Audit Risk Financial Statement Level and Assertion Level - Lesson 3

In this lecture 4.02 Audit Risk Financial Statement Level and Assertion Level Lesson 3 Roger Philipp CPA CGMA provides a quick summary of the the Audit Risk Financial Statement Level and Assertion Level discussion and provides a big picture view.
Audit Risk equals inherent risk IR times control risk CR times detection risk DR.
In solving for DR audit risk is divided by IR times CR equals DR.
Control risk is high when reliance on the operating effectiveness of controls is low which drives up DR.
DR consists of AP the risk that the auditors analytical procedures will not detect material misstatements and TD the risk that the auditors tests of details Roger mnemonic: ICORRIIA will not detect material misstatements.
Why do we care about audit risk substantive testing financial statement level assertions and management assertions regarding account transactions and balances? Because the auditors objective is to obtain sufficient appropriate audit evidence in order to substantiate or confirm the assertions management is making in the form of financial statements.
And in order to do so the auditor performs substantive tests: the nature timing and extent of which are determined by the auditors assessment of the risk of material misstatement RMM and the acceptable level of detection risk DR for the engagement. Connect with us: Website: Blog: Twitter: Facebook: Instagram: Pinterest: LinkedIn: Are you accounting faculty looking for FREE CPA Exam resources in the classroom? Visit our Professor Resource Center: Video Transcript Sneak Peek: Now all this stuff wasnt that fascinating but lets summarize.
What did we just say? We said audit risk equals well do it right here.
Audit risk equals IR times CR times DR.
In solving for DR audit risk over IRCR equals DR.
We also said if reliance is low this goes up.
We want our acceptable level low.
We better do more substantive testing.
We said that were concerned with DR because DR relates to both test of details risk and analytical procedures risk the risk that you the auditor do not detect the problem while youre doing test of details of accounts transactions and balances or analytical procedures which is again ratio analysis.
I havent defined these for you yet.
Were going to talk about them in detail in a few minutes.
Those are called the audit procedures the actual substantive test.
This is the dee-da.
So while youre doing your inquiry confirmations observations recalculations and so-on you dont detect the problem or analytical procedures we talked about in the planning phase and as a substantive test as a review phase that study of that in comparisons relationships like inventory turnover receivable turnover ratios gross profit percentages and so-on thats analyzing the numbers themselves you dont detect the problem.
Thats what your analytical procedures or your AP risk actually talks about as well.
So were looking at both the different levels thats what were heading into.
Now why do we care about this? Because management assertions ties to the objectives ties to the audit procedures.
Heres how it all ties together.
Were going to go out and pick up these statements.
Whose statements are these? Management.
What are the assertions theyre making? Those are these things.
Out of the assertions grows our objective.
Out of the objective grows the actual audit procedures or substantive tests.
These are the tests were going to do test of details and analytical procedures.
These are the tests to meet our objective which youll see in a minute.
What is our objective? To corroborate or substantiate all of these assertions that management is making in the form of financial statements.

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