Flashcards
Lecture 5+6 - risk based approach/audit evidence
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- 1What is meant by risk at financial statement level and assertion level?- Risk at financial statement level refers to the risks of material misstatement that relate to the financial statements as a whole and potentially affect many assertions.
-Risk at assertion level refers to risks of material misstatement of individual transactions, account balances and balances.Consists of two components: Inherent risk and control risk. - 2Distinguish between audit risk and business risk.Audit risk- the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated or the risk that the auditor will not detect a misstatement by the company.
Business risk - A risk resulting from significant conditions, events, circumstances, actions or inactions that could adversely affect an entitys ability to achieve its objectives and execute its strategies, or from the setting of inappropriate objectives or strategys. ISA 315 is most concerned with those business risks that cause material misstatement. - 3What is meant by inherent risk?Inherent risk is the susceptibility of an assertion to a misstatement that could be material, assuming there are no related controls.
- 4What is meant by control risk?the risk that a misstatement that could occur in an assertion and that could be material will not be prevented or detected and corrected on a timely basis by the entity's internal control.
- 5What is meant by detection risk?The risk that the auditor will not detect a misstatement that exists in an assertion that could be material. Detection risk is a function of the effectiveness of an audit procedure and of its application by the auditor.
- 6What can be done to reduce the risks?1. Investigate the legitimacy of a company and the integrity and competence of the management before acceptance of the audit assignment, and before commencing each subsequent audit.
2. Consider the independence of the audit company and its staff in relation to the entity and its staff in relation to the entity before acceptance of the assignment.
3. Understand the nature of the entity and the environment in which it operates before commencing any detailed audit work.
4. Audit planning to minimize risk of material misstatement.
5. Design of audit approach
6. Design of audit programmes - 7What is the audit risk model?-In the past (less common now)
AR= IR x CR x DR
IR=inherent risk
CR= Control rsk
DR= Detection risk - 8How do audit firms deal with business risk?-Top down approach, looking at the wider issues affecting the client business and how these may impact on the financial statements.
- 9What are the implications of the business risk approach?-Setting business objectives and assessing associated risks is a job for management
-By identifying and discussing with management the risks facing a client, an auditor can improve their own knowledge of the business, offer advice to the client and tailor their audit work towards the riskiest areas.
- This adds value to the audit product in the eyes of the client and can also lead to NAS being provided by the audit firm.
-But does it take auditors attention away from the financial statements?
- The BR approach makes audit more efficient. - 10Under ISA 520 what is analytical review?Analytical review is used to analyse relationships between data to determine if data is reasonable/predictable or to identify significant or unusual fluctuations/relationships.
Ratio analysis is a very common form of analytical review.
AR is performed during the planning stage of the audit to aid the understanding of the business and identify risk areas. This helps the auditor identify the programme of work that is required. Auditors will continue to perform AR throughout the audit. - 11What is a letter of engagement?ISA 210 requires audit frims to agree the terms of the engagement with a client and to put the agreement in writing - a letter of engagement in which both parties should sign. This reduces the risk of misunderstandings at a later date.
-The main contents include
1) Clear statement of the respective responsibilities of directors and auditors.
2) The scope of the audit will be clarified, brief decription of what an audit entails, Its limitations and the requirement that the directors will assist fully with the audit process
3) The basis on which fees will be charged
4) arrangements for planning, confirmation from management and others
5)Circumstances under which auditors might reported directly to regulators
6) Disclaimer of responsibility other than to shareholders
7) Flagging up of auditors duties with regard to governance - 12Summarize the audit process1. Appointment
-Letter of engagement
2.First steps
-Initial Analytical review
-Evaluation of accounting systems and internal controls
3. Testing and gathering evidence
4. Completion and review
5. Reporting - 13What is audit evidence?The information used by the auditor in arriving at the conclusions on which the auditors opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information.
- 14What are the four stages of the audit process?1. Objectives
2. Evidence
3.Audit procedures
4.Judgement and opinion - 15What are the audit objectives?1) Overall objective - True and fair
2) General Objectives -Compliance with companies Act and FRS, disclosures adequate, Internal controls working
3) Specific objectives-completeness, existence, accuracy, valuation, ownership, presentation, occurence. - 16Describe ISA 500 in regards to audit evidence?'Auditors should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion.'
-Sufficiency and appropriateness are interrelated and apply to audit evidence obtained from both tests of control and substantive procedures. Sufficiency is the measure of the quantity of audit evidence, appropriateness is the measure of the quality or reliability of audit evidence and its relevance to a particular assertion. - 17Why is the concept of audit evidence so important?-Accounting has to be verifiable, has to be capable of being examined to verify the means to which it has been processed and measured to ensure that it has conformed with known and accepted standards.
-Audit testing should provide sufficient appropriate evidence to support the final audit opinion. - 18What is the nature of audit evidence?-Persuasive (not conclusive)
-consistency
-sampling - 19How does the auditor gather evidence?-Inquiry, of persons within and without the entity, oral or written.
-Inspection, of records, documents or assets
-Observation, Of a process or procedure
-Confirmation, obtaining a representation of information directly from a 3rd party.
-Recalculation or re-performance, auditor themselves checks mathematical accuracy or procedures or controls
-Analytical procedures, investigates relationships between sets of data, looking for fluctuations or inconsistencies. - 20What are the factors to consider in the choice of evidence?-Original documents are more reliable than photocopies.
-Evidence created in the course of the business is more reliable that evidence created for the auditor.
-evidence about the future is problematic
-Must be relevant
-Availability, timeliness and cost must be balanced against the usefulness of the evidence being sought. - 21What is corroboration?The need to obtain evidence from different sources or of a different nature that from items of evidence considered individually.
- 22In auditing a company you understand that the customer base has dropped by 50 percent due to a new entrant into the market increasing competition. What are the inherent risks at financial statement level and at assertion level?-at financial statement level, is the company likely to survive in the foreseeable future? going concern status of the entity.
-at assertion level, has cut-off been manipulated to increase recorded sales and trade receivables, have inventories been overstated to make the balance sheet appear more healthy, has the company made insufficient provisions for bad and doubtful debts, have trade payables been understated to make the company appear more liquid than it really is? - 23Describe business risk in more detail!The risk that an entity will fail to meet its objectives.
Examples of objectives include: attaining a certain level of profitability, maximizing shareholder wealth, ensuring efficiency and effectiveness of operations, meeting a desired market share, giving customer satisfaction, maintaining a desired level of liquidity etc. - 24Describe five risks which can be categorized under audit risk?-engagement risk
-inherent risk
-control risk
-detection risk
-independence in fact risk - 25Describe engagement risk in more detail.-the risk that the competitive tendering process has forced auditors to accept an unreasonably low fee, thus restricting time available to perform an effective audit and increases pressures on independence. Auditors may accept clients who inherent risks at entity level is unduly high because of management with low integrity.
- 26describe control risks in more detail?inherent limitations, trade off between cost and benefit. not directed to non-routine transactions. human error, controls not keeping pace with change, over riding internal controls, Complex computer systems.
Factors reducing control risk include a good control environment, specific controls over account balances and classes of transactions. - 27What is independence in fact risk?-The risk that even though the procedures have detected misstatements that cause the financial statements not to give a true and fair view, the auditor may fail to report the misstatement because of the lack of independence in fact.
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- University Auditing Flashcards on Lecture 5+6 - risk based approach/audit evidence, created by Michelle Ritchie on 04/02/2016.
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