AUDIT RISK AND INTERNAL ASSESSMENT. Audit risk means the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated. Thus, it is the risk that the auditor may fail to express an appropriate opinion in an audit assignment. Audit risk is a function of the risks of material misstatement and detection risk. COMPONENTS OF AUDIT RISK (a) Inherent risk—The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. (b) Control risk—The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. (c)Detection risk: The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, cither individually or when aggregated with other misstatements ASSESSING THE RISKS OF MATERIAL MISSTATEMENT As per SA 315 - “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment”, the objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment, including the entity’s internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement. This will help the auditor to reduce the risk of material misstatement to an acceptably low level. RISK ASSESSMENT PROCEDURES Inquiries of Management and Others within the Entity: Much of the information obtained by the auditor's inquiries is obtaincd from management and those responsible for financial reporting. However, the auditor may also obtain information, or a different perspective in identifying risks of material misstatement, through inquiries of others within the entity and other employees with different levels of authority Analytical Procedures: Analytical procedures performed as ris identify aspects of the entity of which the auditor was unaware and may assist in ass assessment procedures may 1g therisks of material misstatement in order to provide a basis for designing and implementing responses to the assessed risks. Analytical procedures performed as risk assessment procedures may include both financial and non-financial information, for example, the relationship between sales and square footage of selling space or volume of goods sold. Observation and Inspection: Observation and inspection may support inquiries of management and others, and may also provide information about the entity and its environment. Example: plans and strategies), records, and internal control manuals INTERNAL CONTROL, Internal control comprises of the policies and procedures adopted by the management of an entity to assist in achieving the following objectives: © Orderly and efficient conduct of business. * Adherence to management policies # Safeguarding of assets © Prevention and detection of fraud and errors Documents (such as busin: Accuracy and completeness of accounting records Timely preparation of financial statements “Internal control is regarded as the whole system of controls, financial and otherwise established by the management in the conduct of a business including internal check, internal audit and other forms of control “ According to American Institute of Certified Public Accountants: Internal control comprises of the plan of organization and all the coordinate methods and measures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency and to encourage adherence to prescribed managerial policies.” OBJECTIVES OF INTERNAL CONTROL * To encourage adherence to prescribed policies: The system of internal control is introduced to provide reasonable assurance that the various plans, policies and procedures laid down by the entity are being followed. * To avoid frauds and errors: The main objective of any control system is to detect and prevent frauds and errors by keeping an inherent check. * To promote operational efficiency: The internal controls within an organization are meant to prevent unnecessary duplication of efforts, protect against waste and discourage any inefficient use of resources of the organization. * To safeguard assets and records: The other important objective of internal control system is to safeguard the assets and records from unauthorized access, use and disposition. + To provide accurate and reliable data: The internal control system ensures that all the transactions are recorded in the correct amount, in the appropriate account and in the accounting period to which they relate.© To assist in timely preparation of Financial Information: Information is of no use if itis, not provided in time. Internal control system facilitates timely preparation of financial statements, INTERNAL CHECK Internal check is used as tool for executing internal control. It is the arrangement of duties of staff in such a manner that the work of one person is automatically checked by another which minimizes the chances of errors and frauds. “Internal check may be defined as an arrangement of accounting routine that errors and frauds are automatically prevented or discovered by the very operation of book keeping itself”. According to Spicer and Pegler “A system of internal check is an arrangement of staff duties whereby no one person is allowed to carry through and to record every aspect of the transaction, so that without collusion between two or more persons, fraud is prevented and at the same time the possibilities of errors are reduced to the minimum.” OBJECTIVES OF INTERNAL CHECK 1. Early Detection of Errors and Frauds: The main objective of internal check is to detect and prevent the occurrence of errors and frauds at an early stage. This is possible as the work of each and every person is independently checked. 2. Minimization of Errors and Frauds: It is one of the primary objectives of internal check. ‘As the work performed by each individual is checked by another person, there is a check on the work of dishonest person. Hence, the possibility of errors and frauds are minimised to a greater extent. 3. Division of Work: Internal check provides for proper division of work based upon each and every persons skill, ability, specialisation and effectiveness. 4. Fixation of Responsibility: The total work is divided into smaller units and assigned to different persons. Each and every person knows what is expected from hinvher and he/she will be held responsible for any errors or fraud which takes place in it, Internal check provides for clear determination of responsibility, PRINCIPLES OF INTERNAL CHECK * Responsibility: Responsibility of each individual must be properly defined and fixed. ‘The work of the business should be allocated amongst various clerks in such a manner that their duties and responsibilities are clearly and judiciously divided. * Completion: The work should be divided in such a way that no single person is allowed to complete the work solely by himself from the beginning to the end. However, there should be no duplication of work. Rotation of employees: A good system of internal check should not allow person having custody of assets to have access to the books of account. A system of transfer or rotation of employees from one seat of work to another must be followed by the business.Automatic check: A good system of internal check must provide for an automatic checking of the work of one clerk by the other. Reliance: No clerk of the business should be relied upon too much. Safeguards: Safeguards should be prescribed to keep un-used cheque books, files and securities etc. Supervision: A strict supervision should be exercised to ensure that the prescribed internal checks and procedures are fully operative. Formal sanction: No deviation should be allowed from the established procedures till it is formally sanctioned by the top official. Periodical review: The system of internal check be reviewed from time to time to introduce improvements.Difference between Internal Check and Internal Internal check is an arrangement | Internal audit is an of work in such a way that independent appraisal of the another person automatically operations of the company. checks the work of one person. The object of internal check is to | The object of internal audit prevent the occurrence of errors | is to detect errors and frauds. and frauds. Internal audit is a device for checking the work. In internal audit errors and frauds are discovered after the completion of the work. Discovery of In internal check errors and errors and frauds are discovered during the frauds course of doing the work. Internal audit commences only when accounting process is completed. Internal check is in operation during the course of transactions. Commencement of work In internal audit the work is performed by a separate group of persons specifically appointed for this purpose. In internal check no new staff is appointed to perform the work. Performance of work