Chapter 5 - Risk Flashcards
What is risk of material misstatement?
the risk the financial statements are materially misstated prior to the audit commencing
How is material misstatement caused?
caused by the client processing transaction incorrectly during the year, or preparing the FS incorrectly at the year end
What could material misstatement result in?
- an incorrect balance
- an accounting treatment not in line with the relevant accounting standard
- a required disclosure being omitted or inadequate
What does risk of material misstatement comprise off?
- inherent risk
- control risk
What is inherent risk?
Inherent risk represents the amount of risk that exists in the absence of controls.
What increases the level of inherent risk?
complexity, subjectivity and uncertainty
What is control risk?
the risk that a misstatement is not prevented, or detected and corrected by the entity’s controls
Controls include activities such as what?
reconciliations, authorisation of transaction and segregation of duties
What is detection risk?
the risk the auditor does not detect the misstatements that could be material
Non-sampling risk relates to what?
to factors other than sampling causing the auditor not to detect misstatements
When is an item material?
if its omission or misstatement could reasonably be expected to affect the economic decisions
The entity’s environment can include what?
industry conditions, laws and regulations, competition and other external factors
What is audit risk?
The risk that auditor gives an inappropriate opinion on the financial statements
Detection risk breaks down further into what?
Sampling and non-sampling risk
What are percentages for knowing if an item is material?
Profit before tax 5%
Total assets 1%
Revenue 0.5%
What is the purpose of risk assessment?
- 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
What are risk assessment procedures?
the techniques the auditor will use to identify the risks which will then be addressed
Risk assessment techniques include what?
- making enquiries of knowledgeable people (internal and external)
- conducting analytical procedures on the financial statements numbers
- observing things at the client
- inspecting documents
What is the response to risk assessment?
the actions the auditor can take to reduce detection risk and therefore audit risk
Responses to risk assessment can include what?
- 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
What are the different areas an auditor should understand?
- the environment
- the entity
- the applicable financial reporting framework
- The clients internal controls
What should the auditor understand about the entity?
its operations, ownership and governance, structure and finance, objectives and strategies, and incentives and pressures
what does the applicable financial reporting framework include?
revenue recognition, unusual or complex transactions, and areas for which there is a lack of authoritative guidance
What are the internal controls the auditor must understand?
- 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
How can the auditor obtain an understanding?
- from your firm
- the client
- you
- other
How would an auditor obtain understanding from your firm?
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
How would an auditor obtain understanding from the client?
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
How would an auditor obtain understanding from you?
Apply experience you have made in past
How would an auditor obtain understanding from other sources?
Companies House
Credit report
Internet
What are analytical procedures?
used at the planning stage of the audit to help identify risks. essentially a sense check of the numbers.
At the planning stage what are analytical procedures known as?
preliminary analytical procedures
What are some examples of analytical procedures?
- comparing related pieces of financial information
- comparing the same number across periods
- comparing the same number with budget
