Control Risk
Control risk is another key term CPA candidates need to thoroughly understand for the AUD section of the exams. It’s the risk that a material misstatement in a company’s financial statements will not be prevented or detected on a timely basis by the company’s internal control system. Auditors evaluate control risk to determine the efficacy of a company’s internal controls over financial reporting. This helps in deciding how much reliance can be placed on these controls during the audit.
Factors that contribute to control risk include:
1. Inadequate Design: Poorly designed controls can fail to catch errors or fraud.
2. Implementation Flaws: Even well-designed controls can falter if not implemented properly.
3. Human Error: Control risk increases if employees can easily bypass or override controls.
Example: Let’s assume you’re auditing a small but growing tech startup. They have implemented some basic controls but, due to rapid growth, there are inconsistencies and loopholes. In some cases, the same person who approves an expenditure also has the authority to make the payment, presenting a separation of duties issue. Your assessment would likely conclude that control risk is high, warranting more extensive substantive procedures.