Module 13 - Audit Process: Fundamental Concepts Flashcards
Audit risk definition
The risk that the auditor gives the wrong opinion on the financial statements when the financial statements are materially misstated
Misstatement definition
Where there is a difference between an amount, classification, presentation or disclosure reported in the financial statements and the correct treatment in accordance with the applicable financial reporting framework
Misstatements can arise from error or fraud
What is the ‘risk-based’ approach to auditing (required by the ISAs) designed to do:
Provide the highest quality evidence in a given time or for given fee
Ensure that adequate evidence is collected on which the audit opinion can be based
Risk-based approach definition
Where the auditor tailors the nature, extent and timing of audit procedures performed on each area of the financial statements according to the risk of there being a misstatement in that area
In addition to risk, there are some underlying fundamental concepts that related to the practical process of auditing - such as:
Materiality
Evidence
Audit judgement
Materiality definition
An expression of the relative significance or importance of a particular matter in the context of financial statements as a whole
A matter is considered to be material if it’s omission or misstatement would reasonably influence the economic decision of the users taken on the basis of the financial statements
Two ways in which materiality can impact audit:
It determines the scope of the work performed (which items are tested and to what degree)
It determines the nature of the final audit opinion. Where a material misstatement exists in the financial statements, they do not show a true and fair view
Materiality should be considered by the auditor when:
Identifying transactions and balances that are individually material
Evaluating the potential impact of identified risks
Determining the nature, timing and extent of audit procedures
Evaluating whether sufficient, appropriate evidence has been gathered
Evaluating the effect of unadjusted misstatements
An auditor can only express an opinion over whether the accounts are ‘true and fair’ if they have…
Collected enough evidence to support the figures
What does reasonable assurance mean?
The auditor must gather sufficient, appropriate audit evidence to reduce audit risk to an acceptably low level
Methods of gathering evidence for an audit
Understanding the entity - risks that exist due to the nature of the entity (gathered at the planning stage of the audit)
Testing the controls of the entity (gathered at the systems and controls stage of the audit)
Testing the numbers in the financial statements - substantive testing (gathered at the substantive testing and completion stages of the audit)
An audit judgement is often referred to as a
Professional judgement
Is professional skepticism important in a good quality audit?
Yes
What is audit risk?
The risk the auditor gives the wrong opinion on the financial statements
The risk an auditor will miss a material misstatement in the financial statements
Audit risk is the product of three different components:
Inherent risk
Control risk
Detection risk
Audit risk formula?
Audit risk = inherent risk X control risk X detection risk
Inherent risks can arise from two sources
Business risk
Account specific risk
Inherent risk can arise from two sources: Business risk & Account specific risk
The impact of these risks can then be categorised into two categories
Financial statement level risks - something that will impact the financial statements as a whole
Assertion level risks - specific area of the accounts only
When is inherent risk assessed?
From the start of the audit
Majority of work on IR performed in the planning stage
How does the auditor gather evidence over inherent risk?
By gaining an understanding of the entity
When does control risk increase?
Where the internal control systems at an entity are poorly designed or do not operate effectively
When is control risk assessed?
Predominantly at the systems and controls stage of the audit
Although some understanding will come from work done at the planning stage to understand the entity
Risk of Material Misstatement (‘ROMM’) definition:
It is the combination of what?
The combination of inherent risk and control risk
It is the risk that a material misstatement may exist in the financial statements prior to the auditor undertaking any procedures
What is detection risk?
The balancing figure in the audit risk equation
The risk that the auditor will not find a misstatement
What type of relationship does Risk of Material Misstatement (‘ROMM’) have with Detection Risk?
An inverse relationship
Detection risk level will determine the nature, extent and timing of what?
Substantive testing
What element of risk is the only element controlled by the auditor?
Detection risk
Detection risk can be split into two types
Low detection risk
High detection risk
How does low detection risk work?
Auditor is less willing to accept the chance that they will not detect a material misstatement
Therefore, auditor will increase the work performed to detect misstatements
How does high detection risk work?
Auditor is more willing to accept the chance that they will not detect a material misstatement
Therefore, the auditor can reduce the work performed to detect misstatements
When ROMM is low, there is “what” chance of an error occurring in the financial statements:
Less
If ROMM is low, what level of detection risk can the auditor accept?
A much higher level of detection risk
Where ROMM is high, there is a “what” risk of misstatement in the accounts?
Higher
Where ROMM is high, what level of detection risk can be accepted by the auditor?
A much lower risk
Elements of detection risk:
Sampling risk (‘SR’) - (sample isn’t representative)
Non-sampling risk (‘NSR’) - (inappropriate audit procedure, failure to perform an audit procedure (correctly))
Audit risk equation components explained (a photo)
