Lecture 2 - Planning and Risk assessment (1) Flashcards
What does risk assessment involve:
- Understanding the client
- Identifying risk and strategy
- Assess risks & Materiality
Places of potential misstatements at an entity level
-What does the client do?
-Where is the business done?
-Regulation – Accounting policy
-Who are the key customers?
-Who are the key stakeholders?
-Competence of key staff?
-Are suitable systems and controls in place? –
Management decisions
Places of potential misstatements at an industry level
- Competition
- Reputation
- Demands for goods/services
- Shareholder expectations
- Other pressures - analysts
Places of potential misstatements at a broader economic level
- Interest rates, Foreign exchange rates
- Government support & regulation
External information examples:
companies house, banks, credit reference
agencies, government statistics
Client information examples:
Discussions with management, board minutes,
previous financial statements, budgets
Prior knowledge sources :
Audit files, engagement team
members, communication with previous auditors.
Engagement risk can be subdivided into three separate types of risk:
(i) client’s business risk
(ii) auditor’s business risk
(iii) audit risk
Client’s business risk is:
The risk associated with conditions, circumstances, events that impair management’s ability to do business:
- Profitability
- Survival.
Auditor’s business risk is…..
The auditor’s exposure to loss or injury to professional practice from litigation, adverse publicity or other events arising in connection with financial statements audited and reported on.
Audit risk is……
The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
The audit risk model is……
AR is a function of IR, CR, DR
AR = IR X CR X DR
where: AR=audit risk IR=inherent risk CR=control risk DR=detection risk.
Inherent risk is……
Auditor’s assessment of the likelihood that information in the financial statements will be materially misstated,
regardless of the internal controls
Control risk is…….
What the client does to reduce the inherent risks,
e.g. put in place appropriate information and internal
control systems
-If measures have been taken, and they are effective,
control risk will be lower.
Detection risk is……
The risk that audit procedures won’t pick up any material errors in the financial statements.
-This is under the auditor’s control, and determined by the extent of inherent and control risk.
The two elements of detection risk are…..
- Sampling risk
- Non-sampling risk
Sampling risk is…….
Audit gives incorrect opinion because sample chosen for testing does not reflect the population as a whole
Non-sampling risk is……
Auditor gives incorrect opinion for any other reason, eg the test chosen was inappropriate for the risk, or the auditor did not understand the client’s business, etc.
Materiality is…….
Information is material if its omission or
misstatement could influence the economic
decisions of users taken on the basis of the
financial statements. Materiality depends on the
size of the item or error judged in the particular
circumstances of its omission or misstatement
Materiality at a planning level…..
Decide what to consider as material at the
start of an audit:
o Which accounts have changed the most
o Consider an amount above which is material
Materiality at a financial statements level…..
Entire financial statements level:
- errors or irregularities
- individually or in aggregate
- not presented fairly according to framework (IFRS)
Materiality at an account balance level….
Assess materiality at different class or account
levels: E.g. sales
- Again consider nature and size of materiality. May be immaterial individually but material to the FS as a whole.
Tolerable error is……
The amount of materiality allocated to an account or class of transactions. -Common benchmarks are 2-15% of the account
ISA 240 clarifies that it is the job of
management to…..
Detect and prevent fraud
Analytical procedures involve evaluating financial
information by…..
Comparing it with other financial and non-
financial information
