evidence that the auditor will target.

Risk is a measure of uncertainty or the auditor's failure to detect errors....

Materiality is a measure of the size and number of misstatements in the financial statements....

Illustrative example:

For example, in the item of revenues amounting to 5 million pounds

Assuming that the risk of non-detection = 5% .... Relative importance = 100,000 pounds

This means that there is a 5% risk of detecting distortions in the financial statements that exceed the estimated value of 100 thousand pounds as the amount of distortion accepted in the statements (materiality).

Matching the balances in the trial balance with the financial statements : -

Evaluation of internal control systems on the item : -

  • Examine and evaluate the documentary and accounting cycle applied to the item, identify the strengths and weaknesses, and identify risks
  • Identify the powers of those responsible for the documentary cycle related to the item

Audit Program :

Objectives and Procedure :


  • Obtaining a comparative analytical statement of customer balances and matching the statement with the general ledger and with the last year's working papers or approved budget.
  • Review the statement to determine the unusual balances (credit balances) that should be displayed among other credit balances.
  • Obtain a detailed statement of the reconstruction of debts.

2. Completion:

  • View the documents supporting the movement from (sales invoices and matching them with exchange permits and delivery permits to the customer).
  • Ensure that the customer receives the issued sales invoice.
  • Ensure that the invoice date was issued in the same period in which the warehouse exchange permit was issued and recorded in the sales for the same period.
  • If there is a high percentage of sales returns after the balance sheet date, inquire about the reasons for this and determine whether this will require any adjustment restrictions or any provisions.

3- Existence:

  • Match the book balance on authenticatio

Procedures for verifying the objectives of the audit program :-

Objectives and Procedure:


  • The balance of the first period was reviewed and it was found that the balance shown in the balance of the first period did not match the balance shown in the budget on 31-12-2020.
  • Customeranalytical disclosure facility on 30-6-2021.

2. Completion:

  • Documentary samples of sales invoices were examined.
  • The debit balance in customers was tested with the credit side of the revenues.

3- Existence:

  • Obtaining and matching approvals from customers.

Detailed procedures for the review process :-

Criterion for selecting the documentary sample:

1- The criterion for selecting the documentary sample for the debtor movement.

  • I selected a sample that corresponds to the relative importance of the item and the criterion for selecting the sample was:
  • Bulk amounts
  • Documents dated at the beginning or end of the month in order to achieve confirmation for each of the

(Completeness – Existence)

2- Criterion for selecting the documentary sample for the credit transaction:

  • selected a sample that corresponds to the relative importance of the item and the criterion for selecting the sample was:
  • Bulk amounts
  • Settlements made on the account other than sales movement and its returns (sales invoice - sales return - receipt vouchers)

3. Item validation tests:

  • 1-City Movement:
  • Examine the movement of the sales invoice and the resulting documents through the screen.
  • The debit side movement (the total debit side of customers shows a value of 19,886,364.95) with the credit side of the revenue account and shows a value of 18,379,284.05 and differences of 1,507,080.9 EGP were found.
  • 2- Credit Transaction:
  • Checking payment documents (checks).
  • Checking the sales revenue movement.
  • Examine the settlement restrictions made on the customer's account.

Statement of reviewed samples :-

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