Chapter 7 - Assessing the Risk of Material Misstatement Flashcards
What is the difference between determining the risk of material misstatement for the OVERALL STATEMENTS and for the SPECIFIC ASSERTIONS related to classes of transactions, balances, and disclosures?
Overall statements – affect the financial statements as a whole and possibly impact many assertions
E.g., management integrity issues, poor internal controls, going concern issues
Specific assertions – risks that managements assertions aren’t true for specific balances, transactions, etc.
What are the 5 types of risk assessment procedures?
- Inquiries of management and others within the entity.
- Analytical procedures.
- Observation and inspection.
- Discussion among engagement team members.
- Other risk assessment procedures.
What is a significant risk?
A significant risk represents an identified and assessed risk that, in the auditor’s professional judgment, requires special audit consideration.
What should auditors consider in regards to significant risks?
- Risk of fraud
- Risk related to recent key economic, accounting, or other developments
- Complexity of transactions
- Significant related party transactions
- Degree of subjectivity in measurement of financial information
- Significant transactions outside the normal course of business
What is involved in a fraud risk assessment? (4)
- Discuss with audit team members the risk of material misstatement due to fraud.
- Make inquiries to management, those in charge of governance, and others regarding processes for identifying and responding to fraud risk.
- Evaluate unusual/unexpected relationships when performing analytical procedures
- Evaluate the risk for revenue fraud and management override, and understand period-end.
What are the 3 elements of the fraud triangle? (the 3 conditions for fraud)
- Incentives/pressures - Management or other employees have incentives or pressures to commit fraud.
- Opportunities - Circumstances provide opportunities for management or employees to commit fraud.
- Attitudes/rationalization - An attitude, character, or set of ethical values exists that allows management or employees to intentionally commit a dishonest act, or imposes pressure sufficient to cause them to rationalize committing a dishonest act.
What is audit risk?
Audit risk is the risk that the auditor will express an inappropriate audit opinion when the financial statements are materially misstated.
What is the audit risk model (equation)?
DR = AAR / (IR x CR)
What is inherent risk?
Inherent risk - The auditor’s assessment of the susceptibility to material misstatement of an assertion about a class of transactions, an account balance or disclosure, either individually or in aggregate, BEFORE considering the effectiveness of related internal controls.
(auditors should attempt to predict where misstatements are most and least likely in the financial statement segments)
What are some factors that affect inherent risk?
- Nature of the client’s business
- Results of previous audits
- Related parties
- Complex or non-routine transactions
- Judgment required to correctly record account balances and transactions
- Makeup of the population
- Factors related to fraudulent financial reporting and misappropriation of assets
- Management motivation and biases
- Initial versus repeat engagement
What is control risk?
Control risk - The auditor’s assessment of the risk that a material misstatement could occur in an assertion about a class of transaction, an account balance, or a disclosure, and not be prevented or detected on a timely basis by the client’s internal controls.
Inherent Risk (IR) x Control Risk (CR = ?
Risk of material misstatement
What is detection risk?
Detection risk – The risk that the audit evidence for an audit assertion will fail to detect misstatements exceeding performance materiality.
Describe the relationship between detection risk and inherent risk/control risk.
Detection risk is inversely related to inherent risk and control risk:
As inherent risk and control risk go up, so does the overall risk of material misstatement.
Therefore, the auditor is going to reduce the risk that their own procedures won’t detect those errors (reduce detection risk).
What is acceptable audit risk?
Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified audit opinion has been issued.
