Final answer:
Control risk in an examination of management's discussion and analysis (MD&A) is the risk that material misstatements will not be prevented or detected by internal controls. The correct definition aligns with option 1, which focusses on the entity's internal control over financial reporting.
Step-by-step explanation:
In an engagement to examine management's discussion and analysis (MD&A), control risk is defined as the risk that a material misstatement will not be prevented or detected on a timely basis by the entity's internal control over financial reporting. Therefore, the correct answer to the student's question is: 1) The risk that a material misstatement will not be prevented or detected on a timely basis by the entity's internal control over financial reporting.
Internal controls are processes and procedures put in place by an entity's management to ensure the reliability of financial reporting, efficient operations, and compliance with laws and regulations. When auditors assess control risk, they are evaluating the effectiveness of an entity's internal controls in preventing or detecting material misstatements within financial statements. If control risk is assessed as high, auditors may rely less on the controls and perform more substantive testing.
A material misstatement is an error or omission that could influence the economic decisions of users taken on the basis of the financial statements. Control risk, as part of the audit risk model, plays a significant role in an auditor's planning and determination of the nature, timing, and extent of substantive procedures to be carried out.