Chapter 4 Flashcards
(15 cards)
Audit Risk
The risk that an auditor will issue an unqualified opinion on materially misstated financial statements.
At the assertion level, audit risk consists of:
- The risk that the relevant assertions related to the account balances or disclosures contain misstatements that could be material to the financial statements (inherent risk and control risk).
- The risk that the auditor will not detect such misstatements (detection risk).
Inherent Risk (IR)
The susceptibility of an assertion in an account or disclosure to a misstatement due to an error or fraud before consideration of any related controls.
Control Risk (CR)
The risk that the misstatement could occur in an assertion about an account or disclosure and that could be material, either individually or when aggregated with other misstatements will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.
Risk of Material Misstatement (RMM)
The combination of IR and CR.
Detection Risk (DR)
- 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 and that could be material, either individually or when aggregated with other misstatements.
- It is determined by the effectiveness of the audit procedures and how well the procedures are applied by the by the auditor.
The Audit Risk Model
AR = RMM X DR
Detection risk has an _______ relationship to inherent risk and control risk.
Inverse.
If IR and CR are low, the auditor can accept higher detection risk because there is a low likelihood that material misstatement exists. And vise versa.
Engagement Risk
The risk that the auditor is exposed to financial loss or damage to his or her professional reputation from litigation, adverse publicity, or other events arising in connection with the audited financial statements.
Analyze the audit risk model when the auditor has determined that the planned audit risk for the AR balance to be set at .5, based on the significance of the account to the financial statements.
By establishing a relatively low level of audit risk , the auditor is minimizing the possibility that the account may contain a material misstatement.
Analyze the audit risk model when the auditor assesses the RMM for AR to be 0.60.
Substituting the values for AR and RMM into the equation indicates that the auditor should set DR at approximately .08 for testing the AR balance. Thus, the auditor establishes the scope of the substantive audit procedures for AR so that there is only an 8% chance that a material misstatement, if present, is not detected.
What should the auditor due when the management will not eliminate the material misstatement that has been recognized?
They should issue a qualified/modified or adverse opinion. On the other hand if the uncorrected total misstatements do not cause the financial statements to be materially misstated, the auditor should issue an unqualified opinion.
Fraud involving senior management and fraud that causes a material misstatement of the financial statements should be reported directly to the…
Audit committee. In addition, the auditor should reach an understanding with the audit committee regarding the expected nature and extent of communications about misappropriations perpetrated by lower-level employees.
The disclosure of fraud to parties other than the entity’s senior management and its audit committee ordinarily is not part of the auditor’s responsibility and ordinarily would be precluded by…
The auditor’s ethical or legal obligations of confidentiality.
A duty to disclose outside the entity may exist:
- To comply with certain legal and regulatory requirements.
- To a successor auditor when the successor makes inquiries of the predecessor auditor about the client.
- In a response to a subpoena.
- To a funding agency or other specified agency in accordance with requirements for the audits of entities that receive governmental financial assistance.
