For the items below identify Situation 1 OR Situation 2 is most accurate with th
ID: 2508724 • Letter: F
Question
For the items below identify Situation 1 OR Situation 2 is most accurate with the identified statement; only one situation will be appropriate for each question. In both situations assume Inherent risk is at a high level.
Situation 1: While obtaining an understanding of internal control, you have determined that it appears to be adequate-not strong, but weak. You choose to test controls in the area-they revel that the system functions as expected. (Hint: CR = Moderate)
Situation 2: While obtaining an understanding of internal control, you have determined that it appears to be very strong. You choose NOT to test controls in the area. (Hint CR = High)
1) The planned assessed level of control risk is lower for this situation.
2)The planned allowable detection risk is lower for this situation.
3)More tests of controls will be performed for this situation.
4)More substantive procedures will be performed for this situation.
5)The assessed level of control risk will be lower for this situation.
6)The risk of misstatement will be lower in this situation.
Explanation / Answer
First of all we have to understand these 2 situations
One fact stated there is that inherent risk is high in both situations IT MEANS (IR MEANS) THE CHANCES OF HAVING MATERIAL MISSTATEMENTS IN FINANCIAL STATEMENT ARE HIGH IF NO CONTROLS ARE THERE.
when we assessed control risk it means we verify that
• Is any control system are there?
• If yes whether they are adequate and
• Whether working effectively?
Situation 1
In the situation 1 we found that controls are implemented-adequate(fit for the auditee)- but not working properly means not effective for finding and preventing the material misstatements. So we performed further audit procedures and test the controls , after that auditor found that control system are working properly or say effectively so the CR is moderate in this situation, which appeared high before applying further audit procedure. In this situation the risk of misstatements will become lower because ROMMS = IR* CR = HIGH *MODERATE. = LOWER OR MODERATE.
So from the above explanation we found that case 5 & 6 is related to situation 1.
Now we found that case 5 is in situation 1 because case 5 states that assessed level of control risk is lower, we assessed a high level of control risk before applying test of control in area but concluded after test of control that they are effective so assessed level of CR is lower.Reliance on internal control are high.
Case 6 Risk of misstatements will be lower because CR is moderate and detection risk will be maintained at low level.
Situation 2 As clearly stated in situation 2 that it APPEARS ONLY very strong BUT NOT TESTED SO CR IS HIGH.
Case 1,2,3,4 are in situation 2
Case 1 Because we didn’t TEST THE CONTROL and only have an understanding of control say Having the knowledge that auditee implement the control system but not sure about it’s effectivenes because we ourselves not checked it So reliance on IC is lower.
Case 2 Situation 2 High INHERENT RISK MULTIPLIED BY HIGH CONTROL RISK REQUIRES LOWER ALLOWABLE DETECTION RISK to reduce the Overall Audit Risk So
For lower detection risk More test of control (case 3)
& More Substantive procedure (case 4). will be performed.