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Audit Risk: Concepts, Model, and Assessment - ACCT 3222, Exams of Accounting

Louisiana State University (LSU) - ShreveportAccounting

A comprehensive overview of audit risk, covering key concepts, the audit risk model, and the assessment process. It delves into the components of audit risk, including inherent risk, control risk, and detection risk, and explores their relationships. The document also examines the role of management's strategies and business risks in the audit risk assessment process, outlining the procedures auditors use to understand the entity and its environment. It further discusses the identification and assessment of fraud risk factors, including the fraud risk triangle, and provides insights into the auditor's response to risk.

Typology: Exams

2024/2025

Available from 03/27/2025

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LSU - ACCT 3222 - Chapter 4 – Questions –
with complete solutions
Audit Risk correct answer: - The risk that the auditor expresses
an inappropriate audit opinion when the financial statements are
materially misstated.
- Risk auditor will issue an unqualified opinion on materially
misstated financial statements.
Assertions in relation to Audit Risk correct answer:
Consideration of audit risk at even lower levels/account
balances/disclosures.
- Audit risks at the assertion level consist of:
1) The risk that the relevant assertions related to the account
balances or disclosures contain misstatements that could be
material to the financial statements (inherent risk and control
risk).
2) The risk that the auditor will not detect such misstatements
(detection risk).
Inherent Risk (IR) correct answer: The susceptibility of an
assertion in an account or disclosure to a misstatement due to
error or fraud that could be material, either individually or in
combination with other misstatements, before consideration of
any related controls.
Control Risk (CR) correct answer: The risk of material
misstatement that could occur in an assertion about an account
or disclosure and that could be material, either individually or
when aggregated with other misstatements, will not be
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LSU - ACCT 3222 - Chapter 4 – Questions –

with complete solutions

Audit Risk correct answer: - The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

  • Risk auditor will issue an unqualified opinion on materially misstated financial statements. Assertions in relation to Audit Risk correct answer: Consideration of audit risk at even lower levels/account balances/disclosures.
  • Audit risks at the assertion level consist of:
  1. The risk that the relevant assertions related to the account balances or disclosures contain misstatements that could be material to the financial statements (inherent risk and control risk).
  2. The risk that the auditor will not detect such misstatements (detection risk). Inherent Risk (IR) correct answer: The susceptibility of an assertion in an account or disclosure to a misstatement due to error or fraud that could be material, either individually or in combination with other misstatements, before consideration of any related controls. Control Risk (CR) correct answer: The risk of material misstatement that could occur in an assertion about an account or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be

prevented, or detected and corrected, on a timely basis by the entity's internal control Risk of Material Misstatement (RMM) correct answer: - The combined inherent and control risk; in other words, the likelihood that material misstatements may have entered the accounting system and not been detected and corrected by the client's internal control.

  • Misstatements caused by errors or fraud.
  • Auditor has little or no control over these risks.
  • A.K.A. : Client Risk - stems from decisions made by the entity, not the auditor. Detection Risk (DR) correct answer: - The risk that the procedures performed by the auditor 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.
  • Determined by effectiveness of audit procedures and how well the auditor applies those procedures. Relationship between Detection Risk and Inherent/Control Risk correct answer: - Inverse relationship
  • Inherent Risk / Control Risk is high, auditor would accept a lower level of detection risk in order to achieve the planned level of audit risk. Audit Risk Model correct answer: AR = IR x CR x DR AR = RMM x DR

Relationship of Entity's Business Risks to Audit Risk Model correct answer: Management's Strategies, Objectives and Business Risks correct answer: - Strategies are the operational approaches used by management to achieve its objectives.

  • Business risks are threats from significant conditions, events, circumstances, actions, or inactions that could adversely affect the entity's ability to achieve its objectives and execute its strategies.
  • Management addresses business risks by implementing a risk assessment process. Auditor Risk Assessment Procedures correct answer: - Used to obtain an understanding of the entity and its environment, including its internal control.
  1. Inquiries of those charged with governance (board of directors / audit committee), internal audit function, employees, management, in-house legal counsel, other entity personnel, and others outside the entity (customers, suppliers, valuation specialists).
  2. Analytical Procedures are evaluations of financial information made through analysis of plausible relationships between both financial and non-financial data; REQUIRED
  3. Observation and Inspection - entity activities / operations, documents, records, & internal control manuals, reading reports by management, audit committee, those charged with governance, & IAF, entity's premises & plant facilities, and transactions through the information system (walkthrough). Auditor's Risk Assessment Process correct answer:

