9-31 a. Acceptable audit risk A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. This is the risk that the auditor will give an incorrect audit opinion.
Inherent risk A measure of the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control. This risk relates to the auditor's expectation of misstatements in the financial statements, ignoring internal control.
Control risk A measure of the auditor's assessment of the likelihood that misstatements exceeding a tolerable amount in a segment will not be prevented or detected by the client's internal controls. This risk is related to the effectiveness of a client's internal controls.
Planned detection risk A measure of the risk that audit evidence for a segment will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. In audit planning, this risk is determined by using the other three factors in the risk model using the formula PDR =
AAR / (IR x CR).
1 2 3 4 5 6
Acceptable Audit Risk .05 .05 .05 .05 .01 .01
IR x CR 1.00 .24 .24 .06 1.00 .24
/ (IR x CR) .05 .208 .208 .833 .01 .042
Planned Detection Risk
in percent 5% 20.8% 20.8% 83.3% 1% 4.2%
1. Decrease; Compare the change from situation 1 to 5.
2. Increase; Compare the change from situation 1 to 2.
3. Increase; Compare the change from situation 1 to 2.
4. No effect; Compare the change from situation 2 to 3.
d. Situation 5 will require the greatest amount of evidence because the planned detection risk is smallest. Situation 4 will require the least amount of evidence because the planned detection risk is highest. In comparing those two extremes, notice that acceptable audit risk is lower for situation 5, and both control and inherent risk are considerably higher.