Audit risk Flashcards
What is audit risk?
Risk that the auditor expresses an inappropriate opinion (unmodified) when financial statements are materially misstated.
can lead to legal action by regular body or litigation for auditor.
What is the risk of material misstatement?
This is the risk that the financial statements are materially misstated prior to the audit. This can be due to fraud or error occurring during transactions being processed.
What level of work do auditors do?
Auditors need to do enough to cover themselves but not too much that they waste time and money.
What should auditors do to conduct a risk assesment?
- identify areas where misstatements are likely to occur.
- plan procedures to address those risks
- have an efficient, focused and effective audit
- reduce the risks of issuing an inappropriate opinion to an acceptable level
- minimise the risk of reputational and punitive damage.
What is inherent risk?
The susceptibility of a transaction, account balance or disclosure to material misstatement, irrespective of the controls in place.
entity level (profit related bonus)
industry level (banking)
balance level (inventory/complex item)
subjectivity, complex, uncertainty
examples of inherently risky situations?
PPE - undergone refurbishment
Depreciation - subjective, useful life?
Provisions - obligation?
intangibles - research and development?
What is control risk?
Risk that the material misstatement would not be prevented, detected or corrected by the accounting/internal control systems.
What questions should the business be thinking?
are these controls working as they should?
are they effective? will they prevent or detect material misstatement?
if controls are missing/not effective will they increase the risk of misstatement in financial statements.
what is Detection risk?
Risk that the procedures performed by the auditor to reduce the audit risk to an acceptable low level will not detect a misstatement that exists and could be material.
What is sampling risk?
The risk that the auditors conclusion based on a sample is different from the conclusion that would have been reached if the entire population were evaluated.
What is the audit risk formula?
audit risk = inherent risk x control risk x detection risk
How to the auditors know how much to test?
If inherent risk and control risks are inherently low then detection risk can be lowered and therefore the auditors can do less detailed testing, smaller samples, cheaper (using junior staff).
What do auditors need to do?
Identify risks
Assess whether the risks relate to what can go wrong in the financial statements
Consider whether the risks are of magnitude that could result in a material misstatement
Consider the likelihood of risks causing a material misstatement
What should the auditors response be to high-risk assessment?
Emphasise need for professional scepticism.
Assign more experienced staff to complex/risky areas.
Chane the nature, timing and extent of supervision, review the work.
incorporate unpredictability.
Change overall strategy.
What is a related party?
An individual or organisation who influences or has influence over the entity. They are material by nature and therefore hight risk.
Transactions with related parties might take place for reasons other than normal business this is normal but should be brough to shareholders attention
