Text PAQ 4.37

Assessing preliminary materiality

Required:

Discuss the factors to consider when determining preliminary materiality for MaxSecurity.

Preliminary materiality assessment is based on the auditor’s assessment of the risk of material misstatement and the client’s users’ information needs.

Inherent risk for MaxSecurity is high because of the sensitivity of the information surrounding its products and clients; its reliance on one main product; difficulty costing and pricing products; concerns over waste and damaged goods and components.

Control risk for MaxSecurity would be affected by the following factors:

• control over pricing and sales contracts, approval of credit
• procedures to handle security risks relating to both products and foreign clients
• nature of tendering process for government contracts
• ability to gather accurate costing information to assist tendering
• integration of product costing, inventory movements for sales and waste, damaged stock, and success of installation of new inventory costing system
• controls over personnel and payroll – particular reference to obtaining highly skilled staff required for product design and manufacture and obtaining security clearances, as required, for all staff working with sensitive information.

Control risk is likely to be assessed as high, although successful testing of product costing controls would reduce control risk. Together with high inherent risk, high to moderate control risk would result in a low planned detection risk, and a low planning materiality.

Now you need to consider them together (risk of material misstatement), and notice how that brings you to a consideration of planned detection risk (using the audit risk model) as a guide to what your planning materiality needs is likely to be!

Together with high inherent risk, high to moderate control risk would result in a higher risk of material misstatement and a lower planned detection risk, and a lower planning materiality.

Now, once you get into the next Lesson you will see how you go applying these principles for the Lakeside Company case, but this time with some numbers (amounts) to consider as well as the case factors … hopefully things are starting to fall into place, but IF NOT, keep asking questions!