CH9a risk assessment

Question 2

What is defined as a risk resulting from significant conditions, events, and circumstances that could adversely affect an entity’s ability to achieve its objectives?

Answer 2

Business risk

Defined in ISA 315 (UK)

Question 3

What are the three general categories of business risk?

Answer 3

• Financial risks
• Operational risks
• Compliance risk

Question 4

What do financial risks arise from?

Answer 4

Financial activities or financial consequences of an operation

Examples include cash flow issues or overtrading

Question 5

What are operational risks?

Answer 5

Risks arising with regard to operations

Example: the risk that a major supplier will be lost

Question 6

What is compliance risk?

Answer 6

Risk that arises from non-compliance with laws and regulations surrounding the business

Example: a restaurant failing to comply with food hygiene regulations

Question 7

Fill in the blank: Financial risks are the risks arising from _______.

Answer 7

[financial activities or financial consequences of an operation]

Question 8

True or False: Compliance risk can lead to fines and legal action.

Answer 8

True

Question 9

What might happen if a restaurant fails to comply with food hygiene regulations?

Answer 9

It might face fines, enforced closure, or legal action from customers

Question 10

Fill in the blank: Operational risks include the risk that a major _______ will be lost.

Answer 10

[supplier]

Question 11

What is an example of financial risk?

Answer 11

Cash flow issues or overtrading

Question 12

Why are auditors interested in business risk?

Answer 12

Because issues posing threats to the business may impact the financial statements potentially being misstated.

Question 13

What is a component of audit risk?

Answer 13

Financial statements potentially being misstated.

Question 14

What business risk does a high street chain selling chart CDs face?

Answer 14

Competition from supermarkets.

Question 15

What is a potential financial statement risk associated with obsolete inventory?

Answer 15

Overvalued inventory (IAS 2).

Question 16

Which IFRS standard addresses assets held for sale and discontinued operations?

Answer 16

IFRS 5.

Question 17

What does IAS 36 address in relation to financial statements?

Answer 17

Impairments.

Question 18

What does IAS 37 cover regarding financial statements?

Answer 18

Provisions.

Question 19

Fill in the blank: Business risk may lead to financial statement risks such as _______.

Answer 19

obsolete inventory.

Question 20

True or False: Changes in the industry, such as online downloads, do not affect business risks.

Answer 20

False.

Question 21

List three financial statement risks associated with business risks.

Answer 21

• Overvalued inventory (IAS 2)
• Assets held for sale & discontinued operation (IFRS 5)
• Impairments (IAS 36)

Question 22

What is audit risk?

Answer 22

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

Audit risk is a critical concept in auditing, as it highlights the potential for error in the auditor’s opinion due to misstatements in the financial statements.

Question 23

What is inherent risk?

Answer 23

A factor that increases the susceptibility of an assertion to misstatement that could be material, either individually or when aggregated with other misstatements.

Inherent risk is influenced by various factors including complexity, subjectivity, change, uncertainty, and susceptibility to bias and fraud.

Question 24

What does control risk refer to?

Answer 24

The risk that a misstatement will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Control risk is a crucial component in assessing the overall audit risk.

Question 25

Define detection risk.

Answer 25

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists. ## Footnote Detection risk is a function of the effectiveness of the audit procedures and the inherent and control risks.

Question 26

What are indirect controls?

Answer 26

Controls that affect the risk of material misstatement at a financial statement level. ## Footnote Examples include the control environment, entity’s risk assessment process, and processes to monitor internal controls.

Question 27

What are direct controls?

Answer 27

Controls that affect the risk of material misstatement at an assertion level. ## Footnote Examples include information systems and communication, and control activities such as authorisation, reconciliation, segregation of duties, and physical controls.

Question 28

What components make up detection risk?

Answer 28

Detection risk is made up of two components: * Sampling risk * Non-sampling risk ## Footnote Sampling risk relates to not sampling 100% of transactions, while non-sampling risk includes factors like recent appointment, rush job, poor approach, and lack of objectivity.

Question 29

What is sampling risk?

Answer 29

A risk that a material misstatement will not be discovered due to the fact that the auditor does not sample 100% of transactions. ## Footnote Sampling risk can lead to undetected errors in financial statements.

Question 30

What is non-sampling risk?

Answer 30

A risk that material misstatement is not discovered due to other factors. ## Footnote Factors contributing to non-sampling risk include recent appointment, rush job, poor approach, and lack of objectivity and professional scepticism.

Question 31

What factors should be considered regarding complexity in inherent risk?

Answer 31

Factors include: * Regulation * Risk of non-compliance * Business model * Structure * Alliances * Joint ventures * Applicable accounting standards ## Footnote Complexity can significantly impact the assessment of inherent risk.

Question 32

What factors should be considered regarding subjectivity in inherent risk?

Answer 32

Choices in applicable accounting standards and valuation techniques used. ## Footnote Subjectivity can introduce significant variability and uncertainty in financial reporting.

Question 33

What changes should be considered regarding inherent risk?

Answer 33

Changes include: * Stability of economic conditions * Customer change * Change in supply chain * New products or services * New locations ## Footnote Changes in these areas can increase the inherent risk of material misstatement.

Question 34

What uncertainties should be considered regarding inherent risk?

Answer 34

Existence of estimates and degree of uncertainty attached. ## Footnote Uncertainties can make it difficult to accurately assess risks and valuations.

Question 35

What is the spectrum of inherent risks?

Answer 35

Each factor will be considered in terms of likelihood and materiality of a misstatement and plotted on a spectrum in terms of high or low. ## Footnote This helps in prioritizing risks for further investigation.

Question 36

True or False: Control environment is a direct control.

Answer 36

False ## Footnote The control environment is considered an indirect control affecting material misstatement at the financial statement level.

Question 37

Why might TRs be o/s and what procedures could you use to test?

Answer 37

Question 38

Why might TPs be u/s and what procedures could you use to test?

Answer 38

Question 39

Why might EE costs be u/s and what procedures could you use to test?

Answer 39

Question 40

Why might inv be o/s and what procedures could you use to test?

Answer 40

Question 41

***Why might GC be a risk and what procedures could you use to test?

Answer 41