Module 13 Audit Process: Fundamental Concepts Flashcards

1
Q

What is audit risk?

A

The risk that the auditor gives the wrong opinion on the financial statements when the financial statements are materially misstated.

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2
Q

What is misstatement?

A

Where there is a difference between an amount, classification, presentation or disclosure reported in the financial statements and the correct treatment in accordance with the applicable financial reporting framework. Misstatements can arise from fraud or error.

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3
Q

What is the risk-based approach?

A

This is where auditors tailors the nature, extent and timing of audit procedures performed on each area of the financial statements according to the risk of there being a misstatement in that area.

(it allows auditors to focus audit work on the areas that are most likely to contain issues and so ensures that the audit is efficient)

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4
Q

What is materiality?

A

An expression of the relative significance or importance of a particular matter in the context of the financial statements as a whole.

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5
Q

How does materiality impact audit work?

A

It determines the scope of the work performed (which items are tested and to what degree)

It determines the nature of the final audit opinion. Where a material misstatement exists in the financial statements, they do not show a true and fair view.

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6
Q

Why is gathering evidence during audits important?

A

An auditor can only express an opinion over whether the accounts give a true and fair view if they have collected sufficient and appropriate evidence to support the figures.

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7
Q

What are the three methods of gathering evidence?

A

Understanding the entity and the overall control environment

Testing the controls of the entity

Testing the numbers in the financial statements

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8
Q

What is audit judgement often referred to as?

A

The appropriateness of an auditor’s judgement is dependent on the competence and experience of the auditor and the need to comply with accepted methodology, this is often known as professional judgement.

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9
Q

What is professional scepticism?

A

Having an attitude that includes a questioning mind that challenges management with a degree of doubt that demands hard evidence, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.

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10
Q

What are the three risk components of audit risk?

A

Inherent Risk (IR) - The susceptibility of a financial statement account to a material misstatement, irrespective of related internal controls.

Control Risk (CR) - The risk that the entity’s controls will not prevent or detect and correct a material misstatement in the financial statements on a timely basis.

Detection Risk (DR) - The risk that the auditor’s procedures will not detect material misstatements that exists in the financial statements.

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11
Q

What is the audit risk formula?

A

Audit risk = Inherent Risk X Control Risk X Detection Risk

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12
Q

Where can inherent risk come from?

A

Business risk - business risks that would have an impact on the financial statements would be considered an inherent risk

Account specific risk - accounts that contain non-routine, complex or judgemental transactions are inherently risky

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13
Q

What are the two categories that risk can be categorised into?

A

Financial statement level risks - Something that will affect the financial statement as a whole (the impact of a misstatement would be at the financial statement level)

Assertion level risks - this relates to a specific area of the accounts only (the impact of misstatement would be at the assertion level)

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14
Q

Where does control risk come from?

A

Control risk increases where the internal control systems at an entity are poorly designed or do not operate effectively

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15
Q

What is risk of material misstatement (ROMM)?

A

The combination of inherent risk and control risk. It is the risk that a material misstatement may exist in the financial statements prior to the auditor undertaking any procedures.

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16
Q

How is risk of material misstatement (ROMM) assessed?

A

It is assessed as either low, medium or high.

17
Q

What is the role of detection risk in the audit risk equation?

A

Detection risk is the balancing figure in the audit risk equation. Detection risk is the risk that the auditor will not find a misstatement.

Detection risk and ROMM have an inverse relationship

18
Q

What does low detection risk mean?

A

High Risk in ROMM and therefore more work needs to be done to reduce the audit risk to low (auditors can only accept a lower level of detection risk as there are potentially a lot of material misstatement in the accounts)

19
Q

What does high detection risk mean?

A

Low risk in ROMM and therefore less work can be done to reduce the audit risk to low (auditors can accept a higher level of detection risk as there is less chance errors exist in the first place)

20
Q

What are the two elements of detection risk?

A

Sampling Risk (SR) - The risk that testing a sample from a population does not give the same conclusions as testing the whole population would have given. It can be reduced by increasing the sample size.

Non-sampling risk (NSR) - The risk that an incorrect judgement is made because the audit procedures used were not appropriate or testing results were wrongly interpreted by the audit team. It can be reduced through adequate planning, professional scepticisim and adequate review of work performed.