Chapter three: Risk assesment part 1: audit risk and audit stategy Flashcards
Three phases (or stages) of the audit
- Risk assessment: The auditor gains a detailed understanding of the client that drives the planning of the audit.
- Risk Response: the auditors perform the detailed work that was planned
- Reporting: auditors form their opinion and issue audit report
4 factors that influence client acceptance and retention
- Integrity of management
- competency issues
- independence issues
- special circumstance and unusual risk
Engagement letter
client acceptance letter that sets out the terms of the audit engagement to avoid any misunderstanding between the auditor and the client. Such as scope of the audit, fees and the responsibilities of both parties.
Audit risk
the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. RISK ASSESSMENT PHASE
Qualitative factors
qualitative material refers to information significant due to its nature rather than its size. Examples include fraud, changes in accounting methods, operational shifts affecting risk, or potential breaches of debt covenants.
Quantitative factors
- Quantitative material refers to information significant due to its dollar magnitude.
- Some items can impact a user’s decision-making because of their dollar magnitude in the financial statements.
- For instance, errors or omissions in inventory, being a large current asset, can be quantitatively material.
Risk of material misstatement RMM)
the risk that the financial statements are materially misstated prior to the audit; a combination of inherent risk and control risk. The client has messed up financial statements.
Inherent risk IR
The risk that inherently things will have problems. This is a client component. Inherent risk happens inherently everything has risks.
Control Risk
the risk that a client’s system of internal controls will not prevent or detect a material misstatement on a timely basis. This is a client component
Detection Risk
the risk that the auditors testing procedures will not be effective in detecting a material misstatement. Auditor component
Two approaches to testing controls
- Reliance controls
- substantive approach
Fraud triangle
- Pressure- what might incentivize management to cook the books?
- Opportunity- do they have the opportunity to do fraud? due to bad controls.
- Rationalization- what is the justification to commit fraud? “Everyone is doing it”
audit strategy
provides the basis for developing an audit plan that details the nature, extent, and timing of the audit procedures that will be performed
Planning materiality
Bench mark materiality level set
performance materiality
amount or amounts set by the auditors at less than the planning materiality level for particular classes of transactions, account balances, or disclosures