Class 6 notes PDF

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Basic Detection Risk with risks If the actual/achieved risk < planned risk, then you accept the recorded amount, Otherwise you reject it.Basic audit decisions Auditor needs to get sufficient, appropriate evidence o If not, then the auditor needs to qualify or modify o If not, an audit defici...

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Basic Detection Risk with risks 

If the actual/achieved risk < planned risk, then you accept the recorded amount, Otherwise you reject it.

Basic audit decisions 1. Auditor needs to get sufficient, appropriate evidence o If not, then the auditor needs to qualify or modify o If not, an audit deficiency

2. Evaluate the financial Reporting a. This is very much complicated b. The goal is to capture the economic substance so it will be useful for decision making c. Do the financial statements present firm fairly? i. If not, qualify the opinion ii. If not, then an audit deficiency

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To evaluate financial reporting, the auditor needs to evaluate the accounting risk (AccR) Includes the estimation and existence uncertainty Accounting risk = MM from forecast errors o They are basically future oriented o Being future oriented, means forecasts are involved and now we want to determine how to evaluate them

CAS 450, Audit Risk: o Factual audit risk = misstatements o Projected risk o Judgmental risk

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Awareness audit o Opinion shopping = going to auditors and asking how they would report that and only got the report they liked o HB 7600 Standard came out of this. It is about guiding CPAs how to react to opinion shopping o Trust is very important, and it is crucial to regulate the quality to ensure that the trust is maintained The car insurance one

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Revenue recognition Estimated the loss every period Risk of material misstatement from estimated lawsuits

Explanation for P-B results = the risk of material misstatements is 90% with estimated losses 

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Auditor plans an audit risk of 90% and achieved it === this is not reasonable assurance and unacceptable because it violates the concept of reasonable assurance. Audit assurance has to be high Auditor plans audit risk of 0.5 but gets 0.9 ==== not acceptable because audit risk > planned risk. Not a competent auditor The risks are different then audit risks because they deal with risks in predicting the losses. To counter this, we need to introduce a new topic = the accounting risk concept = AccR Concept

AccR Concept        

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AccR is not part of audit risk It is related to the risks associated with predicting AccR is very much Business Risk oriented = lawsuits, sales of new products and etc. Then we ask ourselves should it be a part of audit risk? The audit procedures will not affect the business risk so shouldn’t be a part of audit risk Existence relates to whether the lawsuit will be successful Estimation relates to whether the lawsuit will happen and what amount What affect will this have on audit risk? o Audit procedures will not impact on whether the lawsuit is going to happen or no? No o We are talking about two different independent scenarios o It’s going to be there whether the audit does the procedures or no You can combine these both risks by recognizing that these two are independent o PMM = AccR + (1- Audit Risk) * Audit Risk o If audit risk = 0.5 and PMM = 0.9, the AccR = .89 o This tells us that the biggest risk is something that is not captured by the audit risk model, but by the accounting risk! This above explanation tells us that the audit risk model is not wrong, but limited to certain categories

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From slide 4 in Class 7-8 slides Asset 1 = a normal asset = must record $1 million Asset 2 = kind of lottery ticket = the payoff is not known until next year. o How do you record this lottery ticket? o 2 possible outcome: 1% chance of $100 million and 99% chance of $0 o Take the weighted average = $1 million = this is the expected payout o The market value of this would be = $ 1 million o The question is now how do we report it?  99% of MM if the $100 million is recorded as an asset  This is why we can’t record it because the risk of MM would be too high  You cannot record it at 1 million because there is 100% of MM  If you can assume that the management will sell the ticket with 95% CL, then you can record it at market value  But if you knew for sure that management will hold it until maturity, then there will be a huge MM if you record it as $1 million  If we stuck to our decision rule, you will only accept recording it as $0 because only this has acceptable risk level. o If all the information given is true, then evidence risk = audit risk = 0 o And all the risk of MM = AccR o So how do we reduce this?  Through proper entry

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Market Value and Historical Values are not always relevant. Weighted Averages are not always relevant Expected Values are not statistically data, so we need more structured formula Slide 6 = The Paradox = you are not willing to pay that much? o This evaluates that expected values are not good measures. Slide 18 – 19 = The horse business o

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