4.1 - Risk of Material Misstatement in the Financial Statements

Question 1

Define inherent risk

Answer 1

The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls (the risk of error or fraud in the financials by how the business operates)

Question 2

What are the first 2 issues that may increase inherent risk?

Answer 2

• balance is, or includes, an estimate
  Financial statements liable to misstatement as:
• company is in trouble
• company is seeking to raise finance
• other motivation for directors (profit related bonuses)

Question 3

What are the other 2 issues that may increase inherent risk?

Answer 3

• balance is important in the account
• financial statement contains balances with complex financial accounting requirements or a choice of treatment

Question 4

Auditors must use professional judgement and all available knowledge to assess inherent risk. What happens if no information or knowledge is available?

Answer 4

Inherent risk is very high

Question 5

What does ISA (UK) 315 require auditors to do?

Answer 5

Determine where on the spectrum of inherent risk an item lies

Question 6

What does the spectrum of inherent risk mean and how does it work?

Answer 6

The spectrum refers to a range of possible risks, organised in terms of their significance. Risks at the upper end of the spectrum may be ‘significant risks’

Question 7

What is inherent risk affected by?

Answer 7

The nature of the entity e.g the industry it is in and the regulations it falls under

Question 8

Define control risk

Answer 8

The risk that a misstatement could occur due in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected on a timely basis by the entity’s system of internal control

Question 9

What is the nicer definition of control risk?

Answer 9

The risk that a material misstatement would not be prevented, detected or corrected by the accounting system and system of internal control