Set 1 - AU Chapter 6 - Risk

Question 1

Define audit risk

Answer 1

The risk that the auditor issues an inappropriate audit opinion when the financial statements are materially mis-stated.

Question 2

What is the audit risk model?

Answer 2

Audit Risk (AR) = Risk of material misstatement (RMM) x Detection Risk (DR)

Question 3

Break down RMM into it’s two components. Is this controlled by the auditor?

Answer 3

Inherent Risk (IR) x Control Risk (CR). No, it is not controlled by auditor. It is just assessed.

Question 4

What is the relationship between DR and RMM (IR and CR)?

Answer 4

Inverse. The lower the risk of IR and CR (RMM), the higher the risk of DR that can be allowed. If the client can rely on controls then they do not need as much audit evidence to keep AR at an appropriate level.

Question 5

What are 3 techniques used by auditors to gather evidence in assessing the RMM?

Answer 5

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

Question 6

What are some IR factors at the OFSL level?

Answer 6

• company in poor financial health
• significant market competition driving down prices
• no prior audit
• upcoming purchase or sale of company
• employees with reliance on net income for bonuses
• upcoming IPO
• stringent regulation

Question 7

What are some CR factors at the OFSL level?

Answer 7

• outdated GL system
• lack of segregation of duties
• lack of internal audit function
• lack of general computer controls
• management has poor attitude towards controls
• management over-ride of controls
• lack of policies
• lack of documentation

Question 8

Once identified, what procedures can be implemented to address RMM at OFSL?

Answer 8

• emphasis on professional skepticism
• assigning more experienced staff to the team
• increased audit supervision
• adding elements of unpredictability to audit procedures
• making changes to nature/timing of audit procedures
• if multiple locations, audit more than one

Question 9

What are some IR factors at the assertion level?

Answer 9

• tech change in industry, making inventory obsolete
• concentration of customers in one industry experiencing a downturn, affecting collectability
• type of inventory - more specialized may become obsolete quicker
• inventory subject to theft - high-value
• significant estimate uncertainty
• complex transactions or calculations
• unusual or non-routine transactions

Question 10

What are some CR factors at the assertion level?

Answer 10

• performance reviews of two sets of data. maybe budget vs actual. investigation of unusual results.
• IT processing controls, checking accuracy, completeness and authorization of transactions.
• physical controls such as secured facilities, authorization to access computer programs etc.
• segregation of incompatible duties. These duties include the custody of assets; the authorization or approval of transactions that affect the assets; and the recording, reconciliation, and reporting of accounts that contain the assets