Week 2: Audit planning, risk and materiality Flashcards
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 whihc the audit opinion is based
What are the factors to consider when slecting audit procedures?
Auditor’s understanding of the entity environment
The auditor’s assessment of business risk and inherent risk
The nature of the internal control system and the assessment of control risk
Materiality of the particular component of the financial report
The financial report assertion involved
Experience gained from previous audits
The results of other audit procedures, including whether they identified specific instances of fraud
Source and reliability of information
Persuasiveness of audit evidences obtained
what are the seven methods and techniques to gather evidence?
The seven methods and techniques to gather evidence:
Enquiry
Inspection
Observation
External Confirmation
Recalculation
Re-performance
Analytical procedures
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 (IR) is the Probability of an assertion to misstatement that could be material individually or when aggregated with other misstatements, assuming there were no related internal controls
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 defined as:
The risk that an entity’s business objectives will not be attained as a result of the external and internal factors, pressures and forces brought to bear on an entity and, ultimately, the risk associated with the entity’s survival and profitability.
Requires extensive knowledge of client’s business and industry.
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 is Information, individually or in aggregate, that if misstated or omitted from a financial report may adversely affect decisions about the allocation of scarce resources made by financial report users. (ISA 320.2).
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?
As noted by ISA 320.6, the auditor will consider the nature of the item when determining the materiality level.
Materiality is a concept of relative significance.
It depends on the amount of the item of interest and some relevant basis of comparison.
To estimate an amount for planning materiality, the auditor selects a base and a suitable percentage to apply to that base.
This requires professional judgment, and not all auditors do it the same way.
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:
‘The amount or amounts set by the auditor at less than materiality for the financial report as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial report as a whole or if applicable for a particular class of transaction, account balance or disclosure.’
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
