A3 (3) - AUDIT RISK

Question 1

Audit Risk Model

Answer 1

• AR = RMM XDR

(1) AR:- Audit risk should be low
(2) RMM:- Risk of material misstatement assessed by auditor
(3) DR:- Detection Risk controlled by auditor

Question 2

Risk of Material Misstatement (RMM = IR x CR)

Answer 2

1- Inherent Risk (“IR”):- susceptibility of a relevant assertion to a material misstatement, assuming there are no reiated controls

2- Control Risk (“CR”):- material misstatement that could occur in a relevant assertion will not be prevented or detected (and corrected) on a timely basis by the
entity’s internal control.

Question 3

Inverse Relationship of RMM to DR

Answer 3

Risk of material misstatement is high, detection risk should be set at a low level. Conversely, when the risk of material misstatement is low, the auditor can justify a higher detection risk.

Question 4

The acceptable level of detection risk decreases, the assurance provided from substantive procedures should
increase.- The auditor may:

Answer 4

(1) Change the nature of substantive tests from a less effective to a more effective procedure (e.g., direct test toward independent parties outside the entity rather
than toward parties or documentation Inside the entity).

(2) Change the extent of substantive tests (e.g., use a larger sample size).
(3) Change the timing of substantive tests (e.g., perform substantive tests at yearend rather than at interim).

Question 5

AUDIT RISK AND MATERIALITY - Overall Considerations

Answer 5

1- Designing the nature, extent & timing audit procedures

2- size and complexity of the entity,

3- Both should be considered at both the financial statement level and the account balance, individual transaction class, or disclosure item level

Question 6

AUDIT RISK AND MATERIALITY - Considerations at the Financial Statement Level

Answer 6

a. Design risk assessment procedures.
b. Identify and assess risk.
c. Design further audit procedures.
d. Evaluate the financial statements taken as a whole

Question 7

AUDIT RISK AND MATERIALITY - Considerations at the Account Balance, Transaction Class, or Disclosure Item Level

Answer 7

Inverse Relationship Between Audit Risk & Materiality :- The risk of a very large misstatement may be low, whereas the risk of a small misstatement may be high