Audit Risk, Financial Statement Level and Assertion Level - Lesson 2

Summary

The script discusses strategies for auditors to mitigate audit risk by addressing it at both the financial statement level and the assertion level. At the financial statement level, auditors consider the users' needs and potential management incentives to misstate financials. They respond by increasing professional skepticism, assigning more experienced staff, and incorporating unpredictability in audit procedures. At the assertion level, auditors tailor the nature, timing, and extent of further audit procedures based on the assessed risks, focusing on the significance and probability of material misstatements. They may use a substantive or combined approach, depending on the effectiveness of internal controls and the specific risks involved.

Takeaways

• 🔍 Auditors aim to reduce audit risk to an acceptably low level by addressing it at both the financial statement level and the relevant assertion level.
• 👀 At the financial statement level, auditors consider the users of financial statements and the potential for management to overstate or understate results.
• 🤔 Auditors respond to risk by increasing professional skepticism, assigning more experienced staff, enhancing supervision, and introducing unpredictability in audit procedures.
• 🗓️ Adjusting the timing of audit procedures, such as shifting interim testing to year-end, can help reduce risk by ensuring more accurate data is assessed.
• 🛠️ The nature, timing, and extent of further audit procedures are tailored to the assessed risks of material misstatement at the assertion level.
• 📊 The significance and probability of material misstatement, along with the characteristics of transactions and controls, guide the auditor's approach to risk assessment.
• 🔑 The nature of audit procedures is paramount, focusing on relevance and reliability of evidence to address the assessed risk of material misstatement.
• ⏰ Timing of substantive procedures is closely linked to the assessed risk, with higher risks warranting procedures closer to the reporting period.
• 📈 Extent of audit procedures is determined by the auditor's judgment, considering tolerable misstatement and the planned degree of assurance.
• 🔎 Auditors scrutinize individual financial reporting elements, such as account balances, to identify risks and determine the most effective assertions and procedures.
• 🔄 Auditors may employ a substantive approach or a combined approach, which includes testing of controls and substantive testing, depending on the effectiveness of internal controls and risk assessment.

Q & A

What are the two ways an auditor should respond to the assessed level of risk to reduce audit risk?

An auditor should respond to the assessed level of risk by considering the risk at the financial statement level and at the relevant assertion level.

What factors does an auditor consider at the financial statement level to determine if management may have an incentive to overstate or understate financial information?

At the financial statement level, the auditor considers the users of the financial statements and the purpose for which they will be used to determine if management may have an incentive to overstate or understate the results of operations and financial position.

What are some of the auditor's responses to reduce audit risk at the financial statement level?

At the financial statement level, auditors may increase professional skepticism, assign more experienced staff, increase the level of supervision, incorporate more unpredictability in audit procedures, and adjust the nature, timing, and extent of further audit procedures.

Why is it important for audit procedures to be unpredictable?

Unpredictability in audit procedures is important to prevent the client from anticipating the auditor's actions, such as the timing and location of inventory observations, which can enhance the effectiveness of the audit.

What does the auditor consider when designing further audit procedures at the assertion level?

At the assertion level, the auditor considers the significance and probability of a material misstatement, the characteristics of the class of transactions, account balances, and disclosures, the nature of the controls, and whether the auditor needs to test the operating effectiveness of the controls.

How does the auditor determine the nature, timing, and extent of audit procedures in response to assessed risks?

The auditor determines the nature, timing, and extent of audit procedures based on the assessed risks of material misstatement, ensuring that the audit evidence is relevant and reliable, and that substantive procedures are performed closer to the period end as the risk of material misstatement increases.

What is the significance of the 'nature' of audit procedures in responding to assessed risks?

The nature of audit procedures is the most important consideration in responding to assessed risks as it includes both its purpose and type, and it directly affects the relevance and reliability of the audit evidence.

Why might an auditor choose to perform substantive procedures closer to the period end rather than at an interim date?

An auditor might choose to perform substantive procedures closer to the period end to ensure that the audit evidence reflects the most accurate and up-to-date financial information, as balances at the end of the year are typically more accurate than those at an interim date.

How does the auditor address risks at the assertion level?

At the assertion level, the auditor scrutinizes individual elements of financial reporting, operating items, and account balances, and determines which assertions are most effective and which procedures will be most effective in obtaining evidence, considering the type of likely misstatements.

What is the difference between a substantive approach and a combined approach in auditing?

A substantive approach focuses solely on substantive testing without relying on internal control testing, while a combined approach includes both tests of operating effectiveness of controls and substantive testing, providing a more comprehensive audit.

Why might an auditor choose to use only substantive procedures for certain relevant assertions and risks?

An auditor might choose to use only substantive procedures for certain relevant assertions and risks if there are no effective controls in place or if the cost-benefit analysis favors substantive testing over control testing.