Activity Based Risk Evaluation Model of Auditing

HOME >> FRAMEWORK >> AUDIT PLANNING STAGE: EVIDENCE EVALUATION ACTIVITIES

Audit planning stage: evidence evaluation:
DR*₂ = AR*₂ / IR₂ x CR₂

ACTIV- ITIES	STAGES
	CA/R	AP	CT	ST	OF
PL	SP	TP	OP	OP	OP
EG	PK	DK	EofO	EofM	CFS
EE	AR1	DR*2	DR*3	AR4	AR5
DM	A/R	AA	CR?	CAB	AO

After the auditor gathers evidence in the audit planning stage, the auditor evaluates the acceptable audit risk AR*₂, the inherent risk IR₂ and control risk CR₂ for each account balance assertion. Using these evaluations, the auditor can estimate the value of the acceptable detection risk DR*₂. In addition, the auditor estimates whether a sufficient quantity and appropriate quality of audit evidence has been gathered in order to make the decision as to the appropriate audit approach.

Thus, for each account balance assertion, the auditor evaluates:

• acceptable audit risk AR*₂, based on the previously evaluated acceptable audit risk at the financial statement level adjusted for evidence gathered of any increased or reduced reliance that is expected to be placed on the particular account balance assertion. The adjusted risk is evaluated as VERY LOW, LOW or MODERATE.
• inherent risk IR₂,
• control risk CR₂
  Again, both the above two evaluations are based on the risk at the financial statement level adjusted for evidence gathered of any increased or reduced risk relating to the particular account balance assertion. (In some instances, it may be more appropriate for the auditor to evaluate the combined risk RMM₂ (the risk of material misstatement). Evaluations of IR₂ and CR₂ range from LOW to HIGH while evaluations of RMM₂ range from VERY LOW to VERY HIGH.

The auditor then estimates the acceptable detection risk DR*₂. Given that the achievable audit risk AR₂ must be equal to or lower than the acceptable audit risk AR*₂, the value of the latter can be substituted for the former in the audit risk model to estimate the value of the acceptable detection risk DR*₂. (See example 2 on the equilibbrium of the audit risk equation). The value of DR*₂ may range from VERY LOW to VERY HIGH.

Finally, the auditor considers whether s/he has gathered evidence of sufficient quantity and appropriate quality, based on its relevance and reliability, to make a decision as to the appropriate audit approach. If not, the auditor gathers further evidence. After the auditor has concluded the estimations and evaluations above, the auditor makes the audit approach decision. Refer to the next activity.

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