Question

The auditors of Dunbar Electronics want to limit the risk of material misstatement in the valuation of inventories to 8 percent. They believe that there exists a 55 percent risk that a material misstatement could have bypassed the client’s internal control and that the inherent risk of the account is 90 percent. They also believe that the analytical procedures performed to test the assertion have a 41 percent risk of failing to detect a material misstatement.
Required:
a. Briefly discuss what is meant by audit risk, inherent risk and control risk.
b. What level of detection risk is implicit in this problem?

Answer 1

Answer:

a. Briefly discuss what is meant by audit risk, inherent risk and control risk.

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

Audit Risk = Inherent Risk x Control Risk x Detection Risk

Auditors will want their overall audit risk to be at an acceptable level. Inappropriate opinion will result in damages / costs  

Inherent risk is the susceptibility of an assertion to a misstatement that could be material individually or when aggregated with other misstatements, assuming there were no related internal controls.

Control risk is the risk that a material misstatement, that could occur in an assertion and that could be material will not be prevented or detected and corrected on a timely basis by the entity's internal control.

b. What level of detection risk is implicit in this problem?

Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement

In this case the detection risk given is 0.41.