Session 4 Flashcards
Risk Assessment
What is inherent risk?
Risk of a misstatement in an account or disclosure, due to fraud or error, before even considering internal controls and safeguards
e.g., obsolescence, client close to violate covenants, cash is more susceptible to be stolen, etc
What is control risk?
Risk that a material misstatement will not be detected or prevented on time by the entity’s internal control
e.g., accounts not reconciled monthly, inadequate segregation of duties, disbursement without proper approval
What is detection risk?
Risk that the auditor’s own measures won’t detect some existing or potential material misstatements
e.g., substantive procedure is omitted, confirmation failed to detect something
How does the cyclical or seasonal activity of a company affect a source of business risks? (3)
- Heavy workforce needed during peak season
- Risk for slow-moving or obsolete products
- Risks of misestimating demand for next season product (both not enough or too much product can be problematic)
How are the costs and availability of material a form of business risk for entities? (2)
- If price of raw mats increases, it will lead to higher sales price for finished product, so either the profit margin will diminish, or demand for the product will decrease.
- If the entity can’t put its hands on the raw material, they can’t sell the finished good, leading to decreases in revenues.
What are 3 conditions that are generally present when fraud occurs
JOI
1. Those involved are able or try to Justify committing a fraudulent act
2. Circumstances exist to give the Opportunity for fraud to happen
3. Management Incentive or pressure to perpetrate fraud
What is the auditor’s responsibility for detecting fraud
The auditor’s responsibilities regarding fraud is to determine, with reasonable assurance, that the financial statements are free of material misstatements, whether due to error or fraud.
ALSO important:
- Professional skepticism
- Detection risk higher for fraud
- Fraud risk meeting
