Auditing: Materiality Inc.

Client name: Gold Explorer Inc. Schedule :X-1 Audit area: Risk Assessment Preparer :M. X Balance sheet date: xx/xx/xx Date: 01/01/2012 Raj, The following memo addresses the risk assessment of one our clients, Gold Explorer Inc.

; a major public Canadian gold mining company. The firm has been auditing this company for the past 8 years, in which very few misstatements were discovered and where management integrity was never a concern.However, in this fiscal year, the audit of Gold Explorer Inc will be more challenging because of increases in inherent risk and lower levels of acceptable audit risk, resulting from different events, mainly a merger with a major U. S. gold company and a significant writedown of ‘PPE’. In the following parts of the memo, an analysis of audit risk, inherent risk and materiality will be described in detail.

Part 1: Audit RiskThe first factor affecting audit risk is the (1) ‘external user’s reliance on financial statements’: Since the company is a large publicly traded company and that it achieved record gold production levels, many investors use the financial statements of this company for different activities. However, the company has no debt, and therefore creditors will not be using these financial statements. Finally, because the company has changed significantly in the course the year, (merger + writedown), the financial statements issued this year will have significant importance in the valuation of the company.Therefore, this factor suggest medium to low acceptable audit risk.

(2) The second factor is ‘the likelihood of financial difficulties’: The company incurred a loss of 944 million $ before taxes in the fiscal year. However, the company has great liquidity, has been profitable in the past few years, does not rely on debt financing, and is established as a key player in its industry. It is obvious that the loss is directly correlated to the huge writedown of 1. 1 billion $ and the merger.

I conclude that the likelihood of the company going bankrupt is relatively small given its past experience and taking into account the effect of nonroutine transactions, however lower levels of audit risk should be accepted for the upcoming audit compared to the past because of significant events and changes. (3) The third factor is ‘Management’s integrity”: Terrence, the chairman of Gold Explorers, is a man of principle and integrity, these values are held by the employees of the company. Also, few misstatements were found in previous audits.However, given that the company incurred a significant loss, professional skepticism will be needed because it is possible that earnings management was used the increase the loss for the current period, a concept known as ‘taking a bath’. Other factors such as ARO fines decrease management integrity, while awards for environmental concern have a little impact because most firms engage in this trend in order to be more profitable.

(4) The last factor is that the company is not a new client increasing the level of acceptable audit risk.Overall, Acceptable audit risk should be low (1-2%) given the important events that took place in the current year and the need to provide reliable information to financial statement users. Inherent risk: Factors that increase inherent risk: Given that the company is public and trades on three different types of stock exchanges, the complexity of accounting is high. Gold Explorers primary product is gold which is very valuable and could be susceptible to misappropriation, the completeness assertion will have to be tested thoroughly.Significant nonrountine transactions occurred during the year such as a merger and a writedown of PPE. The writedown of PPE involves judgement when using fair market values; which are highly relevant but suffer in reliability.

Factors that decrease inherent risk: Few doubts concerning management integrity and a stable and dedicated work force (reduce client motivation to steel, or act unethically). This is a continuing engagement and past audits were successful, with little material misstatements found. Thus, the level of inherent risk is definitely increasing compared to previous years.Inherent risk is defined as being medium to high (80%). The impact of the lower acceptable level of audit risk and the higher expected level of inherent risk will result in the need for thourough analysis of the financial statements in order to meet the desirable audit assurance level and avoid the possibility of contingent legal liabilities. Before determining the amount of evidence and the types of testing required (relates to detection risk), control risk will have to be examined.

I believe that the firm should continue its relationship with Gold Explorers Inc. ased on past experience and the need to provide reliable information to financial statement users, unless we can replace are engagement with companies that are a lot less risky and that provide the same earnings. It is also important to note that our engagement with the company has become ‘routine’ and therefore the independence analysis should put particular emphasis on the familiarity criteria and implement safeguards if needed. Part 2: The most appropriate basis for determining materiality this year is (0. %-5%) of gross profit, because it takes into account the main revenues and expenses of the company, which is important when dealing with a profit oriented company.

It also leaves out the huge writedown which is a nonroutine transactions and finally because the information concerning this figure was provided to me and is comparable to previous years: $678 million vs $642 million. I chose the lower spectrum of the range (1%) because it relates with the low acceptable audit risk determined. We must provide a high level of assurance.Therefore, it is more appropriate to be prudent concerning levels of materiality. The amount of materiality is equal to 6.

78 million $ (678,000,000 x 0. 01). It is important to note that any intentional misstatements are deemed material. Reasons other methods were not selected: 1-IBIT: usually the default method, however, in the case the figure was not comparable to previous years and the company experienced a loss before taxes.

2-Total assets: N/A. 3-Shareholders Equity: unusually high because the firm has no debt. 4- Revenues: does not take into account expenses.