RTI, Nagpur 1

Day 2- Session IV

Internal control and risk measurement

RTI, Nagpur 2

Session overview

Risk assessment and identification of fraud indicators

Sampling methods

RTI, Nagpur 3

Learning objective

Participants will be able to undertake a risk-based approach in planning and performance of audit procedures.

RTI, Nagpur 4

What is audit risk

Risk of expressing an incorrect opinion on financial statements that contain material mis-statements or errorsRisk of expressing audit conclusions on a universe that contains material irregularities but not detected by audit

RTI, Nagpur 5

Components of Audit Risk

Inherent RiskSusceptibility of a class of transactions to mis-statementAlso determined by entity’s business and its environment

Control riskPossibility of errors not being rectified by control

mechanism

Detection riskPossibility of material errors not being detected through

audit procedures

RTI, Nagpur 6

Audit Risk = IR*CR*DR Extent of testing- compliance and substantive- depends onAuditor’s assessment of inherent and control riskAuditor’s satisfaction that the product of the risks will be

less than or equal to Audit risk

Thus, detection risk is derived after assessment of inherent and control risk

Detection risk has two componentsAnalytical procedure risk- failure of detection by analytical procedures

RTI, Nagpur 7

Audit Risk = IR*CR*DR (Contd.)Test of detail risk- failure of detection by detail testingDR = AP*TPAR =IR*CR*AP*TD

Detection risk is modifiable per discretion of auditor given his assessment on inherent and control riskHigher the control and inherent risk, lower will be detection risk

Why?

Auditor will have to perform extensive testing procedures to keep detection risk low

RTI, Nagpur 8

Materiality

Refers to the extent to which error can be tolerated and is determined by– Value– Nature– Context in which the matter arises

As per SAI India, a matter may be judged material if – Knowledge of the same is likely to influence the user of the

audit report.

RTI, Nagpur 9

Materiality (Contd.)

Materiality bears an inverse relationship with audit risk– Higher the materiality, lower will be audit risk and

vice versaAuditor to consider materiality in fixing audit risk, to ensureThat aggregate misstatements through detection and non-detection does not exceed materiality level

Key factor in determining audit procedures to be performed

RTI, Nagpur 10

Risk measurement

Risk measurement is a guide to audit planning

Areas/items for examination are rated ‘high risk’, ‘medium risk’ and ‘low risk’ depending on– Sensitivity– Significance– Materiality

RTI, Nagpur 11

Risk measurement (Contd.)High-risk areas in Govt. environment– Contracts of procurement of service or goods– Inventory and asset management– Cash management– Financial statements– Grants-in-aid– Areas with public interface

RTI, Nagpur 12

Requirement of auditing standardEvidence collected should be sufficient to support audit conclusions

Evidence collected is based on sample selected for audit scrutiny

Sampling broadly two types, statistical and judgment sampling

Statistical sampling random sampling and stratified sampling

RTI, Nagpur 13

Procedure in designing of sampleDefining target population and error/exceptionTolerable error or materiality levels acceptable to the entityLevel of assurance that audit needs to provideOccurrence rate – proportion of items population having errorDetermining appropriate sampling method as per the type of population Projection of results with reference to the population