Auditing

AUDITING

CHAPTER 4

DISCUSSION GUIDE

Audit Risk – the risk that the auditor may fail to modify the opinion on materially

misstated financial statements. It is the combination of: (1) a client’s

financial statements that contains material misstatements and (2) that the

auditor will fail to detect the misstatements. It relates to “reasonable

assurance”.

In this chapter, the authors uses “assertion” to refer to consideration of audit risk at the account balance “assertion level”. This is a level lower than the account balance overall. (For example, it may refer to the assertion of “existence” for the balance in accounts receivable or inventory.)

Audit risk as it relates to the “assertion level” consists of two things. (see page 100):

1.

2.

AUDIT RISK MODEL

Audit risk is considered at the assertion level so that auditors can plan the appropriate audit procedures at the account balance, transaction, or disclosure level.

The audit risk model (or mathematical equation) is:

AR = RMM x DR

The model can be rewritten as: RMM = IR x CR

The risk that relevant assertions may be misstated consists of inherent risk and control risk.

1. Inherent Risk (IR) – the risk of the existence of misstatements in the financial statements of a business without considering the effects of internal controls. (E.g. the risks that are inherent in a mortgage business.)

2. Control Risk (CR) – the risk that a material misstatement could occur in an assertion about a class of transactions, account balance, or disclosure and it could be material;, but it will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. Control risk will always exist because of the limitations of internal controls.

Is the audit risk model a qualitative or a quantitative model? Why?

Risk of Material Misstatement (RMM), the combination of inherent and control risk, is also called...