Chapter 7 reading guide

Question 1

Why is it important for the auditor to consider risk of material misstatement at the overall financial
statement level? 3

Answer 1

Pervasive impact

influences audit strategy

quality of audit opinion

Question 2

What is audit risk?

Answer 2

The risk that the auditor will issue an inappropriate audit opinion when the financial statements are materially misstated

Question 3

What are the three components of the audit risk model? What 3 things is the purpose of this assessment
when planning an audit?

Answer 3

Inherent risk (IR)

control risk (CR)

detection risk (DR)

Audit risk (AR) = IR * CR * DR

Purpose:

determine where to focus audit effort

Design audit procedures

ensures audit risk is reduced to an acceptably low level

Question 4

What does the word ‘pervasive’ mean when considering risk?

Answer 4

risk cannot be isolated to one account, affecting the entire F.S’s as a whole, influecing multiple areas and requires change to audit strategy

Question 5

What is inherent risk, definition, key idea, example?

Answer 5

definition: the susceptibility of an assertion to material misstatement before considering internal controls

key idea: the nature of the account and the business environment

example: diamond inventory valuation (subjective, hard to verify)

Question 6

What is control risk, definition, key idea, example?

Answer 6

definition: risk that a material misstatement will not be prevented or detected, and corrected on a timely basis by the client’s internal controls

key idea: even if the controls exist, they may be poorly designed or ineffective

example: management override of controls, weak segregation of duties in cash receipts

Question 7

What is detection risk, definition, key idea, example?

Answer 7

risk that the auditor’s procedures will fail to detect a material misstatement that exists

key idea: the only risk the auditor can directly influence through the nature, timing, and extent of audit testing

Examples: sampling error in testing

Question 8

What constitutes a significant risk?

Answer 8

an identified inherent risk factor that, in the auditor’s professional judgement, increases the likelihood or magnitude of a material misstatement to a level that requires special audit attention

Question 9

What constitutes a significant risk AS PER CAS?

Answer 9

something is presumed significant risk under CAS when it is

1. Non-routine related-party transactions
2. Fraud in the revenue cycle

Question 10

What are the steps required by CAS 240 when performing a fraud risk assessment? What are the
key elements/considerations in each step

Answer 10

1. Discussion among the audit team
2. inquiries of management, those charged with governance and others
3. perform analytical procedures
4. Evaluate specific fraud risks
5. document and develop responses

KEY CONSIDERATIONS:
skepticism
unpredictability
tailoring

Question 11

What is the fraud triangle? Describe each element of the triangle.

Answer 11

1. incentives/ pressures
   - motivation on management or employees to commit fraud
2. opportunities
   - circumstances that make it possible for fraud to be carried out (weak controls or management override)
3. Attitudes/ rationalization
   - the mindset or values that allow someone to justify the fraud

Question 12

What are fraud risk factors (continued from the fraud triangle)?

Answer 12

fraudulent financial reporting:
- incentives/ pressures: declining profitability
-opportunities: complex estimates, weak oversight
- attitudes: aggressive forecasts

misappropriation of assets:
- incentives: personal financial problems
- opportunities: lack of segregation of duties
- attitudes: employees justifying theft