I want to talk to you today about audit risk and materiality. And the first lesson within this module concerns reasonable assurance and how to go about obtaining reasonable assurance and materiality. So audit risk is the chance that after the audit, the auditor expresses a clean opinion, inappropriately, okay? The notes in front of you here say an inappropriate opinion when the financial statements are materially misstated. Well if the financial statements contain a material misstatement, the inappropriate conclusion would be an unqualified audit opinion. Notice I said unqualified, and you have to recognize that unqualified is used differently in auditing than it is in everyday speech. Someone, in everyday speech, who was unqualified for the job is precisely the person you do not want to use in that job. But what we're talking about here is when...it's more analogous to when if I were to write a letter of recommendation for one of my students. If I recommend them without hesitation or without qualification, that means that there is no hiccups or speed bumps, or there's no caveats, okay? So the audit risk here is the chance, or the risk, that the auditor expresses inappropriate audit opinion, which would be an unqualified or sometimes called a clean opinion, when the financial statements are materially misstated. So how does the auditor go about obtaining reasonable assurance that there are no material misstatements in the financial statements? And what the auditor does is think very carefully about what type of evidence the auditor needs to collect and evaluate. So this is a huge portfolio of data and information that is related to management's financial statement assertions. Now, you gotta be careful about what is not said here. I am not saying everything that the auditor looks at has to be itself financial information. That's not at all the case. It's data or information that you would expect to be associated with information reported in the financial statements. So the evidence you look at, as an auditor, can be very non financial. It can be very soft, like maybe marketing information, or perceptions of customers, assessments of the strength of your client, let's say, as a major supplier to important other businesses. And if you think about data and information even more broadly, this could be assessments of other parties that the auditor may rely upon to help assess the fairness with which assertions in the financial statements are stated. For example, sometimes an auditor may be looking at the financial statements of an oil company, and so one of their main assets would be oil reserves within the soil, buried beneath the soil, and maybe even under the sea, the ocean. You know, most financial statement auditors are not a part time or a full time geologists. So they often will rely on specialists to make an assessment of management's assertions about how much oil is in these reserves, or maybe it's a gold mine that you're looking at. So the data and information could not only include financial numbers that the auditor him or herself extracts from various sources, but also the opinions of third parties that can be very helpful, these third parties are often called third party specialists within auditing standards. So how to obtain reasonable assurance, we've talked about three big concepts here. Reasonable assurance is discussed within the confines of materiality, audit risk, and evidence. I will tell you that one way sometimes the students get questions wrong on exams related to reasonable assurance is that they will misconstrue what audit risk is and is not. It is not simply getting the wrong opinion. The wrong opinion could be that there is a material misstatement, when a factor is not. That is not part of audit risk. One big reason that that is not part of audit risk is because you can pretty much depend on management to tell you if you're the auditor, if you say there's something wrong with their financial statement, that something is materially misstated, and there is not. Believe me, most management will rise to their own defense. And so normally, that's not a concern.
