Chapter 5 - Risk

Question 1

What is risk of material misstatement?

Answer 1

the risk the financial statements are materially misstated prior to the audit commencing

Question 2

How is material misstatement caused?

Answer 2

caused by the client processing transaction incorrectly during the year, or preparing the FS incorrectly at the year end

Question 3

What could material misstatement result in?

Answer 3

• an incorrect balance
• an accounting treatment not in line with the relevant accounting standard
• a required disclosure being omitted or inadequate

Question 4

What does risk of material misstatement comprise off?

Answer 4

• inherent risk
• control risk

Question 5

What is inherent risk?

Answer 5

Inherent risk represents the amount of risk that exists in the absence of controls.

Question 6

What increases the level of inherent risk?

Answer 6

complexity, subjectivity and uncertainty

Question 7

What is control risk?

Answer 7

the risk that a misstatement is not prevented, or detected and corrected by the entity’s controls

Question 8

Controls include activities such as what?

Answer 8

reconciliations, authorisation of transaction and segregation of duties

Question 9

What is detection risk?

Answer 9

the risk the auditor does not detect the misstatements that could be material

Question 10

Non-sampling risk relates to what?

Answer 10

to factors other than sampling causing the auditor not to detect misstatements

Question 11

When is an item material?

Answer 11

if its omission or misstatement could reasonably be expected to affect the economic decisions

Question 12

The entity’s environment can include what?

Answer 12

industry conditions, laws and regulations, competition and other external factors

Question 13

What is audit risk?

Answer 13

The risk that auditor gives an inappropriate opinion on the financial statements

Question 14

Detection risk breaks down further into what?

Answer 14

Sampling and non-sampling risk

Question 15

What are percentages for knowing if an item is material?

Answer 15

Profit before tax 5%
Total assets 1%
Revenue 0.5%

Question 16

What is the purpose of risk assessment?

Answer 16

• identify the areas where errors may exist
• plan audit procedures
• perform a more efficient and effective audit
• reduce the chance of giving the wrong audit opinion
• reduce the risk of being sued, paying damages and losing our reputation

Question 17

What are risk assessment procedures?

Answer 17

the techniques the auditor will use to identify the risks which will then be addressed

Question 18

Risk assessment techniques include what?

Answer 18

• making enquiries of knowledgeable people (internal and external)
• conducting analytical procedures on the financial statements numbers
• observing things at the client
• inspecting documents

Question 19

What is the response to risk assessment?

Answer 19

the actions the auditor can take to reduce detection risk and therefore audit risk

Question 20

Responses to risk assessment can include what?

Answer 20

• assigning risky areas to more experienced team members
• increasing the level of supervision over the audit team
• introducing unpredictability into testing
• detailed substantive testing
• professional scepticism

Question 21

What are the different areas an auditor should understand?

Answer 21

• the environment
• the entity
• the applicable financial reporting framework
• The clients internal controls

Question 22

What should the auditor understand about the entity?

Answer 22

its operations, ownership and governance, structure and finance, objectives and strategies, and incentives and pressures

Question 23

what does the applicable financial reporting framework include?

Answer 23

revenue recognition, unusual or complex transactions, and areas for which there is a lack of authoritative guidance

Question 24

What are the internal controls the auditor must understand?

Answer 24

• control environment
• control activities
• whether or not the client has an internal audit function
• to what extent the client uses IT in its internal control systems

Question 25

How can the auditor obtain an understanding?

Answer 25

• from your firm
• the client
• you
• other

Question 26

How would an auditor obtain understanding from your firm?

Answer 26

if an existing client you could consult with people who were on the team last year.
Read the clients file.
If new the partners can help if they have experience in that industry and you can do research

Question 27

How would an auditor obtain understanding from the client?

Answer 27

Plan meetings with the client.
If new find our more about the company. Focus on any chances occurred in the year.
Observe processes and controls.
Use websites and marketing materials

Question 28

How would an auditor obtain understanding from you?

Answer 28

Apply experience you have made in past

Question 29

How would an auditor obtain understanding from other sources?

Answer 29

Companies House
Credit report
Internet

Question 30

What are analytical procedures?

Answer 30

used at the planning stage of the audit to help identify risks. essentially a sense check of the numbers.

Question 31

At the planning stage what are analytical procedures known as?

Answer 31

preliminary analytical procedures

Question 32

What are some examples of analytical procedures?

Answer 32

• comparing related pieces of financial information
• comparing the same number across periods
• comparing the same number with budget