Question

1-MW & Co., CPAs, is planning its audit procedures for its tests of the valuation of inventories of EC Manufacturing Co. The auditors on the engagement have assessed inherent risk and control risk for valuation of inventories at 80% and 40%, respectively. Calculate the appropriate level of detection risk for the audit of this assertion, given that the auditors wish to restrict audit risk for the assertion to 5%

Answer 1

Audit risk is the risk that auditor express an inappropriate opinion when financial statements are materially misstated.There are three different types of audit risk ,as explained below:

1.Inherent risk(IR): it defines the degree of susceptibility of an account balance or class of transaction and disclosure that may be misstated materially either individually or on aggregate.Such risk are identified assuming there is no internal control exist in the entity

2.Control risk(CR): Such risk to the same level of susceptibility as to theri misstatements when internal control in the entity exist.It is the test of internal control existing in entity whether it is best enough to evade such misstatements or not.

3. Detection risk(DR) : Risk as to procedure performed by auditor is unable to detect such misstatements which is material either individually or in aggregate.

These all risks are interrelated with each other .Keeping all these risk in mind,audit risk is calculated by formula as :

Audit risk(Ar)= IR*DR*CR

In question:

AR required is 5%

IR=40%

CR= 80%

THUS , FRIM ABIVE EQUATION

AR=IR*DR*CR

.05=.4*.8*DR

DR=.05/(0.4*0.8)=0.15625=15.625%

So, appropriate level of detection risk is 15.625%.