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    The Audit Risk Model Accounting Essay

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    The Audit Risk Model ( ARM ) is defined as:

    Built-in Hazard is the hearer ‘s step of measuring whether stuff misstatements exist in the fiscal statement before sing of internal controls. Ignoring internal controls, if the hearer assesses that the likeliness of material mistakes is high, the hearer will presume that the Inherent Risk is high. As the Control Risk constitutes a separate constituent of the Audit Risk Model, it is ignored here.

    Control Risk is the hearer ‘s step of measuring the likeliness that the client ‘s internal control system is unable to forestall or observe material misstatements transcending a tolerable degree. In measuring the degree of the Control Risk, the hearer will measure the effectivity of the house ‘s internal control system during his audit, e.g. through questionnaires. The lower the effectivity of internal controls the greater the frequence of mistake.

    Detection Hazard is the hearer ‘s step of measuring the likeliness that the hearer wo n’t observe material misstatements. Hearers will transport out more audit work to increase the sensing rate if Internal Risk and Control Risk are excessively high in order to run into the Audit Risk mark.

    When using the Audit Risk Model, the hearer has to find a mark degree of Audit Risk that is in conformity with supplying sensible confidence. The Internal Risk and Control Risk can be pooled together as Occurrence Risk ( OR ) , i.e. the hazard of the being of misstatements before the existent audit. The Detection Risk on the other manus is the hazard of the being of misstatements during the existent audit. The first measure in using the Audit Risk Model is to find a tolerable degree of Audit Risk. In the following measure the Audit Risk is decomposed into its three constituents. The hearer has no control over the Internal Risk and Control Risk but must measure their degrees in order to find the degree of Detection Risk that is sufficient to accomplish the mark Audit Risk. The Detection Risk can be influenced by the extent of proving.

    Using the expression of the Audit Risk Model, the hearer will necessitate to execute more testing, that is cod more grounds, and therefore cut down the Detection Risk, in instance the degree of Internal Risk and/or Control Risk is high in order to accomplish ( maintain ) the mark. The Detection Risk can be influenced by the nature, timing, and extent of the audit processs.

    2. One of the constituents of the audit hazard theoretical account is built-in hazard. Describe typical factors that hearers evaluate measuring built-in hazard. With the benefit of hindsight, what built-in hazard factors were present during the audits of the 1989 through 1992 Comptronix fiscal statements?

    Internal Risk is the hearer ‘s step of measuring whether stuff misstatements exist in the fiscal statement before sing the effectivity of internal controls. Besides factors related to the curious averment, the hearer needs to take external fortunes into history that might act upon the Internal Risk. Those can consist the nature of concern and industry, the unity of direction, the size of history balances, the being of related parties, the deficiency of sufficient working capital to go on operations, etc. Taking into history those legion factors, professional judgement has to be applied by the hearer.

    Examples of histories that pose low Internal Risk comprise traded securities or fixed assets in contrast to histories with high Internal Risk such as those for which estimations have to be used or complex computation have to be conducted.

    With hindsight the undermentioned built-in hazard factors were present:

    Fabricated purchases of equipment – An audit that would hold included a physical review of Comptronix ‘s equipment might hold revealed that certain recognized assets do non be or that sing the age of and therefore the depreciation for the equipment that certain pieces of equipment are non worth their book values.

    Fabricated histories payments for the equipment – Besides scrutinizing in a mode that would hold revealed the nonentity of certain purchases of equipment the hearers could hold besides audited cheque records and bank statements to see where and by whom the cheques were cashed in. This would hold revealed that the cheques were ne’er cashed in by a 3rd, outside party, but were cashed internally.

    Fabricated gross revenues and histories receivables – In the same mode as with the fabricated histories for equipment, the hearer could hold checked the stock list to verify the lessening in stock list of goods for sale every bit good as the payments by the clients. The former would hold revealed the deficiency of gross revenues while the latter would hold revealed the deficiency of external clients for no outside party deposited money in Comptronix ‘s history. Another attack would hold comprised fiting the gross revenues with the order documents and bills. Here the hearer would hold realized that there are no records for the fake gross revenues and hence no gross revenues were realized.

    3. Another constituent of the audit hazard theoretical account is control hazard. Describe the five constituents of internal control. What features of Comptronix ‘s internal control increased control hazard for the audits of the1989 – 1992 year-end fiscal statements?

