audit risk

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CA Abhishek Singh (Querist)
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05 June 2009 dear all
while going through module i did not understand the given sentence
"if inherent & control risk is low then auditor can reduce his audit risk to acceptable low level"

please explain if possible with example.

Manmohan ACA, CS

Manmohan ACA, CS (Expert)
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05 June 2009 First understand theses three terms :

"Inherent risk" is the risk that there will be a material error or misstatements (either in account balance or class of transactions ) assuming that there were no related internal controls.
For example - a company which makes maximum sale in credit , Another company which makes a few sales in credit . The possibility or risk that 'debtors will be omitted or not properly recoded' in more in first company , not due to internal control but due to nature of company or nature of transaction or due to any other inherent reason.

"Control risk" is the risk that a material error or misstatement, (account balance or class of transactions ), will not be prevented or detected and corrected on a timely basis by the accounting and internal control systems. This risk is possibility that internal control system will be ineffective to find out error.

Audit risk : the risk that an auditor's substantive procedures will not detect a material error or misstatement that exists in books of accounts.

So
Inherent risk = Risk of material error occurred due to nature of transaction or nature of business being audited irrespective of internal control system .

Control risk = Risk of material error occurred due to possibility internal control system will be ineffective. This risk is high where internal control system is not properly structured. . This is also called detection risk

Audit risk == Risk that material error will be undetected after examination of books by an auditor. This is also called detection risk

So, when the inherent risk is less (less inherent risk = there is less inherent error) and internal control risk is less (less control risk = internal control will deduct risk and possibility of failure of internal control is less), the audit risk will be less. Because if the inherent risk is less and control risk is less all the error will be deducted at an early stage , so that possibility that an error will ne undetected will be also less.

{I REQUEST YOU TO GO THROUGH AS- 6 , THIS IS JUST A EXPLANATION AS PER MY VIEW, FOR ANY PROBLEM SEND ME A PM}