Chapter 4 - Risk Assessment Flashcards
Star - Define Audit Risk
The risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
Always have to consider the nature, timing, and extent of our evidence.
Inherent Risk vs. Control Risk
Inherent risk is inherent to the client (e.g. industry, complexity)
Control risks are risks internal controls are an issue. If you can’t test controls, then control risk must be set as HIGH
Star - Audit Risk Calculation
Inherent Risk * Control Risk * Detection Risk
Star - What is Detection Risk?
Risk that the auditor will NOT detect misstatements that exits and could be material.
Risk of Material Misstatement (RMM) calculation
Inherent Risk * Control Risk
What is RMM’s relationship to DR?
Risk of material misstatement is the inverse of detection risk. The lower the detection risk, the more testing the auditor must do because the inherent and control risks are high.
What is Engagement Risk?
An auditor’s exposure to financial loss and damage to their professional reputation from litigation or adverse publicity from audited financial statements.
Formula to Determine the Appropriate Level of Detection Risk
Detection Risk = Audit Risk / RMM (IR * CR)
How do Auditors use Detection Risk?
Auditors use the planned level of detection risk to design substantive procedures that will reduce audit risk to an acceptable level.
Factors relevant to an Auditor’s Understanding of the Entity and in Identifying Risks of Material Misstatements
Industry Conditions
Regulatory Environment
Other External Factors
Relevant Industry Conditions for an Auditor
The Market and Competition
Cyclical or Seasonal Activity
Product Technology relating to the Entity’s Products
Energy Supply Costs
Regulatory Environment Factors to be Mindful Of
Industry specific practices and acct. principles
Regulatory framework for an industry
Legislation and regulation
Taxation legislation and regulations
Govt. policies affecting the conduct
Environmental requirements
Other External Factors that are Relevant for an Auditor
General economic conditions
Interest rates and availability of financing
Inflation and currency revaluation
Star - What does the Auditor do if Fraud is Detected?
Auditor must bring it to the attention of the appropriate level of management. If it involves Sr. management and causes a material misstatement, fraud should be brought to the attention of the audit committee
(ESSAY QUESTION) What Would Auditors Discuss During a Brainstorming Session?
They would discuss the entity’s financial statements’ susceptibility to fraud.
Internal and external factors affecting the entity
Risk of management override to controls
Consider circumstances that might indicate earnings management or manipulation
Emphasize importance of professional skepticism
Discuss how auditor might respond to susceptibility of fraud