    Control hazard is an auditors¶ appraisal of the internal control systems of a company. This besides includes the attitude and expertness managers and direction have towards internal controls.

    If control hazard is high so the sum of substantial processs that have to be conducted additions consequently.

    The internal control: Integrated Framework published 1994 by COSO interruptions effectual internal control into five interconnected constituents:

    control environment

    hazard appraisal

    control activities

    information and communicating


    The control environment encompasses the internal control model and is considered a foundation for all other elements. Included factors are unity, ethical values, competency, direction ‘s doctrine, runing rhythms, assignment of authorization and the attending and way provided by the board. By and large the control environment materializes in a written statement being the codification of behavior.

    The hazard appraisal is best described as the agencies of placing and analysing internal and external hazards to the accomplishment of fiscal describing control aims. Control activities are developed to turn to each control nonsubjective and to minimise hazards identified.

    Information and communicating from direction to personnel must be clearly stated and should emphasize that control duties must be taken earnestly. The forces must understand its function in the internal control system. Thus the company identifies methods and processs by which right information is provided to the right people.

    Finally, monitoring is the procedure ( internal or external ) to measure the public presentation of the internal control system over clip.

    At Comptronix assorted factors increased the control hazard for the company. First, the loss of one of the major clients is a circumstance that increases control hazard as direction has an inducement to misstate net incomes and other histories to remain profitable. Second, the accounting system could be bypassed by direction with dissentious manual entries. This increases control hazard as it grants limitless authorization to exceed direction for altering and pull stringsing histories.

    Besides hard currency expenses could be approved by direction based entirely on an bill. Finally the computerized accounting system in the transportation section, which constitutes a good internal control device, could be accessed and manipulated by the accountant. In drumhead direction had excessively much authorization to come in and alter the electronic accounting systems of the company, while there were no dual cheques in topographic point to verify and command manual alterations in the system.

    4. The board of managers, and its audit commission, can be an effectual corporate administration mechanism

    .a ) Discuss the pros and cons of leting inside managers to function on the board. Describe typical duties of audit commissions.

    Inside managers on the board can ease its effectivity by set uping strong connexions between the board and twenty-four hours to twenty-four hours concern. However, inside managers can besides consist the independency of the board when it comes to personal involvements. For illustration, the ability of the board to put fillips that are tied to public presentation and wages of direction is an of import statement against inside managers. Another common subject in research is that adding insiders to the board of managers reduces board monitoring. On the other manus, a survey by George Drymiotes shows that a less independent board, one that besides looks after the agent ‘s involvements to some grade, can sometimes carry through its monitoring function more efficaciously than a board that is wholly independent. A to the full independent board ‘s inability to perpetrate to a specific degree of supervising attempt makes supervising uneffective. Having insiders as portion of the board, nevertheless, shifts the board ‘s involvements closer to those of the agent and mitigates the board ‘s inducements to short-change the agent ( Drymiotes, 2007 ) . The paper besides suggests that any other mechanisms that align the board ‘s involvements, to some extent, with those of the director may be good to organisations. For case, board and direction involvements can go more aligned when direction owns a part of the house. Giving direction a portion of the house means that a group of stockholders is pull offing the house. Importantly, this peculiar group of stockholders discoveries ex station monitoring desirable, the same manner inside managers do. Thus, a board stand foring stockholder involvements may hold stronger inducements to supervise the agent ex station.

    The audit commissions ‘ duties can be summarized as helping the board of managers in verifying:

    the unity of the company ‘s fiscal statements

    the independency, unity, making and public presentation of the external hearers

    the public presentation of the company ‘s internal audit maps

    the rightness of the internal control systems

    the monitoring of conformity with Torahs and regulative demands and the codification of behavior

    B ) What strengths or failings were present related to Comptronix ‘s board of managers and audit commission?

    First of all the CEO and COO of Comptronix represented direction of the board which constitutes already for 28.6 % of the board of managers. Despite the grounds above and sing that the directors engaged in fraud, the high per centum of inside managers on the board is a considerable failing. Furthermore, the staying five outside board managers, instead undermined than strengthened the board ‘s independency: Two of them had close associations with direction, the other maintained dealingss that were non that apparent at first glimpse, but however significant. One, for illustration, was the spouse in the venture capital house that owned over 5 % of Comptronix.

