Module 13 - Audit Process: Fundamental Concepts

Question 1

Audit risk definition

Answer 1

The risk that the auditor gives the wrong opinion on the financial statements when the financial statements are materially misstated

Question 2

Misstatement definition

Answer 2

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

Question 3

What is the ‘risk-based’ approach to auditing (required by the ISAs) designed to do:

Answer 3

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

Question 4

Risk-based approach definition

Answer 4

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

Question 5

In addition to risk, there are some underlying fundamental concepts that related to the practical process of auditing - such as:

Answer 5

Materiality

Evidence

Audit judgement

Question 6

Materiality definition

Answer 6

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

Question 7

Two ways in which materiality can impact audit:

Answer 7

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

Question 8

Materiality should be considered by the auditor when:

Answer 8

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

Question 9

An auditor can only express an opinion over whether the accounts are ‘true and fair’ if they have…

Answer 9

Collected enough evidence to support the figures

Question 10

What does reasonable assurance mean?

Answer 10

The auditor must gather sufficient, appropriate audit evidence to reduce audit risk to an acceptably low level

Question 11

Methods of gathering evidence for an audit

Answer 11

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)

Question 12

An audit judgement is often referred to as a

Answer 12

Professional judgement

Question 13

Is professional skepticism important in a good quality audit?

Answer 13

Yes

Question 14

What is audit risk?

Answer 14

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

Question 15

Audit risk is the product of three different components:

Answer 15

Inherent risk

Control risk

Detection risk

Question 16

Audit risk formula?

Answer 16

Audit risk = inherent risk X control risk X detection risk

Question 17

Inherent risks can arise from two sources

Answer 17

Business risk

Account specific risk

Question 18

Inherent risk can arise from two sources: Business risk & Account specific risk

The impact of these risks can then be categorised into two categories

Answer 18

Financial statement level risks - something that will impact the financial statements as a whole

Assertion level risks - specific area of the accounts only

Question 19

When is inherent risk assessed?

Answer 19

From the start of the audit

Majority of work on IR performed in the planning stage

Question 20

How does the auditor gather evidence over inherent risk?

Answer 20

By gaining an understanding of the entity

Question 21

When does control risk increase?

Answer 21

Where the internal control systems at an entity are poorly designed or do not operate effectively

Question 22

When is control risk assessed?

Answer 22

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

Question 23

Risk of Material Misstatement (‘ROMM’) definition:

It is the combination of what?

Answer 23

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

Question 24

What is detection risk?

Answer 24

The balancing figure in the audit risk equation

The risk that the auditor will not find a misstatement

Question 25

What type of relationship does Risk of Material Misstatement (‘ROMM’) have with Detection Risk?

Answer 25

An inverse relationship

Question 26

Detection risk level will determine the nature, extent and timing of what?

Answer 26

Substantive testing

Question 27

What element of risk is the only element controlled by the auditor?

Answer 27

Detection risk

Question 28

Detection risk can be split into two types

Answer 28

Low detection risk

High detection risk

Question 29

How does low detection risk work?

Answer 29

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

Question 30

How does high detection risk work?

Answer 30

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

Question 31

When ROMM is low, there is “what” chance of an error occurring in the financial statements:

Answer 31

Less

Question 32

If ROMM is low, what level of detection risk can the auditor accept?

Answer 32

A much higher level of detection risk

Question 33

Where ROMM is high, there is a “what” risk of misstatement in the accounts?

Answer 33

Higher

Question 34

Where ROMM is high, what level of detection risk can be accepted by the auditor?

Answer 34

A much lower risk

Question 35

Elements of detection risk:

Answer 35

Sampling risk (‘SR’) - (sample isn’t representative)

Non-sampling risk (‘NSR’) - (inappropriate audit procedure, failure to perform an audit procedure (correctly))

Question 36

Audit risk equation components explained (a photo)

Answer 36