Question

Audit Risk = (Inherent Risk) * (Control Risk) * (Detection Risk)

We want audit risk to be no greater than 5%.

We assess Inherent Risk as 60% and Control Risk at 20%.

So Detection Risk must be no greater than ……?

Auditors report to the Audit Committee. What are the qualifications to serve on the Audit Committee?

Answer 1

Audit Risk = Inherent Risk x Control Risk x Detection Risk

0.05 = 0.60 x 0.20 x Detection Risk

0.05 = Detection Risk = 0.416 = 41.6%
0.12

Detection risk must not be greater than 41.6%

2) Independence and qualifications of members

Audit committee members must be independent directors, and their independence should be continuously maintained and reviewed at least annually. Listed companies should have policies in place to allow timely identification of changing relationships or circumstances that may affect the independence of audit committee members. Companies generally require directors to complete questionnaires when joining the board and each year thereafter and to notify the company of any changes that may affect independence. For audit committee members, these questionnaires should be tailored to reflect the independence criteria of either the NYSE or NASDAQ. Companies may want to involve legal counsel in assessing the independence of directors.

NYSE and NASDAQ requirements. The NYSE and NASDAQ listing standards incorporate the SEC’s independence requirements, but each has its own additional requirements.NYSE listing standards state that an audit committee member is not independent if any of the following applies:

•He or she is an employee or an immediate familymember1 is or was an executive officer of thecompany during the past three years.

•He or she or an immediate family member receivedmore than $120,000 in direct compensation from thecompany in any 12-month period during the previousthree years, except for director fees and otherpermitted payments.

•He or she or an immediate family member is a currentpartner of the company’s internal or independentauditor; he or she is a current employee of such afirm; he or she has an immediate family member whois a current employee of such a firm and personallyworks on the company’s audit; he or she or animmediate family member was, but is no longer, apartner or employee of such a firm and personallyworked on the company’s audit during the previousthree years

.•He or she is a current employee, or an immediatefamily member is a current executive officer, ofanother company that made payments to, or receivedpayments from, the listed company for property or services in an amount that, in any one of the previous three fiscal years, was in excess of the greater of $1 million or 2 percent of the other company’s consolidated gross revenues .