When planning a financial statement audit, a CPA must understand audit risk and

Question

When planning a financial statement audit, a CPA must understand audit risk and its components. The firm of Pack & Peck evaluates the risk of material misstatement (RMM) by disaggregating RMM into its two components: inherent risk and control risk.

Required:

For each illustration, select the component of audit risk that is most directly illustrated. The components of audit risk may be used once, more than once, or not at all.

Note if each illustration below is Control risk, Detection risk or Inherent risk


1. A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.
2. Cash is more susceptible to theft than an inventory of coal.
3. Confirmation of receivables by an auditor fails to detect a material misstatement.
4. Disbursements have occurred without proper approval.
5. There is inadequate segregation of duties.
6. A necessary substantive audit procedure is omitted.
7. Notes receivable are susceptible to material misstatement, assuming there are no related internal controls.
8. Technological developments make a major product obsolete.
9. The client is very close to violating debt covenants.
10. XYZ Company, a client, lacks sufficient working capital to continue operations.

Explanation / Answer

Inherent Risk is the risk of a material misstatement in the financial statements arising due to

1.error or omission or

2 as a result of factors other than the failure of controls .

Control Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity.

Detection Risk is the risk that the auditors fail to detect a material misstatement in the financial statements.

considering the above ;

We can conclude the following;

1.control risk

2. Inherent risk

3. Control risk

4. Control risk

5 control risk

6.detection risk

7.inherent risk

8.inherent risk

9.inherent risk

10.inherent risk.

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