    Finally four one-year board meetings seem to non hold been sufficient to exercise control over direction. Refering the audit commission it can be maintained that it was neither independent nor qualified. The commission members, two exterior and one grey manager, were drawn from the board of managers which was already evaluated as non being independent. Furthermore, non any of the members had accounting or fiscal coverage backgrounds, hence missing important expertness and experience in their map as an audit commission.

    5. Public Companies must register quarterly fiscal statements in Form 10-Qs, that have been reviewed by the company ‘s external hearer. Briefly describe the cardinal demands of Auditing Standards ( AU ) Section 722, Interim Financial Information. Why would n’t all companies ( public and private ) engage their hearers to execute timely reappraisals of interim fiscal statements?

    The SEC requires all public companies to hold quarterly fiscal statements reviewed by the external hearer on a timely footing. SAS No. 71 provides counsel on the nature, timing, and extent of processs to be applied by the independent comptroller in carry oning a reappraisal of interim fiscal information. The aim of a reappraisal of interim fiscal information is to find whether material alterations should be made for such information to conform to GAAP. A reappraisal of interim fiscal information consists chiefly of enquiries and analytical processs. It does non include ( 1 ) trials of accounting records, ( 2 ) the rating of confirming evidentiary affair in response to enquiries, or ( 3 ) other normal processs normally performed during an audit. Therefore, the comptroller does non obtain sensible confidence that would function as the footing for an sentiment on that fiscal information.

    In executing a reappraisal of interim fiscal information, the accountant demands to hold sufficient cognition of a client ‘s internal control as it relates to the readying of both interim and one-year fiscal statements. That cognition assists the comptroller in placing the likeliness of possible stuff misstatements in interim fiscal information and in choosing the enquiries and analytical processs that will supply the comptroller a footing for describing whether material alterations should be made to the interim fiscal information in order for it to conform to GAAP.

    Non-public companies are non required to prosecute independent comptrollers to execute a reappraisal of interim fiscal statements. Therefore, a private company ‘s determination to prosecute an independent comptroller to carry on a reappraisal of interim fiscal information is a cost-benefit determination. The services associated with obtaining such a reappraisal require clip and money. If top executives and the board of managers do non believe the related benefits exceed the costs, so they are non likely to prosecute independent comptrollers. The counsel in SAS No. 71 applies to interim fiscal information that is included in a note to the audited fiscal statements of a non-public company. If the interim fiscal Information for the non-public company is presented in a separate complete set of interim fiscal statements, the comptroller should follow with the AICPA ‘s

    Statements on Standards for Accounting and Review Services.

    Recently, there has been increased attending on interim reappraisals because of alleged fiscal coverage fraud affecting interim fiscal statements. The SEC demand for timely interim reappraisals for public companies was sparked by the February 1999 Report and Recommendations of the Blue Ribbon Committee on Bettering the Effectiveness of Corporate Audit Committees

    ( The Blue Ribbon Report ) . That study included a recommendation that the SEC necessitate a coverage company ‘s outside hearer to carry on a SAS No. 71 interim reappraisal prior to the company ‘s filing of its Form 10-Q with the SEC. Harmonizing to the Blue Ribbon Panel ‘s study, the ?increased engagement by the outside hearers and the audit commission in the interim fiscal coverage procedure should ensue in more accurate meantime coverage.

    7. Supply a brief sum-up of each of the three fraud conditions. Additionally, provide anexample from the Comptronix fraud of each of the three fraud conditions.

    1 )


    ncentive or force per unit area to commit fraud ± Bonus for brilliant public presentation. Company awardstock inducement to identify employees2 ) An chance to transport out the fraud ± Executive places that may short-circuit bing accountsystem.


    nternal controls are deficient. Board of managers composes of largely internaldirectors and acquaintances.3 ) Attitude or rationalisation to warrant the deceitful action. ± helped company avoidingreporting net losingss.

    8. Auditing Standards ( AU ) Section


    16, Consideration of Fraud in a Financial StatementAudit, notes that there is a possibility that direction override of controls could happen inevery audit and consequently, the hearer should include audit processs in every audit toaddress that risk.a ) What do you believe is meant by the term ?management override? ?

