AUDIT RISK
DEFINE AUDIT RISK
•It is the risk that the auditor might give an
incorrect opinion when the financial
statements are materially misstated.
MISSTATEMENT
• Difference between the amount, classification, presentation or
disclosure of reported financial statement item and the amount ,
classification, presentation or disclosure that is required for the
item to be in accordance with the applicable financial reporting
framework.
• It could be by error or by fraud.
• Types- FACTUAL, JUDGEMENTAL and PROJECTED.
MATERIALITY
• Misstatements , including omissions , are considered to be material if they,
individually or in aggregate , influence the economic decisions of users taken
on the basis of f/s.
• ½- 1% of revenue
• 5-10% of PBT.
• 1-2% of total assets.
• Matter of professional judgement.
• MATERIAL BY NATURE
• MATERIAL BY SIZE
PERFORMANCE MATERIALITY
• Misstatements are material when aggregated.
• Therefore, performance materiality refers to the amount or
amounts set by the auditor at less than the materiality level or
levels for particular class of transactions, account balances or
disclosures.
HOW TO IDENTIFY AND ASSESS RISK?/ RISK
ASSESSMENT PROCEDURES
• Understanding the entity and it’s environment.
• Enquiries with management and others.
• Analytical Procedures.
• Observation.(e.g control procedures)
• Inspection.(key strategic documents and procedural manuals)
WHY DO WE NEED TO ASSESS RISK? OR WHAT IS
IT’S PURPOSE/RELEVANCE/SIGNIFICANCE?
• Identify areas of the financial statements where misstatements are
likely to occur early in the audit .
• Plan procedures that address the significant risk areas identified .
• Determine the extent of the detailed substantive procedures to be
carried out.
• Carry out an efficient, focussed and effective audit.
• Minimise the risk of reputational and punitive damage.
COMPONENTS
RISK OF MATERIAL
OF AUDIT RISK
DETECTION RISK
MISSTATEMENT IN (from auditor’s viewpoint)
THE F/S (before the
audit,i.e, management’s
mistake)
Inherent risk Risk that auditor’s procedures will
( before considering any not detect misstatements in the
controls) f/s.
- Inadequate planning
Control risk (client’s ICS will - Audit team incompetence
not detect MMS) - Lack of professional
scepticism etc.
ISA 315
It states, ‘The objective of the auditor is to identify and
assess the risk of MMS, whether due to error or fraud, at
the financial statement and the assertion levels, through
understanding the entity and it’s environment, including the
entity’s internal control, thereby providing a basis for
designing and implementing responses to the assessed risks
of MMS’.
INHERENT RISK
• It is the susceptibility of an assertion about a class of
transaction, account balance or disclosure to misstatement
that could be material before considering any related
controls.
• It describes something about the nature of the business or
it’s transactions which make it susceptible to MMS.
EXAMPLES OF INHERENT RISK
• Changes in industry it operates in.
• Operations that are subject to a high degree of regulation.
• Going concern and liquidity issues including loss of significant
customers.
• Moving into new lines of business.
• Expanding into new locations.
• Application of new accounting standards or complex standards.
CONTROL RISK
The risk that a misstatement that could occur in an
assertion about a class of transaction, account balance or
disclosure and that could be material, either individually or
aggregated with other misstatements , will not be
prevented detected or corrected, on timely basis by entity’s
internal control.( controls are weakly designed or
implemented)
EXAMPLES OF CONTROL RISK
• Lack of personnel with appropriate accounting and financial reporting skills.
• Changes in key personnel including departure of key management.
• Changes in IT environment.
• Installation of new IT system.
DETECTION RISK
The risk that the procedures performed by the auditor to reduce
audit risk to an acceptably low level will not detect a misstatement
that exists and that could be material, either individually or when
aggregated with other misstatements.
- SAMPLING RISK= Sample is not representative of the population.
- NON-SAMPLING RISK= auditor’s procedures or the conclusion
reached are incorrect.
FORMULA OF AUDIT RISK
AUDIT INHERENT CONTROL DETECTION
RISK= RISK RISK RISK
Needs to be at an HIGH HIGH MUST BE LOW!!!!!!!!!!!!
acceptably low level.
AUDITOR’S RESPONSES TO RISK
ISA 330 LISTS OVERALL
RESPONSES THAT MAY BE USED
BY THE AUDITOR:
• Emphasizing to the audit team the need to maintain professional
scepticism .
• Assigning more experienced staff, those with special skills, or using
experts.
• Providing more supervision.
• Making general changes to the nature, timing or extent of audit
procedures.