Audit A3

Question 1

Name two type of fraud

Answer 1

Fraudulent financial reporting

Misappropriation of assets, or defalcation

Question 2

3 conditions that generally are present when fraud occurs

Answer 2

• Incentives/Pressure
• Opportunity
• Rationalization/attitude

Question 3

When analyzing fraud risk, what are the four attributes should the auditor consider?

Answer 3

• Type of risk
• Significance of risk
• Likelihood of the risk
• Pervasiveness of the risk

Question 4

Distinguish between the three types of material misstatements

Answer 4

1. Factual - no doubt
2. Judgmental - due to estimates from accounting policies
3. Projected - best estimate of misstatement in population

Question 5

What is audit risk? List and define the two element of audit risk.

Answer 5

Audit risk is the risk that the auditor may unknowingly fail to modify appropriately the opinion on financial statements that are materially misstated.

It compromises:

• Risk of material misstatement (RMM) - risk FS materially misstated.
• Detection risk - the risk that the auditor will not detect a material misstatement that exists in a relevant assertion.

Audit Risk = RMM x Detection risk
-> there is an inverse relationship between RMM and DR. As the acceptable level of detection risk increases, the assurance required from substantive tests decreases.
As the acceptable level of detection risk decreases, the assurance required from substantive testing must increase.

Question 6

List examples of factors that would increase inherent risk:

Answer 6

• Technological developments that make a product obsolete
• A lack of working capital
• A decline in overall industry or economy
• High volume transactions
• Complex transactions
• Amounts derived from estimates

Question 7

Two component of Risk of Material Misstatement

Answer 7

Inherent Risk: the susceptibility of a relevant assertion to a material misstatement assuming that there are no related controls.

Control Risk: The 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.

Question 8

How may the auditor obtain more assurance from substantive procedure?

Answer 8

The auditor may obtain more assurance from substantive procedure by changing the (NET):

• changing the nature - direct test to external parties, rather than internally
• changing the extent - using larger sample size
• changing the timing - performing sub tax at year end rather than interim

Question 9

When are tests of controls performed in a financial statement audit?

Answer 9

When the auditor’s risk assessment is based on the assumption that controls are operating effectively.

OR

When substantive procedures alone are insufficient, such as when there is a significant amount of electronic processing.

Question 10

What influences the auditor’s decision regarding the sufficiency of evidential matter?

Answer 10

• the risk of material misstatement

- the quality of audit evidence

Question 11

PCAOB standards state that the relevance of audit evidence depends on:

Answer 11

• the design of audit procedure, designed to test assertion
• test for understatement or overstatement
• timing of the audit procedure