Chapter three: Risk assesment part 1: audit risk and audit stategy

Question 1

Three phases (or stages) of the audit

Answer 1

1. Risk assessment: The auditor gains a detailed understanding of the client that drives the planning of the audit.
2. Risk Response: the auditors perform the detailed work that was planned
3. Reporting: auditors form their opinion and issue audit report

Question 2

4 factors that influence client acceptance and retention

Answer 2

1. Integrity of management
2. competency issues
3. independence issues
4. special circumstance and unusual risk

Question 3

Engagement letter

Answer 3

client acceptance letter that sets out the terms of the audit engagement to avoid any misunderstanding between the auditor and the client. Such as scope of the audit, fees and the responsibilities of both parties.

Question 4

Audit risk

Answer 4

the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. RISK ASSESSMENT PHASE

Question 5

Qualitative factors

Answer 5

qualitative material refers to information significant due to its nature rather than its size. Examples include fraud, changes in accounting methods, operational shifts affecting risk, or potential breaches of debt covenants.

Question 6

Quantitative factors

Answer 6

• Quantitative material refers to information significant due to its dollar magnitude.
• Some items can impact a user’s decision-making because of their dollar magnitude in the financial statements.
• For instance, errors or omissions in inventory, being a large current asset, can be quantitatively material.

Question 7

Risk of material misstatement RMM)

Answer 7

the risk that the financial statements are materially misstated prior to the audit; a combination of inherent risk and control risk. The client has messed up financial statements.

Question 8

Inherent risk IR

Answer 8

The risk that inherently things will have problems. This is a client component. Inherent risk happens inherently everything has risks.

Question 9

Control Risk

Answer 9

the risk that a client’s system of internal controls will not prevent or detect a material misstatement on a timely basis. This is a client component

Question 10

Detection Risk

Answer 10

the risk that the auditors testing procedures will not be effective in detecting a material misstatement. Auditor component

Question 11

Two approaches to testing controls

Answer 11

1. Reliance controls
2. substantive approach

Question 12

Fraud triangle

Answer 12

1. Pressure- what might incentivize management to cook the books?
2. Opportunity- do they have the opportunity to do fraud? due to bad controls.
3. Rationalization- what is the justification to commit fraud? “Everyone is doing it”

Question 13

audit strategy

Answer 13

provides the basis for developing an audit plan that details the nature, extent, and timing of the audit procedures that will be performed

Question 14

Planning materiality

Answer 14

Bench mark materiality level set

Question 15

performance materiality

Answer 15

amount or amounts set by the auditors at less than the planning materiality level for particular classes of transactions, account balances, or disclosures

Question 16

example of planning and performance materiality

Answer 16

If Starbucks’ planning materiality is $58 million, auditors may decide that half that amount, $29 million, is an appropriate performance materiality amount at the account level. Auditors will then plan and perform their procedures using the performance materiality amount of $29 million to determine if individual accounts or transactions have been materially misstated. If any account balances are less than the performance materiality amount, auditors may decide not to perform detailed procedures on the account because the entire account balance is considered immaterial.

Question 17

Nature of audit procedure:what type of audit procedure will be used when responding to assessed risk

Answer 17

1. test of controls
2. substantive approach

Question 18

substantive approach

Answer 18

audit procedures designed to detect material misstatements at the account and assertion level