$4-27$

When planning a financial statement audit, a CPA must understand audit risk and its components. The firm of Pack & Peck evaluates the risk of material misstatement $($RMM$)$ by disaggregating RMM into its two components: inherent risk and control risk Required:

For each illustration, select the component of audit risk that is most directly illustrated. The components of audit risk may be used once, more than once, or not at all.

Components of Audit Risk:

$$Control risk

$$Detection risk

$$Inherent risk

Illustration

$$A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.

$$Cash is more susceptible to theft than an inventory of coal.

$$Confirmation of receivables by an auditor fails to detect a material misstatement.

$$Disbursements have occurred without proper approval.

$$There is inadequate segregation of duties.

$$A necessary substantive audit procedure is omitted.

$$Notes receivable are susceptible to material misstatement, assuming there are no related internal controls.

$$Technological developments make a major product obsolete.

$$ The client is verv close to violatino debt covenants

Component of Audit Risk