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 is used to determine the nature, timing, and extent of substantive audit procedures. The components of audit risk model usually stated as follows: DR = AR/(IR x CR)
Where: DR = detection risk; AR = audit risk; IR = inherent risk; CR = control risk Detection Risk: auditors’ procedures will lead them to conclude that a financial statement assertion is not materially misstated when in fact such misstatement does exist. If auditors want to decrease DR, they had better collect more evidence and make sure the validity of evidence. Audit Risk: auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated. If AR should be keep in low level, which means the other risks also should be low. Inherent Risk: The risk of material misstatement of a financial statement assertion, assuming there were no related controls. As inherent risk increases, PDR decreases, which in turn increases the auditor’s need for stronger evidence. Control risk: The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control. If the strength of internal control is assessed as decreasing, the auditor should pay more attention to control risks.
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? Inherent risk is a measure of the auditor’s assessment of the susceptibility of an assertion to a material misstatement assuming there are no related internal controls. Some believe that inherent risk would be greater for some assertions and related account based on some conditions as follows: •
Complex calculations rather than simple calculations.
Non-routine rather than routine transactions.
Subjective data rather than objective data.
More importantly is that inherent risk is always be effected by external factors as follows: •
Changes in economic environment
Insufficient capital to continue operations
Transactions with related parties.
Susceptibility of assets to misappropriation.
The inherent risk factors present during the 1989 through 1992 financial statement audits as follows: •
Loss of Key Customer: Comptronix lost a key customer to SCI after the public offering of stock. Once the company lost their a key customer, Management have a strong motivation manipulate sales and operating performance to satisfy investor expectations because the loss of a key customer put too much pressure on management to meet the requirements of external users. •
Public Offering of Stock: After Comptronix made its public offering of stock , they have the pressure which push the management to manipulate operating performance too meet the expectations from the external users. •
Technological Improvement: Comptronix is a manufacture company which main products are circuit boards and the circuit boards’ development depend on technological improvement. The technological improvement has a negative impact on operating performance. •
Pressures from a new star Company: By the first year of the fraud (1989), Comptronix became a new company which can employ more than 1,800 employees in less than a decade , and at same time, the company expanded its the size of the company in three different locations. The rapid development of company made the management adjusted their operations instead of monitoring company operations. •
Estimation of Accounts: The high inherent risk accounts include Accounts...
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