RTI, Nagpur1 Day 2- Session IV Internal control and risk measurement

RTI, Nagpur2 Session overview Risk assessment and identification of fraud indicators Sampling methods

RTI, Nagpur3 Learning objective Participants will be able to undertake a risk- based approach in planning and performance of audit procedures.

RTI, Nagpur4 What is audit risk Risk of expressing an incorrect opinion on financial statements that contain material mis- statements or errors Risk of expressing audit conclusions on a universe that contains material irregularities but not detected by audit

RTI, Nagpur5 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

RTI, Nagpur6 Audit Risk = IR*CR*DR Extent of testing- compliance and substantive- depends 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, Nagpur7 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

RTI, Nagpur8 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.

RTI, Nagpur9 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 performed

RTI, Nagpur10 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

RTI, Nagpur11 Risk measurement (Contd.) High-risk areas in Govt. environment –Contracts of procurement of service or goods –Inventory and asset management –Cash management –Financial statements –Grants-in-aid –Areas with public interface

RTI, Nagpur12 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

RTI, Nagpur13 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