For Situation #2, you will be asked a question regarding the impact on the components of the Audit Risk Model, Detection Risk, and Planned Evidence.

Situation	Acceptable AR	IR	CR	Planned DR	Planned Evidence
2. The shareholder-manager of the client has decided to sell her shares. Several parties are interested in buying the shares based on a business valuation of five times normalized earnings.	??	??	??	??	??

Situation #2: Assume that Situation #2 arose in the current year and you learned about this during the Planning phase of the audit. Consider the impact that Situation #2 should have on the Audit Risk Model and Planned Evidence, compared to prior year.

Select all of the answers below which are correct.

Group of answer choices

Inherent Risk should increase because management now has a greater motivation to overstate earnings because the formula for determining the purchase price is a function of earnings.

This is an example of applying the audit risk model at a Financial Statement level (i.e. a high level), as opposed to applying the audit risk model at an account-assertion level (i.e. a detailed level).

Control Risk should decrease because management now has a greater motivation to overstate earnings because the formula for determining the purchase price is a function of earnings.

Control Risk should not change because there is a trade-off between the cost of implementing internal controls compared to the benefits to be derived.

Planned Detection Risk should increase and, therefore, Planned Evidence should decrease.

Control Risk should not change because there is no indication of any changes to the client's internal controls.

The Acceptable Level of Audit Risk should decrease because the current owner will be selling her shares.

Control Risk should not change because there is no change to the practical/inherent limitations of internal control.

This is an example of applying the audit risk model at an account-assertion level (i.e. a detailed level), as opposed to applying the audit risk model at a Financial Statement level (i.e. a high level).

Planned Detection Risk should decrease and, therefore, Planned Evidence should decrease.

Planned Detection Risk should decrease and, therefore, Planned Evidence should increase.

Control Risk should increase because management now has a greater motivation to overstate earnings because the formula for determining the purchase price is a function of earnings.

The Acceptable Level of Audit Risk should decrease because there are more users who will be relying on the financial statements.