Question

(TCO H) Audit Risk consists of inherent risk, control risk, and detection risk. (a) Please completely define each of the above. (b) Indicate whether each of the statements below is true or false and explain your position: (1) The risk that material misstatement will not be prevented or detected on a timely basis by internal controls can be reduced to zero by having effective controls in place. (2) Detection Risk is a function of the efficiency of an auditing procedure. (3) Cash is more susceptible to theft than an inventory of coal because it has greater inherent risk? (4) The Inherent risk of the theft of an inventory of cellphones at a mall store is greater than the misappropriation of cash at a COSTCO Store?

Answer 1

(a)

Audit risk is the risk that an auditor may express an unqualified report (that the financial statement are free from material misstatements) even though the financial statements contain material misstatement. Audit risk has three components namely, inherent risk, control risk, and detection risk. To keep the overall audit risk under acceptable limits, an auditor must assess the level of risk of each of the three components.

Inherent risk is the risk that the financial statements may contain some materials misstatements caused by errors or omissions due to factors other than failure of controls. When the transactions are very complex, or a high degree of estimation and judgements are used, inherent risk is considered to be higher.

Control risk is the risk that the financial statements may contain some materials misstatements caused by errors or omissions due to failure of controls.

Detection risk is the risk that the auditor may not be able to detect a material misstatement in the financial statements even though the audit was carried out by folowing all audit procedures and in compliance with the relevant standards.

(b)

1. The risk that material misstatement will not be prevented or detected on a timely basis by internal controls can be reduced to zero by having effective controls in place. False

Even effective internal controls would not be able to reduce the risk to zero if a high degree of estimations and judgements are invloved or the transactions are very complex in nature.

2. Detection Risk is a function of the efficiency of an auditing procedure. False

Detection risk is the risk that the auditor may not be able to detect a material misstatement in the financial statements even though the audit was carried out by folowing all audit procedures and in compliance with the relevant standards.

3. Cash is more susceptible to theft than an inventory of coal because it has greater inherent risk. True

Cash has a higher liquidity than coal inventory and therefore is more susceptible to theft than an inventory of coal.

4. The Inherent risk of the theft of an inventory of cellphones at a mall store is greater than the misappropriation of cash at a COSTCO Store. True

Internal controls would not be so effective at a mall store as in case of a COSTCO store. Small items of inventory can be easily embezzled at stores than cash which is certainly under strict controls.