Case 4.2

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

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Case 4.2 – Comptronix Corporation [1] The Audit Risk Model is defined as: AR = IR x CR x DR IR - Internal Risk - Internal Risk is the auditor’s measure of assessing whether material misstatement exist in the financial statement before considering the effectiveness of internal controls. Ignoring internal controls, if the auditor assesses that it is likely that the material error is high, the auditor will assume that the Internal Risk is high. CR - Control Risk - Control Risk is the auditor’s measure of assessing the likelihood that the client’s internal control system is unable to prevent or detect material misstatements exceeding a tolerable level. In assessing the level of the Control Risk, the auditor will assess the effectiveness of the firm’s internal control system during his audit. The lower the effectiveness of internal controls the greater the frequency of error. DR - Detection Risk - Detection Risk is the auditor’s measure of assessing the likelihood that the auditor will not detect material misstatements. Auditors will carry out more audit work to increase the detection rate if Internal Risk and Control Risk are too high in order to meet the Audit Risk target. When applying the Audit Risk Model, the auditor has to determine a target level of Audit Risk that is in accordance with providing reasonable assurance. The Internal Risk and Control Risk can be put together to make the OR (Occurrence Risk). The OR is the risk of the existence of misstatements before the actual audit. The Detection Risk on the other hand is the risk of the existence of misstatements during the actual audit. The first step in applying the Audit Risk Model is to determine a tolerable level of Audit Risk. In the next step, the Audit Risk is decomposed into its three components. The auditor has no control over the Internal Risk and Control Risk, but must assess their levels in order to determine the level of Detection Risk that is sufficient to achieve the target Audit Risk. The Detection Risk can be influenced by the extent of testing. When applying the formula of the Audit Risk Model, the auditor will need to perform more testing. In order to do this, the auditor must collect more evidence, and thus reduce the Detection Risk, in case the level of Internal Risk and/or Control Risk is high in order to achieve (maintain) the target. The Detection Risk can be influenced by the nature, timing, and extent of the audit procedures. [2] Internal Risk is the auditor’s measure of assessing whether material misstatements
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exist in the financial statement before considering the effectiveness of internal controls. Other than factors related to the peculiar assertion, the auditor needs to take external circumstances into account that may influence the Internal Risk. These circumstances can comprise the nature of the business and industry, the integrity of management, the size of account balances, the existence of related parties and the lack of sufficient working capital to continue operations. Taking into account those factors,
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Case 4.2 - Case 4.2 Comptronix Corporation [1] The Audit...

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