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Assessing the Risk of Material Misstatement

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These all need to be based on the United States

1) Explain the three steps associated with assessing the risk of material misstatement

2) How would the auditor change the audit strategy if a risk is a financial statement level risk versus an assertion level risk?

3) What is a substantive test and what is its purpose?

4) What are the advantages and disadvantages of using analytical procedures as substantive tests?

5) Explain a situation where the concepts of audit sampling do not apply to substantive tests

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The following posting helps explain the three steps associated with assessing the risk of material misstatement.

Assessing the Risk of Material Misstatement

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The three steps associated with assessing the risk of material misstatements are (www.icai.org):
1. Inquiries to management and other employees within the organization that the auditor feels may have information that can help him with identifying risk of material misstatement due to fraud or error.
2. Analytical procedures: The procedures are techniques based on the concept that there are relatively stable relationships among the economic events recorded in financial statements. The auditor's expectation is that the amounts in the financial records that summarize and represent these economic events will be demonstrated by stable relationships. When deviations from these expected relationships in the financial statements are identified, then the auditor will investigate to determine whether material errors, irregularities, or operating inefficiencies have occurred (www.allbusiness.com).

3. Observation and inspection: The observation and inspection procedures are used by auditors to support the inquiries of management regarding the organization and its environment. The procedure includes the observation of the organization's operations, inspection of documents, reading management reports, short term financial statements and board minutes along with walking through the organization (www.thefreelibrary.com).

2. How would the auditor change the audit strategy if the risk is a financial statement level risk v an assertion level risk?
A financial statement level risk is a risk that may affect several different accounts and several assertions. Examples of financial level risk would be fraud, incompetent management and related department transactions (www.aicpa.org). The audit strategy used for financial level risk is to provide more auditors to the team auditing the organization and/or adding more elements of randomness in selection to their audit procedures (www.aicpa.org). The assertion level risk is limited to one or more specific assertion in one account or several accounts. Examples of assertion level risk are the valuation of inventory and the occurrence of sales (www.aicpa.org). The audit strategy used for assertion level risk to design further audit procedures that will address the nature, timing and extent of the risk. The audit strategy for the assertion level risk would include more substantive procedures or a combination of test of ...

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