Page 49 - CA Inter Audit PARAM

CA Ravi Taori

QNO— Business Risk Leads to Inherent Risk New Course – (SM25)
315.01.50 Bhaskar CNO - SA315.P1.020
Wear & Tear Private Limited is a “start-up” engaged in providing holistic solutions to problem of paddy
stubble burning mainly catering to needs of farmers of Northwestern India. Due to importance given by
governments to this issue, companies have entered in the market in past few years. Many of these
companies have not been successful and have gone bust. As an auditor of the company, can you spot
the component of risks of material misstatement involved in above?
Answer Inherent Risk
• Inherent Risk is the susceptibility of an account balance or class of transactions to misstatement
that could be material either individually or, when aggregated with misstatements in other
balances or classes, assuming that there were no related internal controls. External circumstances
giving rise to business risks may also influence inherent risk.

• For example, Technological developments might make a particular product obsolete, thereby
causing inventory to be more susceptible to overstatement.

• In the above case, it has been stated that many companies engaged in providing holistic solutions
to problem of stubble burning have not been successful. It shows that line of activity is inherently
risky. Therefore, there is a greater possibility of misstatements. Hence, the component of risks of
material misstatement involved is “inherent risk.”

QNO— Identify Component of RMM New Course – (SM25)
315.01.60 Bhaskar CNO - SA315.P1.020
A company has devised a control that its inventory of perishable goods is stored in appropriate
conditions- in a controlled environment to prevent any damages to inventory. Responsibility is fixed on
two persons to monitor environment using sensors and to report on deviations. Identify the component
of risks of material misstatement involved as an auditor of the company.
Answer Control Risk
• Control Risk is the risk that a misstatement that could occur in an assertion about a class of
transaction, account balance or disclosure and that could be material, either individually or when
aggregated with other misstatements, will not be prevented, or detected and corrected, on a
timely basis by the entity’s internal control.

• It is a function of the effectiveness of the design, implementation and maintenance of internal
control by management to address identified risks that threaten the achievement of the entity’s
objectives relevant to preparation of the entity’s financial statements.

• In the above case, the company has devised a control that its inventory of perishable goods is
stored in appropriate conditions and responsibility is fixed on two persons to monitor environment
using sensors and to report on deviations. There is a possibility that persons given responsibility
do not perform their work and report deviations. The component of risks of material misstatement
is “control risk”.

QNO— Identifying Risk New Course – (SM25)
315.01.70 Bhaskar CNO - SA315.P1.020
Shree Foods Private Limited is engaged in manufacturing of garlic bread. The auditors of company have
planned audit procedures in respect of recognition of revenues of the company. Despite that, there is a
possibility that misstatements in revenue recognition are not identified by planned audit procedures.
Which risk is being alluded to?
Answer Detection Risk
• It is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably
low level will not detect a misstatement that exists and that could be material, either individually
or when aggregated with other misstatements.

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