Slide4.1 1

Learning Objectives

Illustrate risk model

Determine level of OAA

Identify risks

Calculate detection risk

Slide4.1 2

Session Overview

Purpose of identifying and assessing risk

Components

Factors influencing risk

Risk model

How to assess risk

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Inherent Risk

Inherent risk is defined as the risk that in the absence of preventive internal accounting controls, a material error will occur in the

accounting process.

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Inherent Risk(short definition)

The risk of material error occurring in the first place

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Control Risk

Control risk is the risk that error that has occurred in the component and that could be

material, when aggregated with errors in other components, will not be detected on a timely

basis by the internal controls in place.

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Detection Risk

Detection risk is the risk that the auditor’s procedures will not detect error that exists

in the component and that could be material when aggregated with error in

other components.

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Overall Audit Risk

Overall audit risk is the maximum risk that the auditor is prepared to assume that error in the financial statements aggregating to

more than materiality will remain undetected at the end of the audit.

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The Audit Risk Model

OAR = IR x CR x DR

where:

OAR = Overall Audit Risk

IR = Inherent Risk

CR = Internal Control Risk

DR = Detection Risk

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THE RELATIONSHIP BETWEENTHE RELATIONSHIP BETWEEN IR,CR,DR AND AR IR,CR,DR AND AR

OAR = IR x CR x DROAR = IR x CR x DR

DR = DR = OAR OAR X

CR x IRCR x IR

OAR = 1- ASSURANCE LEVELOAR = 1- ASSURANCE LEVELRESIDUAL RISKRESIDUAL RISK

DSTDST

SBASBA

Assu

rance

DST - Detailed Substantive TestingSBA - Systems Based Assurance (I.e. CR + IR)

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Substantive Work Level Matrix

High Medium Low

High H H M

Medium H M L

Low M L L

Assessment of control risk

Assessmentof inherentrisk

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Risk Model Steps

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1.1. Starting point is to set the level of Starting point is to set the level of overall audit risk;overall audit risk;

2.2. Assess the component risks starting Assess the component risks starting with inherent risk then control with inherent risk then control

risk;risk;

3.3. Rearrange model and solve DRRearrange model and solve DR

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Assurance GuidelineAssurance Guideline

95 % : Most common level95 % : Most common level

97 % : Few sensitive entities97 % : Few sensitive entities

99 % : Extremely sensitive cases99 % : Extremely sensitive cases

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Factors to Consider WhenFactors to Consider WhenAssessing Inherent RiskAssessing Inherent Risk

Number of adjustments

Significance of adjustments

Complexity

Susceptibility to misappropriation

Quality of accounting personnel

Judgment involved

Mix of population

Management intentions In

heren

t Risk

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Factors to Consider When Assessing Control RiskFactors to Consider When Assessing Control Risk

Control Risk

Control systemControl systemworking effectivelyworking effectively

Operated Operated adequatelyadequately

IndependentIndependentof processingof processingproceduresprocedures

Require collusionRequire collusionto by-passto by-pass

Recorded inRecorded indocumentarydocumentary

evidenceevidence

Control objective is metControl objective is met

Carried outCarried outon timeon time

Carried out by Carried out by staff of appropriatestaff of appropriate

seniorityseniority