Question

Discuss the three categories of factors that affect acceptable risk and list the factors that the auditor can use to indicate the degree to which category exists.

Answer 1

Risk in Auditing

Auditors must accept some level of risk or uncertainity in performing audits.There are two components to risk at the assertion level i.e.Inherent Risk and Control risk. The risk assessment proedures includes the following :

1. Inquries of management and others with in the entity
2. Analytical procedures
3. Observation &Inspection
4. Discussion among engagement team members
5. Other risk assessment procedures

Assessing Acceptable Audit Risk

Auditors must decide appropriate acceptable audit Risk . Auditors must first decide engagement risk and use it to modify acceptable audit risk.Engagement risk is the risk that the auditor will suffer harm after the audit is finished,even though the report was correct. Engagement risk is closely related to client business risk because the risk that the auditor will be sued is often related to business failure after the audit is finished

Factors affecting acceptable audit risk

1. The degree to which external users can rely on the statements based on these factors

• Client Size
• Distribution of ownership
• Nature and amount of liabilites

1. The Likelihood that a client will have financial difficulties after the audit based on these factors

• Liquidity position
• Profits (Losses) in previous years
• method of financing growth
• Nature of client operations
• Competence of management

The auditor's evaluation of management's integrity making the acceptable audit risk decision

Risks of material misstatement can arise from a variety of sources, including external factors, such as conditions in the company's industry and environment, and company-specific factors, such as the nature of the company, its activities, and internal control over financial reporting. For example, external or company-specific factors can affect the judgments involved in determining accounting estimates or create pressures to manipulate the financial statements to achieve certain financial targets. Also, risks of material misstatement may relate to, e.g., personnel who lack the necessary financial reporting competencies, information systems that fail to accurately capture business transactions, or financial reporting processes that are not adequately aligned with the requirements in the applicable financial reporting framework. Thus, the audit procedures that are necessary to identify and appropriately assess the risks of material misstatement include consideration of both external factors and company-specific factors.

Conclusion

The auditor should obtain an understanding of control activities that is sufficient to assess the factors that affect the risks of material misstatement and to design further audit procedures, as described in paragraph .18 of this standard.¹⁸ As the auditor obtains an understanding of the other components of internal control over financial reporting, he or she is also likely to obtain knowledge about some control activities. The auditor should use his or her knowledge about the presence or absence of control activities obtained from the understanding of the other components of internal control over financial reporting in determining the extent to which it is necessary to devote additional attention to obtaining an understanding of control activities to assess the factors that affect the risks of material misstatement and to design further audit procedures.