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.

Outlines

00:00

🔍 Audit Risk Management Strategies

The paragraph discusses the importance of managing audit risk to an acceptably low level. Auditors should address risk at both the financial statement level and the assertion level. At the financial statement level, auditors consider the users and the potential for management to overstate or understate financial results. To mitigate this risk, auditors may increase professional skepticism, assign more experienced staff, enhance supervision, and introduce unpredictability in audit procedures. They may also adjust the nature, timing, and extent of further audit procedures, such as shifting interim testing to year-end. At the assertion level, auditors consider the risk of material misstatement, the characteristics of transactions and balances, the nature of controls, and the need to test their effectiveness. They must design audit procedures that are responsive to the assessed risks, taking into account the significance and probability of misstatements, and the reliability of audit evidence. The auditor's approach may vary from a substantive approach to a combined approach, depending on the effectiveness of internal controls and the cost-benefit analysis.

05:02

🛠️ Substantive and Combined Audit Approaches

This paragraph elaborates on the substantive and combined approaches in auditing. In situations where there are no effective controls or when cost-benefit analysis favors it, auditors may perform only substantive procedures for certain assertions and risks. This approach focuses solely on the accuracy of financial statement amounts without relying on the effectiveness of internal controls. Conversely, the combined approach involves testing the operating effectiveness of controls and conducting substantive testing. This integrated method allows auditors to assess both the internal control environment and the actual financial data, providing a more comprehensive audit. The choice between these approaches depends on the specific context and the auditor's professional judgment.

Keywords

💡Audit Risk

Audit risk refers to the possibility that an auditor may fail to detect a material misstatement in financial statements. It is central to the video's theme as it discusses strategies to reduce this risk to an acceptable level. The script mentions that auditors should respond to assessed risk at both the financial statement level and the assertion level, indicating the comprehensive approach needed to manage audit risk.

💡Financial Statement Level

This term pertains to the overall assessment of a company's financial statements as a whole. In the context of the video, it is used to describe where auditors consider the potential for management to manipulate financial results and how they plan their audit approach to mitigate this risk.

💡Assertion Level

Assertion level focuses on specific financial statement assertions such as existence, completeness, accuracy, and valuation. The video script emphasizes that auditors must assess risks and design audit procedures at this detailed level to ensure the accuracy of each assertion, which is crucial for the integrity of the financial statements.

💡Professional Skepticism

Professional skepticism is the auditor's质疑态度, questioning and doubting the information provided by the client. The script highlights the increased need for skepticism as a response to audit risk, suggesting that auditors should not take information at face value but should质疑和验证 everything to ensure accuracy.

💡Unpredictability

Unpredictability in audit procedures refers to the variation in the timing, nature, and extent of the audits conducted. The video script stresses the importance of being unpredictable to prevent clients from anticipating audit procedures, which can enhance the effectiveness of the audit and reduce the risk of undetected errors or fraud.

💡Interim Testing

Interim testing is the audit work performed before the end of the fiscal year, with results then projected to the year-end. The script contrasts interim testing with year-end testing, suggesting that auditors may choose to perform substantive procedures closer to the period-end to obtain more accurate and reliable information.

💡Substantive Procedures

Substantive procedures are audit tests conducted to detect material misstatements in financial statement amounts. The video explains that auditors should design and perform these procedures based on the assessed risks, with a focus on obtaining evidence that is relevant and reliable.

💡Material Misstatement

A material misstatement is an error in financial statements that could significantly influence the decisions of users relying on that information. The video discusses how auditors must consider the risk of material misstatements when planning their audit work at both the financial statement and assertion levels.

💡Nature, Timing, and Extent

These three aspects describe how auditors should tailor their audit procedures based on the assessed risks. 'Nature' refers to the type of audit evidence sought, 'timing' to when the audit work is performed, and 'extent' to how much audit work is needed. The video script uses these terms to illustrate the auditor's approach to risk assessment and response.

💡Tolerable Misstatement

Tolerable misstatement is the auditor's predetermined limit for misstatements in the financial statements that would still be considered acceptable and not require adjustment. The script mentions that auditors consider tolerable misstatement when planning their audit procedures, balancing the level of assurance they aim to obtain with practical audit constraints.

💡Substantive Approach vs. Combined Approach

The substantive approach focuses solely on substantive procedures to detect material misstatements, while the combined approach includes both testing of internal controls and substantive procedures. The video script explains that auditors may choose between these approaches based on the effectiveness of controls and the assessed risks, with the combined approach providing a more holistic audit.

Highlights

Auditor should respond to risk at both financial statement level and assertion level.

At the financial statement level, auditors consider users and their purposes for using financial statements.

Auditors determine if management has incentives to overstate or understate financial results.

To reduce audit risk, auditors increase professional skepticism, assign more experienced staff, and increase supervision.

Unpredictability in audit procedures is key to prevent client anticipation of audit strategies.

Shifting interim testing to year-end can increase the accuracy of financial statement audits.

Audit procedures should be designed to be responsive to the assessed risks of material misstatement.

