Credit risk is the risk of loss from business partner

Credit risk is the risk of loss from business partner defaults; it is measured by internal rating
models. Operational exposures—also called operating risks—originate from human actions or
systems. They may relate to litigation, technology systems or regulatory actions. Auditors
assign ratings—high, medium, low— to areas reviewed and allocate resources based on
risk severity.
Example: An audit manager might assign more auditors to an area deemed “high-risk”.
10.2.2 Internal Controls Testing
Auditors review and internal controls related to financial recording and reporting processes.
They assess policies, procedures and guidelines existing in revenue-producing areas and verify
that such procedures are operating correctly. Auditors tests two criteria: design and operating
effectiveness. Controls are adequately designed if procedures are clearly stated, responsibilities
are defined, and there are consequences for control breaches. Controls are operating effectively
if they remedy deficiencies or internal weaknesses for which they are designed.
Example: An auditor might review the cash disbursement process to verify that duties
are segregated between inventory receipt, warehouse management, vendor checks’ scheduling,
treasury activities and bank statements’ reconciliation.
Notes
Auditors who review firms’ financial statements focus on internal controls and
processes, operating guidelines, business risks and policies in financial reporting programs.
10.2.3 Analytical Procedures
Auditors apply analytical procedures in areas where adequate controls and processes are noted.
Analytical procedures refer to comparisons between historical and current-year data, evaluations
of key ratios and appraisals of financial trends. Audit specialists also verify that financial
statements—balance sheet, income statement, owners’ equity statement and statement of cash
flows—are prepared and presented in accordance with accounting principles generally accepted
in the industry.
Example: An auditor might review salespeople’s commissions for five years and check
whether increases in such figures are consistent with increases in revenues.

188 LOVELY PROFESSIONAL UNIVERSITY
Auditing Theory
Notes
10.2.4 Tests of Details
Auditors check whether financial statements are accurate by conducting detailed tests on
individual accounts, groups of accounts or financial statement sections. They focus on journal
entries, financial records, operating agreements and business estimates to confirm amounts
recorded in financial statements.
Example: An auditor reviews the firm’s legal reserves at year-end and notes a balance of
` 1.5 million. The auditor could ask the legal department to confirm and explain such figures.
Self Assessment
Fill in the blanks:
1. Analytical procedures for financial audit refer to
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