Audit Chapter 9 - Assessing the Risk of Material Misstatement

Inquiries of Management and Others within the entity

Inquiries with those in charge may provide information about environment and strategy of the business.

As the acceptable level of detection risk​ decreases, the auditor may do one or more of the following except change the

assurance provided by audit procedures to a lower level

Inherent risk and control risk differ from planned detection risk in that they

exist independently of the financial statement audit.

When auditors perform risk assessment procedures to assess the risk of material misstatement due to fraud or error, the risk of not detecting a misstatement due to fraud is _____________ than the risk of not detecting a misstatement due to error.

higher

Auditors accept some level of ______ or uncertainty in performing the audit function.

risk

Inherent Risk

Assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of related internal controls.

Discussion Among Engagement Team Members

Auditing standards require engagement team to discuss susceptibility of the client's financial statements to material misstatement.

Risk of Material Misstatement at the Assertion Level

Auditing standards require the auditor to assess risk of materiality at assertion level for classes of transactions, account balances, and presentation and disclosure in order to determine the nature, timing and extent of further audit procedures.

The auditor's consideration of the risk of material misstatement due to fraud is made at both the _______________ statement level and at the _______________ level for classes of transactions, account balances, and presentation and disclosures.

Financial statement level and at the assertion level for classes of transactions.

Matters that require significant judgment can lead to _____________ risk.

Higher

The performance of risk assessment procedures is designed to help the auditor do what?

Obtain an understanding of the entity and its environment, including internal controls, for purposes of assessing the risk of material misstatement when planning the audit.

Audit Risk Model

Planned detection risk = acceptable audit risk / (inherent risk X control risk) Helps auditor decide how much and what types of evidence to accumulate for each relevant audit objective.

The Degree to which external users rely on statements is dependent on several factors:

- Client's size - Distribution of ownership - Nature and amount of liabilities

The Likelihood that a client will have financial difficulties after the Audit Report is Issued is dependent on several factors

- Liquidity position - Profits (losses) in previous years - Method of financing growth - Nature of the client's operations - Competence of management

The auditor must consider several major factors when assessing inherent risk:

- Nature of the client's business - Results of previous audits - Initial versus repeat engagement - Related parties - Complex or nonroutine transactions - Makeup of the population - Factors related to fraudulent financial reporting - Factors related to misappropriation of assets.

Describe the types of procedures that constitute risk assessment procedures.

1. Inquiries of management and others within the entity 2. Analytical procedures 3. Observation and inspection 4. Discussion among engagement team members 5. Other risk assessment procedures

Significant Risk (definition?)

A significant risk represents an identified and assessed risk of material misstatement that, in the auditor's professional judgment, requires special audit consideration.

At what two levels does the auditor assess the risk of material misstatement?

Financial statement level and at the assertion level for classes of transactions.

Risk Assessment Procedures include the following:

1. Inquiries of management and others within the entity 2. Analytical procedures 3. Observation and inspection 4. Discussion among engagement team members 5. Other risk assessment procedures

There are two ways that auditors can change the audit to respond to risks.

1. The engagement may require more experienced staff 2. The engagement will be reviewed more carefully than usual.

Prior​ to, or in conjunction​ with, the​ information-gathering procedures for an​ audit, audit team members should discuss the potential for material misstatement due to fraud. Which of the following best characterizes the mindset that the audit team should maintain during this​ discussion? 1. Criticizing 2. Questioning 3. Judgmental 4. Presumptive

2. Questioning

Which of the following circumstances most likely would cause the auditor to suspect that there are material misstatements in the​ entity's financial​ statements? 1. The​ entity's management places no emphasis on meeting publicized earnings projections. 2. Significant differences between the physical inventory count and the accounting records are not investigated. 3. Cash transactions are electronically processed and​ recorded, leaving no paper audit trail. 4. Monthly bank reconciliations ordinarily include several large outstanding checks.

2. Significant Differences between the physical inventory count and the accounting records are not investigated

Which of the following statements describes why a properly designed and executed audit may not detect a material misstatement in the financial statements resulting from​ fraud? 1. An audit is designed to provide reasonable assurance of detecting material​ errors, but there is no similar responsibility concerning fraud. 2. The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements as a whole. 3. Audit procedures that are effective for detecting an unintentional misstatement may be ineffective for an intentional misstatement that is concealed through collusion. 4. The factors considered in assessing control risk indicated an increased risk of intentional​ misstatements, but only a low risk of unintentional errors in the financial statements.

3. Audit procedures that are effective for detecting an unintentional misstatement may be ineffective for an intentional misstatement that is concealed through collusion.

Nonroutine Transactions

Transactions that are unusual, either due to size or nature, and that are infrequent in occurence.

Some account​ balances, such as those for pensions and​ leases, are the result of complex calculations. The susceptibility to material misstatements in these types of accounts is defined as

inherent risks

Auditors begin their assessments of inherent risk during the _____________ phase of the audit.

the planning phase

How do nonroutine transactions increase the risk of material misstatement

Because they often involve a greater extent of management intervention.

Risk of Material Misstatement at the Overall Financial Statement Level

Refers to risks that relate pervasively to the financial statements as a whole and potentially affect a number of different transactions and accounts.

Audit Risk for Segments

The risk of material misstatement, control risk, and inherent risk are assessed for each audit objective in each segment of the audit.

Control Risk

The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control.

Planned Detection Risk

The risk that the audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality

Engagement Risk

The risk that the auditor is exposed to financial loss or damage to his or her professional reputation from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on.

Acceptable audit risk

a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unmodified opinion has been issued