Audit Risk Model Inherent, Control, & Detection Risks

MUS is based on attribute sampling techniques and is often used in tests of controls and appropriate when each sample can be placed into one of two classifications – ‘exception’ or ‘no exception’. It turns monetary amounts into units – for example, a receivable balance of $50 contains 50 sampling units. Monetary balances can also be subject to varying audit risk model degrees of exception – for example, a payables balance of $7,000 can be understated by $7, $70, $700 or $7,000 and the auditor will clearly be interested in the larger misstatement. If inherent risk and control risk are assumed to be 60% each, detection risk has to be set at 27.8% in order to prevent the overall audit risk from exceeding 10%.

Exam results

The ‘elephant in the room’ is the use of sample size caps, especially in areas of significant audit risk. This does not get a mention at all, despite previously being raised as a significant thematic weakness by the FRC in its Developments in Audit 2021 report, which led at least one of the major methodology providers to completely dispense with sample size https://www.bookstime.com/ caps. This has had a huge bearing on sample sizes – especially for transaction tests – and made firms think very hard about their risk assessments and possible reliance on non-sampling procedures. The FRC also found that auditors are not always clear about the basis for reliance on alternative audit procedures to limit sample sizes for tests of detail.

• Organizations must have adequate internal controls in place to prevent and detect instances of fraud and error.
• The company also lacks an internal audit department which is a key control especially in a highly regulated environment.
• If inherent risk and control risk are assumed to be 60% each, detection risk has to be set at 27.8% in order to prevent the overall audit risk from exceeding 10%.
• The FRC also found that auditors are not always clear about the basis for reliance on alternative audit procedures to limit sample sizes for tests of detail.
• Detection risk forms the residual risk after taking into consideration the inherent and control risks pertaining to the audit engagement and the overall audit risk that the auditor is willing to accept.
• In table 2 it is assumed, for illustrative purposes, that the auditor has chosen an audit risk of 5 percent for an assertion where inherent risk has been assessed at the maximum.

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Haphazard samplingWhen the auditor uses this method of sampling, he does so without following a structured technique. ISA 530 also recognises that this method of sampling is not appropriate when using statistical sampling (see further in the article). Care must be taken by the auditor when adopting haphazard sampling to avoid any conscious bias or predictability. The objective of audit sampling is to ensure that all items that make up a population stand an equal chance of selection. This objective cannot be achieved if the auditor deliberately avoids items that are difficult to locate or deliberately avoids certain items.

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• In order to keep the overall audit risk of engagements below acceptable limit, the auditor must assess the level of risk pertaining to each component of audit risk.
• This article will consider the various sampling methods in the context of AA and FAU.
• However, the person doing the selections will probably skew the selections (even if inadvertently), so the selections are not truly random.
• This method does not include the use of tables or statistical percentages, but rather it relies upon professional judgment on the part of the auditor as well as the policy implemented by the firm.

This approach is the most theoretically correct, but can require more time to make selections. For example, an auditor elects to use block sampling to examine customer invoices, and intends to pick 50 invoices. In order to successfully gather a sample, it is important to consider the collection as a whole and the relevance of the particular items. The most common successful method is to select an even number of items which accurately represents the list as a whole. An example of block selection is where the auditor may examine all the remittances from customers in the month of January.

Selecting a Sampling Approach

• MUS is based on attribute sampling techniques and is often used in tests of controls and appropriate when each sample can be placed into one of two classifications – ‘exception’ or ‘no exception’.
• Control Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity.
• An auditor assesses inherent and control risk, and plans and performs substantive tests (analytical procedures and substantive tests of details) in whatever combination to reduce audit risk to an appropriate level.
• 9The auditor who prefers to think of risk levels in quantitative terms might consider, for example, a 5 percent to 10 percent risk of assessing control risk too low.
• Alternatively, low inherent risk, effective controls, or effective analytical procedures and other relevant substantive tests may lead the auditor to conclude that the sample, if any, needed for an additional test of details can be small.

Audit risk model is used by the auditors to manage the overall risk of an audit engagement. Under systematic sampling, selections are taken from the population at fixed intervals, such as every 20th item. Under stratified sampling, the auditor splits the population into different sections (such as high value and low value) and then selects from each section. Example 1You are the auditor of Jones Co and are undertaking substantive testing on the sales for the year ended 31 December 2010. In its Manifesto, ICAEW sets out its vision for a renewed and resilient UK, including the reforms that are needed to audit and corporate governance. • ICAEW’s professional judgement hub brings together a range of resources, insights and expert insights to help you develop your skills in approaching difficult judgements.

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Non-sampling risk is the risk that the auditor forms the wrong conclusion, which is unrelated to sampling risk. An example of such a situation would be where the auditor adopts inappropriate audit procedures, or does not recognise a control deviation. Organizations must have adequate internal controls in place to prevent and detect instances of fraud and error.

Sampling in Tests of Controls

• Keeping the objective of sampling in mind, which is to provide a reasonable basis for the auditor to draw valid conclusions and ensuring that all samples are representative of their population, will avoid bias.
• Control risk is considered to be high where the audit entity does not have adequate internal controls to prevent and detect instances of fraud and error in the financial statements.
• Ideally, the auditor should use a selection method that has the potential for selecting items from the entire period under audit.
• For example, if the auditor tests only 20% of trade receivables for existence at the reporting date by confirming after-date cash, this is hardly representative of the population, whereas, say, 75% would be much more representative.
• Under this approach, it is common practice for most accounting firms to create universal guidelines for auditors in order to determine a proper sample size.
• AA and FAU students must ensure they fully understand the various sampling methods available to auditors.

Detection Risk

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