In: Accounting
Audit Risk = RMM × DR
Audit Risk = IR × CR × DR
can you explain the components of RMM (IR and CR)
please ? Thank you
Audit is a kind of inspection work.
Inspection carries two types of risks:
Type I: to accept a defective material
Type II: to reject a good material (non-defective)
In case of audit work, the audit risk is Type I risk ie, risk that the materially incorrect Financial Statement being certified by the auditor.
Hence two components of audit risks are
Audit Risk(AR)=DR*IR*CR
DR=Detection Risk
IR=Inherent Risk
CR=Control Risk
IR or inherent risk is the risk of an error or misstatement without considering internal controls. As the name suggests, this is the inherent risk in any operation.
CR or control risks is the risk that the internal control system in place (policies, procedures, checks and balances) fail to prevent or detect the error or misstatement .
DR or detection risk is the risk that the auditor will fail to detect a material misstatement
Audit Risk and detection risks are related to the auditors’ competence. Inherent Risk and Control Risk are related to client and its systems. These are independent of the auditor
Inherent Risks depends upon various factors like: Nature of business, IT environment of the client, integrity of management, clients motivation for misstatement, related party transactions, conflict of interest etc
Control Risks depends on the adequacy and type of controls in place in the clients organization