Question

Using the audit risk model, state the effect on control risk, inherent risk, acceptable audit risk, and planned evidence for each of the following independent events. In each of the events cirlce one letter for each of the three independent variables and planned evidence: I=increase, D=decrease, N= no effect, and C= cannot determine from the information provided.

A. The client's management materially decreased long-term contractual debt: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

B. The client changed from privately held company to a publicly held company: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

C. The auditor decided to set assessed control risk at the maximum (it was previously assessed below the maximum: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

D. The client aquired a new subsidiary located in Italy: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

E. The account balance increased materially from the preceeding year without apparent reason: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

F. You determine through the planning phase that working capital, debt-to-equity ratio and other indicators of financial condition improved during the past year: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

G.This is the second year of the engagement, and there were few misstatements found in the previous year's audit. The auditor also decided to increase reliance on internal control: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

H. The client began selling products online to customers throughits Web page during the year under audit. The online customer ordering process is not integrated with the company's accounting system. Client sales staff print out customer order information and enter that data into the sales accounting system: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

I. There has been a change in several key management personnel. You believe the management is somehow lacking in personal integrity compared with the previous management. You believe it is still appropriate to do the audit: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

J. In discussion with management, you conclude that management is planning to sell the business in the next few months. Because of the planned changes, several key accounting personnel quit several months ago for alternative employment. You also observe that the gross margin percent has significantly increased compared with that of the preceding year: Control risk IDNC Acceptable audit risk IDNC Inherent risk IDNC Planned evidence IDNC

Answer 1

Before starting with the required answer, I would like to first give a brief description of what control risk, inherent risk & acceptable audit risk mean on the basis of which I have assessed the impact of various events on them :
Control Risk : It refers to the risk of internal controls not operating effectively throughout the year or not detecting and preventing material misstatements.
Inherent Risk : It refers to the risk which is inherent in the management's ERP systems and the auditor can only assess such risk.
Acceptable Audit Risk : It is a measure of how much risk an auditor is willing to undertake that the financial statements may be misstated after an unqualified opinion has been issued.
Answer :
S. No.	Events	Control Risk	Inherent Risk	Acceptable Audit Risk	Planned Evidence	Remarks
A.	The client's management materially decreased long-term contractual debt	N	N	I	D	Since the client has materially reduced its long-term debt, that means chances of us not being able to detect a misstatement reduces and accordingly our acceptable audit risk would increase which leads to a decrease in the planned audit evidence to be obtained.
B.	The client changed from privately held company to a public held company	N	N	D	I	Since the client has changed from a privately held company to public company, the number of disclosures have compliances have risen and hence our acceptable audit risk would decrease as it is the first year after conversion and our planned evidence would increase.
C.	The auditor decided to set assessed control risk at the maximum (it was previously assessed below the maximum)	I	N	N	I	Since the auditor has decided to set the assessed control risk at maximum, our control risk would increase and accordingly our level of planned evidence will also go up.
D.	The client aquired a new subsidiary located in Italy	N	I	N	I	Since it is a new subsidiary, our inherent risk will increase and since we will also be now required to obtain evidences regarding the transactions at such subsidiary, our planned evidence will also go up.
E.	The account balance increased materially from the preceeding year without apparent reason	N	I	N	I	Since the balance has gone up without any apparent reason, our inherent risk will increase and so will our planned evidence.
F.	You determine through the planning phase that working capital, debt-to-equity ratio and other indicators of financial condition improved during the past year	N	N	I	D	Since the financial indicators have imoproved, that is a good sign and the auditor will be able to increase his acceptable audit risk and decrease the level of planned evidence.
G.	This is the second year of the engagement, and there were few misstatements found in the previous year's audit. The auditor also decided to increase reliance on internal control	D	D	N	D	Since only a few misstatements were found in the first year and the auditor has increased his reliance on the internal controls, our control & inherent risk will go down and subsequently our level of planned evidence should also decrease.
H.	The client began selling products online to customers throughits Web page during the year under audit. The online customer ordering process is not integrated with the company's accounting system. Client sales staff print out customer order information and enter that data into the sales accounting system	I	I	N	I	Since the new online system is not integrated with the accounting system and everything is being done manually, it increases our control risk that a deficiency in internal control may not be detected and it also increases our inherent risk.
I.	There has been a change in several key management personnel. You believe the management is somehow lacking in personal integrity compared with the previous management. You believe it is still appropriate to do the audit	I	N	D	I	Since auditor is of the belief that the current management is lacking, and since management is the ultimate process owners for the internal controls, our control risk will increase and also since we do not have reliance on the management our acceptable audit risk will decrease.
J.	In discussion with management, you conclude that management is planning to sell the business in the next few months. Because of the planned changes, several key accounting personnel quit several months ago for alternative employment. You also observe that the gross margin percent has significantly increased compared with that of the preceding year	I	I	D	I	From the given information, we can easily conclude that there is a lot of potential for misstatement as the management is going to close the business and many accounting personnel have left and hence our risk, both control and inherent will increase and our acceptable audit risk will decrease.