W6 Assessing Audit Risks Flashcards
What do we mean by ‘material’
Misstatements including omission are considered material if they individually or in aggregate could be expected to influence the economic decisions of users taken on the basis of the financial statements
What is performance materiality
Amount set by auditor at a value lower than overall materiality, and uses this lower threshold when designing and performing audit procedures.
Reduces the risk of the auditor failing to identify misstatements that are material in combination
What is materiality by size
A monetary amount established by auditors at the start of the audit
Any amount above would be considered material
Usually determined with regard to the size of the account
What is materiality by nature
Misstatements that when adjusted turn a reported profit into a loss
Misstatements that affect compliance with debt covenants
Disclosures relating to directors or related parties
Why is materiality important
If financial statements contain material misstatement, then they do not give a true and fair view
What is professional judgement
Application of relevant training, knowledge and experience in making informed decisions necessary in the audit engagement
What is audit risk? How can it be managed?
The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated
auditors must manage this risk and reduce it to an acceptably low level by obtaining sufficient appropriate audit evidence
What does audit risk comprise
- Risk of material misstatement; (inherent risk and control risk)
- Detection risk
Audit risk = inherent risk * Control Risk * Detection Risk
What is inherent risk
Risks of misstatement that stem from the nature of the organization, its activities, or its transactions
What is control risk?
Risk of a misstatement not being corrected or prevented from internal controls
*can never be eliminated
What is detection risk? What can it sub-divided into
Risk that procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect misstatement that exists and that could be material (either individually or in aggregate)
- detection risk can be sub-divided into sampling and non-sampling risk
What is sampling risk
Risk that the auditors conclusions based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure
What is non-sampling risk
the auditor reaches an incorrect conclusion for any reason not related to sampling risk
What is the audit risk model
AR = IR * CR * DR
- Auditors first assess the levels of inherent and control risk, then decide on n audit strategy that will reduce detection risk to a level such that the consequent audit risk is acceptably low
- the more testing the auditor performs, the lower detection risk will be, therefore the lower the audit risk will be
What is analytical procedure
Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data and investigation of fluctuations, inconsistent relationships or amounts that differ from expected values by significant amount
when are analytical procedures used
used in all stages of the audit
Preliminary analytical procedures
- auditors perform analytical procedures as a risk assessment procedure in order to help the auditor gain an understanding of the entity and assess the risk of material misstatement
Substantive analytical procedures
Final analytical procedures
use at the completion stage when forming an overall conclusion whether the financial statements are consistent with the auditor’s understanding of the entity
How is materiality determined
Matter of professional judgement
Auditor must consider:
- Whether the misstatement would affect the economic decision of the users
- size and nature of misstatements
- the information needs of the users as a group
Why are analytical procedures performed
Identify aspects of the entity of which the auditor was unaware
Assist in assessing the risks of material misstatement
Help identify unusual transactions/event/amounts/ratios or trends that may have audit implications
Help identify risks of material misstatement due to fraud or error
Why is professional judgement needed
Needed when making decisions about:
- materiality and audit risk
- the nature, timing and extent of audit procedures to be performed
- Whether sufficient audit evidence has been obtained
What factors effect control risk
The quality and quantity of management/staff
The nature of control activities, frequency of their operation
The segregation of duties in the course of their operation
