• Explanation

Risk assessment is an essential step in audit planning. Identifying the areas with high risk of material misstatement and the types of errors or fraud that could occur is a necessary step in planning an effective and efficient audit in response to those risk. Risk assessment requires the auditor to have a strong understanding of the entity under audit, especially its accounting processes and internal controls (I/C).

Walkthroughs allow the auditor to achieve the required understanding and can provide evidence of the effectiveness of I/C. In a walkthrough, the auditor follows a transaction through the company's processes (including information systems), from the transaction's origination to its recording in the F/S. During the walkthrough, the auditor may observe the company's operations, make inquiries of personnel, inspect documents, and reperform control procedures, although not necessarily in that order.

(Choice A) Tests of controls are used to evaluate the effectiveness of specific controls, not to understand the system as a whole. Walkthroughs are a good means of determining which controls to test, but they do not necessarily include such testing.

(Choices B and C) Walkthroughs typically involve both the observation of operations and inspection of relevant records. However, neither procedure by itself constitutes a walkthrough.

Things to remember: In a walkthrough, an auditor follows a transaction from its origin to its final recording in the F/S in order to gain an understanding of the possible sources of misstatements. Walkthroughs can involve reperformance, inquiry, inspection, and observation.

Lecture References :

• AUD 3.03 : Understanding an Entity & Its Environment: Understanding the I/C Structure