B1

• Audit risk


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


  • Considered at the planning meeting as it depends on the auditors' knowledge of the business
  • Examples: Cash based business, Fast moving industry
• Control Risk


  • The risk of material misstatement due to inadequate internal controls within the business
  • Examples: No segregation of duties, No controls over access to assets, No controls over access to IT
• Detection Risk


  • The risk that the work carried out by the auditor does not uncover a material misstatement that exists
  • Can be split into sampling risk and non-sampling risk
  • Non-sampling risks: Auditor did not sufficiently investigate, Procedures used were inappropriate or misinterpreted
  • Sampling risk: Conclusion based on sample may be different from conclusion reached if entire population was tested
  • Increased by things like inexperienced audit staff or tight deadlines
• Inherent risk


  Risk that cannot be affected by the auditor as it is internal to the entity
• Control risk


  Risk that cannot be affected by the auditor as it is internal to the entity
• Detection risk


  The risk that the auditor's procedures will not detect a material misstatement
• If inherent and control risk are judged to be high


  The auditor must attempt to minimise detection risk
• Auditor's response to high inherent and control risk


  1. Increase the amount of tests or the number of samples

  2. Ensure there is less chance of a material misstatement being overlooked or missed
• What the candidate has to do

  1. Explain what the risk is

  2. Explain what the auditor would do to address the risk
• Audit risk


  The risk relating to the audit of the financial statements, not the general business risks
• Types of assertions that audit risks should relate to


  • Assertions about classes of transactions and events for the period under audit
  • Assertions about account balances at the period end
  • Assertions about presentation and disclosure
• Audit risks can also relate to practical problems the audit team may face
• Audit risks


  • Treatment of capital and revenue expenditure
  • Valuation of inventory
  • Completeness of liabilities
  • Completeness of revenue
• Auditor's responses


  • Focus on how the team will obtain evidence to reduce the risks identified to an acceptable level
  • Confirm whether the financial statement assertions have been adhered to, and whether the financial statements are true and fair
• Auditor's responses should not be too vague or impractical
• Risk-based approach to the audit


  • Carrying out a financial statement risk assessment helps the auditor ensure that the high risk areas where material misstatement might occur are adequately investigated and tested during the audit
  • Helps the auditor identify low risk areas where reduced testing may be appropriate, ensuring time is not wasted by over-testing these areas
• Audits conducted in accordance with ISAs must follow the risk-based approach
• Auditors are not concerned with individual routine transactions, although they will still be concerned with material, non-routine transactions
• Materiality


  Information is material if 'its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements'
• Material items


  • Large transactions or significant events
• Materiality is important to the auditor


  If a material item is incorrect, the financial statements will not show a 'true and fair view'
• Materiality levels


  • 0.5 - 1% of turnover
  • 5 - 10% of profits reported
  • 1 - 2% of gross assets
• Materiality level judgement


  • Depends on the type of business and the risks it faces
• Considerations for materiality


  • Quantity
  • Quality
• Tolerable error


  The auditor accepts the error, e.g. finding one error out of 100 tested might be ignored
• Performance materiality


  Lower than normal materiality, to prevent small undetected errors aggregating to become material
• There are now 2 standards to consider: ISA 320 Audit Materiality and ISA 450 Evaluation of Misstatements Identified During the Audit
• Materiality is calculated at the planning stage


  But it might change later due to events
• The new standard recognises that certain classes of transactions, account balances or disclosures might be affected by misstatements which are less than the materiality level for the financial statements as a whole, but which may well influence the decisions of the user of those financial statements
• Specifically, the clarified ISA 320 suggests performance materiality be applied to areas such as related party transactions and directors' remuneration
• Financial statement risk assessment


  The first step in a risk-based approach to the audit, where the auditor evaluates the risks of material misstatement in the financial statements due to fraud or error.
• High risk areas


  Areas where material misstatement is likely to occur, requiring more attention and testing to ensure accuracy.
• Adequate investigation and testing


  The process of performing tests and procedures to obtain evidence about the high-risk areas, determining whether the financial statements are free from material misstatement.
• Low risk areas


  Areas where the risk of material misstatement is low, requiring less testing and saving time and resources.
• Reduced testing


  The process of reducing testing in low-risk areas, allowing for more time and resources to be allocated to high-risk areas.