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Day 2- Session IV
Internal control and risk measurement
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Session overview
Risk assessment and identification of fraud indicators
Sampling methods
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Learning objective
Participants will be able to undertake a risk-based approach in planning and performance of audit procedures.
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What is audit risk
Risk of expressing an incorrect opinion on financial statements that contain material mis-statements or errorsRisk of expressing audit conclusions on a universe that contains material irregularities but not detected by audit
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Components of Audit Risk
Inherent RiskSusceptibility of a class of transactions to mis-statementAlso determined by entity’s business and its environment
Control riskPossibility of errors not being rectified by control
mechanism
Detection riskPossibility of material errors not being detected through
audit procedures
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Audit Risk = IR*CR*DR Extent of testing- compliance and substantive- depends onAuditor’s assessment of inherent and control riskAuditor’s satisfaction that the product of the risks will be
less than or equal to Audit risk
Thus, detection risk is derived after assessment of inherent and control risk
Detection risk has two componentsAnalytical procedure risk- failure of detection by analytical procedures
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Audit Risk = IR*CR*DR (Contd.)Test of detail risk- failure of detection by detail testingDR = AP*TPAR =IR*CR*AP*TD
Detection risk is modifiable per discretion of auditor given his assessment on inherent and control riskHigher the control and inherent risk, lower will be detection risk
Why?
Auditor will have to perform extensive testing procedures to keep detection risk low
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Materiality
Refers to the extent to which error can be tolerated and is determined by– Value– Nature– Context in which the matter arises
As per SAI India, a matter may be judged material if – Knowledge of the same is likely to influence the user of the
audit report.
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Materiality (Contd.)
Materiality bears an inverse relationship with audit risk– Higher the materiality, lower will be audit risk and
vice versaAuditor to consider materiality in fixing audit risk, to ensureThat aggregate misstatements through detection and non-detection does not exceed materiality level
Key factor in determining audit procedures to be performed
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Risk measurement
Risk measurement is a guide to audit planning
Areas/items for examination are rated ‘high risk’, ‘medium risk’ and ‘low risk’ depending on– Sensitivity– Significance– Materiality
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Risk measurement (Contd.)High-risk areas in Govt. environment– Contracts of procurement of service or goods– Inventory and asset management– Cash management– Financial statements– Grants-in-aid– Areas with public interface
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Requirement of auditing standardEvidence collected should be sufficient to support audit conclusions
Evidence collected is based on sample selected for audit scrutiny
Sampling broadly two types, statistical and judgment sampling
Statistical sampling random sampling and stratified sampling
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Procedure in designing of sampleDefining target population and error/exceptionTolerable error or materiality levels acceptable to the entityLevel of assurance that audit needs to provideOccurrence rate – proportion of items population having errorDetermining appropriate sampling method as per the type of population Projection of results with reference to the population