Chapter 4 Flashcards
It is the possibility that an audit team will express an inappropriate audit opinion when the financial statements are materially misstated.
Audit Risk = Inherent risk Control risk Detection risk
Define audit risk.
The two components of RMM are inherent risk and control risk.
The components of the audit risk model are inherent risk, control risk, and detection risk.
What are the components of the risk of material misstatement (RMM)? What are the components of the audit risk model?
Nature–the type of procedure and the purpose of the procedure.
Timing–when the audit procedures will be completed.
Extent–the number of tests performed.
What is meant by the terms “nature, timing, and extent” of further audit procedures?
the auditor uses the audit risk model to determine the nature, timing, and extent of audit procedures by evaluating the risk of material misstatement for each relevant assertion related to each significant account and disclosure.
How is the audit risk model used to plan the audit?
Errors are usually unintentional, while fraud is intentional.
What is the primary difference between a material misstatement due to fraud or error?
Auditors are only concerned with fraud only as it affects the financial statements.
What is the auditor’s responsibility regarding fraud risk?
White-collar crime–usually financial frauds
Employee fraud–the use of fraud to misappropriate funds or other property from an employer.
Embezzlement–type of fraud involving employees or nonemployees wrongfully misappropriating funds or property entrusted to their care and other forms of deception and cover-up.
Larceny–theft.
Defalcation–misappropriation of assets; employee fraud, embezzlement, and larceny.
Errors–unintentional misstatements or omissions of amounts or disclosures in financial statements.
What are the defining characteristics of white-collar crime, employee fraud, embezzlement, larceny, defalcation, management fraud, and errors?
MANAGEMENT’S CHARACTERISTICS AND INFLUENCE
Management has a motivation (bonus compensation, stock options, etc.) to engage in fraudulent reporting
-Management fails to display an appropriate attitude about internal control and financial reporting.
-Managers’ attitudes are very aggressive toward financial reporting.
-Managers place too much emphasis on earnings projections.
-Managers engage in frequent disputes with auditors
INDUSTRY CONDITIONS
-Company profits lag those of the industry
-The company’s market is saturated due to fierce competition
-The company’s industry is declining.
-The company’s industry is changing rapidly
OPERATING CHARACTERISTICS AND FINANCIAL STABILITY
-A weak internal control environment prevails.
-The company is not able to generate sufficient cash flows to ensure that it is a going concern.
-There is pressure to obtain capital.
-The company has significant transactions or balances that are difficult to audit.
-The company has significant and unusual related-party transactions.
-Company accounting personnel are lax or are not experienced in performing their duties.
Identify three different categories of fraud risk factors.
Next, for each category, what are some of the conditions that can help contribute to a higher likelihood of financial statement fraud?
Inherent risk assessment helps to guide the auditor in allocating more and stronger resources to test specific accounts and disclosures that present a higher likelihood of material misstatement and therefore present a higher level of inherent risk. In effect, inherent risk assessment provides the basis for executing an appropriate response to the risks identified.
Why is it important for an auditor to carefully assess inherent risk on each audit engagement?
The nature of the company includes:
-The company’s organizational structure and management personnel.
-The sources of funding of the company’s operations and investment activities
-The company’s significant investments.
-The company’s operating characteristics, including its size and complexity.
-The sources of the company’s earnings, including the relative profitability of key products and services as well as key supplier and customer relationships.
What is meant by the nature of the company, and why is it important to inherent risk assessment?
