AUD 3.2 - Audit Risk Flashcards
The risk that the auditor may unknowingly fail to appropriately modify the opinion on financials that are material misstate
Audit risk
Why does audit risk occur?
Because auditor obtains only reasonable assurance (not absolute)
An omission or misstatement of accounting information that, in light of circumstances, makes it probable that the judgement of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
Material misstatement
What are the three types of misstatements?
Factual misstatements
Judgemental misstatements
Projected misstatements
Misstatements about which there is no doubt:
Factual misstatement
Differences arising from the judgements of management concerning accounting estimates that the auditor considers unreasonable or the selection or application of accounting policies that the auditor considers inappropriate:
Judgemental misstatements
The auditors best estimate of misstatements in populations, involving the projection of misstatements identified in audit samples to the entire population from which the samples were drawn:
Projected misstatements
Formula for calculating audit risk:
(Inherent risk X control risk) X detection risk
(IR X CR) = risk of material misstatement
How is the risk of material misstatement different from detection risk?
RMM exists independent of the financial statement audit
Detection risk is controlled by the auditor and RMM is assessed by the auditor
In the assessment of RMM, the auditor can:
Make a single overall assessment
OR
Separately assess inherent risk and control risk and then combine these risk assessments
The susceptibility of a relevant assertion to a material misstatement, assuming that there are no related controls
Inherent risk
The auditor assesses inherent risk as HIGH if:
The account is more likely to contain a material misstatement
(High volume transactions, complex calculations, estimates, cash)
The auditor assess inherent risk as LOW if:
The account is not likely to contain a material misstatement
The risk that a material misstatement that could occur in a relevant assertion will not be prevented or detected on a timely basis by the entity’s internal control. This is a function of the effectiveness of the design and operation of internal controls:
Control risk
The auditor assess control risk as HIGH if:
No effective controls related to the assertion in place
The implemented controls are not operating effectively
Not efficient to test the operating effectiveness of controls
The risk that the auditor will not detect a material misstatement that exists in a relevant assertion. This is a function of the effectiveness of the audit procedures and of the manner in which they are applied:
Detection risk
Detection risk can be divided into what two things?
Test of details risk and substantive analytical procedures risk
When the auditor determines that the risk of material misstatement is high, detection risk should be set at?
LOW
When the auditor determines that the risk of material misstatement is low, detection risk should be set at?
HIGH
If RMM is high, detection risk is low, why?
Because we perform more work to reduce the detection risk
If RMM is low, detection risk is high, why?
Because we perform less work to reduce the detection risk
What are the steps required in assessing audit risk during engagement planning?
- Determine audit risk
- Assess inherent risk
- Assess control risk
- Determine detection risk
Audit risk is usually set at what level?
Low to ensure that the auditor does not render an incorrect opinion
If the control risk is assessed below high, then the auditor needs to do what?
Test internal controls to prove that the controls are operating effectively
