Ch5. ACCA — Audit and Assurance (AA): Risk, Controls & Opinions
What Is an Audit?
An external audit is an independent examination of an entity’s financial statements to express an opinion on whether they give a true and fair view and comply with applicable standards (e.g., IFRS).
The auditor does NOT prepare the financial statements — that is management’s responsibility. The auditor’s job is to provide reasonable assurance.
Auditor Independence
Independence is the cornerstone of audit credibility.
Five Threats to Independence (ACCA Framework)
| Threat Type | Example |
|---|---|
| Self-review | Audit firm also prepared the client’s accounts |
| Self-interest | Auditor holds shares in the audited entity |
| Advocacy | Auditor represents the client in legal proceedings |
| Familiarity | Long-standing relationship erodes critical objectivity |
| Intimidation | Client threatens auditor with dismissal for a qualified opinion |
The Audit Risk Model
Audit Risk (AR) = Inherent Risk (IR) × Control Risk (CR) × Detection Risk (DR)
| Component | Definition |
|---|---|
| Inherent Risk (IR) | Risk of material misstatement without any controls |
| Control Risk (CR) | Risk that internal controls fail to prevent/detect misstatement |
| Detection Risk (DR) | Risk that audit procedures fail to detect the remaining misstatement |
Key relationship: AR and DR move inversely. High IR × CR means auditors must reduce DR → more extensive audit procedures.
Internal Control Systems
COSO Framework — 5 Components
- Control Environment: Ethical tone, board/audit committee oversight
- Risk Assessment: Identifying and analyzing risks to objectives
- Control Activities: Segregation of duties, authorization, physical controls
- Information & Communication: Timely, accurate information flows
- Monitoring: Internal audit, management self-assessment
Segregation of Duties — Most Fundamental Control
Must separate these four roles:
- Authorization: Approving transactions
- Execution: Processing transactions
- Custody: Holding assets
- Recording: Maintaining records
Audit Evidence and Procedures
Types of Audit Procedures
| Procedure | Description |
|---|---|
| Inspection | Examining records, documents, tangible assets |
| Observation | Watching a process being performed |
| Inquiry | Asking management and staff questions |
| Confirmation | Direct third-party verification (e.g., bank confirmations) |
| Recalculation | Re-performing calculations |
| Analytical Procedures | Comparing data against expectations |
Audit Report Opinion Types
| Opinion | Condition |
|---|---|
| Unmodified (clean) | No material misstatements |
| Qualified | Material but not pervasive misstatement, or scope limitation |
| Adverse | Material AND pervasive misstatements |
| Disclaimer | Severe scope limitation (unable to obtain sufficient evidence) |
Chapter 6 Preview
Next: Financial Management (FM) — WACC, NPV/IRR investment appraisal, Modigliani-Miller capital structure theory, and working capital management.
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