upQuestion.

Using examples ,define the following terms.

Audit risk-is the risk that an auditor express an opinion when the financial statements are materially
misstated.

Significant risk

-According to the IAASB Glossary of terms significant risk is an identified and assessed risk of material
misstatement that,in the auditor's judgement ,requires special audit consideration.

-The consideration is required if the likelihood/ probability of misstatements is very high.

-For example ,a significant inventory of precious metals or gems might be a significant risk in an audit of
a jellewery business.Such risks may arise due to unique transactions ,adjustments or critical
accruals ,such as the estimation of highly subjective allowances.

Business risk

According to the IAASB Glossary of terms business risk is defined as a risk resulting from signficant
conditions ,events ,circumstamces ,actions or inactions that could adversely affect an entity's ability to
achieve its objectives and execute its strategies ,or from the setting if inappropriate objectives and
strategies.

-The following is a list of business risks faced by the entities.The risks are explained in subsequent
paragraphs.

-Each example explains how the business risk may lead to a risk of material misstatement of the financial
statements.

Laws and regulation-laws and regulations are referred to as external/ macro factors which means that
they are beyond the entity's control.Businesses are at a risk of higher taxes and risk of inadvertantly
breaking laws due to dynamic business enviroment /changing legislation and volatile political
enviroment.These may lead to a range of material misstatements in the financial statements ,for those
that are related to taxation ,legal obligations and provisions.

Financing -a company may find itself in shortage of cash and the management / those charged with
governance may find themselves to show a better picture of the business in the financial statements
inorder to secure additional financing .Hence there is a greater possibility of management bias in
estimates and accounting policies.

Competition-fierce competition may result in a company finding it difficult to stay in business.If the
company's financial statements are prepared in a going concern basis,there is a risk that the company
might not actually be a going concern and therefore the financial statements materially mistated.
Risk of material misstatement-According to the IAASB Glossary of terms ,risk of material misstatement is
defined as the risk that the financial statements are materially misstated prior to audit.Material
misstatement consists of two vital components which are inherent and control risk.Risk of material
mistatement is the risk that the subject matter information is materially misstated prior to the
engagement.[ISAE3000(revised)].

-Misstatement is a difference between the reported amount ,classification ,presentation ,or disclosure
of a financial statement item and the amount ,classification ,presentation ,or disclosure that is required
for the item to be in accordance with the applicable financial reporting framework.They can arise from
error or fraud.[IAASB].

-Misstatement in financial statements are material when they are reasonably be expected to influence
the economic decisions taken on the basis of the finacial statements.

Examples of risk of material misstatement at financial statement level are managerial

inncompetence ,poor oversight by board of directors and inadequate accounting system and records.

Conclusively misstatements can aslo emanate from prior based judgements regarding estimates and
accounting policies.For example when management uses an accelerated depreciation method for an
asset which generates benefits evenly over its useful life.

Detection Risk-is the risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement that exists and that could be material ,either
individually or when aggregated with other misstatements.Detection risk can be manipulated by various
means such as changing the composition of the engagement team,changing the types of audit
procedures and changing the duration of audit work.[IAASB]

Obtaining of a new client - there is a greater possibility of undetected material misstatements as the
auditors are not familiar with the client.

Limited time /tight deadline give rise to detection risk in the sense that the auditors might not have
sufficient time to obtain audit evidence which resulting in undetected material misstatements in the
financial statements.[lecturer's slides]

Inherent risk-The susceptibility of an assertion about a class of transaction ,account balance or

disclosure to a misstatement that could be material ,either individually or when aggregated with other
misstatements ,before consideration of related controls.Certain items are more likely to be misstated
just because of their nature.For instance estimate of a legal obligation.[IAASB Glosary Of terms]

Control risk-is the risk that a misstatement