Question

Our audit firm, Green& Associates, emphasises to new graduates in professional development training sessions the importance of understanding audit risk to the planning phase of an audit of a financial statements engagement. Green & Associates evaluates the desired level of audit risk by disaggregating it into three components: inherent risk, control risk and detection risk.

For each example test in the left hand columnof the Table below, write which of the three components is being most directly illustrated by each example in the right hand column.

Note:only one risk component is “most directly illustrated” for each test.

Our audit firm, Green& Associates, emphasises to new graduates in professional development training sessions the importance of understanding audit risk to the planning phase of an audit of a financial statements engagement. Green & Associates evaluates the desired level of audit risk by disaggregating it into three components: inherent risk, control risk and detection risk.

For each example test in the left hand columnof the Table below, write which of the three components is being most directly illustrated by each example in the right hand column.

Note:only one risk component is “most directly illustrated” for each test.

Example test	Most directly illustrated risk
A client has insufficient working capital to continue its operations.
Segregation of duties is inadequate.
Technological innovations within a client’s industry have caused one of their major products (inventory items) to become obsolete.
Our confirmation of receivables failed to detect a material misstatement.
A substantive procedure required under the ASAs has not been carried out.
An audit client has a very material cash balance.
Cash payments have occurred without proper approval.

Answer 1

The Audit risk are classified into 3 catageory, which are as below:

1) Inherent risk:

2) Control risk: Control risk is the chance that financial statements are materially misstated because of failures in a company’s system of internal controls.

3) Detection risk: Detection risk is the risk that the auditors’ procedures are unable to detect any material misstatements in a company’s financial statements.

Auditors have to do a risk assessment of each component of audit risk and ensure the accuracy of the information in the financial statements.

Sr. No.	Example test	Most directly illustrated risk
1	A client has insufficient working capital to continue its operations.	Inherent Risk
2	Segregation of duties is inadequate.	Control Risk
3	Technological innovations within a client’s industry have caused one of their major products (inventory items) to become obsolete.	Inherent Risk
4	Our confirmation of receivables failed to detect a material misstatement.	Detection Risk
5	A substantive procedure required under the ASAs has not been carried out.	Detection Risk
6	An audit client has a very material cash balance.	Inherent Risk
7	Cash payments have occurred without proper approval.	Control Risk