Although the planning went well, the actual testing yielded some surprises. When conducting tests of controls over acquisitions and additions to the perpetual inventory, the staff person performing the tests found that the exception rates for several key controls were significantly higher than expected. As a result, the staff person considered internal control to not be operating effectively, supporting an 80% control risk rather than the 50% level used. Accordingly, the staff person “reworked” the audit risk model as follows:
TDR = .05/1.0 x .8 x.6
TDR = .10
A 10% test of details risk still seemed to the staff person to be in the “moderate” range so he recommended no increase in planned sample size for substantive tests.
Do you agree with the staff person’s revised judgments about the effect of tests of controls on planned substantive tests? Explain the nature and basis of any disagreement. Also, describe the implications of these results on the auditor’s report on internal control over financial reporting.