Topic 4 - Risk Flashcards
Audit Risk, Def. and formula
Obtain sufficient and appropriate evidence to reduce risk to acceptable level.
Focus on areas that most likely to cause material misstatements.
Inherent Risk (nature of business) x Control Risk (entities controls) x Detection Risk*
*Auditor has control of Detection Risk; if IR and CR are too high risk the auditor will increase procedures performed to reduce risk and vice versa
Risk Assessment Procedures
-Analytical procedures – comparing financial information through analysis - plausable relationships, identify unusual changes.
-Enquiries – seeking information from knowledgeable persons.
-Inspection – examining records or documents or physical examination of an asset.
-Observation – looking at a process being performed by others.
Ratios
Profitability
-Gross Profit (Gross Profit/ Sales) x 100%
-Net Profit (Net Profit / Sales) x 100%
Planning
-Receivables Days (Average receivables / Credit Sales) x365
-Inventory Turnover Cost of goods sold / Average inventory
-Payables Days (Average Payables / Credit purchases) x 365
Testing
-Current Ratio Current assets / Current liabilities
-Acid Test / Quick Ratio (Current assets – Inventory) / Current liabilities
Reporting
-Return on Capital Employed (Operating profit / Capital employed) x 100
Materiality
PBT - 5% - 10%
Revenue - 0.5% - 1%
Gross Assets - 1% - 2%
*Prudence = lower tolerance of the above figures.
Performance Materiality - Set by the auditor at a lower level than materiality.
Examples of Control, Inherent and Detection risks
Control:
-Change in staff.
-Clients have many locations.
-Lack of locks, passwords, monitoring.
-New computer systems installed.
-Lack of authorisation.
-Lack of segregation of duties.
Inherent
-Performance related pay.
-Cash-based business.
-Foreign exchange transactions.
-Specialist/ ever-changing industry.
-Unusual or complicated transactions.
Detection
-First year as a client.
-Tight audit deadline.
-Small engagement team.
-Untrained auditors.
