Day 2- Session IV
Internal control and risk
measurement
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Session overview
Risk assessment and identification of fraud
indicators
Sampling methods
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Learning objective
Participants will be able to undertake a riskbased approach in planning and performance of
audit procedures.
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What is audit risk
Risk of expressing an incorrect opinion on
financial statements that contain material misstatements or errors
Risk of expressing audit conclusions on a
universe that contains material irregularities but
not detected by audit
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Components of Audit Risk
Inherent Risk
Susceptibility of a class of transactions to mis-statement
Also determined by entity’s business and its environment
Control risk
Possibility of errors not being rectified by control
mechanism
Detection risk
Possibility of material errors not being detected through
audit procedures
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Audit Risk = IR*CR*DR
Extent of testing- compliance and substantivedepends on
Auditor’s assessment of inherent and control risk
Auditor’s satisfaction that the product of the risks will be
less than or equal to Audit risk
Thus, detection risk is derived after assessment of
inherent and control risk
Detection risk has two components
Analytical procedure risk- failure of detection by
analytical procedures RTI, Nagpur
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Audit Risk = IR*CR*DR (Contd.)
Test of detail risk- failure of detection by detail testing
DR = AP*TP
AR =IR*CR*AP*TD
Detection risk is modifiable per discretion of auditor given his
assessment on inherent and control risk
Higher the control and inherent risk, lower will be detection risk
Why?
Auditor will have to perform extensive testing procedures to
keep detection risk low
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Materiality
Refers to the extent to which error can be tolerated and
is determined by
– Value
– Nature
– Context in which the matter arises
As per SAI India, a matter may be judged material if
– Knowledge of the same is likely to influence the user of the
audit report.
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Materiality (Contd.)
Materiality bears an inverse relationship with audit
risk
– Higher the materiality, lower will be audit risk and
vice versa
Auditor to consider materiality in fixing audit risk, to
ensure
That aggregate misstatements through detection
and non-detection does not exceed materiality level
Key factor in determining audit procedures to be
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performed
Risk measurement
Risk measurement is a guide to audit planning
Areas/items for examination are rated ‘high risk’,
‘medium risk’ and ‘low risk’ depending on
– Sensitivity
– Significance
– Materiality
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Risk measurement (Contd.)
High-risk areas in Govt. environment
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Contracts of procurement of service or goods
Inventory and asset management
Cash management
Financial statements
Grants-in-aid
Areas with public interface
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Requirement of auditing standard
Evidence collected should be sufficient to support
audit conclusions
Evidence collected is based on sample selected for
audit scrutiny
Sampling  broadly two types, statistical and
judgment sampling
Statistical sampling random sampling and
stratified sampling
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Procedure in designing of sample
Defining target population and error/exception
Tolerable error or materiality levels acceptable to the entity
Level of assurance that audit needs to provide
Occurrence rate – proportion of items population having
error
Determining appropriate sampling method as per the type of
population
Projection of results with reference to the population
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