ACC 3600 Week 3 - Risk Assessment

Three stages of an audit

1. Risk Assessment, 2. Risk Response, 3. Reporting.

Core purpose of audit risk assessment procedures

To identify areas with a higher risk of material misstatement and direct audit resources accordingly.

Five key processes in risk assessment

Understanding the client, identifying significant accounts, understanding internal controls, assessing materiality, and developing audit strategy.

Three interconnected levels of audit risk assessment

Entity level, Industry level, and Economy level.

Entity-level risk examples

Poor governance, weak employee relations, customer reliance, IT weaknesses, and high debt dependence.

Industry-level risk examples

Intense competition, reputation concerns, heavy regulation, and demand changes.

Economy-level risk examples

Interest rate increases, inflation, economic downturns, and currency movements.

Corporate governance and audit risk relationship

Better corporate governance leads to better financial reporting quality and lower audit risk.

Indicators of high-quality corporate governance

Board oversight, independent audit committees, risk management frameworks, and ethical culture.

Key IT risks under ASA 315

Unauthorised system access, program errors, data loss, and inadequate backup systems.

Significance of IT weaknesses in modern audits

A single IT weakness can affect multiple accounts simultaneously due to automated accounting systems.

Three elements of fraud risk factors

Pressure, opportunity, and rationalization.

Professional skepticism in auditing

Maintaining a questioning mind, seeking corroborating evidence, and not relying solely on management or past positive experiences.

Financial effect of premature revenue recognition

Revenue is overstated now and understated later.

Financial effect of fictitious revenue

Revenue is overstated.

Financial effect of concealed liabilities

Liabilities are understated.

Financial effect of improper asset valuation

Assets are misstated.

Financial effect of improper disclosures

Reporting is misleading.

Going concern responsibility

Management is responsible for remaining a going concern; auditors evaluate if this assumption is reasonable.

Evidence gathered for going concern risks

Cash flow forecasts, revenue projections, debt agreements, board minutes, and legal advisor discussions.

Mitigating factors for going concern risk

Parent company guarantees, saleable assets, capital-raising ability, and new borrowing arrangements.

Purpose of analytical procedures

To identify unusual trends and unexpected relationships that may indicate material misstatement.

Trend (horizontal) analysis

Examines changes over time, such as receivables increasing significantly compared to sales.

Vertical (common size) analysis

Examines account proportions, such as inventory increasing as a percentage of total assets.

Ratio analysis in auditing

Examines relationships between accounts to provide evidence regarding liquidity, profitability, and solvency.

Components of Risk of Material Misstatement (RMM)

Inherent Risk (IR) and Control Risk (CR); conceptually combined as RMM = IR + CR.

Detection Risk (DR)

The only risk auditors can directly influence through planning, staffing, and testing.

Relationship between RMM and Detection Risk (DR)

Inverse relationship: Higher RMM requires lower DR (more audit work); lower RMM allows higher DR.

Predominantly substantive audit approach

Used when IR and CR are high, involving limited control reliance and extensive substantive testing.

Lower assessed control risk audit approach

Used when controls are strong (low CR), involving greater control reliance and less substantive testing.

Definition of materiality in auditing

Information is material if it could influence the decisions of users of financial statements.

Qualitative vs. Quantitative materiality

Qualitative is material due to nature (e.g., fraud); quantitative is material due to size (benchmarks like PBT or revenue).

Relationship between risk and materiality threshold

Higher risk leads to a lower materiality threshold and requires more audit evidence.