Audit planning, risk assessment and materiality
Audit planning
Planning involves understanding the entity, its environment, and internal control; assessing risks of material misstatement; and designing further audit procedures. It is continuous and involves materiality determination.
Risk assessment
Auditors identify and assess risks at financial statement and assertion levels. Significant risks require special attention. Risk = inherent risk × control risk (risk of material misstatement). Detection risk is managed by the auditor.
Materiality
Materiality is the amount by which misstatements could influence economic decisions of users. It is a matter of professional judgement. Performance materiality is set lower to reduce aggregation risk. Common benchmarks: 5% of profit before tax, 1% of total assets, 0.5-1% of revenue.
Traps in questions
- Confusing materiality with performance materiality.
- Assuming materiality is a fixed formula (it's judgemental).
- Forgetting that risk assessment is ongoing.
- Overlooking that significant risks require substantive procedures.
- Mixing up inherent, control, and detection risk.
Worked example / rule of thumb
If profit before tax is £1,000,000, using 5% benchmark, materiality = £50,000. Performance materiality might be 75% of that = £37,500. Rule: materiality is not a simple calculation; consider both quantitative and qualitative factors.
Key points
- Planning includes risk assessment and materiality.
- Risk of material misstatement = inherent risk × control risk.
- Performance materiality is lower than overall materiality.
- Significant risks require substantive procedures.
- Materiality is judgemental, not purely numerical.