Chapter 4: Section 2

Question 1

What is audit risk?

Answer 1

Risk that auditor does not detect one or more of the risks that relate to an audit and gives an opinion that financial statements are true and fair, when, in reality, they are materially misstate in some way due to incorrect and/or inappropriate accounting or disclosure.

Question 2

What is audit risk a factor of?

Answer 2

Inherent risk, control risk and detection risk

Question 3

How does the audit risk model work?

Answer 3

Isolating elements of the audit process and reviewing each one to see what the impact on audit work will be

Question 4

What is the audit risk model?

Answer 4

Audit risk = inherent risk x control risk x detection risk

Question 5

What is audit risk in the audit risk model?

Answer 5

Risk that you give an incorrect opinion e.g., auditor may wish to limit the chance of this happening to only 5% (i.e, working towards 95% accuracy)

Question 6

What is inherent risk in the audit risk model?

Answer 6

Such risk is always present in areas of the client that are susceptible or prone to fraud or error - are then prioritised on a spectrum of inherent risk by impact and likelihood

Question 7

what is control risk?

Answer 7

There is another risk only ever present at clients, representing the risk of controls not preventing or detecting fraud or error (e.g., human error or management override)

Question 8

What do inherent risk and control risk put together make up?

Answer 8

Risk of material misstatement

Question 9

What makes up risk of material misstatement put together

Answer 9

Inherent risk and control risk

Question 10

What is detection risk?

Answer 10

Risk that audit procedures will not detect a misstatement.
Representation of the acceptable amount of risk faced by the auditor

Question 11

What is the relationship between inherent and control risk AND detection risk?

Answer 11

As inherent and control risk increase, level of acceptable detection risk decreases

Question 12

What will the auditor have to do when the level of detection risk decreases?

Answer 12

Auditor performs more testing to keep audit risk at an acceptable level

Question 13

During the process of testing to address detection risk, what will be used frequently?

Answer 13

Sampling

Question 14

When will sampling be used in relation to detection risk?

Answer 14

During the process of testing to address detection risk

Question 15

What does using sampling during the process of testing to address detection risk expose the auditor to?

Answer 15

2 types of detection risk:
Sampling risk
Non-sampling risk

Question 16

What is sampling risk?

Answer 16

Risk that occurs every time a sample is selected and represents the risk the sample does not adequately represent the population

Question 17

What is non-sampling risk?

Answer 17

Subtly different from sampling risk and occurs from poor interpretation of a sample by the auditor

Question 18

Give an example of non-sampling risk

Answer 18

The auditor may have limited experience of sampling and may have selected a suitable sample but fails to derive the right conclusions from the data obtained - may occur if the auditor is short of time or does not fully understand the client

Question 19

In general terms, what could the audit risk model be looked at as?

Answer 19

A mathematical equation where you are looking for the balancing figure

Question 20

How does detection risk look for the balancing figure?

Answer 20

Considers the desired audit risk and likely inherent and control risks posed by the client - auditor then has to consider the amount of work that needs to be done to balance the equation

Question 21

What can auditors use to help them assess risks ?

Answer 21

Graphical means

Question 22

How can auditors use graphical means to help them assess risks?

Answer 22

By assigning each risk a category or description in terms of two characteristics:
a) Likelihood - how possible a risk is to occur
b) Impact - if it does occur, how significant will it be

Question 23

Once risk is assigned a category or description on the basis of likelihood and impact, what can then be done?

Answer 23

Can be plotted on a risk matrix

Question 24

What does the risk matrix look like?

Answer 24

Likelihood on y-axis and impact on x-axis with bars going along bottom and side from low to medium to high

Question 25

Where will the risk be on the matrix, the higher the assessment of risk? How will this risk be assessed?

Answer 25

Closer to the top right-hand corner Will be assessed as being more significant

Question 26

What can be assigned as assessment of risk as an alternative to a graphical representation?

Answer 26

A numerical grade may be assigned using a similar approach

Question 27

How is a numerical grade used when looking at risk assessment?

Answer 27

Impact and likelihood are both scored for each risk being assessed (E.g., from 1 to 5) and then these scores are multiplied to give a product (in this case, anything from 1 to 25)

Question 28

What is the relationship between the numerical grade and risk?

Answer 28

The higher the numerical grade, the higher the risk

Question 29

Why will the auditor's professional judgement be important when looking at risk assessment?

Answer 29

Clearly, and form of assessment will be subjective to some extent

Question 30

In its 2012 publication on professional scepticism, the FRC identified conditions it felt were necessary for what?

Answer 30

For auditors to be able to demonstrate the appropriate degree of professional scepticism

Question 31

what are the 2 factors that support an appropriately sceptical audit?

Answer 31

Behavioural and organisational factors

Question 32

Who can the required conditions identified by the FRC apply to?

Answer 32

Various groups involved in the audit

Question 33

What are the 4 required conditions identified by the FRC necessary for auditors to be able to demonstrate the appropriate degree of professional scepticism?

Answer 33

1. Individual auditors 2. Engagement teams 3. Audit firms 4. Audit committees and management

Question 34

What does individual auditors mean as a condition necessary for auditors to be able to demonstrate the appropriate degree of professional scepticism?

Answer 34

Need to be professionally curious, sufficiently informed about the client and possess the confidence to challenge evidence if required

Question 35

What does engagement teams mean as a condition necessary for auditors to be able to demonstrate the appropriate degree of professional scepticism?

Answer 35

Share knowledge about the client, making appropriate decisions and revisions about the audit that evolve as evidence is collected

Question 36

What does audit firms mean as a condition necessary for auditors to be able to demonstrate the appropriate degree of professional scepticism?

Answer 36

Foster a culture of scepticism and a rigourous system of quality via appropriate recruitment, training, supervision, review, coaching and consultation. Within the firm, both teams and individual auditors are to be supported in demonstrating scepticism especially when there is potential evidence of fraud or error due to directors' actions or motivations

Question 37

What does audit committees and management mean as a condition necessary for auditors to be able to demonstrate the appropriate degree of professional scepticism?

Answer 37

Audit committee has an important role to play in supporting the external audit process by dealing constructively with any challenge made by the auditor as part of its role in displaying suitable levels of professional scepticism