Audit Risk and Its Assessment Assignment

Added on - 21 Apr 2020

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AUDIT RISK AND ITS ASSESSEMENT1QUESTION 1PART (A)Inherent Risks in MaxSecurity Limited:Audit risk is the risk of provision of inappropriate audit opinion by the auditor in the situationwhere financial statements of the company are materially misstated. There can be variousreasons due to which audit risk arises(Bell, Landsman & Shackelford, 2001). The process ofaudit suffers from some inherent limitations which imposes the various kinds of risks on it.Inherent risk is one of the major element of audit risk that is imposed on the entity due itsinherent nature. It is the risk of occurrence of material misstatements in financial reports dueto errors and omissions other than control failures. This type of risk exists irrespective of theaudit of the financial statements(Cassell, Drake & Rasmussen, 2011).Therefore, it isimpracticable to avoid such risk even with the help of creation of adequate controls in auditprocedures and enhanced audit training. In the present case inherent risk is particularly highbecause of the fact that company belongs to the industry where the product designs areconsidered to be quite sensitive. These designs of vehicles of every carrier manufacturingcompany generally requires to be maintained confidentially due to high competiveness in themarket place. Since, the company has adopted a new system of costing to replace the oldsystem which was not compatible with the needs of the company. The first audit engagementis inherently risky because the auditor has no enough knowledge of entity’s newmanufacturing costing system. Also, the complex nature of the manufacturing costing systemmay lead to misstated costing records which could finally lead to misstatement financialstatements of the company. Further, the product designs are also cost sensitive so there ishigher inherent risk due to this factor as incorrect determination of cost may cause incorrectcost records(Houston, Peters & Pratt, 1999). Inherent risk is also higher in the situationswhere there is an involvement of more judgements and financial estimations. In the current
AUDIT RISK AND ITS ASSESSEMENT2case, the company is indulged in filing tenders to win contracts it might be using theestimated prices giving rise to higher inherent risk(Rittenberg, Johnstone & Gramling, 2010).PART (B)Factors Affecting the Determination of Preliminary Materiality:Determination of audit materiality is the matter of auditor’s professional judgement.Materiality is the degree of significance of any audit matter or item to influence the decisionof users of audit report. Materiality of an item can be judged on the basis of quantity as wellas the quality. It must not be seen only from the point of view of its individual effect ratherwhile deciding the materiality of a transaction its overall impact on the financial statementmust be considered. Factors determining the audit materiality in the present case MaxSecurityare as follows:Determination of materiality of an item majorly depends upon the professional judgment ofthe auditor and is entirely based on perception of auditor about the financial informationrequirements of the intended users of financial reports of the company. As there are varioususers of the financial reports such as investors, shareholders, government etc. and the auditorhas to carry out extensive audit procedures in the areas from where more relevant informationcan be obtained by the users(Eilifsen & Messier, 2014).Moreover, the degree of internal controls in the particular area also affects the materiality ofthat item. Since, if internal controls are weak in a specific area, there arises higher risks ofmisstatements therefore, an auditor is required to apply more audit procedures in those areas.Higher risk of misstatement increases the audit materiality of an item(Akresh, 2010).
AUDIT RISK AND ITS ASSESSEMENT3Complexity of financial reports may require the auditor to carry audit procedures in detailstherefore higher materiality level must be set in those situations. Even uniformityhomogeneous nature transactions affects the level of audit materiality(Joldoş, Stanciu &Grejdan, 2010).The possibility of risk of frauds in particular areas also increases the audit materiality. Incases where auditors has found greater degree of risk of fraud on part of management, theauditor has to carry detailed audit procedures in those areas and ignorance of such areas mayresult in incorrect or inappropriate opinion by the auditor(Keune & Johnstone, 2012).Even in the areas where there are stringent rules and regulations to be complied, the auditorhas to set higher audit materiality benchmarks for those items(Zhou, 2012).As misstatementin those areas may lead to provision or supply of incorrect or untrue information to regulatorybodies. Here, the participation in the government contracts may require the auditor to sethigher materiality level in the areas which are directly associated with the government(Legoria, Melendrez & Reynolds, 2013).The framework of financial reporting also affects the materiality level of the transactions. Asgeneral purpose financial statements may not require consideration of certain transactionswhereas specific purpose financial statements may require auditor to carry detailed auditprocedures in the special areas so that proper checking and verification of those areas couldto form an appropriate opinion(Aqel, 2011).In the current case the company is participatingin the government contracts so it might require preparation of special purpose financialstatements to fill the tenders for governmental contracts.The previous year audit results may also affect the audit materiality level in the current periodas the adverse or qualified opinion on certain matters in the earlier years may require the
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