Auditor's Understanding of an Entity and its Environment correct answer: Gather knowledge about:

  • Nature of the entity: information about the entity's business operations, investments & investment activities, financing & financing activities, and financial reporting.
  • Industry, regulatory, and other external factors
  • Objectives, strategies and related business risks
  • Entity performance measures
  • Internal Control PCAOB Additional Procedures to Better Understand an Entity correct answer: - Reading public information about the entity.
  • Observing/reading transcripts of earnings calls.
  • Obtaining info about significant unusual developments about trading of company's securities.
  • Obtaining understanding of senior management compensation arrangements. Industry, Regulatory, and Other External Factors correct answer: Assessing the Risk of Material Misstatement correct answer: - The auditor uses the understanding of the entity and its environment, including its internal controls, to assess the risk of material misstatement at the financial statement level and at the relevant assertion level, and to identify any significant risks.
  • Includes considering how the entity's risk assessment process may affect the likelihood and magnitude of potential misstatements.
  1. Judgmental Misstatements - arise from judgments of management concerning accounting estimates that auditor considers unreasonable or inappropriate.
  2. Projected Misstatements - auditor's best estimate of misstatements in populations, resulting from misstatements in audit sample being applied to entire population from which sample was drawn. Fraud Risk Assessment Process correct answer: - Discussion among audit team members regarding RMM due to fraud (brainstorming sessions); share insights about entity, its environment and business risks, provide opportunity for team to discuss how and where entity might be susceptible to fraud, and emphasize importance of maintaining professional skepticism.
  • Inquiries of management, audit committee and others at the company; understand the programs and controls management has establish to mitigate specific risk factors and how well management monitors those programs and controls.
  • Consideration of any unusual or unexpected relationships.
  • Understanding of entity's period-end closing process
  • Identification and assessment of fraud risk factors. Identification and Assessment of Fraud Risk Factors correct answer: Three conditions generally present when material misstatements due to fraud occur:
  1. Management or other employees have an incentive or are under pressure that provides a reason to commit fraud.
  2. Circumstances exist that provide an opportunity for fraud to be carried out.
  3. Those involved are able to rationalize committing a fraudulent act.
  • Referred to as Fraud Risk Triangle.
  • Fraud may be concealed through collusion or management override of controls. Risk Factors Relating to Fraudulent Financial Reporting correct answer: Risk Factors Relating to Misappropriation of Assets correct answer: Auditor's Process of Responding to RMM correct answer: Types of items that may result in significant risks include:
  • Assertions identified with fraud risk factors.
  • Non routine or unsystematically processed transactions.
  • Significant accounting estimates and judgments.
  • Highly complex transactions.
  • Application of new accounting standards.
  • Revenue recognition.
  • Industry specific issues. Risks with Special Audit Consideration correct answer: - Auditor should determine if any of the risks identified in the risk assessment process require special audit consideration.
  • If risk is significant, auditor must determine the nature of the risk, likely magnitude of potential misstatement, and likelihood of risk occurring. Significant Risk of Material Misstatement correct answer: When auditor has determined that an assessed RMM at a relevant assertion level is a significant risk, the auditor should perform tests of controls that mitigate the significant risk or

auditor's risk assessment procedures and audit responses to identified risks.

  • Discussion among engagement team.
  • Steps performed to understand the entity's business and environment - risks identified, evaluation of management's response to such risks, and the auditor's assessment of the risk of error or fraud considering the entity's response.
  • Fraud risk or other significant risk issues identified.
  • Nature, timing, and extent of procedures performed.
  • Nature of communications about error or fraud made to management. Communications about Fraud to Entity correct answer: - Whenever auditor finds evidence that fraud may exist, the matter should be brought to the appropriate level of management.
  • Auditor should reach an understanding with audit committee regarding the expected nature and extent of communications about misappropriations perpetrated by lower-level employees. Disclosure of Fraud to Outside Parties correct answer: Not part of auditor's responsibility except in the following scenarios:
  • To comply with certain legal and regulatory requirements.
  • To a successor auditor when successor makes inquiries of predecessor auditor.
  • In response to a subpoean.
  • To a funding agency or other specified agency in accordance with requirements for the audits of entities that receive governmental financial assistance.