February 9_Accounting Fraud and Auditor Legal Liability_Internal Control Over Financial Reporting

Auditing Cases: An Interactive Learning Approach (4th Edition)

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= × PDR AARIR CR PDR = planned detection risk AAR = acceptable audit risk IR = inherent risk CR = control risk Auditors deal with risk in planning audit evidence primarily by applying the audit risk model . This model comes from the professional literature in SAS 110 (AU 350) on audit sampling and in SAS 107 (AU 312) on materiality and risk. The audit risk model help auditors decide how much and what types of evidence to accumulate in each cycle. Planned detection risk is the risk that audit evidence for a segment will fail to detect misstatements exceeding tolerable misstatement. Planned detection risk is dependent on the other three factors in the model. It will change only if the auditor changes one of the other risk model factors. Planned detection risk determines the amount of substantive evidence that the auditor plans to accumulate, inversely with the size of planned detection risk If planned detection risk is reduced, the auditor needs to accumulate more evidence to achieve the reduced planned risk. Inherent risk measures the auditor’s assessment of the likelihood that there are material misstatements (errors or fraud) in a segment before considering the effectiveness of internal control. If the auditor concludes that a high likelihood of misstatement exists, ignoring internal controls, the auditor will conclude that inherent risk is high. Inherent risk is inversely related to planned detection risk and directly related to evidence (the higher the inherent risk, the more evidence accumulation needed). Control risk measures the auditor’s assessment of whether misstatements exceeding a tolerable amount in a segment will be prevented or detected on a timely basis by the client’s internal controls. The more effective the internal controls, the lower the risk factor that can be assigned to the control risk. As with inherent risk, the relationship between control risk and planned detection risk is inverse, whereas the relationship between control risk and substantive evidence is direct. If the auditor concludes that internal controls are effective, planned detection risk can be increased and evidence therefore decreased. [2] Factors to evaluate when assessing client inherent risk: Nature of the Client’s Business Inherent risk is most likely to vary from business to business for accounts such as inventory, accounts and loans receivable, and property plant, and equipment. The nature of the client’s business should have little or no effect on inherent risk for accounts such as cash, notes, and mortgages payable. industry obsolescence (electronics) accounts receivable Results of Previous Audits Misstatements found in the previous year’s audit have a high likelihood of occurring again in the current year’s audit, because many types of misstatements are systemic in nature, and organizations are often slow in making changes to eliminate them. n/a
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February 9_Accounting Fraud and Auditor Legal Liability_Internal Control Over Financial Reporting

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