Exam Sample questions.docx

Exam Sample questions.docx - 4.9 Define each of the...

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4.9 Define each of the components of the audit risk model; explain how each component is set, and which components make up the risk of material misstatement? Audit risk is a function of the risks of material misstatement and of detection. The risk of material misstatement consists of two components: inherent risk and control risk. The audit risk model is a function of inherent risk, control risk and detection risk. The audit risk model is described as follows. AR = f (IR, CR, DR), where: AR = audit risk, which is the risk that the auditor will give an inappropri- ate auditor’s opinion when the financial report is materially misstated. Au- dit risk is set by the auditor and will always be relatively low, as the auditor does not want to give an inappropriate opinion. The level set by the auditor for a particular client will be affected by the engagement risk, which is the auditor’s exposure to loss or injury to the professional practice from litiga- tion, adverse publicity or other events arising in connection with a finan- cial report audit. IR = inherent risk, which is the susceptibility of an assertion to material misstatement about a class of transactions, account balance or disclosure, given the inherent and environmental characteristics, but without regard to related internal controls. Inherent risk is determined by the characteristics of the entity and the environment in which it operates. CR = control risk, which is the risk that a material misstatement in an as- sertion about a class of transactions, account balance or disclosure may not be prevented or may not be promptly detected and corrected by the en- tity’s internal control. Control risk is essentially determined by the entity’s internal control, although an auditor can set it at high if it they do not want to rely on internal control for cost benefit reasons, irrespective of the inter- nal control system being strong. DR = detection risk, which is the risk that an auditor’s substantive proce- dures performed to reduce audit risk to an acceptably low level, will not detect a material misstatement. The desired detection risk is effectively de- termined by the other factors in the model. The actual detection risk can then be altered to the required level by changing the nature, timing and ex- tent of testing, as well as quality control factors on the audit, such as as- signment of staffing and extent of supervision and review. Assessment of each component is subjective and is based on the profes- sional judgment of the auditor. The levels high, medium or low are gener- ally used, rather than specific percentages. A detection risk matrix is shown as Exhibit 4.1 on page 163 of the textbook.
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5.29 The results of the ratio analysis undertaken as part of your analytical procedures may include the following ratios: Ratios 2013 2014 2015 Current ratio 2.7 2.2 1.8 Quick asset ratio 1.3 1.2 0.9 Receivables turnover ratio * 8.4 5.75 Days in receivables * 43.2 days 63.5 days Inventory turnover ratio * 4 3.1 Return on total assets 0.44 0.43 0.31 Return on shareholders’ equity 1.6 2 2.5 Debt/Equity 2 2.4 4 Gross profit ratio 0.47 0.47 0.43 Net profit ratio 0.27 0.26 0.22
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