Read the business characteristics of high inherent risk on page 145 of your text and think of a company that you would consider to be a risky audit. Go to the company's website and review their annual report and/or 10-K and read the Management's Discussion and Analysis. What information concerning risk is in this discussion and what would the auditor need to consider in determining the audit risk and controlling it? Please find a high risk company

Page 145 & 146 below

Page 146

Generally, the transactions with the highest level of inherent risk are estimatio transactions, which are the activities that create accounting estimates. These activi have high inherent risk because they involve management judgments or assumptione Examples of estimation transactions include estimating the allowance for uncollectihi accounts, establishing warranty reserves, and assessing assets for impairment tions, including information obtained in prior year audits, to assess inherent risk for the financial statement assertions The auditors use their knowledge of the client's industry and the nature of its o Control risk is the risk that a material misstatement could occur in a relevant a tion and not be prevented or detected on a timely basis by the client's internal control It is a function of the effectiveness of both the design and operation of intermal con in achieving the client's objectives relevant to the preparation of its financia stts Both inherent risk and control risk exist independently of the audit of financ, stat ments. That is, the risk of misstatement exists regardless of whether an audit is performed The auditor may make separate assessments of the two risks or an overall assessment of asser Detection risk is the risk. that the auditors' procedures will not detect a material mis- statement that exists in a relevant assertion. Detection risk is a function of the effectiveness of the audit procedures and their application by the auditors. Accordingly, unlike inherent risk and control risk, it does not exist when no audit is performed. Rather than "assessin detection risk, auditors seek to restrict it through performance of substantive procedures. the risk of material misstatement for the relevant assertions Detection risk exists because the auditors' substantive procedures are not 100 percent effec- tive, due to both sampling and other factors. As discussed later in this chapter, substantive procedures of two general types are performed: (1) tests of details of balances, transactions, and disclosures, and (2) substantive analytical procedures. For a given level of audit risk, detec- tion risk varies inversely with the risk of material misstatement; for example, the greater the risk of material misstatement, the less the detection risk that can be accepted by the auditors. Figure 5.2 describes the interrelationships between the three components of audit risk. The bag of sand in the figure represents inherent risk, the susceptibility of an account balance to material misstatements. The sieves represent the ways by which the client and the auditors attempt to remove the misstatements from the financial statements. The first sieve represents the client's internal control, and the risk that it will fail to detect or pre- vent a misstatement is control risk. The auditors' audit procedures are represented by the second sieve, and the risk that it will fail to detect a misstatement is detection risk udit Risk lustrated ris k that the misstatements will get through both sieves is audit risk. Measuring Audit Risk Auditors may either consider the risk of material misstatement directly, or se consider its components of inherent risk and control risk. For purposes of cons the relationships among the risks, we provide a separate assessment approac standards allow either a quantified or nonquantitative approach, but they also the following formula to illustrate the relationships among audit risk, inheren control risk, and detection risk: ately AR = IR CR DR RMM re AR Audit risk IR Inherent risk ris Generally, the transactions with the highest level of inherent risk are estimatio transactions, which are the activities that create accounting estimates. These activi have high inherent risk because they involve management judgments or assumptione Examples of estimation transactions include estimating the allowance for uncollectihi accounts, establishing warranty reserves, and assessing assets for impairment tions, including information obtained in prior year audits, to assess inherent risk for the financial statement assertions The auditors use their knowledge of the client's industry and the nature of its o Control risk is the risk that a material misstatement could occur in a relevant a tion and not be prevented or detected on a timely basis by the client's internal control It is a function of the effectiveness of both the design and operation of intermal con in achieving the client's objectives relevant to the preparation of its financia stts Both inherent risk and control risk exist independently of the audit of financ, stat ments. That is, the risk of misstatement exists regardless of whether an audit is performed The auditor may make separate assessments of the two risks or an overall assessment of asser Detection risk is the risk. that the auditors' procedures will not detect a material mis- statement that exists in a relevant assertion. Detection risk is a function of the effectiveness of the audit procedures and their application by the auditors. Accordingly, unlike inherent risk and control risk, it does not exist when no audit is performed. Rather than "assessin detection risk, auditors seek to restrict it through performance of substantive procedures. the risk of material misstatement for the relevant assertions Detection risk exists because the auditors' substantive procedures are not 100 percent effec- tive, due to both sampling and other factors. As discussed later in this chapter, substantive procedures of two general types are performed: (1) tests of details of balances, transactions, and disclosures, and (2) substantive analytical procedures. For a given level of audit risk, detec- tion risk varies inversely with the risk of material misstatement; for example, the greater the risk of material misstatement, the less the detection risk that can be accepted by the auditors. Figure 5.2 describes the interrelationships between the three components of audit risk. The bag of sand in the figure represents inherent risk, the susceptibility of an account balance to material misstatements. The sieves represent the ways by which the client and the auditors attempt to remove the misstatements from the financial statements. The first sieve represents the client's internal control, and the risk that it will fail to detect or pre- vent a misstatement is control risk. The auditors' audit procedures are represented by the second sieve, and the risk that it will fail to detect a misstatement is detection risk udit Risk lustrated ris k that the misstatements will get through both sieves is audit risk. Measuring Audit Risk Auditors may either consider the risk of material misstatement directly, or se consider its components of inherent risk and control risk. For purposes of cons the relationships among the risks, we provide a separate assessment approac standards allow either a quantified or nonquantitative approach, but they also the following formula to illustrate the relationships among audit risk, inheren control risk, and detection risk: ately AR = IR CR DR RMM re AR Audit risk IR Inherent risk ris