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following is a kaplan question and the answer given. i have reproduced it:
Q: Define ‘test of controls’ and explain why they are an important procedure in the statutory audit of any company
A: a test of control tests the operating effectiveness of controls in preventing, detecting and correcting material misstatements
it is important for the ext. auditor to test controls to ensure their initial understanding obatined when assessing the control environment and internal controls is appropriate.
this will allow the auditor to identify and assess the risks of material mistatements in the FS and to determine to what extent to rely on the internal control system during the audit.
the auditor will then be able to desing sufficient and appropriate substantive procs to reduce detection risk and therefore the audit risk.
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my question/understanding is: that the test of controls have to do with Control risk … why does the answer mention Detection risk??
can u explain pls.
thank u
If the internal control system is good (and the auditor must test that to decide) then control risk is low (the client is likely to pick up and correct any errors because they have a good IC system). If control risk is low then the auditor has to do less work (ie can live with a higher detection risk).
so the statement
“the auditor will then be able to desing sufficient and appropriate substantive procs to reduce detection risk and therefore the audit risk.”
is really saying that in case of lo control risk, you just concentrate on the detection risk…. which was what u said.
correct?
If inherent and control risk are high there is a high chance of mistatements in the draft FS. The auditor responds by designing audit tests to make detection risk low (ie the auditor should pick up the errors.)
If control risk is low, then there is little risk of errors in the FS so the auditor can do less testing ie doesn’t spend as long trying to detect errors that are probably not there.
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