Week 2: Audit planning, risk and materiality Flashcards
(25 cards)
What are the three stages of the audit process?
the three stages of the audit process are:
1) planning
2) evidence gathering
3) completion & review
What are audit procedures?
audit procedures are the actions tken by the auditor in acquring eveidence
What is audit evidence?
audit evidence is all of the information used in arriving at conclusions on which the audit opinion is based
What are the nine factors to consider when selecting audit procedures?
- Auditor’s understanding of the entity and its environment
- Assessment of business risk and inherent risk
- Nature and effectiveness of the internal control system (control risk)
- Materiality of the financial report component
- Relevant financial statement assertion (e.g. completeness, accuracy)
- Results and findings from previous audits
- Outcomes of other audit procedures (e.g. fraud detection)
- Source and reliability of information
- Persuasiveness and quality of audit evidence
what are the seven methods and techniques to gather evidence?
The seven methods and techniques to gather evidence are:
“Every Important Owl Eats Really Amazing Ramen.”
1) E. Enquiry
2) I. Inspection
3) O. Observation
4) E. External Confirmation
5) R. Recalculation
6) A. Analytical Procedures
7) R. Re-performance
What is Audit risk?
Audit risk is the probability that the auditor will give an inappropriate opinion.
Whats the equation for the audit risk model?
AR = IR x CR x DR
AUDIT RISK =
Inherent Risk
X
Control Risk
X
Detection Risk
What is inherent risk?
Inherent risk is the likelihood that there is a material mistatement in a financial statement assertion , assuming there are no internal controls in place to prevent or detect the error.
What is Control risk (CR)?
Control risk (CR) is the Risk that material misstatement might not be prevented or detected by internal control procedures.
What is Detection risk (DR)?
Detection risk (DR) is the Risk that auditors’ substantive procedures will lead auditor to conclude no material misstatement exists when, in fact, one does
How do we reduce audit risks?
we reduce audit risks by:
Adequate planning
Proper assignment of personnel to audit engagement team
Application of professional scepticism
Appropriate decisions on nature, timing and extent of audit procedures
Effective performance of audit procedures and evaluation of results;
Supervision and review of audit work performed.
What is Business Risk?
Business risk is the chance that a company might not meet its goals because of things inside or outside the business — like changes in the market, economy, or how the company is run. It includes the risk of losing money or even going out of business..
what is Control Testing ?
Control Tests are designed to assess control risk and the effectiveness of the internal control system
what is Substantive Testing?
Substantive Testing are Tests designed to reduce Detection Risks and whether the $ is materially misstated
What is materiality?
Materiality means how important a piece of information is in a financial report. If leaving it out or getting it wrong could change someone’s decision — like an investor or lender — then it’s considered material.
When does an auditor use materiality?
An auditor uses materiality:
Planning the audit – preliminary assessment
Performing the audit – determine the nature, timing and extent of audit procedures
Completion and Review stage of the audit
For what does the auditor determine materiality?
Financial report as a whole – overall materiality
Particular classes of transactions
Particular account balances and disclosures
What financial information is used as a base?
Financial report to be audited (if available)
Annualised interim financial information
Previous period’s financial reports.
What qualitative factors should be considered in setting materiality?
The significance of the item to the particular entity
The pervasiveness of the misstatement
The effect of the misstatement on the financial report as a whole
What is noted in ISA 320.6?
ISA 320.6 says that materiality depends not just on the size of an item, but also on its nature. Even small amounts can be material if they relate to sensitive areas, like fraud or director pay.
Auditors estimate planning materiality by picking a financial base (like profit or revenue), applying a percentage, and using professional judgment — there’s no one-size-fits-all rule.
what is ISA 320.11?
ISA 320.11 requires the auditor to set performance materiality for the purposes of assessing further audit procedures.
what is ISA 320.9?
ISA 320.9 defines performance materiality as:
Performance materiality is a lower amount set by the auditor (below overall materiality) to make sure that small errors don’t add up and cause the financial statements to be wrong as a whole. It helps reduce the chance that total uncorrected or undetected mistakes go over the main materiality limit.
How do you select the chouce of base?
The choice of a base depends on value judgements about relevance, stability and predictability.
Net profit may be the most relevant base for a company with publicly traded securities. However, because net profit can fluctuate significantly from year to year it lacks stability, and it is not relevant to entities such as non-profit organisations.
Size-related bases such as total assets or total revenue may be preferred because of their relative stability.
What is the Inverse relationship between materiality and audit risk?
An auditor sets a lower materiality threshold for accounts that have a higher audit risk. This means the auditor will need to collect more evidence for these riskier accounts; and vice versa
