Question

Discuss the relationship of inherent and control risk to detection risk. Then explain how nature, timing and extent of audit testing is related to detection risk.

Answer 1

The risks of material misstatement at the acceptable level consist of two components

1. INHERENT RISK AND

2. CONTROL RISK

Above both risk are the organization risks, they exist independently of the audit of financial statements.

1. Inherent risk :-It is higher for some assertions and related classes of transactions, account balance and disclosures than for others.E.g it may higher for complex calculation. In some cases external business risk may also influence inherent risk. Example technological development may also influence the inherent risk related to specific assertion.

Inherent risk factors are considered while designing tests of control and substantive procedures.

The susceptibility of assertion about a class of transaction account balance or disclosure to a misstatement that could be material either individually or aggregate with other misstatements.

2. Control Risk:- It is a function of the effectiveness of a design, implementation and maintenance of internal control by management. However internal control can only reduce but not eliminate risks of material misstatements in the financial statements. This is because of inherent limitations of internal control.

Detection Risk

The risk that the procedures performed by the auditor to reduce audit risk to an acceptable low level will not detect a misstatement that exists and that could be material, either individually or when aggregate with other misstatement.