Audit Holt Exam 1 Ch. 4

audit risk

the risk that the auditor expresses and inappropriate audit opinion when the financial statements are materially misstated

audit risk =

risk of material misstatement * detection risk

risk of material misstatement =

inherent risk * control risk

so, AR =

IR * CR * DR

inherent risk

susceptibility of misstatement before any controls are put in place

control risk

risk that the controls do not detect material misstatements

detection risk

risk that the auditor does not discover misstatement

low AR is typically __%

10

low IR, CR, and DR is typically __%

20%

two ways to describe audit risk

numerically (10%) or with words (low)

two subsets of detection risk

sampling risk and non-sampling risk

sampling risk

the risk that the characteristics of the sample do not represent the population as a whole

non-sampling risk

anything else that could impair the audit (ex: not performing a procedure correctly)

DR is directly related with __ and inversely related with __

AR; IR and CR

engagement risk

auditor's exposure to financial or repetitional loss from an engagement; can come in the form of litigation or adverse publicity

a higher engagement risk would lead an auditor to plane for a _____ audit risk

lower

3 steps of the audit risk model

1 - set planned level of audit risk

2 - access IR and CR and determine RMM

3 - determine appropriate level of DR

formula for determining appropriate level of DR

DR = AR / (IR*CR)

nature, timing, and extent of an engagement with a lower level of DR allowed

nature: more effective tests

timing: testing at year end

extent: more tests

(more audit effort)

nature, timing, and extent of an engagement with a higher level of DR allowed

nature: less effective tests

timing: testing at interim

extent: fewer tests

(less audit effort)

2 limitations of audit risk model

-risk levels are judgement based

-no way to measure achieved risk

who controls:

audit risk?

inherent risk?

control risk?

detection risk?

auditor

nobody

client

auditor

errors vs fraud

errors are unintentional misstatements; fraud is intentional

2 primary types of fraud

fraudulent FS and asset misappropriation

which type of fraud is most common?

asset misappropriation

which type of fraud results in the biggest losses?

fraudulent FS

what is the most common way of detecting fraud?

by tip (43% of cases)

how often is the external auditor the one who detects fraud?

3% of the time

fraud triangle

opportunity, pressure, and rationalization

which component of the fraud triangle is the only one that management can control?

opportunity

fraud auditors must approach FS with:

suspicion

who should fraud involving senior management be reported to?

audit committee

Auditors must plan the audit to detect material misstatements due to ____ or ____

error; fraud