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Risk

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8 views4 pages

Risk

Uploaded by

nandanasagar33
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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RISK

PROFESSIONAL SKEPTICISM

Professional scepticism is an attitude that includes a questioning mind, being alert to


conditions which may indicate possible misstatement due to fraud, error and a critical
assessment of audit evidence.

MATERIALITY

Misstatements, including omissions, are considered to be material if they, individually or in the


aggregate, could reasonably be expected to influence the economic decisions of users taken on
the basis of the financial statements.

Material by size

Common measures are as follows

½ – 1 % of revenue

5% – 10% of profit before tax

1 – 2% of total assets.

Material by nature

Materiality is not just a purely financial concern. Some items may be material by nature.

• Misstatements that a ect compliance with regulatory requirements.


• Misstatements that a ect compliance with debt covenants.
• Misstatements that, when adjusted, would turn a reported profit into a loss for the year.
 Transactions with directors, e.g. salary and benefits, personal use of assets, etc.
 Disclosures in the financial statements relating to possible future legal claims or going
concern issues

PERFORMANCE MATERIALITY

Performance materiality is the amount set by the auditor at less than materiality for the financial
statements as a whole to reduce undetected misstatements for the financial statements as a
whole.

Performance materiality is always set lower than the overall materiality.


Example: Material level = $550,000

Misstatements identified $ 300,000, $200,000, $400,000. When we take them individually they
were immaterial amounts When we took aggregate $300,000 + $200,000 + $400,000 = $900,000
which is material amount. Therefore, we need to reduce the materiality level in order to avoid at
least some misstatements.

AUDIT RISK

Audit Risk is defined as the risk of issuing a wrong audit opinion. This mean that the auditor
issues an unmodified opinion when the financial statements is misstated.

RISK OF MATERIAL MISSTATEMENTS

Risk of material misstatements is the risk that the financial statements are materially misstated
prior to audit and it consist of two components – inherent risk and control risk.

INHERENT RISK

Inherent risk is the risk on financial statements that an account balance, class of transactions
may be materially misstated due to nature of client’s business or nature of client’s transactions.

For example: Fashion based industry where inventory changes very often leading to inventory
becoming obsolete. This will impact the valuation of the inventory which may have not been
considered by the client leading to material misstatements on the FS

CONTROL RISK

Control risk is the risk on the financial statements that a material misstatement will not be
prevented or detected and corrected by the entity’s internal controls.
DETECTION RISK

Detection risk is the risk arising from the audit procedures being insu icient to determine a
material misstatement on FS

Detection risk comprises of the following:

SAMPLING RISK

It is the risk that auditor conclusion based on a sample is di erent from the conclusion that
would be reached if the whole population is tested.

For example: Wrong sample size, wrong sample selection method

NON-SAMPLING RISK

It is the risk that the auditor’s conclusion is inappropriate for any other reasons. For example:
Application of inappropriate audit procedures

IMPACT OF AUDIT RISK ON AUDIT

If the audit risk is high, then it will influence the following:

• Assigning more experienced sta to risk areas

• Increasing supervision levels

• Increasing sample size

RISK ASSESSMENT

The auditor should perform the following risk assessment procedures:

Enquiries, Analytical procedure, Observation, Inspection

UNDERSTANDING THE ENTITY AND ITS ENVIORNMENT

In order to identify the risks of material misstatement in the financial statements

the auditor is required to obtain an understanding of the following:

• Industry in which they operate

• Laws and regulations

• Client – Operations, products, services, major vendors and customers

• Internal Competences – Management, systems and controls, accounting policies adopted

• External relationships
The reason to obtain an understanding of the client

• To be able to assemble the audit team based on the skills required


• To develop the audit strategy and audit plan
• To identify significant areas to reduce those risks

The information used to obtain this understanding can came from a wide range of sources
including:

Firm- Partners, Managers, industry experts, Prior year team, Prior year team.

You- Past experience, Industry knowledge.

Client- Discussions, Observations, Websites, Minutes of board meeting

OTHERS- Industry surveys, Internet, National press.

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