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 misstatement.The risk of occurrence of a material 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 RISKIn contrast to audit risk, it is the

auditor’s 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 integrity2. Management Characteristics3. Operating Characteristics4. Industry Characteristics

Factors affecting inherent risk at the account balance level:

1. Susceptibility of the account to theft

2. Complexity of calculations3. The complexity of underlying

transactions4. 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 auditor’s

substantive procedure will not detect a material misstatement.

Sampling riskNon-sampling risk

AUDIT RISK MODELAudit 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 ModelStep 1

• Set the desired level of Audit Risk

Step 2

• Assess the level of Inherent Risk

Step 3

• Assess the level of Control Risk

Step 4

• Determine the acceptable level of Detection Risk

Step 5

• Design Substantive Tests

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 entity2. Analytical procedures3. Observation and inspection

ANALYTICAL PROCEDURESSteps 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 auditor’s understanding of the client’s 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