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  • CH - 1 - Materiality and Audit Risk (3 of 3)

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    Module Name: Auditing II Module Code: ACC309 Lecturer Name: Dr. Yasmine Magdi [1] The document discusses audit risk and its components - inherent risk, control risk, and detection risk. It provides examples of how to calculate detection risk using the audit risk model given levels of inherent risk, control risk, and acceptable audit risk. [2] Lowering inherent risk or control risk through more extensive audit procedures implies a lower necessary detection risk and more audit work. Conversely, higher inherent or control risk allows for a higher detection risk and less audit work. [3] The audit risk model helps auditors assess business risks and the potential for misstatements,

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    Module Name: Auditing II Module Code: ACC309 Lecturer Name: Dr. Yasmine Magdi [1] The document discusses audit risk and its components - inherent risk, control risk, and detection risk. It provides examples of how to calculate detection risk using the audit risk model given levels of inherent risk, control risk, and acceptable audit risk. [2] Lowering inherent risk or control risk through more extensive audit procedures implies a lower necessary detection risk and more audit work. Conversely, higher inherent or control risk allows for a higher detection risk and less audit work. [3] The audit risk model helps auditors assess business risks and the potential for misstatements,

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    1 views14 pages

    CH - 1 - Materiality and Audit Risk (3 of 3)

    Uploaded by

    mamse08
    Module Name: Auditing II Module Code: ACC309 Lecturer Name: Dr. Yasmine Magdi [1] The document discusses audit risk and its components - inherent risk, control risk, and detection risk. It provides examples of how to calculate detection risk using the audit risk model given levels of inherent risk, control risk, and acceptable audit risk. [2] Lowering inherent risk or control risk through more extensive audit procedures implies a lower necessary detection risk and more audit work. Conversely, higher inherent or control risk allows for a higher detection risk and less audit work. [3] The audit risk model helps auditors assess business risks and the potential for misstatements,

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    of 14

    Module Name Auditing II

    Module Code ACC309


    1
    Lecturer Name Dr. Yasmine Magdi
    Chapter 1

    Materiality and Audit Risk

    2
    Audit Risk
    Auditors accept some level of
    risk in performing the audit.

    Risks exist, are difficult to


    measure, and require careful
    thought in response.

    Proper risk response is critical


    3
    to achieving a high-quality audit.
    Audit Risk
    Risk and Evidence

    Auditors need to understand the client’s


    business and assess business risk.

    The audit risk model helps identify the


    potential and likelihood of misstatements. 4
    Audit Risk
    Audit Risk Model for Planning

    PDR = AAR ÷ (IR × CR)

    where: PDR = Planned detection risk

    AAR = Acceptable audit risk

    IR = Inherent risk

    CR = Control risk 5
    Audit Risk
    Audit Risk Model for Planning

    Example (1): If the auditor is willing to accept an audit risk of 5 percent, or in


    other words setting the confidence level at 95 percent, and the auditor has
    assessed inherent risk and control risk as 70 and 50 percent.
    Required: What level of detection risk is implied by this information?

    Answer

    6
    DR= 0.05/ (0.7× 0.5)= 14%
    Audit Risk
    Audit Risk Model for Planning

    Example (2): An Auditor has set an overall level of acceptable audit risk in respect
    of a client of 10%. Inherent risk has been assessed at 50% and control risk at 80%.
    Required:
    (a) Explain the meaning of a 10% level of audit risk.
    (b) What level of detection risk is implied by this information?
    (c) If the level of audit risk were only 5%, how would this affect the level of
    detection risk and how would the audit work be affected by this change?
    7
    Audit Risk
    Audit Risk Model for Planning

    Solution
    (a)A 10% level of audit risk means that the auditor will be 90% certain that his opinion on the
    financial statements is correct (or there is a 10% risk that his opinion will be incorrect).
    (b)AR= IR × CR × DR
    Then DR= AR/ (IR × CR)
    Therefore DR= 0.25= 25%
    (a)If AR is reduced to 5%, DR would now be 12.5%. More audit work will be needed to achieve
    8
    this lower level of detection risk.
    Audit Risk
    Audit Risk Model Components

    Planned
    Inherent
    Detection
    Risk
    Risk

    Acceptable
    Control Audit
    Risk Risk 9
    Audit Risk
    Relationships within the Audit Risk Model

    10
    Audit Risk
    Relationships within the Audit Risk Model
    Example (3): The following assumptions are provided:
    1. Individual audit risk is set a low level (5 percent) because of the low overall audit risk.
    2. Inherent risk is set at 0.80 rather than 0.70 because the auditor believes there is a high risk of
    misstatement.
    3. Control risk is set at 50 percent.
    AR= 5%; IR= 80%; CR= 50%
    What level of detection risk is implied by this information?
    (a)If the control risk is set at 20 percent rather than 50 percent because the auditor believes there is a lower
    risk that internal control will not prevent or detect misstatements that render the assertion invalid and
    the inherent risk is set at 70 percent rather than 80 percent.
    11
    What level of detection risk is implied by this information?
    Audit Risk
    Relationships within the Audit Risk Model

    Solution

    The above calculations show that the external auditor will plan on a lower
    detection risk and will have to increase the scope of audit procedures to
    achieve this lower risk. 12
    Audit Risk
    Relationships within the Audit Risk Model

    Solution

    = 36%
    This indicates that the external auditor will plan on a higher detection risk
    13
    and can decrease the scope of audit procedures to achieve this higher risk.
    14

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