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AUDIT RISK

AUDIT RISK is the risk that the


auditor gives an inappropriate audit
opinion on the financial statements.
It also means that the auditor
accepts some level of uncertainty in
performing the audit function.

For each financial statement account,


audit risk consists of the possibility that:
1. A material misstatement in an
assertion about the account has
occurred.
2. The auditors do not detect the
The risk of occurrence of a material
misstatement.
misstatement may be separated into
two components, inherent risk and
control risk. The risk that auditors will
not detect the misstatement is called
detection risk.

BUSINESS RISK
In contrast to audit risk, it is the
auditors risk of loss or injury from events
arising in connection with financial
statements that have been reported on
and on which auditors has issued an
appropriate opinion.

Inherent Risk

Is the susceptibility of an account


balance or class of transactions to a
material misstatement assuming that
were no related internal controls.

Factors affecting inherent risk at the


financial statement level includes:
1. The management integrity
2. Management Characteristics
3. Operating Characteristics
4. Industry Characteristics

Factors affecting inherent risk at the


account balance level:
1. Susceptibility of the account to
theft
2. Complexity of calculations
3. The complexity of underlying
transactions
4. The degree of judgment involved
in determining account balances

Control Risk

Is the risk that a material


misstatement could occur in an
account balance or class of
transactions will not be prevented or
detected and corrected on a timely
basis by accounting and internal
control systems.

Detection Risk

Is the risk that an auditors


substantive procedure will not detect
a material misstatement.
Sampling risk
Non-sampling risk

AUDIT RISK MODEL


Audit risk = Inherent Risk X Control Risk X Detection
Risk

Auditors use this relationship


to determine the nature, timing,
and extent of audit procedure to
manage and control audit risk

Steps in using Audit Risk Model


Step Set the desired level of Audit Risk
1
Step Assess the level of Inherent Risk
2
Step Assess the level of Control Risk
3
Step
4

Determine the acceptable level of


Detection Risk

Step Design Substantive Tests


5

Relationship between materiality


and risk
There is an inverse relationship
between materiality and the level of audit
risk. The higher the materiality level, the
lower the audit risk and vice versa.

Risk Assessment
Procedure
These includes:
1. Inquiries of management and
others within the entity
2. Analytical procedures
3. Observation and inspection

ANALYTICAL PROCEDURES
Steps in applying analytical
procedures:
Step 1: Develop expectations
regarding financial statements
Step 2: Compare expectations with the
financial statements under audit
Step 3: Investigate significant
differences

Analytical Procedures in
planning an audit

Analytical procedures used in


planning an audit should focus on:
Enhancing the auditors
understanding of the clients
business
Identifying areas that may
represent specific risks

Documenting the Auditing Plan

Audit Plan contains an overview of


the expected scope and conduct of the
audit
Audit Program a set of audit
procedures specifically designed for
each audit
Time Budget an estimate of the time
that will be spent in executing the audit
procedures listed in the audit program