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ACFI 301 Auditing Theory and Practice January 2013 Note on solutions Note: These solutions only represent broad notes to assist marking. They are not model answers Question 1 - Prenton Risk Different elements of audit risk Inherent risk: the risk of material error arising regardless of related internal controls/risks associated with the nature and characteristics of the business. Control risk: the risk that internal controls fail to prevent or detect a material error. Detection risk The risk that the auditor’s substantive procedures will fail to detect a material error. Detection risk is split into sampling and non-sampling risk. Sampling risk is the risk that the sample is not representative of the population. Non-sampling risk is the risk that all other work by the auditor fails to detect a material error. Why auditor needs to consider Risk assessment enables the auditor to plan his audit effectively ensures audit attention is devoted to appropriate areas. The higher the risk, the greater the amount of assurance work required. If inherent risk is high, then the auditor must take steps to reduce detection risk. Steps taken will affect the nature, timing and extent of audit procedures. Factors contributing to high audit risk New audit to your firm. Fashion is a volatile/seasonal business, especially “out-of-fashion” inventory. Large chain of stores. Company sells luxury goods. Small number of suppliers. Large number of cash transactions (sales/wages). Company deals in foreign currency. Failure to record transfers between stores may mean that the profit of each store is not properly recorded. This may means losses being incurred by a stores and inappropriate impairments Dominant/majority shareholder managing director. Managing director’s extravagant lifestyle. Managing director is 60, soon to retire. Company’s customer returns policy. Large bank borrowings. Why a risk Risk of obsolete inventory as company may be stuck with last year’s trend (dif