Comptronix Corporation Fraud Case
1. Professional auditing standards present the audit risk model, which is used to determine the nature, timing, and extent of audit procedures. Describe the components of the model and discuss how changes in each component affect the auditor's need for evidence.
The Audit Risk Model (ARM) is defined as:
a. Inherent Risk is the auditor’s measure of assessing whether material statements exist in the financial statement before considering internal controls. Ignoring internal controls, if the auditor assesses that the likelihood of material errors is high the auditor will assume that the Inherent Risk is high. As the Control Risk constitutes a separate component of the Audit Risk Model, it is ignored in this step. b. Control Risk is the auditor’s measure of assessing the likelihood that the client’s internal control system is unable to prevent or detect material misstatements exceeding a tolerable level. In assessing the level of the Control Risk, the auditor will assess the effectiveness of the firm’s internal control system during his audit, e.g. through questionnaires. The lower the effectiveness of internal controls the greater the frequency of error. c. Detection Risk is the auditor’s measure of assessing the likelihood that the auditor won’t detect material misstatements. Auditors will carry out more audit work to increase the detection rate if Internal Risk and Control Risk are too high in order to meet the Audit Risk target. When applying the Audit Risk Model, the auditor has to determine a target level of Audit Risk that is in accordance with providing reasonable assurance. The Internal Risk and Control Risk can be pooled together as Occurrence Risk (OR), i.e. the risk of the existence of statements before the actual audit. The Detection Risk on the other hand is the risk of the existence of misstatements during the actual audit. The first step in applying the Audit Risk Model is to determine a tolerable level of Audit Risk. In the next step the Audit Risk is decomposed into its three components. The auditor has no control over the Internal Risk and Control Risk but must assess their levels in order to determine the level of Detection Risk that is sufficient to achieve the target Audit Risk. The Detection Risk can be influenced by the extent of testing.
2. One of the components of the audit risk model is inherent risk. Describe typical factors that auditors evaluate when assessing inherent risk. With the benefit of hindsight, what inherent risk factors were present during the audits of the 1989 through 1992 Comptronix financial statements?
One type of risk Auditors have to be aware of is Inherent risk. While assessing this level of risk, the auditor ignore whether the client has internal controls in place (such as a secondary review of financial statements) in order to help mitigate the inherent risk. He must consider the strength of the internal controls when assessing the client’s control risk. A few key factors can increase inherent risk.
Environmental and external factors that can lead to high inherent risk: Rapid change: A business whose inventory becomes obsolete quickly experiences high inherent risk. State of the economy: The general level of economic growth is another external factor affecting all businesses. Availability of financing: Another external factor is interest rates and the associated availability of financing. If your client is having problems meeting its short-term cash payments, available loans with low interest rates may mean the difference between your client staying in business or having to close its doors. Prior-period misstatements:
If a company has made mistakes in prior years that weren’t material (meaning they weren’t significant enough to have to change), those errors still exist in the financial statements. The Auditor has to...
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