If however the auditor is giving a separate opinion

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Unformatted text preview: will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. Acceptable audit risk A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. 9-56 9-11 (continued) Inherent risk A measure of the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control. Control risk A measure of the auditor's assessment of the likelihood that misstatements exceeding a tolerable amount in a segment will not be prevented or detected by the client's internal controls. SAS 107 (AU 312) notes that the combination of inherent risk and control risk reflect the risk of material misstatement. 9-12 Planned detection risk is a measure of the risk that the audit evidence for a segment will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. When planned detection risk is increased from medium to high, the amount of evidence the auditor must accumulate is reduced. 9-13 An increase in planned detection risk may be caused by an increase in acceptable audit risk or a decrease in either control risk or inherent risk. A decrease in planned detection risk is caused by the opposite: a decrease in acceptable audit risk or an increase in control risk or inherent risk. 9-14 Inherent risk is a measure of the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control. Factors affecting assessment of inherent risk include: Nature of the client's business Results of previous audits Initial vs. repeat engagement Related parties Nonroutine transactions Judgment required to correctly record transactions Makeup of the population Factors related to fraudulent financial reporting Factors related to misappropriation of assets 9-15 Inherent risk is set for segments rather than for the overall audit because misstatements occur in segments. By identifying expectations of misstatements in segments, the auditor is thereby able to modify audit evidence by searching for misstatements in those segments. When inherent risk is increased from medium to high, the auditor should increase the audit evidence accumulated to determine whether the expected misstatement actually occurred. The effect on audit evidence is in the opposite direction compared to Review Question 9-12. 9-57 9-16 Extensive misstatements in the prior year's audit would cause inherent risk to be set at a high level (maybe even 100%). An increase in inherent risk would lead to a decrease in planned detection risk, which would require that the auditor increase the level of planned audit evidence. 9-17 Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. Acceptable audit risk has an inverse relationship to evidence. If acceptable audit risk is reduced, planned evidence should increase. 9-18 When the auditor is in a situation where he or she believes that there is a high exposure to legal liability, the acceptable audit risk would be set lower than when there is little exposure to liability. Even when the auditor believes that there is little exposure to legal liability, there is still a minimum acceptable audit risk that should be met. 9-19 The first category of factors that determine acceptable audit risk is the degree to which users rely on the financial statements. The following factors are indicators of this: Client's size Distribution of ownership Nature and amount of liabilities The second category of factors is the likelihood that a client will have financial difficulties after the audit report is issued. Factors affecting this are: Liquidity position Profits (losses) in previous years Method of financing growth Nature of the client's operations Competence of management The third category of factors is the auditor's evaluation of management's integrity. Factors that may affect this are: Relationship with current or previous auditors Frequency of turnover of key financial or internal audit personnel Relationship with employees and labor unions 9-20 Exact quantification of all components of the audit risk model is not required to use the model in a meaningful way. An understanding of the relationships among model components and the effect that changes in the components have on the amount of evidence needed will allow practitioners to use the audit risk model in a meaningful way. 9-58 9-21 The auditor should revise the components of the audit risk model when the evidence accumulated during the audit indicates that the auditor's original assessments of inherent risk or control risk are too low or too high or the original assessment of acceptable audit risk is too low or too high. The auditor should exercise care in determining the additional amount of evidence that will be required. This should be do...
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