Philip is a resident of the great state of New York, but has inspired and motivated fellow Roger students through online forums and social media platforms across the globe. Philip has already passed FAR.
I want to discuss two key elements of audit risk and how they made perfect sense while studying them. So inherent risk is the risk of misstatement assuming no controls are in place, while control risk is the risk of misstatement if the controls dont work. These are the two elements of audit risk that the auditor doesnt control, but are very important. So how did I learn these risks other than pure memorization which I dont do, never have and never will?
Easy. I think of my three year old daughter. This next part gets a little philosophical, so I apologize for the liberal arts discussion ahead of time. Some argue that man is born with a clean slate and inherently good natured, while others argue that man is born with an inherent bad nature. I believe the latter, and heres why. My daughter was on her toy phone telling the non-existent listener to shut up. I asked her why she just said those naughty words. Her reply solidified my concept of the inherent nature of man. She said, I didnt say shut up. Grammy did. She lied. She lied and was never taught how to lie. Lying is inherent to my daughter, that is, she was able to lie without learning how.
Inherent risk then is a risk without any controls. Rather simple. It deals with the inherent nature of the element in question. Roger will tell you that his lecture tables and chairs have low inherent risk of being stolen, and I would agree had I not been brought up in a 100% Italian household where tables and chairs are prime real estate during the holidays. Cash, on the other hand has a higher inherent risk. It deals with the nature, just like my daughter.
Control risk is much easier. My daughter learns her vocabulary from Dora, Phineas and Ferb and my wife and I. We control what she learns. We set up controls over naughty words to keep her from learning them. When she walks around the house telling someone to shut up on her toy phone, I know we had a control break down, my wife. I really hope my wife isnt reading this.
The same is true with control risk in auditing. What is the risk that the controls will break down and misstatements will occur? I ask, what is the risk that our home controls will break down and my daughter will make naughty statements?
Inherent vs. control risk was made simple by a 5 minute conversation with my daughter. Luckily, in that instance, even though the inherent risk was high and controls broke down, I was able to detect her statements and prevent ongoing issues. Who knew parenting paralleled accounting and auditing so closely?