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Auditing Evidence, audit risk, responses to high risk

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5-36: Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item.

a. Copies of client's sales invoices.
b. Auditors' independent computation of earnings per share.
c. Paid checks returned with a bank statement.
d. Response from customer of client addressed to auditors' office confirming amount owed to client at balance sheet date.
e. Representation letter signed by controller of client company stating that all liabilities of which she has knowledge are reflected in the company's accounts

5-49: Audit risk should be considered when planning and performing an audit of financial statements in accordance with generally accepted auditing standards.

a. Define audit risk
b. Describe its components of inherent risk, control risk, and detection risk.
c. Explain the interrelationship among these components.
d. Which (if any) of these components is completely a function of the sufficiency of the evidence gathered by the auditors' procedures? Explain your answer.
e. Comment on the following: "Since cash is often less than 1 percent of total assets, inherent and control risk for that account must be low. Accordingly, detection risk should be established at a high level."

6-25.
Mary Deming has been asked to accept an engagement to audit a small financial institution. Deming has not previously audited a financial institution.

a. Describe the types of knowledge about the prospective client and its environment that Deming must obtain to plan the engagement.
b.Explain how Deming may obtain this knowledge.
c. Discuss how this knowledge of the client and its environment will help Deming in planning and performing an audit in accordance with generally accepted auditing standards.

6-26.
Assume that you have been assigned to the audit of Lockyer Manufacturing Company. You have completed the procedures for gathering information about the company and its environment, including internal control.
a. Describe the next stage of the audit process.
b. Explain how the auditors may respond to high risk audit engagements and high risk audit assertions.
c. Describe the nature of further audit procedures, including when the procedures must include tests of controls.

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5-36
Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item.

The quality of evidence has a "pecking order." That is, some evidence is more reliable and persuasive. External knowledgeable evidence is more reliable than internal evidence. Copies are less reliable than originals. Documented evidence is better than verbal. Viewing a control is better than hearing about how one might work or is supposed to work.

a. Copies of client's sales invoices.
Copies are low quality/reliability evidence.

b. Auditors' independent computation of earnings per share.
Auditor computation is high quality/reliability evidence because it is not client created.

c. Paid checks returned with a bank statement.
Evidence from disinterested third parties that are knowledgeable is high quality and highly reliable.

d. Response from customer of client addressed to auditors' office confirming amount owed to client at balance sheet date.
Evidence from disinterested third parties that are knowledgeable is high quality/reliability.

e. Representation letter signed by controller of client company stating that all liabilities of which she has knowledge are reflected in the company's accounts

This is low quality/low reliability since it is just "their word" and the client is not a neutral party.

5-49.
a. Define audit risk
Audit risk is the risk that the audit report will be wrong. That is, that the auditor issues a "clean" or unqualified report when the financial reports contain material (large and important) misstatements (errors or misleading aspects). Alternatively, but unlikely, that the audit issues a qualified or adverse (bad report card) when the financial statements are just fine.

b. Describe its components of inherent risk, control risk, and detection risk.
Inherent risk comes from aspects of the business, its environment or the particular financial statement item. ...

Solution Summary

Your discussion is 1,338 words and explains the audit risk, its components, how they interact, the audit process and responses to high risk.

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9-23 (Detection risk and audit evidence) risk components matrix

9-23 (Detection risk and audit evidence) Shown below are five situations in which the auditor wishes to determine planned acceptable levels of detection risk and the planned levels of evidence needed for specific financial statement assertions. The auditor has used judgment in arriving at the nonquantitative expressions for various risk factors.
Situation
A B C D E
Desired audit risk Very low Very low Very low Very low Very low
Assessed inherent risk Maximum High Moderate Low Maximum
Planned assessed level of control risk Low High High Moderate High
Planned assessed level of analytical procedures Moderate Moderate Low Low High
Planned assessed level
of tests of details risk
Planned evidence

Required
a. Using the risk components matrix in Figure 9-4, determine the acceptable level of tests of details risk for each situation.

b. Rank the five situations from the most evidence required from substantive tests (1) to the least evidence required from substantive tests (5). You may have ties.

c. Explain your ranking of situation D.

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