Questions and Answers
What is the formula for the Audit Risk Model?
What does Inherent Risk (IR) signify?
The likelihood of a material misstatement without considering the effects of internal controls.
What does Control Risk (CR) represent?
The likelihood that a material misstatement that would otherwise occur will not be detected or corrected by the internal control system.
What is Detection Risk (DR)?
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How does an auditor use the Audit Risk Model?
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Planned DR = ___ / Inherent Risk x Control Risk.
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When planned DR is higher, the auditor must obtain more persuasive evidence.
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When planned DR is lower, the auditor must have achieved a lower probability of not detecting material misstatements.
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How does materiality affect audit strategy?
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What happens when materiality increases?
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What occurs when materiality decreases?
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Study Notes
Audit Risk Model (ARM)
- Formula: Audit Risk = Inherent Risk x Control Risk x Detection Risk or 1 - Reasonable Assurance
- ARM determines the probability and events related to audit risk.
Inherent Risk (IR)
- Definition: Likelihood of material misstatement without considering internal controls.
- Affected by management choices and decisions.
- Auditors assess IR but do not control or alter it.
Control Risk (CR)
- Definition: Likelihood that a material misstatement will not be detected, prevented, or corrected by the internal control system.
- Determined by the quality of the internal control system chosen by management.
- Auditors assess CR but do not influence it; it assumes a misstatement will occur.
Detection Risk (DR)
- Definition: Likelihood of not detecting material misstatements that have evaded the internal control system.
Use of the Audit Risk Model
- ARM helps determine the required level of DR for audits.
- A planning tool for financial statement audits.
- Achieved DR relies on the procedures chosen and the quality of implementation.
Planned Detection Risk
- Planned DR = Audit Risk / (Inherent Risk x Control Risk).
When Planned DR is Higher
- Indicates the auditor accepts a higher probability of undetected material misstatements.
- Allows for less persuasive evidence to support audit conclusions.
When Planned DR is Lower
- Requires the auditor to achieve a lower probability of failing to detect material misstatements.
- Demands more persuasive evidence to ensure reliability.
Materiality's Impact on Audit Strategy
- Each ARM component is defined based on materiality, influencing the overall audit approach.
Higher/Increasing Materiality
- Lowers the Risk of Material Misstatement (RMM): IR x CR.
- Increases DR, allowing auditors to accept less persuasive evidence.
- Fewer big misstatements occur, leading to lower risk.
Lower/Decreasing Materiality
- Increases the RMM, indicating a potential for more significant financial inaccuracies.
- Decreases DR, requiring more persuasive evidence.
- Facilitates easier detection of large misstatements by the internal control system.
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Description
Test your knowledge of the Audit Risk Model with these flashcards. This quiz covers essential components like Inherent Risk, Control Risk, and Detection Risk, providing definitions and formulas crucial for understanding audit processes. Perfect for students and professionals in accounting and auditing.
