Chapter 05 - Audit Evidence and Documentation
Audit Evidence and Documentation
5-1 through 5-32, 5-33, 5-34, 5-36, 5-38, 5-39, 5-42, 5-43, 5-45, 5-47, 5-49 (MC), 5-50, 5-52, 5-54, 5-55
Audit risk is the possibility that the auditors may unknowingly fail to appropriately modify their
opinion on financial statements that are materially misstated.
It is composed of the possibility that
(1) a material misstatement in an assertion about an account has occurred (inherent risk and control
risk), and (2) the auditors do not detect the misstatement (detection risk).
Detection risk is this
second component, the risk that the auditors' procedures will lead them to conclude that a material
exist in an assertion when in fact such misstatement does exist.
factors held constant, audit risk increases with increases in detection risk.
The two components of the risk of material misstatement include inherent risk and control risk.
Inherent risk is the risk of material misstatement of an assertion about an account, class of
transaction, or disclosure without considering internal control, and control risk is the risk that
internal control will fail to prevent or detect and correct the material misstatement.
Inherent risk refers to the possibility of a material misstatement occurring in an assertion assuming
no related internal controls.
Accordingly, since it exists independently of the auditors, the auditors
cannot “reduce” inherent risk.
Rather, they gather evidence that allows them to make an accurate
assessment of the existing inherent risk.
involve recurring financial activities recorded in the accounting records in
the normal course of business.
Examples include sales transactions, purchase transactions, cash
disbursements, cash receipts, and payroll transactions.
that occur only periodically.
Examples include taking physical inventories, calculating
depreciation, and consolidating financial results.
are financial reporting
activities that involve creating an accounting estimate.
Examples include estimating the allowance
for uncollectible accounts, estimating warranty reserves, and assessing assets for impairment.
Because inherent risk and control risk are a result of characteristics of the client and its internal
controls, auditors assess them.
Because detection risk is a function of the effectiveness of the audit
procedures used to gather evidence, it is restricted to the appropriate level based on the scope of
of audit evidence is a matter of judgment on every audit, because there are no firm
guidelines on the quantity of evidence necessary in a specific audit.
The strength of the client's
internal control, the inherent risk of the audit, the levels of materiality for the audit, and the
existence of related-party transactions are among the factors influencing the auditors' judgment on