Risk Essay

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1999 Semester II AFM 312 Auditing Assignment 1 Audit Risk Model Posting Date: 6 September, 1999 Table of Contents A) DEFINITION OF RISKS 1 INHERENT RISK 1 CONTROL RISK 1 AUDIT RISK 1 DETECTION RISK 1 B) ARMIDALE PTY LTD – YEAR 1 3 INHERENT & CONTROL RISK LEVELS 3 DETECTION RISK & EVIDENCE ACCUMULATION 3 C) ARMIDALE PTY LTD – YEAR 3 4 SETTING AUDIT RISK HIGH 4 WHAT IS A ‘LOW’ LEVEL OF IR & CR 4 D) THE AUDIT RISK MODEL IN PRACTICE 5 A) Definition of Risks Inherent Risk This is defined in AUS 402 as ‘the susceptibility of an account balance … to misstatement that could be material … assuming there were no related internal controls’ (AUS 402.09). Estimating the inherent risk (IR) for each account balance or class of transactions requires the auditor to take into account such factors as the level of complexity involved in determining the ‘correct’ balance of an account, the complexity of transactions involving the particular account(s) and the ‘portability’ of the assets involved. The estimation of IR is done as though no internal controls exist – it looks only at the nature of the account being evaluated. Control Risk AUS 402 defines this as ‘the risk that misstatements that could occur in an account balance … that could be material … will not be prevented or detected on a timely basis by the internal control structure’ (AUS 402.06). The evaluation of the level of control risk (CR) requires the auditor to have a thorough understanding of the internal control structure that is in place, and practiced (not necessarily the same thing) within the organisation to be studied. Elements such as the segregation of duties, the existence of ‘management overrides’, and the level of formalised policies and procedures in use are among the factors to be considered. Audit Risk Defined in AUS 402 as ‘the risk that the auditor gives an inappropriate audit opinion when the financial report

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