Question

Audit risks for particular accounts can be expressed in the model: Audit risk (AR) = Inherent risk (IR) x Internal control risk (CR) x Detection risk (DR).

A. If an audit risk is set at 5 percent, the inherent risk at 80 percent, and the internal control risk at 25 percent, what would be the detection risk?

B. If the audit team wanted to reduce the audit risk to 1 percent, what would be the detection risk?

C. What would the audit team have to do to reduce the audit risk?

Answer 1

A. Audit Risk (AR) = Inherent Risk (IR) * Internal Control Risk (CR) * Detection Risk (DR)

5% = 80% * 25% *Detection Risk

Detection Risk = 5% / (80%*25%)

= 0.0025%

Therefore, Detection Risk is 0.0025%.

B. Detection risk is risk that auditor fails to detect the material misstatement in the books of accounts and issues an imporper opinion to the audited financial statements.

The basic reason for the detection risk is improper audit planning, lack of understanding of audit clients.

Also, While calculating audit risk inherent risk and control risk play the main role too.

Therefore, If the Audit risk reduced by 1% there are proportionate deduction in all three risks considering the actual scenario.

C. As per the below-mentioned details, the Audit team can reduce the audit risk:

The audit team should consider the assessed levels of inherent and control risks in determining the nature, timing, and extent of substantive procedure required to reduce audit risk to an acceptably low level. In this regard the auditor would consider:

• The nature of the substantive procedure, for example, using tests directed toward independent parties outside the entity rather than tests directed towards parties or documentation within the entity, or using tests of details for a particular audit objective in addition to the analytical procedure;
• the timing of the substantive procedure, for example, performing them at the period end rather than at an earlier date; and
• the extent of the substantive procedure, for example, using a larger sample size.