A2 Flashcards
WHAT IS AUDIT RISK?
2 ELEMENTS OF AUDIT RISK
Risk that the auditor may unknowingly fail to modify appropriately the opinion on FS that are materially misstated
Risk of material misstatement - risk that the FS are materially misstated
Detection Risk - risk that the auditor will not detect a material misstatement that exists in a relevant assertion
Factors that would increase inherent risk
Technological developments that make a product obsolete
Lack of working capital
Decline in overall industry or economy
High-volume transactions
Complex transactions
Amounts derived from estimates
2 Components of risk of material misstatement
Inherent Risk: Susceptibility of a relevant assertion to a material misstatement assuming that there are no related controls
Control Risk: Risk that a material misstatement that could occur in a relevant assertion will not be prevented or detected (and corrected) on a timely basis by the entity’s internal control.
Audit risk model
Include the relationship of detection risk to substantive tests
AR = RMM X DR
where: RMM = Risk of material misstatements
DR = Detection risk
There is an inverse relationship between RMM & DR
As the acceptable level of detection risk increases, the assurance required from substantive test decreases.
As the acceptable level of detection risk decreases, the assurance required from substantive testing must increase.
How can the auditor obtain more assurance from substantive procedures?
(N) Changing the nature of substantive tests from a less effective to a more effective procedure (ex: a direct test toward independent parties outside the entity rather than toward parties or documentation inside the entity)
(E) Changing the extent of substantive test (ex: using larger sample sizes)
(T) Changing the timing of substantive testing (ex: performing substantive test at year-end rather than at the interim)
What is the difference between error & fraud?
Error - unintentional misstatement or omission of amounts or disclosures in the financial statements
Fraud - intentional action that results in misstatements or omissions of financial information with the intent to deceive financial statement users
2 Types of fraud
Fraudulent financial reporting
Misappropriation of assets, or defalcation
What fraud risk factors are generally present when fraud occurs?
Incentives/pressures
Opportunity; and
Rationalization/attitude
Auditor identifies & evaluates these fraud risk factors as part of assessing the risk of material misstatement due to fraud.
Auditor’s responsibility to detect errors & fraud.
Auditor has to plan & perform the audit (using due care and professional skepticism) to provide reasonable (not absolute) assurance about whether the FS are free of material misstatement, whether due to errors or fraud.
When analyzing fraud risk, which 4 attributes should the auditor consider?
Type of risk
Significance of risk
Likelihood of the risk
Pervasiveness of the risk
