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Updating Detection Risk after Test of Control using concept of conditional probability

 §1. Basic Audit Risk Model used in all standard textbooks is

AR=DR*IR*CR

Where,

AR= Audit Risk

DR= Detection Risk

IR= Inherent Risk

CR= Control Risk

§2. Control risk at first assessed based on design of the ICS relating to Financial Reporting or relevant to such.

§3. In that stage, the actual implementation of ICS is unknown and to reduce detection risk, audit procedures are designed on the belief of that much information.

§4. When Test of Control is performed, the risk universe gets reduced because the auditor is no more in uncertainty about controls. 

§5. Now the chance of occurring error should be selected from new universe based on results of ToC. 

§6. Based on new conditional probabilities, DR should be updated and audit procedures should be modified, if required, because both AR and IR are constants, and CR become certain hence DR is the only variable that can be changed. We have taken that the Random variable X which is Error for the model, we are considering has been updated using conditional probabilities.


Note: This blog is not to be used as any authentic source for using conditional probabilities in updating Audit Risk Model. 

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