Audit Planning & Materiality

Audit risk model

• Audit risk (AR) = inherent risk (IR) × control risk (CR) × detection risk (DR).
• Risk of material misstatement (RMM) = IR × CR (assessed, not controlled).
• DR = AR ÷ (IR × CR); higher RMM → lower DR → more persuasive substantive work.

Materiality levels

• Overall → evaluate statements as a whole.
• Specific → sensitive items (related parties, executive pay).
• Performance → below overall (≈ 50–75%) to cover aggregate undetected misstatements.
• Tolerable misstatement → performance materiality applied to a sample.
• Clearly trivial → don't accumulate.

Benchmarks

Profit entity: ≈ 5% of pretax income. Volatile: revenue or assets. Not-for-profit: revenue or expenses.

Planning

• Strategy = scope, timing, direction. Plan = detailed nature, timing, extent of procedures.
• Iterative; revise materiality when results differ.
• Qualitative factors: covenants, loss-to-profit swings, fraud, compensation.

Exam traps

• Lower materiality means more audit work — materiality and the amount of evidence move in opposite directions.
• Inherent and control risk are assessed; only detection risk is set by the auditor — and it can be lowered, never to zero.
• "Clearly trivial" is not the same as immaterial: misstatements above the clearly trivial threshold are accumulated even if below performance materiality.