SYLLABUS AREA B- RISK Flashcards
(32 cards)
what are the four types of audit opinions an auditor may give?
1- unmodified opinion- FS GIVE A TRUE AND FAIR VIEW.
auditor concludes that FS are presented fairly, in all material aspects in accordance with the applicable financial reporting framework
Modified opinions:
1-qualified opinion: EXCEPT FOR ____, FS give a true and fair view.
it is the opinion that is expressed when:
a) auditor has obtained sufficient appropriate evidence, concluding that the misstatements, individually or aggregate, are material but not pervasive (extensive) to the financial statements
b) auditor is unable to obtain sufficient appropriate evidence on which to base the opinion, but concludes that the possible effects on the financial statements of undetected misstatements, if any could be material but not pervasive.
2- adverse opinion: F/S DO NOT GIVE A TRUE AND FAIR VIEW, expressed when auditor obtains sufficeint appropriate evidence, concluding that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.
3- disclaimer: WE DO NOT EXPRESS AN OPINION.
when auditor is unable to obtain sufficient appropriate evidence to form an opinion. so auditor concludes that the possible effects on the FS of any undetected misstatements, could be both material and pervasive.
what would happen if auditor gave an unmodified opinion when the FS are materially misstated?
- auditor could be sued by the intended users.
-disciplinary action would be taken by relevant professional body. - firm could damage it’s reputation.
Eg. Arthur Anderson didn’t give correct opinion about enron.
Define audit risk. what are the three type of risks that make up audit risk?
Audit risk is the risk that auditor will give an incorrect opinion by missing material errors and fraud in financial statements.
audit risk comprises of risk of material misstatement and detection risk/
1- inherent risk (MM)
2- control risk (MM)
3- detection risk
what is the risk of material misstatement?
Risk of material misstatement is the risk that the financial statements are materially misstated prior to the audit, due to fraud or errors
what is a misstatement?
‘A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.’
3 categories of misstatements?
There are three categories of misstatements:
(i) Factual misstatements: a misstatement about which there is no doubt.
(ii) Judgmental misstatements: a difference in an accounting estimate that the auditor considers unreasonable, or accounting policies that the auditor considers inappropriate.
(iii) Projected misstatements: auditor’s best estimate of the total misstatement in a population through the projection of misstatements identified in a sample.
what is inherent risk?
Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or disclosure to misstatement that could be material, before consideration of any related controls
easy words;
risk of material misstatement due to
-complex A/C treatments
-final time adoption of IFRS
-inclusion of estimates
what are the qualitative and quantitative inherent risk factors?
- complexity
- subjectivity
- change
- uncertainty
- susceptibility to misstatement due to management bias.
what is control risk?
Control risk is the risk that a material misstatement will not be prevented, or detected on a timely basis by the company’s internal controls.
Control risk may be high either because they aren’t designed sufficiently or they aren’t being implemented
what is detection risk?
Detection risk is the risk that the audit procedures being done to reduce audit risk to an acceptably low level will not detect a material misstatement ,
what are the two elements of detection risk?
1) Sampling risk is when the sample taken by auditor is not representative of the population it was chosen from, and the auditor’s conclusion based on the sample is different from the conclusion that would be reached if the whole population was tested.
2) Non-sampling risk is the risk that the auditor’s conclusion is inappropriate for any other reason, e.g. the application of inappropriate procedures or the failure to recognise a misstatement.
what can auditor do to reduce detection risk?
• professional scepticism:
- use experienced staff in risky areas
-more supervision.
-hire experts when needed
– less reliance on internal controls
– more substantive procedures.
Why is there a need to conduct a thorough assessment of risk?(5)
In conducting a thorough assessment of risk, auditors will be able to:
• Identify areas of the financial statements where misstatements are likely to occur early in the audit.
• Plan procedures that address the significant risk areas identified.
• Carry out an efficient, focused and effective audit.
• Reduce the risk of issuing an inappropriate audit opinion to an acceptable level.
• Minimise the risk of reputational and punitive damage.
What is the objective of the auditor regarding Material misstatements according to IAS?
-The objective of the auditor is to identify and assess the risk (is it fraud or error?)
-understanding the entity and its environment, and it’s internal controls
-designing procedures for the assessed risks
What is professional skepticism ? How can an auditor apply professional skepticism?
