Risk Flashcards
What is the definition of Audit risk?
Audit risk is the risk that the Auditor expresses an inappropriate opinion on the financial statements. It is comprised of the risk of material misstatement and detection risk.
What is meant by Professional Scepticism?
This is essentially being questioning and critical of information provided.
Test it for gaps, inconsistencies and potential bias.
Clients may not always provide a full or accurate picture.
What is meant by Professional Judgement?
Professional judgement is what must be exercised when applying audit standards and ethical frameworks.
No two situations will be the same so standards cannot be equally enacted or applied on a mechanical basis.
What is meant by a Misstatement and what are the 3 main reasons for these occurring?
Misstatements are:
- A number which is not correct
- An accounting treatment which is not inline with the relevant standard.
- A missing and Necessary disclosure
- An inadequate disclosure.
They may occur for one of 3 main reasons:
- Numbers have been misstated due to transactions not being carried out or internal controls not working effectively.
- Disclosures are missing or inadequate e.g. going concern disclosures being omitted.
- The basis of preparation is inappropriate - i.e going concern when should have been break up basis.
What is Inherent Risk and where is it likely to arise?
Inherent risk - the susceptibility of an assertion about transactions, balances or disclosures to a misstatement that could be material, before consideration of any related internal controls.
Think Scout risk assessments - what could go wrong before safeguards are put in place = Inherent risk.
Qualitative inherent risk factors include:
- Complexity
- Subjectivity
- Change
- Uncertainty
- Susceptibility to misstatement due to management bias.
What are the Main accounting standards examined in the exam?
IAS® 1 Presentation of Financial Statements
There is a risk of inadequate disclosure of going concern uncertainties if the directors do not make such disclosures which are required by IAS 1.
IAS 2 Inventories
There is a risk that inventory may be overstated if the company has not valued the inventory at the lower of cost and net realisable value. This may be indicated by an increase in the inventory holding period.
IAS 10 Events After the Reporting Period
There is a risk that receivables are overstated if the company does not adjust the financial statements in respect of the bankruptcy of a customer after the year end where that customer is included as a receivable at the year end.
IAS 16 Property, Plant and Equipment
There is a risk of overstatement of property, plant and equipment if expenditure on repairs is treated as capital expenditure.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
There is a risk that provisions are overstated if the recognition criteria of IAS 37 have not been met, e.g. if no obligation exists at the year end.
IAS 38 Intangible Assets
There is a risk that intangible assets are overstated if the recognition criteria of IAS 38 have not been met for development costs, e.g. if research costs are treated as development expenditure.
IFRS® 15 Revenue From Contracts With Customers
There is a risk that revenue is overstated if the company has recognised revenue before the performance obligations within the contract have been fulfilled.
What is control risk?
Control Risk - the risk that a misstatement is not prevented, detected or corrected by the entities controls.
What is Detection risk?
Detection risk - risk that the procedures performed by the auditor do not detect a misstatement that exists and could be material.
Sampling Risk - Conclusion from sample would be different from conclusion if whole population was tested.
Non sampling risk - the risk of drawing the wrong conclusion for other reasons.
How is materiality defined?
Misstatements including omissions are considered material if they, individually or in aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of financial statements.
In other words would the error change the results enough that users would make a different decision.
What is performance materiality?
Performance materiality is:
- Set at less than materiality, judgement should be used to determine.
- To reduce risk of aggregate of smaller misstatements exceeding materiality for financial statements as a whole.
What are analytical procedures and how would we apply them?
Analytical procedures are evaluations of financial information through analysis of plausible relationships among both financial and non financial data, and investigations of identified fluctuations, inconsistent relationships or amounts that differ from expected values.
This is done by:
- Comparing current year statements to prior periods.
- Comparing actual performance to budgets and targets.
- Comparing performance to industry sector.
- This may include the use of various ratios i.e. profit margins ROCE and turnover days.
How should a typical exam question be approached?
Remember that an audit risk may be a risk of material misstatement or a detection risk.
When describing a risk of material misstatement your answer should have three elements to it:
1 The information taken from the scenario which indicates a risk, e.g. the company has recently upgraded its production facility.
2 Which balances in the financial statement could be wrong and how they could be wrong, e.g. property, plant and equipment may be overstated and expenses understated.
3 A link between points 1 and 2 e.g. because the company may have capitalised expenditure which should have been expensed.
When describing a detection risk your answer should include:
1 The information taken from the scenario which indicates a detection risk, e.g. the company is a new audit client.
2 An explanation of why this creates a risk, e.g. the audit firm has no cumulative knowledge and experience of the company.
3 A statement that this increases the detection risk of the auditor.
