A3 - Audit Risks

Question 1

what is audit risk?

Answer 1

the risk that auditor may unknowingly fail to appropriately modify the opinion on the FS that are materially misstated

Question 2

what are the types of misstatements?

Answer 2

1. Factual misstatements: misstatements where there is no doubt. based on facts
2. Judgmental misstatements: arising from the judgments of management, including recognition, measurement, presentation, and disclosure in the FS; or selection/application of accounting policies; or misstatements related to accounting estimates
3. Projected misstatements: auditor’s best estimate of misstatements or use of sampling and application to the client’s entire populations

Question 3

what is audit risk model?

Answer 3

Audit Risk = RMM x Detection Risk

Audit Risk = Inherent Risk x Control Risk x Detection Risk

RMM = IR x CR = exists independently of the financial statement audit = both are client system that CPA assesses = auditor cannot change these two risks but auditor can change his/her assessment

Question 4

what is inherent risk?

Answer 4

the susceptibility of a relevant assertion to a material misstatement, assuming that there are no related controls. Client’s environment/accounting system has errors (prevent)

Factors generally have a HIGH inherent risk:
- High volume transactions
- Complex calculations
- Amounts derived from estimates
- Cash

Others:
- Technology that renders a product obsolete
- Lack of working capital
- Decline in the overall industry or economy

Question 5

what is control risk?

Answer 5

Risk that a MM that could occur in a relevant assertion will not be prevented or detected on a timely basis by the entity’s internal control

High if:
- No effective controls relative to the specific assertion
- Implemented controls are not operating effectively
- Not efficient to test the operating effectiveness of controls

Question 6

what is detection risk?

Answer 6

• CPA control and change the (NET) in response to assessed level of RMM
• Risk that auditor misses or makes mistakes or accept MM
• A risk that the auditor will not detect a MM that exists in a relevant assertion

Question 7

what is the relationship of RMM (IR x CR) and DR?

Answer 7

• They have INVERSE relationship
• RMM is high => DR is low (more work = accept less risk)
• RMM is low => the auditor can justify a higher detection risk (less work = accept more risk)

Question 8

what is the relation of RMM and substantive tests?

Answer 8

• They have DIRECT relationship
• greater risk => requires more persuasive evidence, a larger sample size, and/or shift from interim to year-end testing