ACCA Applied Skills · Audit and Assurance

Assessing Audit Risks for ACCA Audit and Assurance

Assessing audit risks means identifying where financial statements could be materially wrong and planning work to match. You use the audit risk model (audit risk = risk of material misstatement × detection risk), understand the entity, set materiality, run analytical procedures, and then design the audit strategy and plan.

What this chapter covers

This chapter is the base of the AA paper. It covers how an auditor decides what could go wrong in the financial statements and how much work is needed to respond. You start with the audit risk model, then learn how to understand the entity, identify business risks and risks of material misstatement, set materiality, use analytical procedures, consider fraud, error and going concern, and finally pull it all into a strategy and plan.

The chapter links to nearly every other part of the paper. Risks you identify here drive the audit procedures and the evidence you gather later. They also shape internal control testing, the completion stage, and the audit report. If you cannot spot and explain a risk, you cannot choose a sensible response.

In the exam, this material appears in both parts. Section A and OT cases test definitions, calculations such as materiality and ratios, and judgement on which risk applies. The constructed response questions give you a scenario and ask you to identify risks, explain why each matters and state the audit response. This is the most commonly tested skill in the paper.

Audit risk assessment is the thread that runs through the whole AA exam, so it earns marks in OT questions and in the longer written questions. A scenario-based risk question rewards a repeatable method: spot the fact, state the risk, link it to a financial statement area, then give the response. Because OT questions are marked all or nothing, precise knowledge of terms and calculations matters. Because written questions reward application, a well-practised method gains marks you would otherwise miss. Time spent here also makes later chapters on controls, evidence and reporting much easier.

Assessing audit risks: topics in the order to study them

1Audit Risk ModelIt gives you the vocabulary of inherent, control and detection risk that every later topic builds on.
2Risk Assessment Procedures and Understanding the EntityYou need to know how the auditor gathers information before you can identify any risk.
3Identifying Business Risks and Risks of Material MisstatementThis turns the information you gathered into specific risks, the core skill for scenario questions.
4Materiality and Performance MaterialityOnce risks are known, you learn how to judge which misstatements matter and set thresholds for testing.
5Analytical Procedures in PlanningIt uses figures and ratios to point to risk areas, so it comes after you know what risks look like.
6Fraud, Error and Going Concern RisksThese are special risk areas with their own requirements, best learned once the general method is secure.
7Audit Planning, Strategy and Engagement AcceptanceIt brings the whole chapter together into the plan and the decision to accept the work.

How to prepare Assessing audit risks

Aim to learn the logic first, then practise applying it to scenarios. Memorising lists without application will not score well in this chapter.

Learn the audit risk model and be able to explain each component in your own words, including how the components relate.
Read the topics on understanding the entity and risk assessment procedures, and list the sources of information and the types of procedure.
Practise a four-part risk answer on short scenarios: the fact, the risk, the effect on the financial statements, and the audit response.
Work through materiality calculations using benchmarks, and make sure you can explain why performance materiality is set below overall materiality.
Practise analytical procedures by calculating ratios from a set of figures and writing one sentence on what each movement might indicate.
Revise fraud, going concern and engagement acceptance as lists of indicators and responses, then test yourself with OT questions.
Finish with timed questions that mix OT items and one written scenario, and mark yourself on application, not just on coverage.

Common mistakes in Assessing audit risks

Listing risks without linking them to the financial statements.
Fix: Always state which account or assertion could be misstated, and why, before giving the response.
Confusing business risk with the risk of material misstatement.
Fix: Business risk comes from the entity's objectives and environment; ask whether it could cause the financial statements to be materially wrong.
Giving generic audit responses such as 'perform more tests'.
Fix: Name the actual procedure, the item it covers and the evidence it gives, for example attending the inventory count for existence.
Treating analytical procedure results as conclusions.
Fix: Say what the change might indicate, give more than one possible reason, and state what you would investigate.
Mixing up materiality and performance materiality.
Fix: Remember that materiality applies to the financial statements as a whole, while performance materiality is lower and used when designing and testing.
Ignoring the numbers in the scenario when calculating or judging materiality.
Fix: Check the entity's profile first, such as loss-making or asset-based, then choose and justify a sensible benchmark.

Last-day revision: Assessing audit risks

Audit risk = risk of material misstatement × detection risk.
Risk of material misstatement combines inherent risk and control risk.
The auditor cannot change inherent or control risk; detection risk is the one the auditor controls through procedures.
Risk assessment procedures include enquiry, analytical procedures, and observation and inspection.
Business risks can lead to risks of material misstatement, but not every business risk does.
Materiality is a matter of judgement, often based on a benchmark such as profit or revenue.
Performance materiality is set below materiality to reduce the chance that uncorrected and undetected errors add up to a material amount.
Unusual ratio movements point to areas for closer audit work; they are not proof of error.
Fraud risks need professional scepticism, and management override of controls is always presumed to be a risk.
Going concern indicators can be financial, operational or other, and the auditor evaluates management's assessment.
The audit strategy sets scope, timing and direction; the audit plan details the procedures.
Consider ethics, competence and integrity of the client before accepting an engagement.

Assessing audit risks in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Assessing audit risks: frequently asked questions

What is the audit risk model?

It shows that audit risk is the product of the risk of material misstatement and detection risk. The risk of material misstatement is itself made up of inherent risk and control risk. The auditor sets detection risk by deciding how much work to do.

How do I answer a risk identification question in the AA exam?

Use a repeatable pattern. State the fact from the scenario, name the risk, explain the financial statement impact, and give a specific audit response. Make each risk a separate point so the marker can credit it.

Do I need to memorise materiality percentages?

Know that benchmarks such as profit before tax or revenue are used and that the percentage is a matter of judgement. If a question gives percentages, apply them as given. Focus on choosing a suitable benchmark and explaining it.

How is this chapter tested in OT questions?

Expect definitions, simple calculations, and scenario items asking which risk or procedure applies. OT questions are marked all or nothing, so read the wording carefully and check any calculation before you answer.