We know that the extent of substantive testing is determined by the risk of material misstatement. This relationship is illustrated by the audit formula: AR = IR x CR x DR The auditors of Willington Electronics want to limit the risk of material misstatement in the valuation of inventories to 2%. They believe that there is a 50% risk that a material misstatement could have bypassed the client's internal controls and that the inherent risk of the account is 80%. They also believe that the substantive analytical procedures performed to test have a 40% risk of failing to detect a material misstatement.
a. Briefly discuss in your own words what is meant by audit risk, inherent risk, control risk, and that the risk that substantive analytical procedures might fail to detect a material misstatement.
b. Calculate the maximum allowable risk of incorrect acceptance by the substantive tests of the detail transactions.
c. What level of detection risk is implicit in this problem?