Audit Risk Model Essay Research Paper This

fraudulent, will occur and some will escape detection, again either by deception

or an oversight. Adopting a minimum level of CR of around 30% allows for this

? in effect the auditor says that they believe the internal controls are

sufficient to ensure that a minimum of 70% of misstatements will be detected

and/or corrected. Inherent risk is, by definition, evaluated as though no

internal control system is in place. While it can be set lower as suggested in

the previous section, the relationship between DR, AR, CR & IR as expressed

in the model means that setting it to a lower value increases the allowable

detection risk to achieve a desired level of audit risk. For a 5% AR with CR set

to 30% and IR to 80% we get a DR value of: DR = 0.05 / (0.3 * 0.8) DR = 0.21 If

we lower IR to 30% DR becomes 0.56 ? our substantive procedures now need to be

less than 50% effective at detecting misstatements because we ?trust? the

client and their systems. Increasing the allowable level of DR could, for

example, lead to a less thorough audit process on ?old & trusted?

clients. D) The Audit Risk Model in Practice Is the audit risk model as outlined

in AUS 402 a useful tool for helping to plan audit evidence requirements in

practice? Much of the documentation and discussion relating to the assessment of

the various risk elements involved in the model addresses the issue at the

individual account balance or transaction class level. An area of concern

(AFM312, 1999; Lea et al, 1992; Wade, 1996) is the link between these many

individual assessments and an ?overall? risk rating at the financial

statement level. As the model uses various independent probabilities it is not

possible to simply ?sum together? the assessment for individual areas. There

have been suggestions of methodologies for providing overall aggregation of

assertion level risk assessments (Lea et al, 1992) however these have not been

included in any of the current Auditing standards. This ?linkage? problem

limits the value of the model to an auditor as the amount of work required to

derive all of the estimates that AUS 402 suggests could be viewed as excessive

and requiring substantial amounts of duplication of effort. This limitation

appears to have led to the model being largely ignored, or at least

circumvented. Studies such as those by Mock and Wright (1999) have investigated

the effect of different levels of assessed risk on the design of actual audit

programs. These studies have found that, in the majority of cases, auditors

utilise a ?standard? set of substantive procedures for all engagements,

regardless of variations in risk factors. Others such as Fitzsimons (1992) and

Jacoby (1995) found that both inherent and control risk are, particularly for

small to medium sized businesses, consistently set to 100%, even with continuing

engagements ? reinforcing the use of a ?standard? test plan. Reliance on

standard plans may give the auditor a sense of security, whether justified or

not, as they have built a level of confidence in the results and can easily

compare this year to last year. Performing less substantive testing than

?normal? may open the auditor to claims of negligence if a material

misstatement escapes detection and a user of the audited statements suffers

damage as a result. The studies assert that the auditor therefore tends to be

conservative and maintain a heavy reliance on substantive testing. If both IR

& CR are automatically set at 100% for all clients, and the auditor relies

on achieving a 5% overall AR, detection risk must, according to the model, also

be set to 5%. Detection risk is made up of two components, sampling risk, and

non-sampling risk. Sampling risk arises from the selection of samples within an

overall population of transactions and accounts. If the samples selected do not

accurately reflect the population the testing may not capture a misstatement.

Sampling risk can be countered by increasing the proportion of the overall

population being tested. Accumulation of evidence, testing the sample, is one of

the high cost areas of an audit and decreasing the sampling risk can, therefore,

be a high cost exercise (Arens et al, 1987). Non-sampling risk derives from the

selection and application of the actual audit procedures to the selected

samples. Inappropriate or ineffective procedures may return misleading

information and lead to incorrect evaluation of results. The audit risk model

assumes that non-sampling risk is negligible and that detection risk is largely

controllable through sample size manipulation. While it is contended by, for

example, Gul et al (1995) that ?this risk can be reduced to a low level

through effective training, planning and supervision? the use of

?standard? test plans for all clients could lead to ?blind rote?

application of procedures without any real understanding of the purpose or

relevance of a particular test. In these conditions a series of small

non-sampling errors could rapidly accumulate and reduce the value of the

substantive testing. Where only a small allowance for error exists, due to the

reluctance of the auditor to place more emphasis on the internal control

systems, the desired level of AR could become unachievable. The audit risk model

outlined in AUS 402 as well as many of the overseas auditing standards would

seem to be useful for planning the level of testing required for specific

accounts or account classes. This is particularly so where the auditor believes

internal control systems are in place and effective (low CR) and where the

inherent risk is also medium to low. It appears, however, that, for many

reasons, the auditing fraternity has not rushed to utilise the model in

developing audit plans ? preferring to rely on standard series of tests ?

although Mock & Wright (1999) did identify some movement towards increasing

use of the model for planning purposes.