Auditing & Assurance Services - Chapter 4: Audit Risk Model and Inherent Risk Assessment

Vocabulary flashcards covering core auditing concepts, the audit risk model, fraud categories, inherent risk factors, and risk assessment procedures from Chapter 4.

Audit Risk (AR)

The risk that the auditor may express an inappropriate audit opinion when the financial statements are materially misstated.

Inherent Risk (IR)

The probability that, in the absence of internal controls, material misstatements enter into the financial statements.

Control Risk (CR)

The likelihood that the client's internal control policies and procedures fail to prevent or detect a material misstatement.

Detection Risk (DR)

The likelihood that the auditor's substantive procedures will fail to detect a material misstatement that exists within an account balance or class of transactions.

Audit Risk Model (ARM)

The mathematical framework expressed as $AR = IR \times CR \times DR$ (or $AR = RMM \times DR$), used by auditors to calculate allowable detection risk via $DR = \frac{AR}{IR \times CR}$.

Sampling Risk

The risk of choosing an unrepresentative sample from a population during audit procedures.

Non-sampling Risk

The risk that the auditor may reach inappropriate conclusions based upon available evidence due to factors unrelated to sample size.

Matrix Approach to Detection Risk

A qualitative method for determining allowable Detection Risk (DR) by plotting levels of assessed Inherent Risk (IR) against Control Risk (CR).

Fraud

The act of knowingly making material misrepresentations of fact with the intent of inducing someone to believe the falsehood and act on it, causing loss or damage.

Cookie Jar Reserve

An accounting fraud practice where excess income is withheld in liability accounts during high-earning years and released in low-earning years to artificiality meet earnings targets.

Fraudulent Financial Reporting

A category of fraud involving intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users.

Misappropriation of Assets

A category of fraud involving the theft or misuse of an entity's assets.

Employee Fraud

The use of fraudulent means by an employee to misappropriate funds or other property from an employer.

Embezzlement

A type of fraud where employees or nonemployees wrongfully misappropriate funds or property entrusted to their care, custody, and control, often accompanied by false accounting entries.

Larceny

Simple theft committed when an employee misappropriates an employer's funds or property that has not been entrusted to their custody.

Defalcation

Another term for employee fraud, embezzlement, and larceny, referred to in auditing standards as misappropriation of assets.

Risk Assessment Process

The auditor's procedure for assessing inherent risk at both the overall financial statement level and at each management financial statement assertion level.

Analytical Procedures

Evaluations of financial data made by developing expectations and comparing them to recorded amounts; required during audit planning and final review stages.

Audit Team Brainstorming Discussions

A required engagement procedure where auditors discuss previous experiences, how fraud might be perpetrated and concealed, and set the tone for the audit.

Significant Risks

Risks identified by the auditor that require special audit consideration due to the nature of the risk or the likelihood and potential magnitude of misstatement.

Audit Strategy Memorandum

An overall planning document that sets the scope, timing, and direction for auditing each relevant assertion based on the audit risk model, forming the basis for detailed audit plans.