Topic 4 Flashcards
(22 cards)
Audit risk
Audit risk is the risk that an auditor expresses an inappropriate audit opinion when a financial report is materially misstated. Audit risk can never be zero. Audit risk is reduced during risk response phase by identifying. g the key risks and adjusting audit effort accordingly.
Audit risk is a function of:
Inherent risk, control risk and detection risk
Inherent risk
Risk that a material misstatement could occur.
Control risk
Risk that client’s system of internal controls will not prevent or detect such a material misstatement.
Detection risk
Risk that the auditor’s testing procedures will not be effective in detecting a material misstatement, should there be one system of internal controls.
Materiality
Materiality guides audit planning, testing, and assessment of information in financial report.
Information is material if it impacts on the decision-making process of users of the financial report.
Qualitative and quantitative materiality:
Information could be considered material because of its qualitative or quantitative characteristics.
Analytical procedures
Evaluation of financial information by studying plausible links among both financial and non-financial data (ASA 520; ISA 520).
Identify fluctuations in accounts that are inconsistent with auditor’s expectations based on their understanding of the client.
Analytical procedures
Examples
Comparisons
Trend analysis
Common-size analysis (vertical analysis
Ratio analysis
Auditor will assess these changes in light of their expectations based upon their understanding of the client.
Profitability ratios:
Gross Profit Margin
Profit margin
Return on assets
Return on shareholders equity
Gross Profit Margin
Gross profit divided by net sales
Profit margin
Profit divided by net sales
Return on assets
Profit divided by average assets
Return on shareholders
Profit divided by average equity
Liquidity ratios
Current ratio
Acid-test quick ratio
Inventories turnover
Receivables turnover
Current ratio
current assets divided by current liabilties
Acid-test quick ratio
Cash + short-term investments + net receivables
divided by
Current liabilities
Inventories turnover
Cost of sales
Divided by
Average inventories
Receivables turnover
Net credit sales
divided by
average net receivables
Solvency ratios
Debt to equity ratio
Times interest earned
Debt to equity ratio
liabilities divided by equity
Times interest earned
Profit before income taxes and interest expense divided by interest expense
