Question

"Minimizing Audit Risk" Please respond to the following:

• According to your textbook, auditors have to make judgments concerning materiality on every audit. Since the auditing standards give no formal guidance for how to determine materiality, auditors must rely on their own experience. Determine at least three (3) qualitative factors that affect the auditor's judgment. Provide a rationale for your response.
• According to the textbook, auditors rely on the audit risk formula to determine the types and amount of audit evidence to collect in order to keep the overall audit risk of engagements to a minimum or below defined tolerable limits. Suggest an alternative to the audit risk equation in order to mitigate audit risk. Support your rationale with examples of the successful use of the alternative strategy.

Answer 1

Part1 Answer:

Auditor has to make judgement concerning materiality on every audit. This materiality can be determined using following 3 qualitative factors: Relevance, Reliability and Completeness. Materiality is relative to the size and particular circumstances of individual companies.

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.

• Relevance: Material information influences the economic decisions of the users and is therefore relevant to their needs.
• Reliability: Omission or misstatement of an important piece of information impairs users' ability to make correct decisions taken on the basis of financial statements thereby affecting the reliability of information.
• Completeness: Information contained in the financial statements must be complete in all material respects in order to present a true and fair view of the affairs of the company.

Example-

A default by a customer who owes only $1000 to a company having net assets of worth $10 million is immaterial to the financial statements of the company. However, if the amount of default was, say, $2 million, the information would have been material to the financial statements omission of which could cause users to make incorrect business decisions.

Part 2 Answer-

Audit procedures that are used to obtain audit evidence are various and are often applied in combination. They can include inspection, observation, confirmation, recalculation, reperformance and analytical procedures, in addition to inquiry, as the latter does not normally provide sufficient audit evidence on its own.

However, audit evidence obtained will only be useful in reducing to an acceptably low level the risk that the auditor could express an inappropriate opinion when the financial statements are materially misstated and, therefore, allow the auditor to draw reasonable conclusions, when it is sufficient and appropriate to the circumstances.

Sufficiency and appropriateness of audit evidence are two qualities that are interrelated. Sufficiency is the measure of the quantity of audit evidence. The quantity of audit evidence needed is affected by the risks of misstatement assessed by the auditor, whereby the higher the risks the more audit evidence required, and by the quality of the evidence, where the higher the quality the less evidence perhaps required. A large amount of audit evidence may, however, not compensate for its poor quality.

Explained as follows:

• Audit inquiry: Auditor inquire management on the certain business transactions or events that on the purpose of obtain an understanding or to confirm some related assertion.For example, auditor might inquire management at the planning stage and auditor could also inquire management to confirm the consignment liabilities at the end of the audit work.Audit inquiry is sometime use by auditor to obtain audit evident and sometime is used to obtain an understanding for some nature of business or accounting transactions in order to gain enough knowledge to design and perform testing.
• Audit observation: Auditor observe the way how certain controls related to financial reporting are perform. For example, auditor join client stock take at the year end and observe whether the way that they counts are in the correct procedures or not. In this procedure, audit is not confirmed whether client counts their inventories correct or not, but it confirm whether clients counting procedure is correct or not is one thing. Another thing is auditor try to confirm whether the counting is really exist.
• Audit Inspection: Inspection is refer to verification or vouching documents. This is one of the most importance and it can be 60% of audit work involve with the inspection of documents. For example, auditor examine the sales invoices that records in financial reports. Auditor might examine whether the invoice issued by client is really based on the goods that receive. And the goods that received is actually the one the company make an order. Auditor might also examine the payments voucher against the authority that approve on the payments vouchers. Auditor might also inspecting the supporting documents recording the inventories movement during the year. This is including the documents related to purchasing raw material.
• Analytical Procedure: Analytical procedure is normally use by auditor to assess the transactions or amounts in the financial statements through others financial and non-financial data.For example, monthly trend analysis of revenue records for whole year compare to the monthly trend of visitor. Auditor might also breakdown the monthly revenues by visitor’s nations as well as sex compare to the quantitative data at the same condition. In additional to trend analysis, auditor might use others procedure as part of their analytical procedure like projection analysis.
• Recalculation: Auditor sometime recalculate some depreciation expenses that prepare by management.
• Re performance: Auditor sometime re perform bank reconciliation that are prepare by client.

Your feedback is appreciated.