Chapter 9 Flashcards
Risk assessment procedures occur during audit planning and include the following: (5)
- Inquiries of management and others within the entity
- Analytical procedures
- Observation and inspection
- Discussion among engagement team members
- Other risk assessment procedures
Auditor must determine whether any of the risks identified are a significant risk. A significant risk is any risk that the auditor deems to require special attention, such as:
- Nonroutine transactions, including related-party transactions.
- Account balances or transactions that require estimation.
- All fraud risks. Because several high-profile cases of financial statement fraud involve misstatements in revenue recognition, auditing standards require the auditor to presume that risks of fraud exist in revenue recognition
DEFINE RISK IN AUDITING
- Auditors accept some level of risk in performing audits.
- Risk of Material Misstatement at the Overall Financial Statement Level: Refers to the risks that relate pervasively to the financial statements as a whole and potentially affect a number of different transactions and accounts.
- Risk of Material Misstatement at the Assertion Level: There are two components to risk at the assertion level. Auditors consider these risks by applying the audit risk model: AAR= IR x CR x PDR or PDR = AAR/(IR*CR)
COMPONENTS OF THE AUDIT RISK MODEL
- Planned Detection Risk:
- Inherent Risk
- Control Risk:
- Acceptable Audit Risk:
Planned Detection Risk:
The risk that the audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality. Planned detection risk is dependent on the other three factors in the model and will change only if the auditor changes one of the other factors.
Inherent Risk:
The auditor’s assessment of the susceptibility of an assertion to material misstatement.
Control Risk:
The auditor’s assessment of the risk that a material misstatement could occur in an assertion and not be prevented or detected by the client’s internal controls.
Acceptable Audit Risk:
How willing the auditor is to accept that the financial statements may be materially misstated after the audit is complete and an unmodified opinion has been issued.
ASSESSING ACCEPTABLE AUDIT RISK, Factors affecting acceptable audit risk include:
Professional standards. Standards specify that audit risk be maintained at a low level. Most illustrations set audit risk at 5 percent.
Engagement risk. Engagement risk is the risk that the auditor (or firm) will suffer harm after the audit is finished, even though the report was correct. Engagement risk is based on these factors:
1.Client size
2.Distribution of ownership
3.Nature and amount of liabilities
Client business risk. Client business risk is the likelihood that a client will have financial difficulties after the audit.
Management integrity.
Assessing inherent risk is an attempt by the auditor to predict where misstatements are most and least likely in the financial statement segments.
- This assessment affects the amount of audit evidence that the auditor needs to accumulate.
- The auditor must assess the factors that make up the risk and modify procedures for audit evidence to take them into consideration during the planning phase and updated throughout the audit process.
Factors to Consider when Assessing Inherent Risk: (9)
- Nature of the client’s business
- Results of previous audits
- Initial versus repeat engagement
- Related parties
- Complex or nonroutine transactions
- Judgment required to correctly record account balances and transactions
- Makeup of the population
- Factors related to fraudulent financial reporting
- Factors related to misappropriation of assets
OTHER CONSIDERATIONS (5)
- The risk of material misstatement, control risk, and inherent risk are assessed for each audit objective in each segment of the audit.
- Although it is common to assess inherent and control risks for each balance-related audit objective, it is not common to allocate materiality to those objectives.
- One major limitation in the application of the audit risk model is the difficulty of measuring the components of the model. It is a highly subjective process, so most auditors use broad categories such as low, medium, and high.
- The concepts of materiality and risk in auditing are closely related and inseparable. Risk is a measure of uncertainty. Materiality is a measure of magnitude.
- In addition to modifying audit evidence, the auditor can also respond to risks by using more experienced staff or by relying on review more carefully than usual.
