Preliminary Assessment, Inherent Risk and Key Assertions of an Audit

Topics: Auditing, Risk, Balance sheet Pages: 10 (1775 words) Published: December 16, 2014

Assignment 2
AFM312
Laura Beattie 220109075
Word count
1780

Question 1
a) Identify the factors that would affect the preliminary assessment of inherent risk and control risk at Queen Island Dairy. The preliminary assessment of risk, also known as the risk assessment phase, is the initial step in an audit that includes gaining an understanding of the client and identifying potential risk factors whilst developing an audit strategy and setting planning materiality. There are three key steps in the risk assessment phase, being; gaining an understand of the client, identifying potential risks and strategies to prevent or control such risks, and risk and materiality assessment. As by this definition there are a few identifiable risks within Queen Island Dairy. Inherent risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls. Control risk is the risk that a client’s system of internal controls will not prevent or detect a material misstatement. Upon a preliminary assessment it appears that the manufacturing process of Queen Island Dairy is upheld to an extremely high standard. This is evidenced through dedicated staff, high product quality, and extremely high standards of food handling and storage. This aspect of Queen Island Dairy has less apparent inherent and control risk than the paperwork side of the business. It has been suggested that Jim Bannock has been poorly documenting some business processes and disputes with customers, making frequent adjustments to debtor accounts using credit notes to deal with customer complaints (which is not the correct way to deal with customer complaints). This suggests an apparent increase in inherent and control risk within the business, as there do not appear to be any preventative measures in place that would help to reduce inherent and control risk from occurring. Also there is a lack of separation of duties within the company, which increases the control risk within the entity. A high detection risk should be set before starting this audit, as the audit risk is high. A high audit risk occurs when there is a high inherent risk, high control risk and low detection risk. Detection risk is the risk that the auditor’s testing procedures will not be effective in detecting a material misstatement. An inverse relationship exists between detection risk and risk of material misstatement. Therefore if a high inherent and control risk exists the auditor will set detection risk as low to ensure that intensive testing is undertaken when the audit is conducted.

b) Explain how these factors would influence your choice between the predominantly substantive approach and the lower assessed level of control risk approach for sales, inventory and debtors. After conducting a preliminary assessment of the risk of material misstatement the auditor needs to determine the appropriate strategy for the rest of the audit. This can either be a predominantly substantive approach or the lower assessed level of control risk. Substantive procedures are audit procedures designed to detect material misstatements at the assertion level. The predominantly substantive approach is adopted in cases where there is a high control risk, e.g. when: there are limited to no significant control procedures that pertain to assertion, relevant control procedures already in place are ineffective, and it would not be efficient to perform a test of controls. This often occurs in small entities that do not implement appropriate controls or have ineffective control methods in place, due to the lack of separation of duties. The design of substantive procedures depends on the level of detection risk, which in this case is low. Therefore this requires a predominantly substantive audit strategy rather than a lower assessed level of control risk approach. The lower assessed level of control...

Bibliography: Accounting Simplified. (2013). Assertions in the Audit of Financial Statements. Retrieved September 14, 2014, from Accounting-Simplified: accounting-simplified.com/audit/introduction/audit-assertions.html
Moroney, R., Campbell, F., & Hamilton, J. (2014). Auditing A Practical Approach (2 ed.). Milton, QLD, Australia: John Wiley & Sons Australia, Ltd.
PCAOB. (2010). Auditing Standard 15. Retrieved September 14, 2014, from Public Company Accounting Oversight Board: pcaobus.org/standards/auditing/pages/auditing_standard_15.aspx
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