05 5 x 5 2 less evidence accumulation is necessary

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Unformatted text preview: s who only look at them for reasonableness. Inherent risk might be set low because of good results in prior year audits and no audit areas where there is a high expectation of misstatement. Control risk would normally be set low because of effective internal controls in the past, and continued expectation of good controls in the current year. Using the formula in a-2, PDR = .05 / (.2 x .2) = 1.25. Planned detection risk is equal to more than 100% in this case. No evidence would be necessary in this case, because there is a planned detection risk of more than 100%. The reason for the need for no evidence is likely to be the immateriality of repairs and maintenance, and the effectiveness of internal controls. The auditor would normally still do some analytical procedures, but if those are effective, no additional testing is needed. It is common for auditors to use a 100% planned detection risk for smaller account balances. It would ordinarily be inappropriate to use such a planned detection risk in a material account such as accounts receivable or fixed assets. 9-64 9-31 a. Acceptable audit risk A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. This is the risk that the auditor will give an incorrect audit opinion. Inherent risk A measure of the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control. This risk relates to the auditor's expectation of misstatements in the financial statements, ignoring internal control. Control risk A measure of the auditor's assessment of the likelihood that misstatements exceeding a tolerable amount in a segment will not be prevented or detected by the client's internal controls. This risk is related to the effectiveness of a client's internal controls. Planned detection risk A measure of the risk that audit evidence for a segment will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. In audit planning, this risk is determined by using the other three factors in the risk model using the formula PDR = AAR / (IR x CR). b. Acceptable Audit Risk IR x CR PDR = AAR / (IR x CR) Planned Detection Risk in percent 1 .05 1.00 .05 5% 2 .05 .24 .208 3 .05 .24 .208 4 .05 .06 .833 5 .01 1.00 .01 6 .01 .24 .042 20.8% 20.8% 83.3% 1% 4.2% c. 1. 2. 3. 4. Decrease; Compare the change from situation 1 to 5. Increase; Compare the change from situation 1 to 2. Increase; Compare the change from situation 1 to 2. No effect; Compare the change from situation 2 to 3. d. Situation 5 will require the greatest amount of evidence because the planned detection risk is smallest. Situation 4 will require the least amount of evidence because the planned detection risk is highest. In comparing those two extremes, notice that acceptable audit risk is lower for situation 5, and both control and inherent risk are considerably higher. 9-65 9-32 a. Low, medium, and high for the four risks and planned evidence have meaning only in comparison to each other. For example, an acceptable audit risk that is high means the auditor is willing to accept more risk than in a situation where there is medium risk without specifying the precise percentage of risk. The same is true for the other three risk factors and planned evidence. b. 1 2 3 4 5 6 Acceptable Audit Risk H H L L H M IR x CR L M H M M M PDR = AAR / (IR x CR) H M L L M M Planned Evidence L M H H M M L = low, M = medium, H = high c. EFFECT ON PDR (1) (2) (3) (4) (5) EFFECT ON EVIDENCE Increase Decrease NA Decrease No effect Decrease Increase Decrease Increase No effect 9-33 Risk Factor Related Audit Risk Model Component 1. Acceptable audit risk 2. Control risk 3. Acceptable audit risk 4. Inherent risk 5. Planned detection risk 6. Acceptable audit risk 7. Inherent risk 8. Inherent risk 9. Planned detection risk 10. Control risk 9-66 9-34 CONTROL RISK INHERENT RISK ACCEPTABLE AUDIT RISK PLANNED EVIDENCE N N D N N D I I I D N or I N N I N D I I I I D D N N I N N D N N I I D I D D I I I C a. b. c. d. e. f. g. h. i. j. Cases 9-35 FACTOR EFFECT ON THE RISK OF MATERIAL MISSTATEMENT AUDIT RISK MODEL COMPONENT 1. Henderson is a new client. Increases Inherent risk 2. Henderson operates in a regulated industry, which increases regulatory oversight and need for compliance with regulations. Increases Acceptable audit risk 3. The company’s stock is publicly traded. Increases Acceptable audit risk 4. The company is more profitable than competitors, but recent growth has strained operations. Increases Acceptable audit risk 5. The company has expanded its use of derivatives and hedging transactions. Increases Inherent risk 6. Henderson has added competent accounting staff and has an internal audit function with direct reporting to the audit committee. Decreases Control risk 9-67 9-35 (continued) FACTOR EFFECT ON THE RISK OF MATERIAL MISSTATEMENT AUDIT RISK MODEL COMPONENT 7. The financial statements contain s...
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This note was uploaded on 02/04/2014 for the course ACCOUNTING 211 taught by Professor Alikapur during the Fall '13 term at American University of Sharjah.

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