Week 4: Risk assessment method Flashcards
What is the difference between audit and business risk?
Audit risk: The risk of the auditor expressing an inappropriate opinion on the financial statements.
Business risk: The risk that the business cannot meet their business objectives
Is audit risk a function of business risk?
Yes, because business risk is much broader and contains the risk of misstatement. E.g., if business doesn’t do well if they expand there is a risk of misstatement in writing down cash and overstating inventory
What are real examples of business risk?
Non-for-profit organizations: if they can’t serve social responsibility
Profit organizations: if they can’t generate profit
What financial statement does the existence assertion refer to?
Asset liabilities and equities exist - the balance sheet
What item does occurrence and completeness relate to?
Occurrence - whether all revenue has occurred (some record revenue in advance before it has actually occurred)
Completeness - whether all expenses have been recorded (some companies record less expenses)
Which risk does the auditor have control over
Detection risk
What reality factors make risk more inherent than is it?
What else can business risk be known as?
Compliance risk
Who handles business risk?
Management
What risk does auditors assess but have no control of
Control risk
Which risk has an inverse relationship with the efforts the auditor puts in
Detection risk, the higher the risk the lower the effort (vice versa)
Which factors contribute to the audit risk
What audit assertions are there?
- Existence or Occurrence
- Completeness
- Cut-off
- Rights and obligations
- Accuracy, classification,
valuation and allocation - Presentation and disclosure
Which paragraph quotes the definition of audit risk?
ASA 200; ISA 200
Can audit risk ever be zero?
No
What are the definitions of the inherent, control and detection risk?
(their definitions)
Inherent risk: Risk that a material misstatement could occur
Control risk: Risk that client’s system of internal controls will not prevent or detect such a misstatement
Detection risk: Risk that the auditor’s testing procedures will not be effective in detecting a material misstatement should there be one system of internal controls
In what stage does audit risk get reduced in and how?
During the risk response stage and identifying the key risks and adjusting audit effort accordingly
What are the stages of an audit?
Phase 1: Perform risk assessment procedures
Phase 2: Assess risk of material misstatement
Phase 3: Respond back to risk
Phase 4: Perform further audit procedure
Phase 5: Evaluate audit evidence
Phase 6: Communite audit findings
How is information material to users?
When it has an impact on their decision making process
What guidance does materiality provide?
It guides audit planning, testing and assessment of information in financial report
What characteristics does information have to be considered material?
Qualitative materiality nature of the item:
- fraud
- non-compliance with laws
- related party transactions
- change of accounting methods
Quantitative materiality magnitude of item
- set as a % of relevant base
How do auditors set materiality?
Auditors use professional judgement
What stage of the auditing process is materiality set?
(testing knowledge and how well I know of the phases)
Risk assessment phase
How does audit firms vary in methods to set materiality percentages?
what documents do they set materiality on
They vary in methods to derive at an appropriate base percentage
- balance sheet bases include total assets or equity
- income statement bases include profit before tax, revenue or gross profit
What is the strongest type of audit evidence?
External confirmation
Whats the weakest form of audit evidence
Verbal evidence
What are the 2 strong indicators of evidence?
Sufficient and appropriate
True or false:
Auditor needs to gather sufficient and appropriate evidence about each assertion for each class of transactions, balances or disclosure
True
Does auditors need to conduct more substantive tests for client with low risk?
(tests understanding of procedures used for client of different risk)
False