    Management override can be defined as the possibility for direction to besiege internalcontrols that appear to work expeditiously, in order to pull strings accounting records and fixing

    deceitful fiscal statements straight or indirectly. As the internal control system is expectedto map decently, the ways in which direction can overrule controls are unpredictable.

    B ) Provide two illustrations of where direction override of controls occurred in theComptronix fraud

    The executives were able to short-circuit the bing accounting system. They could enter fabricated journal entries of gross revenues and purchases manually contriving some client order Numberss andquantities that did non be and evidently were non cross-checked with other internal systems, like the client order- or stock list system. Following to that it was possible to enter fabricated purchases of equipment without making thenecessary paperss attach toing such purchases. The internal control failed to observe thisirregularity.Another illustration is the possibility of overruling control systems over hard currency expenses. With afictitious seller bill it was possible to do an comptroller collectible clerk fix a cheque without the necessity to crosscheck whether the bringing of the goods really took topographic point or anorder figure generated by the seller existed that should hold been found on the bill subsequently on.

    degree Celsius ) Research AU Section


    16 to place the three required hearer responses to furtheraddress the hazard of direction override of internal controls

    Paragraphs 58 ± 67 in Section 316 of the Auditing Standards by the PCAOB describe proceduresthat should be performed to further turn to the hazard of direction override of controls. Thethree chief responses that should be undertaken by the hearer are as follows:1. Examining journal entries and other accommodations for grounds of possible materialmisstatement due to fraud.Material misstatements due to fraud largely occur by: a. entering inappropriate or unauthorised diary entries throughout the twelvemonth or at periodend or b. devising accommodations to sums reported in the fiscal statements that are non reflectedin formal diary entries due to consolidating accommodations, study combinations andreclassifications.Therefore, the hearer should prove the rightness of journal entries recorded in the generalledger and other accommodations.


    n peculiar, the hearer should: iˆˆ Obtain an apprehension of the entity ‘s fiscal coverage procedure and the controls over journal entries and other accommodations



    dentify and choice diary entries and other accommodations for testingiˆˆ Determine the timing of the testingiˆˆ


    nquire of persons involved in the fiscal coverage procedure about inappropriate or unusual activity associating to the processing of journal entries and other adjustments2. Reviewing accounting estimations for prejudices that could ensue in stuff misstatement due tofraud.The premises and ensuing accounting estimations that direction has to do to fix thefinancial statements affect the implicit in accounting techniques and figures. Therefore, a batch of deceitful fiscal coverage is done by knowing false appraisals of direction. Theauditor¶s undertaking is to see retrospectively whether individual estimations are supported by auditevidence and whether the 1s that underlie the reported fiscal figures widely diverge and, if so, look into whether the premises and accounting estimations were deliberately biased in portion of direction. Thereby, the hearer should prove those accounting estimations that are basedon extremely sensitive premises or are otherwise significantly affected by direction opinions.


    f individual direction estimations were biased, impacting the fiscal figuresmaterially, the hearer should look into whether there have been fortunes that led to this prejudice and if these fortunes can represent a hazard for fiscal statement fraud. Besides theestimates taken as a whole should so be re-considered by the auditor.3. Measuring the concern principle for important unusual transactions.Transactions that are outside the normal class of concern for the company or entityinvestigated or that appear to be unusual should be investigated by the hearer.


    T should besides beevaluated whether there is an implicit in principle behind those minutess or whether they are perchance an indicant of deceitful fiscal reportingTo understand the implicit in principle for the minutess in inquiry, the hearer shouldinvestigate: iˆˆ Whether the signifier of such minutess is excessively complex ( e.g. whether it involves multipleentities within a amalgamate group or unrelated 3rd parties ) iˆˆ Whether direction has discussed the nature of and accounting for such minutess withthe audit commission or board of directorsiˆˆ Whether direction is puting more accent on the demand for a peculiar accountingtreatment than on the implicit in economic sciences of the transactioniˆˆ Whether minutess that involve unconsolidated related parties, including particular purposeentities, have been decently reviewed and approved by the audit commission or board of managers

    iˆˆ Whether the minutess involve antecedently unidentified related parties or parties that do nothave the substance or the fiscal strength to back up the dealing without aid from theentity under audit

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