1. 6 Risk assessment

2. Professional scepticism Definition Requirements—audit evidence/management

3. Audit methods Direct verification approach (account-based auditing) 账项基础审计 Systems approach (system-based auditing) 制度基础审计 Risk-based audit 风险基础 / 导向审计

4. Risk-based audit development from the systems based audit focus on key risk areas to concentrate on high-risk client (client screening) and on high-risk areas of a client’s business, not perform detailed audit tests on all areas of a client’s business. cost effective influence external audit, internal audit and all risk management activities.

5. Audit risk The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated The auditor should plan and perform the audit to reduce audit risk to an acceptably low level that is consistent with the objective of an audit

6. Components of AR--ISA AR is a function of the risk of material misstatement of the financial statements (i.e., the risk that the financial statements are materially misstated prior to audit) and the risk that the auditor will not detect such misstatement (“detection risk”).

7. Risk model AR = RMM*DR = IR*CR*DR

8. Inherent Risk—ISA 315 the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming that there are no related controls.

9. Entity level of inherent risk - state of economy and the industry legislation, regulation and accounting practices nature, fashion and high tech of business product - size, location, small/large, new/existing - market forces/competition - dominant and integrity of CEO - the cash situation of the company, - the trading history of the company, the nature and incidence of unusual transactions.

10. Transaction /balance level of IR - the susceptibility to misappropriation, - the complexity of the underlying transactions - the degree of judgement involved in determining account balances

11. Control Risk--ISA the risk that a misstatement that could occur in an assertion 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.

12. Control Risk The preliminary assessment of CR should always be high unless --- the auditor can either identify controls that are likely to prevent or detect misstatements in each area, or --- plans to perform tests of control to support the assessment. Evidence should be obtained through tests of control to support any assessment of control risk that is less than high;

13. Detection Risk the risk that the auditor will not detect a misstatement that exists in an assertion that could be material, either individually or when aggregated with other misstatements. a function of the effectiveness of an audit procedure and of its application by the auditor. Detection risk cannot be reduced to zero

14. Detection risk relates to the nature, timing, and extent of the auditor’s procedures that are determined by the auditor to reduce audit risk to an acceptably low level. The greater the risk of material misstatement (IR*CR) the auditor believes exists, the less the DR that can be accepted. The lower the risk level required, the greater the audit work required.(inverse relation)

15. Try to compute AR = 5% IR =100% CR = 80% DR=??? AR = 5% IR =70% CR = 30% DR=??? Which company need more substantive tests???

16. Management of AR Audit judgement

17. Materiality Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Provides a threshold or cut-off point Qualitative and quantitative aspects

18. Principles The auditor should consider materiality and its relationship with audit risk when conducting an audit.

19. Stages of use Planning (preliminary) determining the nature, timing and extent of audit procedures (to ensure any material misstatement or omissions are discovered) often set at a lower level than is strictly necessary Report stage evaluating the effect of misstatements deciding what opinion to give

20. Steps in Applying Materiality Step1 Set preliminary judgment about materiality. Step2 Allocate preliminary judgment about materiality to segments. Planningextent of tests

21. Step 3 Estimate total misstatement in segment. Step4 Estimate the combined misstatement. Compare combined estimate with judgment about materiality. Step5 Evaluatingresults

22. N/A=not applicable cash audited 100percent Cash Accounts receivable Inventory Total estimated misstatement amount misstatement amount Preliminary judgment about materiality about materiality $ 4,000 20,000 20,000 36,000 36,000$50,000 $ 0 12,000 12,000 31,500 31,500$43,500 $ N/A 6,000 6,000 15,750 15,750$16,800 $ 0 18,000 18,000 47,250 47,250$60,300 TolerablemisstatementDirectprojectionSamplingerror*TotalAccount Estimated misstatement amount *estimate for sampling error is 50%

23. Step1 preliminary judgment about materiality 50,000 Step2 allocate (to determine tolerable misstatement of accounts) cash 4,000 accounts receivable 20,000 inventory 36,000

24. Step 3 estimate misstatement of accounts (direct projection + sampling error) cash 0 accounts receivable 18,000 inventory 47,250 Step 4 estimate the combined misstatement 60,300 Step 5 compare 50,000<60,300

25. How to impact audit work? related to risk and is used in the calculation of sample sizes and tolerable error, and in the performance of analytical procedures. Less work is performed in immaterial areas than in material areas, although some work is always performed because an area that may appear to be immaterial, when tested, prove to be material.

26. assess whether the aggregate of uncorrected misstatements that have been identified during the audit is material If management refuses to adjust the F/S and the results of extended audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor should consider the appropriate modification to the audit report.

27. How to decide percentage of ---profit before tax 5 ---gross profit 0.5-1 ---revenue 0.5-1 ---total assets1-2 ---net assets 2-5 ---profit after tax 5-10

28. Understanding the entity and its environment Why What how

29. Purpose of risk assessment—ISA 315 identify and assess the risks at the F/S and assertion levels by considering the entity and its environment, including relevant controls to determine whether any of the assessed risks are significant risks that require special audit consideration or risks for which substantive procedures alone do not provide sufficient appropriate audit evidence.

30. Material misstatement—F/S level relate pervasively to the financial statements as a whole and potentially affect many assertions. often relate to the entity’s control environment not necessarily risks identifiable with specific assertions at the class of transactions, account balance, or disclosure level

31. MM –assertion level the risk of material misstatement at the class of transactions, account balance, and disclosure level directly assists in determining the nature, timing, and extent of further audit procedures at the assertion level seeks to obtain sufficient appropriate audit evidence to express an opinion on the financial statements taken as a whole at an acceptably low level of audit risk

32. Significant risks Are those that require special audit consideration examples

33. Responsive procedures—ISA330 In order to reduce AR to an acceptable low level, the auditor should determine Overall response to assessed risk at the F/Ss level, and should design and perform further audit procedures to respond to assess risks at the assertion level

34. Overall response—ISA 330 Emphasizing to the audit team the need to maintain professional skepticism in gathering and evaluating audit evidence Assigning more experience staff or those with special skills or using experts Providing more supervision Incorporating additional elements of unpredictability in the selection of further audit procedures Making general changes to the nature, timing, or extent of audit procedures

35. Responses at the assertion level Tests of controls Substantive procedures

36. Fraud Definition Types--Fraudulent financial reporting/misappropriation of assets Responsibilities--management & those charged with governance/auditors Risk of fraud (significant risk)– risk assessment procedures/overall responses/special considerations Written representations Communication (reporting to)

37. Law and regulations Responsibilities--management /auditors Audit procedures for achieving understanding of compliance Written representations Audit procedures when non-compliance is identified or suspected Communication (reporting to)

38. Documentation of risk assessment Auditors must ensure they have documented the work done at the risk assessment stage, such as the discussion among the audit team of the susceptibility of the F/S to material misstatement, significant risks, and overall responses.