Question

Josh and Sharon are conducting the audit of Cloud 9. During an interview with the CFO, they learn that top-level management and the board of directors adopted a code of conduct that emphasizes the importance of management and other employees acting with integrity. Cloud 9’s board members and senior managers attend training and awareness sessions on the code at least annually. In addition there has been a rigorous process of embedding the code’s main points throughout the company’s policies and procedures, most of which have been rewritten in the previous two years. Josh and Sharon also conduct interviews with employees at all levels within Cloud 9. They find that all employees have attended training on the code of conduct.

Discuss this in terms of the Audit Risk Model. How would this information effect your work? (1 paragraph)

Answer 1

AUDIT RISK MODEL

The audit risk model determines the total amount of risk associated with an audit, and describes how this risk can be managed.

The calculation is:
Audit risk = Control risk x Detection risk x Inherent risk

These elements of the audit risk model are:

Control risk:

This risk is caused by the failure of existing controls or the absence of controls, leading to incorrect financial statements.

Detection risk:

This risk is caused by the failure of the auditor to discover a material misstatement in the financial statements.

Inherent risk:

This risk is caused by an error or omission arising from factors other than control failures. This risk is most common when accounting transactions are quite complex, there is a high degree of judgment involved in accounting for transactions, or the training level of the accounting staff is low.

When planning an audit engagement, the auditor must review each of the subsidiary levels of risk to determine the total amount of audit risk. If the risk level is too high, the auditor conducts additional procedures to reduce the risk to an acceptable level. When the level of control risk and inherent risk is high, the auditor can increase the sample size for audit testing, thereby reducing detection risk. Conversely, when control risk and inherent risk are considered to be low, it is safe for the auditor to reduce the sample size for auditing testing, which increases detection risk.

Inorder to determine the total amount of audit risk Josh and Sharon analysed control risk of Cloud 9 , and found that that

"top-level management and the board of directors adopted a code of conduct that emphasizes the importance of management and other employees acting with integrity, Cloud 9’s board members and senior managers attend training and awareness sessions on the code at least annually, In addition there has been a rigorous process of embedding the code’s main points throughout the company’s policies and procedures, most of which have been rewritten in the previous two years, and also found that all employees have attended training on the code of conduct".

Hence, from the above conclusions received by Josh and Sharon ,Control risk is low ,then they try to reduce the sample size for auditing which leads to detection risk.