Problem:
(Audit Risk Model) A staff auditor was listening to a conversation between two senior auditors regarding the audit risk model. Following are some statements made in that conversation regarding the audit risk model.
Indicate whether you agree or disagree with each of the statements. Present the rationale for your answer. (Short but direct Rationale, I am preparing for a similar test and want to review the subject)
1. Audit risk can be applied quantitatively or qualitatively. In essence, it is a concept used to ensure that the auditor gathers sufficient evidence to render an opinion on the financial statements with little likelihood of being wrong.
2. Setting audit risk at 5 percent is a valid setting for controlling audit risk at a low level only if the auditor assumes that inherent risk is 100 percent, or significantly greater than the real level of inherent risk.
3. Inherent risk may be very small for some accounts (for example, the recording of sales transactions at a Wal-Mart). In fact, some inherent risks may be close to 0.01 percent. In such cases, the auditor does not need to perform direct tests of account balances if he or she can be assured that inherent risk is indeed that low.
4. Control risk refers to both (a) the design of controls and (b) the operation of controls. To assess control risk as low, the auditor must gather evidence on both the design and operation of controls.
5. Detection risk at 50 percent implies that the direct test of the account balance has a 50 percent chance of not detecting a material misstatement.
6. Audit risk should vary inversely with engagement risk: The higher the risk with being associated with the client, the lower should be the audit risk taken.
7. In analyzing the audit risk model, it is important to understand that much of it is judgmental. For example, setting audit risk is judgmental, assessing inherent and control risk is judgmental, and setting detection risk is influenced by the individual risk preferences of the auditor.