Ch.6 Risk

Question 1

Audit Risk and CAS #

Answer 1

CAS 200 the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.

Question 2

Audit Risk Model

Answer 2

AR = RMM × DR

AR = audit risk

RMM = IR × CR

IR = inherent risk: general and fraud risks at the overall financial statement level(OFSL) and the assertion level

CR = control risk: control risks at the OFSL and the assertion level

DR = detection risk (set based on the reliance on substantive procedures)

Question 3

Risk of material misstatement

Answer 3

The RMM is the risk in the financial statements prior to audit, because of the clients inherent risk (IR) and control risk (CR). The auditor does not control this risk but merely assesses it.

Question 4

Detection risk

Answer 4

Detection risk is the risk that the procedures performed by the auditor will not detect a material misstatement
bring the detection risk to an acceptably low level to compensate for any RMM and thus bring the overall audit risk to low
inverse relationship between the assessed levels of RMM and the acceptable level of detection risk

Question 5

The IR at the OFSL

Answer 5

A company in poor financial health
Significant market competition that is driving down prices and pressuring cost structures
The company has never been audited before
An upcoming purchase or sale of the company
Imposition of more stringent regulation on the industry and the company
An initial public offering, issuance of new debt, or bank covenants
Employees with reliance on net income for compensation (bonuses)

Question 6

Control risk definition

Answer 6

Control risk is the risk that a material financial statement misstatement, either individually or when aggregated with other misstatements, will not be prevented, detected, or corrected on a timely basis by the entity’s internal control

Question 7

Factors that reduce risk

Answer 7

eg private company = fewer users = fewer incentive to manipulate FS

Question 8

Fraud Risk Definition and CAS #

Answer 8

CAS 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements states that a practitioner assesses the RMM due to fraud (from fraudulent financial reporting and/or misappropriation of assets) at both the OFSL and at the assertion leve

Question 9

Inherent Risk

Answer 9

Inherent risk is the susceptibility to a financial statement misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.