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acc_460_week_3_dq_1.docx

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Assessing Materiality and Risk
Certain accounts must be audited 100% depending on how important they are and the
potential errors that could be found. Accounts like Cash, Lines of Credit, and Intangibles are
very important in this simulation, mainly because they are more liquid accounts and do not have
as many transactions as other accounts. Other accounts have many transactions and can be too
tedious to go threw a 100% audit like, Inventory, Accounts Payable, and Property, Plant, and
Equipment.
Cash is important because it indicates the liquid situation of the company at any given point
of time. Lines of credit are the money that is owed to the company by customers for services
rendered or goods sold. Intangibles are assets that do not have material value, but are expected to
confer future benefits and include categories like goodwill, patents, copyrights, and trademarks.
Materiality is the maximum amount by which the account balance or class of transactions can
be misstated without influencing the decisions of third-party users (Louwers, Ramsay, Sinason &
Strawser, 2007). Materiality has an inverse relationship with sample size, so in other words as
materiality decreases the sample size increases because of the large number of transactions
(Louwers, Ramsay, Sinason & Strawser, 2007). Accounts such as inventory and accounts
payable with more transactions must have fewer misstatements that can influence the decisions
of users.
The Audit Risk has a few components. Inherent risk, control risk and detection risk. Each
of these components has a direct correlation to the auditor, but detection risk is clearly the only
one which is within control of the auditor. Detection risk is the risk that the auditor’s procedures
will fail to detect certain errors dealing with materiality. It deals with the probability that an

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incorrect/incomplete audit conclusion could be drawn from the results of an examination, or that
the audit will fail to detect serious errors that will change the entire audit.
First off, as the accounting formula states: (Audit risk=Inherent risk*Control
risk*Detection Risk). It has been proven that these three risks are all inter-related. Audit risk
and Detection Risk are directly related to each other. This is due to the fact that detection risk is
controlled by the auditor. On the other hand, Inherent risk and control risk are inversely related
to detection risk, due to the fact that they are both controlled by the client, not the auditor. “The
importance of the assessments of inherent and control risk is highlighted by their effects on
detection risk (DR). The effects can be depicted in mathematical form by the equation DR = AR
/ (IR x CR)” (Panel on Audit Effectiveness, 2003).
The auditor can compensate for the measured levels of risk by undergoing procedures to
detect material misstatements. The greater the inherent and control risks, the lower the detection
risk need to be, resulting in more procedures that the auditor would need to carry out. At the end
of the day, the objective is to limit audit risk to an appropriately low level, thus enabling the
auditor to achieve reasonable assurance that the financial statements are free of material
misstatement.

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Assessing Materiality and Risk Certain accounts must be audited 100% depending on how important they are and the potential errors that could be found. Accounts like Cash, Lines of Credit, and Intangibles are very important in this simulation, mainly because they are more liquid accounts and do not have as many transactions as other accounts. Other accounts have many transactions and can be too tedious to go threw a 100% audit like, Inventory, Accounts Payable, and Property, Plant, and Equipment. Cash is important because it indicates the liquid situation of the company at any given point of time. Lines of credit are the money that is owed to the company by customers for services rendered or goods sold. Intangibles are assets that do not have material value, but are expected to confer future benefits and include categories like goodwill, patents, copyrights, and trademarks. Materiali ...
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