3 - audit risk Flashcards
what are the objectives of an audit?
for auditor to obtain reasonable assurance about whether financial statements as whole are free from material misstatement, whether due to fraud or error.
what is reasonable assurance?
obtained when auditor has obtained sufficient appropriate audit evidence to reduce audit risk to acceptably low level.
what are the components of audit risk?
audit risk = inherent risk + control risk + detection risk
define audit risk
risk that the auditor gives inappropriate opinion when in fact financial statements are materially misstated
what is inherent risk?
the susceptibility of an assertion to a misstatement, that could be material, assuming there are no related controls.
what is control risk?
risk that misstatement could occur in an assertion and will not be detected/prevented and corrected on timely basis by entity’s internal control.
what is detection risk?
risk that auditor will not detect misstatement that exists in an assertion that could be material. detection risk if a function of effectiveness of audit procedure and of its application by auditor.
what parts of audit risk are in or out of the auditor’s control?
control and detection risk under auditor’s control
inherent risk is not
how can detection risk be controlled and managed?
adequate planning
proper assignment of personnel to the engagement team
the application of professional scepticism
supervision and review of the audit work performed.
what is engagement risk?
risk to auditor of inadequate resources for conducting audit (manifested in higher detection risk). may arise from competitve tendering, IR factors not known to potential auditors when tendering. particularly high if auditor is unaware of management deficiencies an/or pressures on themselves. minimise through pre-acceptance procedures, checking: potential client engaged in legit activities, background of directors and senior mgrs, potential ethical issues.
what is independence in fact risk?
risk that auditors fail to report material misstatements in financial statements even though detected by procedures. failure of auditor independence.
what is business risk?
risk to achievement of client’s objectives. most business risks will eventually have financial consequences. can heighten risk of material misstatement. therefore, to minimise risk auditor needs to be aware of developments in clients business environment and assess possible consequences for audit risk.
how can risk be assessed in an audit?
ISA 315 covers assessment of risk of material misstatement through understanding entity and its environment. in summary, audit planning sits within the assessment of a range of risks.
what is the business risk approach to audit?
incorporates greater emphasis on business risk than the traditional inherent risk approach
widely used by big audit firms since they see it as: improving basic audit of financial statements and enhancing appreciation of what is the true and fair view; making audit more efficient and therefore more profitable; expanding potential for adding value
advances in IT have resulted in company records becoming inherently more reliable, leaving more scope for audit effort to be devoted to high level assessment. however this type of work is more demanding on the time of senior audit personnel - harder to routinise, so potentially more expensive.
how can auditor manage the audit process?
auditor needs to balance two objectives: audit quality, meeting legal and regulatory requirements and reducing audit risk (more work); while making a profit through their work (not overworking).
key judgements in managing the audit: risk assessment and allocating resources to gathering and assessing evidence
range of personnel available with different levels of experience (partners, managers, seniors and assistants) - who is most appropriate (considering opportunity costs) to do what task? how much of their time should be allocated to the task?
