CTP Oreamuno

Accounting
Twelfth Grade
Sub-area: Accounting Tools for decisions making
Study unit: Auditing

What Is Audit Risk?

Audit risk is the risk that financial statements are materially incorrect, even
though the audit opinion states that the financial reports are free of any material
misstatements (declaración erronea). The purpose of an audit is to reduce the
audit risk to an appropriately low level through adequate testing and sufficient
evidence. Because creditors, investors, and other stakeholders rely on
the financial statements, audit risk may carry legal liability for a CPA firm
performing audit work.

Types of Audit Risks

Inherent Risk
Inherent risk is the risk posed by an error or omission in a financial statement due
to a factor other than a failure of internal control. In a financial audit, inherent risk
is most likely to occur when transactions are complex, or in situations that require
a high degree of judgment in regard to financial estimates. This type of risk
represents a worst-case scenario because all internal controls in place have
nonetheless failed.

Detection Risk
Detection risk is the chance that an auditor will fail to find material misstatements
that exist in an entity's financial statements. These misstatements may be due to
either fraud or error. Auditors make use of audit procedures to detect these
misstatements.

However, because of the nature of audit procedures, some detection risk

will always exist. For example, auditors often sample a certain type of
company transaction because examining every transaction is
impractical. Increasing the sample size can reduce detection risk, but some risk
will always remain.
These are the three main components of detection risk.

1. Applying an audit procedure incorrectly. For example, when an auditor

applies the wrong acceptable ratio when using ratios to evaluate the face
value accuracy of an account balance.
2. Incorrect audit testing method. Choosing an audit testing method that isn’t
right for the type of financial account being audited, for example, testing for
accuracy of the invoice rather than the occurrence of a particular sale.
3. Misinterpreting the results of the audit, or just evaluating the results
wrongly.

Control Risk

Control risk, which is the risk that a misstatement due to error or fraud that could occur
in an assertion and that could be material, individually or in combination with other
misstatements, will not be prevented or detected on a timely basis by the company's
internal control.
FAQs. There are three main types of internal controls: detective, preventative, and
corrective. Controls are typically policies and procedures or technical safeguards that
are implemented to prevent problems and protect the assets of an organization.

Examples:

ABC Auditors is performing a financial audit to Black Cat Company, the auditor took a
sample of entries to analyzed the accuracy of calculations.

Entry #1

May 15th, 2020

Cash ₵ 811 416.48

Accounts Receivable ₵ 1 217 124.40
Tax ₵ 263 679.02
Freight out ₵ 67 000.00
Sales Revenue ₵ 1 415 531.94
Unearned Sales Revenue ₵ 943 687.96
Sale of merchandises to McKornnick Company for $ 3 449.90 (PER: ₵
 576.00, SER: ₵ 588.00, Invoice: 890760, purchase order: 89706, approved
by John Jones), 60% paid in cash (Ck-9087, National Bank) and the
remaining amount is bargained (2/10, n/30). Customer will withdraw 60%
of merchandise paid off on transaction day August 4 th, 2020, and the
remaining will be delivered on August 20 th, 2020. Transportation cost
must be cover by seller.

Remarks:
 The exchange rate that was used to convert dollars to colones is incorrect.
(GAAP Stable Monetary UNIT)
 The purchase order number it´s similar to the invoice number.
 The company is in charge of delivering the merchandise to the customer. On the
other hand, in the footnote it is mentioned that the client will withdraw 60% first
and the rest later.
 Both the cash amount and the tax amount are incorrect (GAAP-Historical Cost).
Besides that the tax account is badly positioned, the account must be on credit
and its correct name is "value added tax"( GAAP-Duality)
 In the footnote it doesn´t specify if it is before or after the tax
 Sales Revenue shouldn´t be in the entry (GAAP-Duakity)
 In the footnote it says nothing about the freight out cost.( GAAP-Objective)

May 15,2020
Cash ₵ 1 347 282.50
Accounts Receivable ₵ 898 188.36
Value Added Tax ₵ 258 328.51
Unearned Sales Revenue ₵ 1 987 142.40
Sale of merchandises to McKornnick Company for $ 3 449.90 before tax (PER:
₵ 576.00, SER: ₵ 588.00, Invoice: 890760, approved by John Jones), 60% paid
in cash (Ck-9087, National Bank) and the remaining amount is bargained (2/10,
n/30). The 60% of merchandise paid off on transaction will be delivered on
August 4th, 2020, and the remaining will be delivered on August 20 th, 2020.
Transportation cost must be cover by seller.
Entry #2

May 28th, 2020

Supplies ₵ 455 677.00

Tax ₵ 59 238.01
Freight in ₵ 7 000.00
Cash ₵ 521 915.01
Purchase of supplies to TR Bookshop (Invoice: 76754, purchase order:
23415, approved by John Jones), (Ck-1232, National Bank).

Remarks:
 The footnote is incomplete.(GAAP-Objective)
 The tax account must be called value added tax is not called tax. (GAAP-Duality)
 The freight in account must be called Transportation Expense (GAAP-Duality)
 In the footnote it doesn´t specify if it is before or after the tax.
 The purchase order is approved by John Jones and he is not in charge of
approving purchase orders but the sales department.

May 28, 2020

Supplies ₵ 455 677.00
Value Added Tax ₵ 59 238.01
Transportation Expense ₵ 7 000.00
Cash ₵ 521 915.01
urchase of supplies to TR Bookshop (Invoice: 76754, purchase order: 23415,
approved by John Jones), (Ck-1232, National Bank).