Audit Chapter 7: Risk Assessment

Question 1

What is inherent risk in audit? Can an entity affect this risk? Can auditors control this risk?

Answer 1

Inherent risk is the risk that financial information is incorrect before we consider internal controls. An entity has no control over this risk. An auditor cannot control this risk.

Question 2

What is Control risk in audit? Can an entity affect this risk? Can auditors control this risk?

Answer 2

control risk is the risk that errors in financial statements are not caught/detected/prevented by internal controls. An entity CAN control this risk. An auditor cannot control this risk.

Question 3

What is detection risk in audit? Can an entity affect this risk?

Answer 3

Detection risk is the risk that an auditor does not pick up an error in the financial statements during substantive procedures. An entity has no control of this risk. An audit can control this risk

Question 4

How can an auditor ensure that audit risk is low? (audit risk model)

Answer 4

• Inherent risk is low, control risk is low, detection risk can be high
• Inherent risk is high, control risk is high, detection risk must be low

Question 5

If detection risk is low, the auditor can increase their reliance on substantive procedures. Why?

Answer 5

Because if detection risk is low, inherent risk is high and control risk is high. If control risk is high, auditor cannot rely on internal controls and must partake in substantive procedures.

Question 6

How is risk assessed by auditors on 2 levels?

Answer 6

• Overall financial statement risks
• Assertion risks (each individal account)

Question 7

If control risk is high, what audit procedure should auditors take. What if its low?

Answer 7

Control risk high = substantive procedure approach
Control risk low = combined approach because

You always have to test controls in both scenarios.

Question 8

If an auditor calculates materiality, of 3% of 1M = 30k, what does this mean?

Answer 8

If total misstatement is greater than 30k, then the auditor must perform futher tests. If total misstatement is less than 30k, this is considered acceptable.

Question 9

What is specific materiality

Answer 9

Specific materiality is a materiality amount for a specific class or balance on the financial statement because the entity is particularly vulnerable to that class or balance for whatever reason (ex. PPE)