Question

Question 2 FACTORS AFFECTING ACCEPTABLE AUDIT RISK (5 marks) The Audit Risk Model is the method by which an auditor determines his exposure to an audit assignment and the consequences of an audit failure. Required: Determine the impact of an audit failure from the perspective of: a) The degree to which users rely on statements 11.5 marks) b) The likelihood that an auditee will have financial difficulties after the audit report issued (1.5 marks) The integrity of management (2.0 marks) Arial 1112

Answer 1

Solution:

The degree to which users rely on the statements:

When the users place heavy reliance on the financial statements, it is appropriate that audit risk be decreased. When the statements are heavily relied on, a great social harm could result if a material misstatement were to remain undetected in the financial statements. The cost of additional evidence can be more easily justified when the loss to users from material misstatements is substantial.

Several factors are good indicators of the degree to which statements are relied on by users:

- Client’s size

- Distribution of ownership

- Nature and amount of liabilities

The likelihood that a client will have financial difficulties after the auditor’s report is issued

If a client is forced to file for bankruptcy or suffers a significant loss after completion of the audit, there is a greater chance of the auditor’s being required to defend the quality of the audit than if the client were under no financial strain. The loss could be due to fraud, the loss for a major customer, or a computer disaster that cripples the company for a period of time. There is a natural tendency for those who lose money in a bankruptcy or because of a stock price reversal to file suit against the auditor. This can result from the honest belief that the auditor failed to conduct an adequate audit or from the user’s desire to recover part of their loss regardless of the adequacy of the audit work.

Integrity of the management

Auditors need to be sensitive to the integrity of the management and the possibility they may see to manipulate the accounting records and financial statements.