Page 86 - CA Final PARAM Digital Book.

NO Audit Risk (Calculation) Old Course – (M19R, M19M, N20M, SM21)
36.500 TITANIUM CNO—MRI.040 New Course– (SM23)
Compute the overall Audit Risk if looking to the nature of business there are chances that 40% bills of
services provided would be defalcated, inquiring on the same matter management has assured that
internal control can prevent such defalcation to 75%. At his part the Auditor assesses that the procedure
he could apply in the remaining time to complete Audit gives him satisfaction level of detection of frauds

& error to an extent of 60%. Analyse the Risk of Material Misstatement and find out the overall Audit Risk.
Answer According to SA-200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, the Audit Risk is a risk that Auditor will issue an inappropriate

opinion while Financial Statements are materially misstated.

➢ Audit Risk, has two components:
Risk of material Misstatement and

Detection Risk.
The relationship can be defined as follows.
• Audit Risk = Risk of material Misstatement X Detection Risk
• Risk of material Misstatement: - Risk of Material Misstatement is anticipated risk
that a material.

➢ Misstatement may exist in Financial Statement before start of the Audit. It has two components
Inherent risk and Control risk. The relationship can be defined as
Risk of material Misstatement = Inherent risk X control risk
• Inherent risk: it is a susceptibility of an assertion about account balance; class of
transaction, disclosure towards misstatements which may be either individually or
collectively with other Misstatement becomes material before considering any
related internal control which is 40% in the given case.

• Control risk: it is a risk that there may be chances of material Misstatement even
if there is a control applied by the management and it has prevented defalcation
to 75%. Hence, control risk is 25% (100%-75%)

Risk of material Misstatement: Inherent risk X control risk i.e. 40% X 25 % = 10% . Chances
of material Misstatement are reduced to 10% by the internal control applied by
management.

• Detection risk: It is a risk that a material Misstatement remained undetected even
if all Audit procedures applied, Detection Risk is 100-60=40%

➢ In the given case, overall Audit Risk can be reduced up to 4% as follows:
Audit Risk: Risk of Material Misstatement x Detection Risk = 10 X 40% = 4%

QNO ICS (Components) Old Course –(SM17, SM20)
40.000 TITANIUM CNO—MRI.360
What are the components of an internal control framework?

Answer Part I -- Relevant Standards & Laws
▪ SA 315, Identifying and Assessing The Risk Of Material Misstatement Through Understanding The

Entity And Its Environment
▪
Part II -- Requirements of Relevant Standards & Laws

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