Question

1a. What are the three audit risks? -Discuss-

1b. state and discuss the five management assertions on the financial statements?

Answer 1

1a. What are the three audit risks? -Discuss-

An Audit risk is the risk that arise when an auditor fails to detect errors, material misstatements or fraud while examining the financial statements of a client. Auditors can increase the number of audit procedures in order to minimize the level of audit risk. Reducing audit risk to an adequate level is a key part of the audit function, since the users of financial statements are relying upon the assurances of auditors when they read the financial statements of an organization.

For example, an auditor needs to perform a physical count of inventory and compare the results to the accounting records, and this work is performed to prove the existence of inventory. If the auditor's inventory count procedures are weak, the detection risk is higher.

The three types of audit risk are as follows:

Control risk:

            Control Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity. A company could accidentally commit fraud by assessing numbers incorrectly or reporting it erroneously. Identifying areas where there may be such problems is vital to recognizing control risks.

Inherent risk:

            An inherent risk is the type of audit risk that could not be identified an auditor or other financial officers. In order to try to prevent the audit risk components, companies must have in place a series of procedures to hopefully prevent any problems. Identifying these types of audit risks involves having a clear audit plan, audit approach and audit strategy. Inherent risk is generally considered to be higher where a high degree of judgment and estimation is involved or where transactions of the entity are highly complex.

Detection risk:

            This is the risk that the audit procedures used are not capable of detecting a material misstatement. And this risk generally occurs because of the poor planning of the auditor. Detection risk require a deep understanding of the nature of the company and business in general. The depth and width of a company’s operation, its financial statements and the methodology of its financial reporting all gather as the components of detection risks. The components of detection risks include classification testing, completeness testing, occurrence testing and valuation testing.

1b. state and discuss the five management assertions on the financial statements?

Management assertions

Financial statement assertions or Management assertions refer to the implicit or explicit assertions of the one responsible for preparing the financial statements, usually management. It is also known as Audit ascertains.The concept is primarily used in regard to the audit of a company's financial statements, where the auditors rely upon a variety of assertions regarding the business. The auditors test the validity of these assertions by conducting a number of audit tests. n preparing financial statements, management is making implicit or explicit claims (i.e. assertions) regarding the recognition, measurement and presentation of expenses, income, assets, equity, liabilities and disclosures in accordance with the applicable financial reporting framework like IFRS.

Management assertions fall into the following three classifications:

• Transaction-level assertions
• Account balance assertions
• Presentation and disclosure assertions

Presentation and disclosure assertions

            The following five items are classified as assertions related to the presentation of information within the financial statements.

• Accuracy & Valuation: The assertion is that all information disclosed is in the correct amounts, and which reflect their proper values. Related party transactions, balances and events have been disclosed accurately at their appropriate amounts.

• Occurrence: The assertion is that disclosed transactions have indeed occurred. Occurrence. Transactions with related parties disclosed in the notes of financial statements have occurred during the period and relate to the audit entity.

• Classification & Understandability: The assertion is that the information included in the financial statements has been appropriately presented and is clearly understandable. The nature of related party transactions, balances and events has been clearly disclosed in the notes of financial statements. Users of the financial statements can clearly determine the financial statement captions affected by the related party transactions and balances and can easily ascertain their financial effect.

• Completeness: The assertion is that all transactions that should be disclosed have been disclosed. All related parties, related party transactions and balances that should have been disclosed have been disclosed in the notes of financial statements.

• Rights and obligations: The assertion is that disclosed rights and obligations actually relate to the reporting entity. Audit entity owns or controls the inventory recognized in the financial statements. Any inventory held by the audit entity on account of another entity has not been recognized as part of inventory of the audit entity.