Modern

Modern Auditing:
Auditing:
Assurance
Assurance Services
Services and
and the
the Integrity
Integrity
of
of Financial Reporting, 8th Edition
Financial Reporting, 8 th
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
Chapter 9
9 Overview
Overview
 Audit
Audit Risk
Risk –– An
An Overview
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
Fraud Defined
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
The Fraud
Fraud Triangle
Triangle
 Fraudulent
Fraudulent Financial
Financial Reporting
Reporting

• Incentives and Pressures

• Opportunity

• Attitudes and Rationalization

 Misappropriation
Misappropriation of
of Assets
Assets
• Incentives and Pressures

• Opportunity

• Rationalization
 Auditing
Auditing for
for Fraud
Fraud
• Risk Assessment Procedures

• Brainstorming Session

• Specific Risks
 Risk
Risk Assessment
Assessment Procedures
Procedures
• Inquiries of Management

• Consider Unusual or Unexpected

Relationships

• Consider Other Information

 Brainstorming
Brainstorming Session
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
Specific Risks
Risks
• Improper Revenue Recognition

• Management Override of Internal

Controls
 Audit
Audit Risk
Risk Model
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
Risk Components
Components Matrix
Matrix
 Assessing
Assessing the
the Components
Components of
of
Audit
Audit Risk
Risk
• Inherent Risk

• Control Risk

• Detection Risk
 Inherent
Inherent Risk
Risk
• Inherent Risk Defined

• Assessing Inherent Risk

• Identifying Significant Inherent

Risks
 Control
Control Risk
Risk
• Control Risk Defined

• Assessing Control Risk

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

• Assessing Detection Risk

– Planned acceptable level of detection
risk
Interrelationships
Interrelationships among
among Materiality,
Materiality,
Detection
Detection Risk,
Risk, and
and Substantive
Substantive Audit
Audit
Evidence
Evidence
Components
Components of
of Preliminary
Preliminary Audit
Audit
Strategies
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
Three Basic
Basic Preliminary
Preliminary Audit
Audit
Strategies
Strategies
• Response to Lower Inherent Risks

• A Lower Assessed Level of Control

Risk

• A Primary Substantive Approach

Preliminary
Preliminary Audit
Audit Strategies
Strategies and
and
the
the Audit
Audit Risk
Risk Model
Model
Preliminary
Preliminary Audit
Audit Strategy
Strategy
Comparison
Comparison