A3-Audit Risk Flashcards
Audit Risk
Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on f/s that are materially misstated.
Material Misstatements Include
- inaccuracies in the collection or processing of data
- departures from GAAP
- Omissions
- Incorrect estimates or judgments
- Inappropriate selection or application of accounting policies
AUDIT RISK
Audit Risk Model
Audit Risk(AR)= Risk of Material Misstatement(RMM) x Detection risk (DR)
RMM= Inherent Risk x Control Risk
AUDIT RISK MODEL
RISK OF MATERIAL MISSTATEMENT
Auditor makes an assessment of the risks of material misstatement by performing risk assessment procedures and where appropriate, test of controls
AUDIT RISK MODEL
RISK OF MATERIAL MISSTATEMENT
Inherent Risk
is the susceptibility of a relevant assertion to a material misstatement, assuming there are no related controls(clients accounting system has errors)
- assertions involving high volume transactions, complex calculations, amounts derived from estimates, and cash have relatively higher inherent risk than assertions without those characteristics.
- technological dvelopments that render a product obsolete, lack of working capital, decline in industry also increase inherent risk
AUDIT RISK MODEL
RISK OF MATERIAL MISSTATEMENT
Control Risk
risk that a 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(client’s internal control doesn’t catch the error).
- control risk if a function of the effectiveness of the design and operation of internal control
- some amount of control risk will always exist due to inherent limitations of any system of internal control
Inhernt Risk, Control Risk, and the Audit
Inherent risk and control risk exist independtly of the audit, and the auditor generally cannot change these risks.
AUDIT RISK MODEL
RISK OF MATERIAL MISSTATEMENT
Detection Risk
is the risk that the auditor will not detect a material misstatement that exists in a relevant assertion(audito misses the mistake and gives wrong opinion).
- detection risk is a function of the effectiveness of audit procedures and of the manner in which they are applied.
AUDIT RISK MODEL
EFFECT ON AUDIT
Inverse relationship of RMM to DR
When the auditor determines that the RMM is high, detection risk should be set at a low level. Conversely, when the RMM is low, the auditor can justify a higher detection risk.
AUDIT RISK MODEL
EFFECT ON AUDIT
The auditor can change detection risk
auditor can change by vary the NET of audit procedures. Example-as the acceptable level of DR decreases, the assurance provided from substantive procedures should increase. The auditor may:
- change the nature of substantive tests from a less effective to a more effective procedure (direct test toward independent parties outside the entity rather than toward parties or documentation inside the entity)
- change the extent of substantive tests (ie-use a larger sample size)
- change the timing of substantive tests (perform substantive tests at year end rather than at interim)
AUDIT RISK MODEL
EFFECT ON AUDIT
Substantive Procedures Required
Note that even when the assessed RMM is low, substantive procedures will always be necessary for all relevant assertions related to material transaction classes, account balances, and disclosures.
AUDIT RISK AND MATERIALITY
Overall Considerations
- Audit risk and materiality should be considered together in designing the nature, extent, and timing (NET) of audit procedures and in evaluating the results of those procedures.
- Considerations of audit risk and materiality are affected by the size and complexity of the entity, as well as the auditor’s experience with and knowledge of the entity, its environment, and its internal control.
- audit risk and materiality must be considered at both the f/s level and the account balance, individual tranasction class, or disclosure item level.
AUDIT RISK AND MATERIALITY
CONSIDERATIONS AT THE FINANCIAL STATEMENT LEVEL ARE USED TO:
- Design risk assessment procedures
- Identify and assess risk
- design further audit procedures
- evaluate the f/s taken as a whole
AUDIT RISK AND MATERIALITY
Considerations at the Account balance, Transaction class, or Disclosure item level are used to:
determine the nature, extent, and timing of audit procedures to be applied to specific account balances, transaction classes, or disclosure items. The audit risk model maybe useful in this regard.
