W6 Assessing Audit Risks

Question 1

What do we mean by ‘material’

Answer 1

Misstatements including omission are considered material if they individually or in aggregate could be expected to influence the economic decisions of users taken on the basis of the financial statements

Question 2

What is performance materiality

Answer 2

Amount set by auditor at a value lower than overall materiality, and uses this lower threshold when designing and performing audit procedures.

Reduces the risk of the auditor failing to identify misstatements that are material in combination

Question 3

What is materiality by size

Answer 3

A monetary amount established by auditors at the start of the audit

Any amount above would be considered material

Usually determined with regard to the size of the account

Question 4

What is materiality by nature

Answer 4

Misstatements that when adjusted turn a reported profit into a loss

Misstatements that affect compliance with debt covenants

Disclosures relating to directors or related parties

Question 5

Why is materiality important

Answer 5

If financial statements contain material misstatement, then they do not give a true and fair view

Question 6

What is professional judgement

Answer 6

Application of relevant training, knowledge and experience in making informed decisions necessary in the audit engagement

Question 7

What is audit risk? How can it be managed?

Answer 7

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

auditors must manage this risk and reduce it to an acceptably low level by obtaining sufficient appropriate audit evidence

Question 8

What does audit risk comprise

Answer 8

• Risk of material misstatement; (inherent risk and control risk)
• Detection risk

Audit risk = inherent risk * Control Risk * Detection Risk

Question 9

What is inherent risk

Answer 9

Risks of misstatement that stem from the nature of the organization, its activities, or its transactions

Question 10

What is control risk?

Answer 10

Risk of a misstatement not being corrected or prevented from internal controls

*can never be eliminated

Question 11

What is detection risk? What can it sub-divided into

Answer 11

Risk that procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect misstatement that exists and that could be material (either individually or in aggregate)

• detection risk can be sub-divided into sampling and non-sampling risk

Question 12

What is sampling risk

Answer 12

Risk that the auditors conclusions based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure

Question 13

What is non-sampling risk

Answer 13

the auditor reaches an incorrect conclusion for any reason not related to sampling risk

Question 14

What is the audit risk model

Answer 14

AR = IR * CR * DR

• Auditors first assess the levels of inherent and control risk, then decide on n audit strategy that will reduce detection risk to a level such that the consequent audit risk is acceptably low
• the more testing the auditor performs, the lower detection risk will be, therefore the lower the audit risk will be

Question 15

What is analytical procedure

Answer 15

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data and investigation of fluctuations, inconsistent relationships or amounts that differ from expected values by significant amount

Question 16

when are analytical procedures used

Answer 16

used in all stages of the audit

Preliminary analytical procedures

• auditors perform analytical procedures as a risk assessment procedure in order to help the auditor gain an understanding of the entity and assess the risk of material misstatement

Substantive analytical procedures

Final analytical procedures

use at the completion stage when forming an overall conclusion whether the financial statements are consistent with the auditor’s understanding of the entity

Question 17

How is materiality determined

Answer 17

Matter of professional judgement

Auditor must consider:

• Whether the misstatement would affect the economic decision of the users
• size and nature of misstatements
• the information needs of the users as a group

Question 18

Why are analytical procedures performed

Answer 18

Identify aspects of the entity of which the auditor was unaware

Assist in assessing the risks of material misstatement

Help identify unusual transactions/event/amounts/ratios or trends that may have audit implications

Help identify risks of material misstatement due to fraud or error

Question 19

Why is professional judgement needed

Answer 19

Needed when making decisions about:

• materiality and audit risk
• the nature, timing and extent of audit procedures to be performed
• Whether sufficient audit evidence has been obtained

Question 20

What factors effect control risk

Answer 20

The quality and quantity of management/staff

The nature of control activities, frequency of their operation

The segregation of duties in the course of their operation