How to Assess Inherent Risk and Control Risk for Revenue

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After identifying the significant accounts and relevant assertions, the auditor should assess the risk of material misstatement. • The risk of material misstatement is a function of both inherent risk and control risk. • Risk of Material Misstatement = Inherent Risk x Control Risk • The auditor thus needs to: • • Assess inherent risk for revenue accounts • • Assess control risk for revenue accounts • Inherent risk is the risk a material misstatement will occur in the absence of internal controls. • Here are 4 factors that affect the inherent risk for revenue: • • Industry-related factors • • The complexity of revenue recognition • • The difficulty of auditing transactions and account balances • • Misstatements from prior audits • Control risk is the risk a material misstatement would not be prevented or detected by the client’s internal controls. • Assuming the auditor plans to rely on the client’s internal controls, there are 3 steps for setting control risk: • • Understand and document the internal control process • • Plan and perform tests of controls on revenue transactions • • Set the achieved level of control risk • Now that the auditor knows both the inherent risk and the control risk for revenue transactions and account balances, the auditor knows the risk of material misstatement (RMM). • Risk of Material Misstatement = Inherent Risk x Control Risk • RMM is the risk that a material misstatement will occur and not be prevented or detected by the client’s internal controls. • You could also think of RMM as the risk that a material misstatement exists prior to the auditors doing their work. Some people refer to RMM as “client risk” because the auditors have no control over it. • A high RMM means the auditors will need to set detection risk lower to achieve an acceptable level of audit risk. • Audit Risk = Risk of Material Misstatement x Detection Risk • 0:00 Introduction • 0:29 What is inherent risk? • 0:35 Four factors that affect inherent risk for revenue • 1:48 What is control risk? • 1:58 Three steps for setting control risk for revenue • 3:11 The risk of material misstatement • — • Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education freely available to the world. • — • SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS: • • A 23-PAGE GUIDE TO MANAGERIAL ACCOUNTING • • A 44-PAGE GUIDE TO U.S. TAXATION • • A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS • • MANY MORE FREE PDF GUIDES AND SPREADSHEETS • http://eepurl.com/dIaa5z • — • SUPPORT EDSPIRA ON PATREON • * / prof_mclaughlin • — • GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT • https://edspira.thinkific.com • — • LISTEN TO THE SCHEME PODCAST • Apple Podcasts: https://podcasts.apple.com/us/podcast... • Spotify: https://open.spotify.com/show/4WaNTqV... • Website: https://www.edspira.com/podcast-2/ • — • GET TAX TIPS ON TIKTOK • / prof_mclaughlin • — • ACCESS INDEX OF VIDEOS • https://www.edspira.com/index • — • CONNECT WITH EDSPIRA • Facebook: / edspira • Instagram: / edspiradotcom • LinkedIn: / edspira • — • CONNECT WITH MICHAEL • Twitter: / prof_mclaughlin • LinkedIn: / prof-michael-mclaughlin • — • ABOUT EDSPIRA AND ITS CREATOR • https://www.edspira.com/about/ • https://michaelmclaughlin.com

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