Risk

Question 1

What is audit risk

Answer 1

Risk an auditor may express an inappropriate opinion when the financial statements are materially misstated.

Risk is calculated as part of the planning stage of an audit.

Question 2

Audit risk formula.

What is the auditors objective

Answer 2

Audit risk= inherent risk x Control risk x Detection risk

The auditor should plan the audit to reduce risk to an acceptable level.

Question 3

What is inherent risk

Answer 3

The susceptibility of an assertion (vulnerability to be affected) about a class of transaction or disclosure to a material misstatement.

This misstatement may be one error that is material or multiple adding up.

Question 4

Examples of things making something have inherent risk

Answer 4

Complex calculations more likely to result in material misstatement

Accounting estimates

Risk with business/ industry. e.g business seeking new funding may tempt directors to manipulate st to look better.

or a failing business may look at illegal activity to improve

Question 5

Control risk

Answer 5

The risk of misstatement in an assertion about a class of transactions, that could be material, are not detected, prevented or corrected by the internal controls of a business.

It may be material due to one large transaction or a series of smaller errors.

Question 6

Detection risk

Answer 6

The risk that procedures performed by an auditor to reduce audit risk to an acceptable level will not detect a material misstatement.

Question 7

How an auditor manages overall audit risk

Answer 7

By manipulating detection risk.

This is the only element of audit risk that the auditor has control of.

The more work the auditors do, the lower the detection risk and therefore audit risk.

Detection risk can still never be eliminated due to inherent limitations of audit.

Question 8

Types of detection risk

Answer 8

Detection risk split into 2

Sampling risk e.g sample too small

Non- sampling risk

e.g not planning the audit enough and understanding the entity

Company first audit

Not enough time/ resources

Question 9

Why an auditor needs to consider if a business is a going concern at the start of the audit?

Answer 9

If the company is not deemed a going concern, we would need to plan differently as the financial statements would be prepared on a different basis ( breakup basis)

Question 10

How an auditor decides if there are any risks of a going concern.

Answer 10

The auditor will need to consider 3 indicators

Financial indicators e.g

Net liability/ net current liability

Loans for repayment

Delayed payments to creditors

Discontinue of dividends

Operating indicators e.g

Loss of management

Loss of major customer/ market

Emergence of competitor

Shortage in supply

Other indicators e.g

Non- compliance with regulations

Uninsured catastrophes e.g climate issues such as tsunami

Pending legal proceedings such as being sued

Question 11

What is a going concern risk

Answer 11

Risks/ factors that raise doubt regarding a company’s ability to continue operating.

Question 12

Climate-related risks categories

Answer 12

Physical Risks- Physical effects as a result of climate change. e.g temp rises and wild fires, storms, flooding etc

Transition risks- Social and Economic risks that arise from transitioning to a low carbon economy. e.g from regulation changes affecting businesses, technology changes etc

Question 13

What is the Auditors responsibility relating to climate related risks

Answer 13

Challenge businesses on how they assessed and reported their impacts and dependencies (business risks)

Consider risk of material misstatement on climate change

Question 14

What is the type of risk, business risk and material misstatement risk of fires/ floods

example

Answer 14

Physical risk

Business risk may be damage to buildings

Risk of material misstatement may be the damage to assets

Question 15

Risk of law moving to electric cars

Answer 15

Transition risk

Business risk may be not being able to sell petrol cars affecting business

Material misstatement risk could be going concern issues, NRV etc

Question 16

what risk would be high during a company’s first audit and why

Answer 16

There is a lack of auditors knowledge on the business and managements behaviour.

As we aren’t as aware as transaction patterns, it may be harder to spot misstatement as we don’t know what “normal looks like.”

Controls haven’t been previously tested/ auditors don’t know which ones are reliable.