(a) Audit risk is the risk that the auditors give an inappropriate audit opinion on the financial

statements. Explain the THREE (3) components of audit risk.

(7 marks)

(b) The risk of material misstatement may be increased, decreased or unchanged in each of the

following situations:

(1) The company has recently installed a new and more advanced accounting software.

The employees have not yet been fully trained on the use of the system.

(2) The company has performed poorly in the past six months. The management of the

company has been under pressure to improve the financial performance of the

company before the year ends.

(3) The company has adopted a new financial reporting standard. The application of the

standard requires technical knowledge which is not available in the company.

(4) The company has documented its accounting policies and procedures in an accounting

manual. The employees are instructed to adhere to the manual in their day to day tasks.

(5) The auditor has experienced a high turnover of staff in recent months. Relatively

inexperienced staff are hired to fill the vacancies.

Required:

In EACH case:

(i) identify the component of audit risk involved, stating whether the risk of material

misstatement is increased, decreased or unchanged.

(5 marks)

(ii) where the risk of material misstatement is increased or decreased, state the component

of the audit risk that should be adjusted (indicating if it should be higher or lower) in

order to maintain the audit risk at an acceptable level.

(5 marks)

(c) Discuss the purpose of obtaining a bank cut-off statement.