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External Audit: relationship between risk and materiality

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To assess your company's liability for the external audit, you must discuss with your team the following topics:

What is the relationship of risk and materiality?
How are risk and materiality related?
How are risk and materiality integrated into the audit process?
What is an example of a statement that includes both risk tolerance and materiality?

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Solution Preview

Risk and materiality are two of the most difficult concepts to grasp in auditing and largely because they are quite subjective. Defining audit risk is the risk that an unqualified audit opinion may be issued which includes a material misstatement. Because the number and types of stakeholders relying on audited financial statements could be impacted by a material misstatement, the risk of litigation and other actions by accounting regulatory bodies is high. High risk can lead to high costs in defense of claims, loss of a client, damage to reputation, increased malpractice insurance, and more.

The assessment of risk is one of the first steps in the audit process (particularly for a new ...

Solution Summary

In a 400 word solution, the concepts of risk and materiality are discussed in terms of audit planning and execution. Several examples are offered to demonstrate situations which deal with both risk tolerance and materiality issues. The fact that these concepts are subjective makes them one of the most difficult areas of external auditing.