Question

2) Define AAR: Then discuss how each of the following items can affect your assessment of AAR -Be specific

a. Third Party Use of Financials

b. Possibility of Financial difficulties

c. Management Integrity

d. What was your assessment of AAR and which of these was the most important for your assessment.

AAR- acceptable audit risk

Answer 1

Acceptable Audit Risk is the measure of how willing the auditor is to accept the financial statements that are materially misstated and an unqualified audit report is to be issued. When the acceptable audit risk is decided to be low by the auditor, he wants to be certain that the financial statements are not materially misstated. Zero risk is certainty and 100% risk is complete uncertainty. Complete assurance of the accuracy of the financial statements is not economically viable. Moreover, an auditor's opinion is considered to be reasonable level of assurance and not absolute assurance.

Further, due to the following factors, audit risk should be kept lower:

1. Third Party Use of Financial Statements: Audited Financial Statements are used by external agencies and are always under public scrutiny in case of publicly held corporations and those corporations that are heavily dependent on external debt.

2. Possibility of Financial difficulties: In case of audit of financial statements of a corporation that is going through difficult financial times and eventually that corporation fails financially, it will become difficult for the auditor to defend the quality of audit. Failure indicators include shortage of funds, Reducing profits, continuous losses, management incompetency. etc

3. Management Integrity: If the integrity of the management is questionable, the auditor is likely to assess the acceptable audit risk to be lower.