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Audit Risk for Payroll Cycle

After identifying the significant accounts, transactions, and assertions for the payroll cycle, the auditor should assess the risk of material misstatement. The risk of material misstatement is a function of both inherent risk and control risk. Risk of Material Misstatement = Inherent Risk × Control Risk Inherent risk is the risk a material misstatement will occur in the absence of internal controls. Inherent risk is high for payroll accounts and transactions when: • The company has significant amounts of executive compensation • The company has significant amounts of share-based compensation • The company has high employee turnover • The company has labor contracts with unions Control risk is the risk a material misstatement would not be prevented or detected by the client’s internal controls. Assuming the auditor plans to rely on the client’s internal controls, there are 3 steps for setting control risk: 1. Understand and document the internal control process 2. Plan and perform tests of controls on payroll transactions 3. Set the achieved level of control risk Once the auditor knows both the inherent risk and the control risk for payroll transactions, the auditor can determine the risk of material misstatement (RMM), which is the risk that a material misstatement will occur and not be prevented or detected by the client’s internal controls. You could also think of RMM as the risk that a material misstatement exists prior to the auditors doing their work. A high RMM means the auditors will need to set detection risk lower to achieve an acceptable level of audit risk. Audit Risk = Risk of Material Misstatement × Detection Risk 0:00 Introduction 0:32 Inherent risk 3:06 Control risk 6:35 Risk of material misstatement 7:52 Detection risk 8:10 PDF guide — Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education freely available to the world. — SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS: • A 23-PAGE GUIDE TO MANAGERIAL ACCOUNTING • A 44-PAGE GUIDE TO U.S. TAXATION • A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS • MANY MORE FREE PDF GUIDES AND SPREADSHEETS http://eepurl.com/dIaa5z — SUPPORT EDSPIRA ON PATREON *  / prof_mclaughlin   — GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT https://edspira.thinkific.com — LISTEN TO THE SCHEME PODCAST Apple Podcasts: https://podcasts.apple.com/us/podcast... Spotify: https://open.spotify.com/show/4WaNTqV... Website: https://www.edspira.com/podcast-2/ — GET TAX TIPS ON TIKTOK   / prof_mclaughlin   — ACCESS INDEX OF VIDEOS https://www.edspira.com/index — CONNECT WITH EDSPIRA Facebook:   / edspira   Instagram:   / edspiradotcom   LinkedIn:   / edspira   — CONNECT WITH MICHAEL Twitter:   / prof_mclaughlin   LinkedIn:   / prof-michael-mclaughlin   — ABOUT EDSPIRA AND ITS CREATOR https://www.edspira.com/about/ https://michaelmclaughlin.com