Risk Flashcards
Materiality
-depends on size and nature of misstatements. It is a matter of judgement
-how much of an impact does it have on the financial statements being true and fair
-materiality is considered throughout the audit in particularly when:
1. Identifying the risks of material misstatement
2. Determining the nature, timing, and extent of audit procedures
3. Evaluating the effect of uncorrected misstatements on the financial statements and informing the opinion in the auditors report
Planning materiality
-materiality level set at the planning stage
-determine sample size
-materiality level is constantly received and may be changed. This may be due to:
1. Draft financial statements being altered
2. External factors may cause changes in risk estimates
Value. %
Revenue. 0.5 to 1
Total assets. 1 to 2
PBT. 5 to 10
Materiality needs to be determined at both
- Financial statement level. Auditors response may include
-> assign more experienced auditors staff
-> design less predictable audit procedures
-> greater supervision over audit work - Assertion/individual account level
Individual accounts are called
-class of transactions or account balances
-financial statements line item (FSLI)
-> tolerable level, for errors, will be decided at the planning stage
Performance materiality
-> the amounts set by the auditor at less than materiality for the financial statements to reduce the probability that the aggregate of uncorrected and undetected misstatements exceeds the overall materiality
-> the auditor estimates these levels prior to commencing the audit work:
1. Select appropriate benchmarks
2. Identify appropriate financial data for benchmarking (last years results/forecasts)
3. Determine percentage to be applied to benchmarks (depending on nature of business)
Audit risk (IMPORTANT)
-> risk that auditor gives an inappropriate opinion on the financial statements
-> analyse risks and direct work towards riskier areas
Audit risk = inherent risk x control risk x detection risk
1. Risk of inappropriate audit opinion
2. Risk an assertation about a class of transactions, account balances or disclosures to a misstatement could be material, before consideration of any related controls
3. Risk that internal control arrangements will fail to prevent material misstatements, or to detect and correct them on a timely basis
4. Risk of auditors failing to detect material misstatement. Risk that audit procedures performed to reduce the audit risk to an acceptably low level will not detect a material misstatement. Auditors have some control over over detection risk (unlike inherent and control) so can manage risk by manipulating detection risk. If audit deemed high, auditors carry out more work to reduce risk. Split into sampling and non sampling risks.
What might increase inherent risk
-amount includes an estimate
-significant/important figures
-entity is having financial difficulties/seeking finance/incentive to manipulate figures
-complex accounting requirements
-inexperienced staff
-cash (based business and completeness of income)
Assessing control risk
- Identify existing controls
- Identify absence of key controls
- Determine potential material misstatements that could result
- Consider possibility of compensating controls
Detection risks
Sampling risks
-> not checking 100%
-> not representative of data
Non sampling risks
-> not sufficiently investigated
-> inappropriate or misinterpreted evidence
Applying audit risk model
- Set a planned level of audit risk for each account balance or class of transactions
- Inherit risk and control risk are assessed. This will involve an assessment of business risk and the risk of material misstatement (due to fraud and error)
- Detection risk is then set at an appropriate level by solving the audit risk equation
Identifying and assessing risks, auditor needs to (isa uk 315)
- Identify risks
- Assess the risks and relate them to what can go wrong in financial statements
- Consider whether the risks are of a magnitude that could result in a material misstatement
- Consider likelihood of risks causing a material misstatement
How.
- Identify essential resources of the business and determine which are the most at risk
- Identify possible liabilities that may arise
- Review the risks that have arisen in the past
- Consider any additional risks imposed by new objectives or new external factors
- Seek to anticipate change by considering problems and opportunities on a continuing basis
What may increase risk
-changes to operating environment
-new key management/staff
-new info systems
-rapid growth
-new technology
-new products or activities
-corporate restructuring
-overseas operations
-new client
Business risks (IMPORTANT)
-> risk inherent to company and its operations and compromises operational, financial, and compliance risks. And may result in a material misstatement in the financial statements.
- Financial risks
-> risks arising from financial activities - Operational risks
-> risk arising from operations - Compliance risks
-> risk arising from non compliance with laws and regulations that a business must operate within
Audit risk V Business risk
Audit risks must be related to the risk arising in the audit of the financial statements and should include the financial statements assertions impacted
-> assertions about classes of transactions and events for the period under audit
-> assertions about account balances at the the period end
-> assertions about presentation and disclosure
-practicable problems (counting stock)
