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Modern Auditing:

Assurance Services and the Integrity


of Financial Reporting, 8th Edition

William C. Boynton
California Polytechnic State
University at San Luis Obispo
Raymond N. Johnson
Portland State University

Chapter 9 – Audit Risk, Including the Risk of Fraud


Chapter 9 Overview
Audit Risk – An Overview
• Concept of Audit Risk
– Inverse of reasonable assurance
– If 99% certainty is desired, the audit
risk is 1%

• Professional Judgment and Audit Risk


– Usually audit firm policy
– Comparable from one audit to another
Fraud Defined
• Acts Resulting in Material Misstatements
– Fraud or Error

– Intentional or Unintentional

• 2 Types of Misstatements Relevant to


Fraud
– Fraudulent Financial Reporting

– Misappropriation of Assets
The Fraud Triangle
Fraudulent Financial Reporting

• Incentives and Pressures

• Opportunity

• Attitudes and Rationalization


Misappropriation of Assets
• Incentives and Pressures

• Opportunity

• Rationalization
Auditing for Fraud
• Risk Assessment Procedures

• Brainstorming Session

• Specific Risks
Risk Assessment Procedures
• Inquiries of Management

• Consider Unusual or Unexpected


Relationships

• Consider Other Information


Brainstorming Session
• Allow junior members to benefit from
senior members

• Allow more seasoned personnel a fresh


set of eyes

• Allows audit management to set the


appropriate tone for the audit

• Emphasize possibility of fraud existing in


any audit
Specific Risks
• Improper Revenue Recognition

• Management Override of Internal


Controls
Study Break
1. Audit risk is set according to:
A. AICPA guidelines
B. Audit firm policy
C. SEC regulations
D. GAAS

B. Audit firm policy


Study Break
2. Which of the following is not a
component of the fraud triangle?
A. Adequate training
B. Opportunity
C. Rationalization
D. Incentives

A. Adequate training
Study Break
3. All of the following are objectives of a
brainstorming session except:
A. Allow management to set the tone
B. Allow for junior members to benefit
from senior members
C. Allow for a fresh outlook on situation
D. Allow for identification of actual
occurrences of fraud

D. Allow for identification of actual


occurrences of fraud
Audit Risk Model
• 3 Components of Audit Risk
– Inherent Risk
– Control Risk
– Detection Risk

• Illustrating the Model


– AR = IR x CR x DR

• Expanded Audit Risk Model


– AR = IR x CR x AP x TD
Risk Components Matrix
Assessing the Components of
Audit Risk
• Inherent Risk

• Control Risk

• Detection Risk
Inherent Risk
• Inherent Risk Defined

• Assessing Inherent Risk

• Identifying Significant Inherent


Risks
Control Risk
• Control Risk Defined

• Assessing Control Risk


– Planned assessed level of control risk
– Actual assessed level of control risk
Detection Risk
• Detection Risk Defined

• Assessing Detection Risk


– Planned acceptable level of detection
risk
Interrelationships among Materiality,
Detection Risk, and Substantive Audit
Evidence
Components of Preliminary Audit
Strategies
• Assessed level of inherent risk

• Planned assessed level of control


risk

• Planned assessed level of analytical


procedures risk

• Planned level of tests of details


Three Basic Preliminary Audit
Strategies
• Response to Lower Inherent Risks

• A Lower Assessed Level of Control


Risk

• A Primary Substantive Approach


Preliminary Audit Strategies and
the Audit Risk Model
Preliminary Audit Strategy
Comparison
Study Break
4. Which of the following is the
correct audit risk model?
A. AR = IR x CR x DR
B. IR = AR x CR x DR
C. CR = IR x AR x DR
D. DR = CR x IR x AR

A. AR = IR x CR x DR
Study Break
5. ______ is the risk that a material
misstatement could occur and will not
be prevented or detected by the
entity’s internal controls.
A. Inherent Risk
B. Audit Risk
C. Control Risk
D. Detection Risk

C. Control Risk
Study Break
6. The components of preliminary audit
strategies include all of the following
except:
A. Assessed level of inherent risk
B. Planned assessed level of control risk
C. Actual assessed level of control risk
D. Planned assessed level of analytical
procedures risk

C. Actual assessed level of control risk