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Professor, how will an external auditors’ audit strategy change, when higher risk of material misstatement is detected, specifically with respect to the following:
i)performance materiality
ii)plans to test operating effectiveness of controls
iii) nature, timing and extent of substantive proceduresConsider the audit risk model on page 57 of the notes:
If RoMM (i.e. IR and CR) is increased, DR must be reduced (otherwise AR will be increased). See at the bottom of the page – DR is determined by “nature, timing and extent” of audit procedures.
Materiality (as a $ amount) is sometimes described as having an “inverse” relationship with risk – if RoMM is high, DR is reduced by doing more audit work – so $ materiality is also reduced. Suppose materiality is $100,000 – all transactions and balances > $100,000 will be tested (and of course some lesser amounts) – if you reduce materiality to $80,000, you will also be testing all transactions and balances in the range $80,000 – $100,000.
RoMM cannot be higher than IR – CR is either 100% (if there will be no TOCs) or assessed as less than 100% if TOCs provide evidence that controls are operating effectively.
Please see the overview at the beginning of Chapter 8 – there is a narrative on the following page that explains how the strategy will change if controls are not operating effectively.
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