Describe the Appropriate Use of the Audit Risk Model

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The Answer is a. The audit risk model should be thought of as an aid to understanding how various factors affect the amount of substantive testing done in an audit. Although the audit risk model is a mathematical formula, its use is more conceptual than computational, and auditors would generally not try to apply it as a tool for calculating risk. Rather, the model provides guidance as to a general level of substantive testing that is needed given the conditions of a client. The audit risk model is not a well specified model and the following concerns have been raised about it:
-The covariance between inherent risk and control risk or between business risk which affects audit risk and inherent risk are ignored
-It presumes a multiplicative form with unitary weights without empirical support for such a mathematical characterization
-Sampling risk on controls is not recognized
-Internal controls prevent as well as detect errors
-Often implemented by asking auditor to categorize as high, medium, or low risk or by number not empirically supported.
-auditors over rely on last year's parameter estimates because revision would require justification
b. When required detection risk is lower, substantive evidence will be more extensive for the assertion being examined. Note that this guidance is extremely general. The exact amount of evidence that is required to achieve the desired detection risk for any specific management assertion cannot be calculated through a mathematical formula. Audit evidence is rarely quantifiable. What the model does indicate when more and better substantive evidence is needed, in order to convince the auditor that the level of detection risk (and therefore audit risk) is as low as desired.
c. The benefit of using the audit risk model for planning substantive tests is that it provides guidance about the appropriate level of detection risk given the established level of audit risk and the assessed level of the risk of material misstatement. It also allows the auditor to focus on specific management assertions where risk of misstatement is most severe. In addition, the relationship between control risk and detection risk reflect the need for auditors to make choices concerning the ability to rely on controls. If controls can be relied upon, then detection risk can be higher thus reducing the need for relatively expensive substantive tests. Auditors must also be aware that the guidance from the model is only as good as the auditor's risk assessments.

Describe the Appropriate Use of the Audit Risk Model

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