Audit Risk

Question 1

What is Audit Risk?

Answer 1

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated

Question 2

What is Reasonable Assurance?

Answer 2

In the context of an audit of financial statements, a high, but not absolute, level of assurance (aka “high level of assurance” and a “low level of audit risk”)

Question 3

What is the Basic Auditor Responsibility?

Answer 3

The auditor should properly plan and perform the audit to obtain reasonable assurance that material misstatements, whether caused by errors or fraud, are detected

Question 4

The one overriding audit planning objective is to limit audit risk to an appropriately low level, which involves the following…

Answer 4

1 Determining the extent and nature of the auditor’s risk assessment procedures
2 Identifying and assessing the risk of material misstatement
3 Determining the nature, timing, and extent of further audit procedures
4 Evaluating whether the financial statements taken as a whole are presented fairly in conformity with GAAP

Question 5

What’s the meaning of Risk of Material Misstatement (RMM)?

Answer 5

The risk that the financial statements are materially misstated prior to the audit

Question 6

What are the 2 levels of Risk of Material Misstatement (RMM)?

Answer 6

1 The overall financial statement level

2 The assertion level for classes of transactions, account balances, and disclosures

Question 7

What is the RMM at the Overall Financial Statement Level?

Answer 7

Risks that are “pervasive” to the financial statements and that potentially affect many assertions

Question 8

What is the purpose of RMM at the Assertion Level?

Answer 8

To determine the nature, timing, and extent of further audit procedures to obtain sufficient appropriate audit evidence

Question 9

What are the 3 components of RMM at the assertion level?

Answer 9

1 Inherent risk
2 Control risk
3 Detection risk

Question 10

What is Inherent Risk?

Answer 10

The probability that a material misstatement would occur in the particular audit area in the absence of any internal control policies and procedures (environment, we have no control)

Question 11

What is Control Risk?

Answer 11

The probability that a material misstatement that occurred in the first place would not be detected and corrected by internal controls (management’s responsibility to design internal controls) (environment, we have no control)

Question 12

What is Detection Risk?

Answer 12

The probability that a material misstatement that was not prevented or detected and corrected by internal control was not detected by the auditor’s substantive audit procedures (auditor’s responsibility)

Question 13

What is the order of Risk?

Answer 13

audit risk is set, then inherent risk is assessed, then control risk is assessed, and finally the implications for the appropriate level of detection risk are considered

Question 14

If IR and CR are seen by the auditor as too high, what must be done?

Answer 14

The auditor must compensate by decreasing DR

Question 15

If IR and CR are perceived as low, what must be done?

Answer 15

The auditor may consider accepting a higher DR

Question 16

How does an auditor adjust increasing or decreasing DR?

Answer 16

By adjusting the nature, timing, and/or extent of the auditor’s substantive audit procedures

Question 17

What does Nature refer to?

Answer 17

What specific audit procedures to perform

Question 18

What does Timing refer to?

Answer 18

When will the procedures be performed? At an “interim” date (prior to year-end) or at “final” (after year-end when the books have been closed)

Question 19

What does Extent refer to?

Answer 19

Are large samples required for the auditor’s test work or can somewhat smaller sample sizes be justified