Risk

Question 1

What is audit risk

Answer 1

Is the risk that an inappropriate opinion is provided on the financial statements

Question 2

Audit risk formula

Answer 2

AR = RMM X DR

RMM = IR X CR

IR = Inherent Risk
CR = Control Risk
DR = Detection Risk

Question 3

What is RMM comprised of

Answer 3

Inherent Risk

Control Risk

Question 4

What is detection risk

Answer 4

The risk that the procedures performed by the auditor will not detect a material misstatement.

Question 5

What is the auditors objective when it comes to risk

Answer 5

The auditor’s objective is to design procedures that will bring the detection risk to an acceptably low level to compensate for any RMM and thus bring the overall audit risk to low.

Question 6

There is an inverse relationship between RMM and Detection Risk

Answer 6

If inherent and control risks are both assessed as high, detection risk will need to be low in order to achieve a low audit risk.

Question 7

Implications of detection risk assessed at low

Answer 7

More assurance is needed from audit evidence to be able to achieve a low detection risk

Question 8

How to gain more assurance from audit evidence

Answer 8

Increase their reliance on substantive procedures

Assign more experienced staff to the audit

Incorporate additional independent review of working papers.

Question 9

Techniques to gather evidence in the assessment of the RMM

Answer 9

• inquiring with management, the internal audit department, the board of directors and legal counsel
• performing analytical procedures over available financial information
• observing and inspecting processes, controls, and significant documents

Question 10

Once RMM at the OFSL has been set, some options for the practitioner’s response are:

Answer 10

• emphasizing professional skepticism to the audit team
• assigning more experienced staff to the audit team
• increasing supervision of the audit
• adding elements of unpredictability in audit procedures
• making changes to the nature, timing, and extent of the audit procedures
• if the company has multiple locations/branches, increasing the number of locations/branches to be tested

Question 11

Inherent risk examples

Answer 11

• Poor financial health concern - going concern
• market competition - concern -mgmt bias to overstate revenue recognition
• First time audit - concern - opening balances
• IPO or upcoming purchase or sale - concern - Mgmt bias to make statement more favourable
• Stringent regulation - concern - new users to FS
• Compensation based on financial performance - concern - mgmt bias
• Rapid growth - concern - lack of opportunity to formalize systems, mgmt bias to make statements look stronger
• Debt fully leveraged - concern - mgmt bias to present favourable statements
• FX transactions - concern - inherently complex transactions
• Newly appointed CEO - concern - mgmt bias to produce improved performance

Question 12

Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements

Answer 12

Per CAS 240.11, with regard to fraud, the objectives of the auditor are as follows:

• to identify and assess the risks of material misstatement of the financial statements due to fraud
• to obtain sufficient appropriate audit evidence regarding the assessment of risks of material misstatement due to fraud through designing and implementing appropriate responses
• to respond appropriately to fraud or suspected fraud identified during the audit

Question 13

Examples of planned audit responses to fraud risks at the OFSL include

Answer 13

• assigning additional audit personnel with specialized knowledge and skills based on the fraud risk factors identified
• evaluating selected accounting policies and their application more carefully
• including an element of unpredictability in the audit procedures
• heightening the practitioner’s level of professional skepticism