Chapter 4 Flashcards
Planning: Audit Risk
What are risk assessment procedures and what do they help eliminate?
Audit procedures undertaken to establish the risks of material misstatement with the client.
Help eliminate the possibility of not detecting information that can jeopardise a client.
What are the two levels of risk in audit?
- The financial statement level
- Factors affecting a set of financial statements - The assertion level
- Factors affecting one specific element of the financial statements due to the characteristics is possesses
Name some circumstances to consider in an entity’s risk assessment process.
- Changes in the operation environment
- New personnel within the organisation
- New or revamped information systems
- Rapid growth
- New technology
- New business models, products, or activities
- Corporate restructurings
- Expanded foreign operations
- New accounting pronouncements
What is audit risk?
The risk that an auditor gives the wrong opinion on a company’s financial statements due to factors of inherent, control, and detection risk.
What does the audit risk model isolate?
FYI: DIC
Detection risk
- Risk that the auditor doesn’t find the misstatements during their audit
Inherent risk
- Risk of mistakes happening naturally in the company’s accounts (always present and things susceptible to fraud and error)
Control risk
- Risk that the company’s internal controls don’t catch these mistakes
What is sampling risk?
Risk that occurs every time a sample is selected and represents the risk that the sample does not adequately represent the population
What is non-sampling risk?
Risk that an auditor makes a mistake in their judgment or procedures due to human error or poor audit techniques
Formula: Audit risk =?
Detection X Inherent X Control
What is the purpose of assessing risks in the risk assessment process?
To assign each risk a category based on likelihood and impact
What are the necessary conditions to demonstrate professional scepticism?
- Individual auditors
- Engagement teams
- Audit firms
- Audit committees and management
- Individual auditors
-Must be professionally curious and confident to challenge - Engagement teams
-Should share knowledge and make decisions as evidence is collected - Audit firms
- Must foster a culture of scepticism - Audit committees and management
- Should support external audit processes
What do analytical procedures help auditors interpret?
Financial information
What do we mean by Overstated and Understated?
Overstated
- Too high
Understated
- Too low
What does materiality refer to?
What makes something material?
What does it determine in Audit?
The importance or significance of an amount, transaction, or error in the financial statements.
Something is deemed material if it is big enough to influence the decisions of users.
Determines the threshold above which further audit work becomes necessary, as well as confirming which elements have to be considered as part of the audit opinion.
What are the 3 basic criteria for calculating materiality?
- 5-10% of profit before tax
- 1-2% of revenue
- 2-5% of total assets
What is performance materiality?
Safety buffer set below the overall materiality to reduce the risk of missing significant errors in an audit.
Not one set materiality level as there could be items below this level but aggregate above the material threshold.
True or False: Materiality levels can remain the same throughout the audit.
False
- Auditors can revise materiality in the event of becoming aware of new information during the audit that would have initially swayed the auditors approach if known before.
What do we mean by Material and Pervasive?
Material
- Is the error big enough to affect users’ decisions?
Pervasive
- Does the error affect the entire financial statement or just one part?
Do these changes in materiality need to be documented?
Yes.