The nature, timing, and extent of audit procedures are crucial in responding to assessed risks.

The auditor must consider the significance and probability of material misstatements.

Auditors evaluate the characteristics of transactions, account balances, and disclosures.

The nature of controls and whether they prevent or detect material misstatements is assessed.

The auditor decides whether to test the operating effectiveness of controls.

Nature of audit procedures includes purpose and type, which is the most important consideration.

Timing of audit procedures should be closer to the period-end for higher risk assessments.

Extent of audit procedures refers to the quantity and is based on the auditor's judgment.

Tolerable misstatement, assessed risk, and desired assurance level influence the extent of procedures.

Auditors scrutinize individual elements of financial reporting for assertion-level risks.

Existence assertion for assets like inventory is critical if they are susceptible to theft.

Auditors may apply a substantive approach or a combined approach of internal control testing and substantive testing.

A combined approach is used when assessing both internal control and substantive testing for certain assertions and risks.

Transcripts

it says in order to reduce audit risk to

an acceptably low level the auditor

should respond to the assessed level of

risk in two ways at the financial

statement level and at the relevant

assertion level so at the financial

statement level versus at the detailed

assertion level all right at the

financial statement level the auditor

will consider the use users of the

financial statements and the purpose for

which they will be used to determine if

management may have an incentive to over

or understate the results of operations

and financial position is management

concerned with overstating or

understating the results of operations

income statement and financial position

is your balance sheet to address the

risk of material M statement at the

financial statement level some of the

Auditors responses to reduce audit risk

to an acceptably low level again we're

trying to reduce audit risk audit risk

IR CR Dr so we're trying to reduce our

audit risk to an exceptionally low level

a or the first bullet an increased need

for professional skepticism skepticism

question and doubt everything consider

assigning more experienced staff

increase the level of supervision

incorporate more

unpredictability in audit procedures

that's important you don't want the

client to know that oh yeah every year

they do the same test week every year

they do the same accounts every year

they have the same level of materiality

we want to be unpredictable it's kind of

like saying we're going to come out and

do an inventory observation but we're

not going to tell you which location

we're going to count

first adjust the nature timing and

extent of further audit procedures such

as shifting interim testing to year end

so what that means is instead of doing

interim interim means before the end of

the year and then rolling it forward it

says you know what if we want to be more

cautious do it at the end of the year

because the balance at December 31st is

more accurate than the balance o October

31st happy Halloween and rolling it

forward the auditor should design and

perform further audit procedures whose

nature timing and extent are responsive

to the assessed risks of material M

statement at the relevant assertion

level the auditor should consider so

here's what we're considering it says

here uh the significance and

probability of uh the the significance

probability that a material misstatement

will occur uh the characteristics of the

class of transactions account balances

disclosures the nature of the controls

used whether the auditor needs to test

the operating effectiveness of the

controls in preventing or detecting

material misstatements now when we talk

about nature timing and extent nature

means what timing when extent how much

it says nature of audit procedures this

includes both its purpose and its type

the nature of audit procedures is the

most important consideration in

responding to the assessed risks uh the

higher the auditor's risk of material M

statement the more relevant and reliable

the audit evidence should be timing

talks about when we're going to do it

and that means should we do it at the

end of the year or interim the higher

the auditor's rmm the closer to period

and substantive procedure should be

performed now the higher the rmm that

means if Reliance is low rmm or control

risk is high that means we want this low

we better do more of this when are we

going to do that closer to your

end extent this refers to the quantity

of specific audit procedures this is

based on the auditor's judgment and the

auditor should be should consider the

tolerable misstatement the assess risk

of material misstatement and the degree

of assurance they plan to obtain so

you'll see that all of that again deals

with information that we've dealt with

in the past so as we're looking at that

we're concerned again with looking at

these risks at both the financial

statement level and also the relevant

assertion level to address the risk at

the assertion level the auditor

considers the individual elements of the

financial reporting operating items

account balances will be scrutinized uh

the type of likely misstatements also uh

determines which assertions are most

effective and which procedures will be

most effective in obtaining the evidence

as well assets like inventory may may uh

represent risk if they are susceptible

to theft in which case the auditor will

concentrate on the existence assertion

so when we talk about existence for

example uh the audit determines if there

are control procedures in place that can

be relied upon and that if operating is

designed designed would be effective in

preventing theft the auditor May apply

substantive procedures such as comparing

physical observations of inventory to

recorded amounts and Performing

analytical procedures to determine if

the relationships among inventory cost

of sales and gross profits are

reasonable uh for sales and we go

through a couple of examples like that

now as mentioned earlier the auditor may

use either a substantive approach or a

combined approach a substantive approach

means you're not going to rely more

substantive boom versus a combined

approach is where you're doing internal

control testing as well as substantive

testing it says a combined approach for

certain relevant assertions and risks

only substan of procedures will be

performed this may occur because either

there are no effective controls or cost

benefit in other situations both tests

of operating effectiveness of controls

and substantive are use that's called

the combined approach that's where

you're looking at both internal control

and substantive testing as well so you

can kind of see how that's all

integrated