Audit risks for particular accounts and disclosures can be conceptualized in this model: Audit risk (AR) 5 Inherent risk (IR) 3 Internal control risk (CR) 3 Detection risk (DR).
Use this model as a framework for considering the following situations and deciding whether the auditor’s conclusion is appropriate:
a. Ohlsen, PA, has participated in the audit of Limberg Cheese Company for five years, first as an assistant accountant and the last two years as the senior accountant. He has never seen an accounting adjustment recommended. He believes the inherent risk must be zero.
b. Jones, PA, has just (November 30) completed an exhaustive study and evaluation of the internal control system of Lang’s Derfer Foods, Inc. (fiscal year ending December 31). She believes the control risk must be zero because no material errors could possibly slip through the many error-checking procedures and review layers used by Lang’s.
c. Fields, PA, is lazy and does not like audit jobs in Toronto, anyway. On the audit of Hogtown Manufacturing Company, he decided to use detail procedures to audit the year-end balances very thoroughly to the extent that his risk of failing to detect material errors and irregularities should be 0.02 or less. He gave no thought to inherent risk and conducted only a very limited review of Hogtown’s internal control system.
d. Shad, PA, is nearing the end of a “dirty” audit of Allnight Protection Company. Allnight’s accounting personnel all resigned during the year and were replaced by inexperienced people. The controller resigned last month in disgust. The journals and ledgers were a mess because the one computer specialist was hospitalized for three months during the year. Shad thought thankfully, “I’ve been able to do this audit in less time than last year when everything was operating smoothly.”