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Audit
Risk
CPA
9-1
Presentation Outline
I.
III.
9-2
9-3
Tolerable
Misstatement
$ 4,000
20,000
36,000
$50,000
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9-7
Account
Cash
Accounts receivable
Inventory
Tolerable
Direct Sampling
Misstatement Projection Error
Total
$ 4,000
$
0 $ N/A
$
0
20,000
12,000
6,000* 18,000
36,000
31,500
15,750* 47,250
Preliminary judgment
about materiality
$50,000
*estimate for sampling error is 50%
9-8
Tolerable
Direct Sampling
Misstatement Projection Error
Total
$ 4,000
$
0 $ N/A
$
0
20,000
12,000
6,000* 18,000
36,000
31,500
15,750* 47,250
Account
Cash
Accounts receivable
Inventory
Total estimated
misstatement amount
Preliminary judgment
about materiality
$50,000
*estimate for sampling error is 50%
$43,500
$16,800
$60,300
9-9
Account
Cash
Accounts receivable
Inventory
Total estimated
misstatement amount
$43,500 $16,800 $60,300
Preliminary judgment
about materiality
$50,000
*estimate for sampling error is 50%
Because the estimated combined misstatement exceeds the
preliminary judgment, the financial statements are not acceptable.
The auditor may perform additional audit procedures to reevaluate
the estimate, or require adjustment for the estimated misstatements.
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A.
Audit
Risk
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Inherent Risk
(IR)
Susceptibility of an assertion to
material misstatement assuming no
related internal controls.
Control Risk
(CR)
Detection Risk
(DR)
Audit Risk
(AR)
Caught by
internal
controls
Caught by
auditor
=
Undetected
misstatement
Audit
Risk
XYZ Co.
Financial
Statements
3. Integrity of Management
If a client has questionable
integrity, the auditor is likely
to assess acceptable audit risk
lower. Indications of integrity
problems include:
Frequent disagreements with
prior auditors, the IRS,
and/or SEC
Frequent turnover of key
financial and internal audit
personnel
Ongoing conflicts with labor
unions and employees
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C. Inherent Risk
Nature of the Clients Business
2.
Results of Previous Audits
3.
Initial vs. Repeat Engagement
4.
Related Parties
5.
Nonroutine Transactions
6.
Judgment Required
7.
Make-up of the Population
1.
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Misstatements found in
the previous years audit
have a high likelihood
of occurring again.
Many types of
misstatements are
systematic in nature,
and organizations are
slow in making changes
to eliminate them.
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4. Related Parties
Examples of related
party transactions are
those between parent and
subsidiary companies,
and management or
owners and the company.
Increases inherent risk
because there is a greater
likelihood of
misstatement.
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5. Nonroutine Transactions
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6. Judgment Needed
Many account balances
require estimates and a
great deal of
management judgment
including:
Uncollectible accounts
receivable
Obsolete inventory
Warranty liabilities
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D. Control Risk
There are two basic phases to an auditors evaluation of
control risk:
1.
Obtain an understanding of internal control. This
phase applies to all audits.
2.
Test the internal controls for effectiveness. This
phase only applies when the auditor chooses to
assess control risk at below the maximum.
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ring
Acc
epta
ble
Aud
it
Risk
Lower
Detection
Risk
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A.
D.
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Direct
Planned
detection risk
Inverse
Planned
audit evidence
Inherent
risk
Planned
detection risk
Planned
audit evidence
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Planned
audit evidence
D
D
I
Planned
detection risk
I
D
I
Planned
audit evidence
D
Tolerable
misstatement
D = Direct relationship; I = Inverse relationship
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A.
Reduce inherent risk not feasible unless new facts are uncovered
during the audit process.
Reduce control risk may be possible to reevaluate control risk to
a lower level by conducting more tests of internal controls.
Reduce achieved detection risk can be achieved by larger sample
sizes and/or additional audit procedures.
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2.
Summary
Audit Process
Applying
Materiality
Risk and Audit
Planning
Evaluating
Results
Risk
Internal Control
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