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Assignment 2

The document discusses audit risk, which consists of the risk of material misstatement (inherent and control risks) and detection risk, along with factors that can increase these risks. It emphasizes the importance of assessing risks during the planning stage of an audit to focus on areas likely to cause material misstatements, leading to a more efficient audit. Additionally, it explains materiality and performance materiality as defined by ISA 320, highlighting their role in influencing economic decisions and ensuring the accuracy of financial statements.

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9 views3 pages

Assignment 2

The document discusses audit risk, which consists of the risk of material misstatement (inherent and control risks) and detection risk, along with factors that can increase these risks. It emphasizes the importance of assessing risks during the planning stage of an audit to focus on areas likely to cause material misstatements, leading to a more efficient audit. Additionally, it explains materiality and performance materiality as defined by ISA 320, highlighting their role in influencing economic decisions and ensuring the accuracy of financial statements.

Uploaded by

nurtushar7
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 DOCX, PDF, TXT or read online on Scribd
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Assignment-2

1) Explain the components of audit risk and, for each component, state an example of a factor
that can result in increased audit risk.

Answer: Audit risk is the risk that the auditor expresses an inappropriate audit opinion when
the financial statements are materially misstated.

Audit risk is made of two components :

i) Risk of material misstatement

Risk of material misstatement is the risk that the financial statements are materially misstated
prior to the audit .this consist of two components:

a) Inherent risk: Inherent risk is the susceptibility of an assertion about a class of


transaction, account balance or disclosure to misstatement that could be material , before
consideration of any related controls.
example of a factor that can result in increased audit risk is “new regulations or changes in
industry standards may increase the risk of misstatements if not properly understood or
implemented”

b) Control Risk: Control risk is the risk that a misstatement that could occur & that could be
material , will not be prevented, or detected and corrected on a timely basis by the
entity’s controls.
example of a factor that can result in increased audit risk is ”Inadequate oversight and
monitoring of controls increase the risk of errors or fraud going undetected”.

ii) Detection Risk.

Detection risk is 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.

example of a factor that can result in increased audit risk is “if the auditor uses small or inadequate
samples, there is a higher chance of not detecting material misstatement that exist in the
population .
2) Discuss the importance of assessing risks at the planning stage of an audit.

ISA 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding
the Entity and Its Environment, requires auditors ‘to identify and assess the risks of material
misstatement, whether due to fraud or error, at the financial statement and assertion levels’.

It is vitally important for auditors to assess engagement risks at the planning stage, this will
ensure that attention is focused early on the areas most likely to cause material misstatements.

Any unusual transactions or balances would also be identified early, so that these could be
addressed in a timely manner.

In addition, as most auditors adopt a risks based audit approach then these risks need to be
assessed early in order for the audit strategy and detailed work programmes to be developed.

Assessing risks early should also result in an efficient audit. The team will only focus their time
and effort on key areas as opposed to balances or transactions that might be immaterial or
unlikely to contain errors.

In addition assessing risk early should ensure that the most appropriate team is selected with
more experienced staff allocated to higher risk audits and high risk balances.

3) Explain the concepts of materiality and performance materiality in accordance with ISA 320
Materiality in Planning and Performing an Audit.

Materiality is defined in ISA 320 as Misstatements including omissions are considered to be


material if they, individually or in aggregate could influence the economic decisions of the users
in relation to the financial statements. If something is material, the financial statement does not
show a true and fair view.

In assessing the level of materiality, there are a number of areas that should be considered. The
auditor should first consider both the amount (quantity) and the nature (quantity) of any
misstatements. The quantitative refers to the size of the misstatement and the quality refers to the
relevance and prominence which could influence the users decision.

They should also consider whether the misstatement would affect the economic decision of the
users and the information needs of the users as a group. Materiality is often calculated using
benchmarks such as 0.5% of Total Revenue, 5% of Total Profit and 1 of Total Assets.

These values are useful as a starting point for assessing materiality. The assessment of what is
material is dependent on the auditor's professional judgement and it is affected by the auditor's
perception of the financial information and the perceived level of risk.

In calculating materiality, the auditor should also set the performance materiality level.
Performance materiality is set at a lower level than overall materiality to reduce the risk that
misstatements could be material in aggregate. The aim of performance materiality is to reduce
the risk that the total of errors in balances and disclosures does not in total exceed
overall materiality.

3) Explain the benefits of audit planning.

An efficient and effective audit plan provides the following benefits:

· Accomplishment of Objectives: Audit plan ensures that it provides right means to


accomplish audit objectives. Further it also ensures that appropriate attention is devoted to
important areas of audit.

· Identification of Problems: A well drawn and established audit plan helps in identifying
potential problems.

· Timely Completion of Work: It ensures that work is completed properly within the
specified time and no important area is left out. It also ensures that all important areas of
management receive attention.

· Facilitates Coordination: It facilitates coordination of the audit work done by auditors


and other experts

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