Professional scepticism means a questioning attitude, being alert to possible misstatements
, and a critical assessment of audit evidence.
Professional scepticism requires the auditor to be alert to:
• Audit evidence that contradicts other audit evidence.
• reliability of documents and responses to enquiries to be used as audit evidence.
• Conditions that may indicate possible fraud.
• Circumstances that suggest the need for audit procedures in addition to those required by ISAs.
Client generated evidence is least reliable so always look for third party evidence
Define the term materiality
Info is material if it’s omission could distort the decision of FS users
It is the judgement of the auditor
Varies from company to company
How is materiality determined?
The determination of materiality is a matter of professional judgment. The auditor must consider:
• Whether the misstatement would affect the economic decision of the users
• Both the size and nature of misstatements
• The information needs of the users as a group.
Materiality is a subjective matter and as such should be considered in light of the client’s circumstances.
What is the financial threshold for materiality according to IAS 320?
A matter is material if it is:
• 1⁄2–1% of revenue
• 5% – 10% of profit before tax
• 1 – 2% of total assets.
The above are common benchmarks but different audit firms may use different benchmarks or different thresholds for each client.
What does it mean to be material by nature?
Materiality is not just financial, some items may be material by nature.
-non compliance with regulations
-non compliance with debt covenants.
-Misstatements that, when adjusted, would turn a reported profit into a loss for the year.
-Misstatements that, when adjusted, would turn a reported net-asset position into a net-liability position.
-Transactions with directors, e.g. salary and benefits, personal use of assets, etc.
-Disclosures of future legal claims ,going concern issues, etc could influence users’ decisions.
How is a suitable preliminary materiality limit set?
A suitable preliminary materiality level is most likely to be one that lies within the overlap of the ranges calculated for profit and total assets.
Materiality is not normally based on revenue except in circumstances when it would not be meaningful to base materiality on profit,
e.g. because the entity being audited is a not-for-profit entity or where there is a small profit (or a loss) as this will result in over-auditing of the financial statements
Preliminary materiality should be set at a lower level if it’s the first audit
What is performance materiality and what is the need for it?
It is unlikely, in practice, that auditors will be able to design tests that identify individual material misstatements. It is much more common that misstatements are material in aggregate
performance materiality is the amount of money that the auditors use as a threshold to determine if financial errors are significant enough to affect the financial statements as a whole.
• The auditor sets performance materiality at a value lower than overall materiality, and uses this lower threshold when designing and performing audit procedures.
• This reduces the risk that the auditor will fail to identify misstatements that are material when added together.
What are the risk assessment procedures to be followed by the auditor? AEIOU
The auditor should perform the following risk assessment procedures:
• Enquiries with management, of appropriate individuals within the internal audit function (if there is one), and others (with relevant information) within the client entity (e.g. about external and internal changes the company has experienced)
• Analytical procedures
• Observation (e.g. of control procedures)
• Inspection (e.g. of key strategic documents and procedural manuals).
How may an auditor understand an entity and its environment?
In order to identify the risks of material misstatement in the financial statements the auditor is required to obtain an understanding of: their clients; their clients’ environments; and their clients’ internal controls. This generally includes:
Relevant industry, regulatory and other external factors, including:
– Financial reporting framework
– Legislation and regulations
– Competition
– Economic conditions.
-Nature of the entity, including: Nature of products and services,Ownership and governance structures,Investment and financing activities, Key customers and suppliers.
-Entity’s selection and application of accounting policies.
-Entity’s objectives, strategies and related business risks
Industry developments
New products and services
New accounting requirements
Current and future financing requirements.
• Measurement and review of the entity’s financial performance
– Performance measures and related incentives to commit fraud
through management bias
– Budgets, forecasts and variance analyses and performance reports
– Comparison of performance with competitors
– Consideration of performance related bonuses.
• Internal controls relevant to the audit (covered in more detail in the Systems and controls chapter).
If the entity has an internal audit function, obtaining an understanding of that function also contributes to the auditor’s understanding, in particular the role that the function plays in the entity’s monitoring of internal control over financial reporting.
Where can an auditor find the information needed to understand the entity and its environment?
From the audit firm:
Last years audit team
last year’s working papers
Manager
Partner
Industry experts
From you: past experience
From the client
Discussions, website, brochures, observation
From external sources
The Internet
Trade press
Companies house
Credit reference agencies
Industry surveys
