Chapter 3 - Risk assessment and materiality. In this chapter you will understand the auditor's requirements for client acceptance and continuance, understand the steps that are involved in the preliminary engagement activities, know what is required to establish an understanding with the client, know the types of information that are included in an engagement letter,. | Risk Assessment and Materiality Chapter Three Audit Risk The risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Financial statement level Individual account balance or class of transactions level Auditor’s Business Risk An auditor’s exposure to financial loss and damage to professional reputation. Client and third party lawsuits Negative publicity The Audit Risk Model Audit Risk = RMM× DR Risk that material misstatements exist Non-sampling risk Sampling risk Detection risk: Risk that auditor will not detect misstatements Inappropriate audit procedure Fail to detect when using appropriate audit procedure Misinterpreting audit results The Audit Risk Model Audit Risk = IR × CR × DR Inherent risk and control risk: Risk that material misstatements exist Non-sampling risk Sampling risk Detection risk: Risk that auditor will not detect misstatements Inappropriate audit procedure Fail to detect when using appropriate audit procedure Misinterpreting audit results Using the Audit Risk Model Set a planned level of audit risk such that an opinion can be issued on the financial statements. Assess risk of material misstatements. Use the audit risk equation to solve for the appropriate level of detection risk: AR = MRR × DR DR = AR MRR Auditors use this level of detection risk to design audit procedures that will reduce audit risk to an acceptable level. Using the Audit Risk Model Set a planned level of audit risk such that an opinion can be issued on the financial statements. Assess inherent risk and control risk. Use the audit risk equation to solve for the appropriate level of detection risk: AR = IR × CR × DR DR = AR IR × CR Auditors use this level of detection risk to design audit procedures that will reduce audit risk to an acceptable level. Using the Audit Risk Model Using the Audit Risk Model Qualitative terms may also be used in the audit risk model. | Risk Assessment and Materiality Chapter Three Audit Risk The risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Financial statement level Individual account balance or class of transactions level Auditor’s Business Risk An auditor’s exposure to financial loss and damage to professional reputation. Client and third party lawsuits Negative publicity The Audit Risk Model Audit Risk = RMM× DR Risk that material misstatements exist Non-sampling risk Sampling risk Detection risk: Risk that auditor will not detect misstatements Inappropriate audit procedure Fail to detect when using appropriate audit procedure Misinterpreting audit results The Audit Risk Model Audit Risk = IR × CR × DR Inherent risk and control risk: Risk that material misstatements exist Non-sampling risk Sampling risk Detection risk: Risk that auditor will not detect misstatements Inappropriate audit procedure Fail to detect when using .
