Management and Organizational Studies 3363A/B Chapter 7: MOS 3363 - Chapter 7

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Management and Organizational Studies
Management and Organizational Studies 3363A/B
Michelle Loveland

Materiality and Risk • Usually done in the planning phase • Risks arise when a situation includes assessing probabilities (what is the likelihood of an event occurring) Risks in Auditing • There is always some level of uncertainty when preforming an audit • The audit risk model is used as part of a strategic auditing approach Audit Risk Model • Audit risk model = inherent risk x control risk x detection risk o AR = IR + CR + DR • Auditors only have control over detection risk, through the amount of audit work done • Audit Risk is set by the auditor at an acceptable level to the firm • Inherent Risk and Control Risk are measured by the auditor but not controllable • Detection Risk is controlled by the auditor through the amount of work done • Determine audit risk, inherent risk and control risk, and then solve for planned detection risk o Detection Risk is the only one you have control over o It determines how much evidence you have to collect • The lower the audit risk, the more evidence you have to collect Audit Risk • A measure of the auditor’s willingness to accept that the financial statements may be materially misstated even though a proper audit has been conducted o The risk that the auditor will issue an unqualified opinion when the financial statements are materially misstated • CAS 450 defines a misstatement as: o A difference between the amount, classification, presentation, or disclosure of a 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. • The risk of material misstatement is a function of: o Inherent Risk o Control Risk • Inherent risk: internal or external factors can create a risk that a material fraud or error has occurred. o The auditor considers both external factors and internal factors o Anything that involves estimates generally has a high inherent risk • Control Risk: This is the risk that any fraud or error that did occur was not identified and corrected by the internal controls. o If there is no reliance on internal controls, the control risk is 100% Audit Assurance • The compliment of audit risk o If Audit Risk is 2%, then Audit Assurance is 98% • You can never have 100% Audit Assurance (because you can never have 0% audit risk) Assessing Audit Risk • Factors that must be considered: o Nature of users o Likelihood of financial difficulties o Management Integrity • In addition, the auditor must consider the business risk facing the auditee Inherent Risk • A measure of the likelihood that there are material misstatements in a segment simply due to the nature of the segment (e.g. cash is more likely to be stolen than sheets of steel). • Inherent Risk is assessed at the account balance assertion level o A company may have a high inherent risk for inventory, but may have a low inherent risk for cash • The auditor needs to consider several factors when considering the inherent risk o Examples: new client, investment in speculative markets, etc. Control Risk • Measure of the likelihood that misstatements will NOT be detected or prevented by the internal control system • We are required to understand and evaluate controls (under GAAS), but we don’t need to rely on them • Control risk should be set at 100% when: o Internal controls are unrel
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