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Definition
Audit Risk is the risk that an auditor expresses an inappropriate opinion on the financial statements.
Explanation:
Audit risk is the risk that an auditor issues an incorrect opinion on the financial statements. Examples of inappropriate audit opinions include the following:
Model:
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Audit risk may be considered as the product of the various risks which may be encountered in the performance of the audit. In order to keep the overall audit risk of engagements below acceptable limit, the auditor must assess the level of risk pertaining to each component of audit risk.
Components:
Explanation of the3 elements of audit risk is as follows:
Inherent Risk is the risk of a material misstatement in the financial statements arising due to error or omission as a result of factors other than the failure of controls (factors that may cause a misstatement due to absence or lapse of controls are considered separately in the assessment of control risk).
Inherent risk is generally considered to be higher where a high degree of judgment and estimation is involved or where transactions of the entity are highly complex.
For example, the inherent risk in the audit of a newly formed financial institution which has a significant trade and exposure in complex derivative instruments may be considered to be significantly higher as compared to the audit of a well established manufacturing concern operating in a relatively stable competitive environment.
Control Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity.
Organizations must have adequate internal controls in place to prevent and detect instances of fraud and error. Control risk is considered to be high where the audit entity does not have adequate internal controls to prevent and detect instances of fraud and error in the financial statements.
Assessment of control risk may be higher for example in case of a small sized entity in which segregation of duties is not well defined and the financial statements are prepared by individuals who do not have the necessary technical knowledge of accounting and finance.
Detection Risk is the risk that the auditors fail to detect a material misstatement in the financial statements.
An auditor must apply audit procedures to detect material misstatements in the financial statements whether due to fraud or error. Misapplication or omission of critical audit procedures may result in a material misstatement remaining undetected by the auditor. Some detection risk is always present due to the inherent limitations of the audit such as the use of sampling for the selection of transactions.
Detection risk can be reduced by auditors by increasing the number of sampled transactions for detailed testing.
Application
Audit risk model is used by the auditors to manage the overall risk of an audit engagement.
Auditors proceed by examining the inherent and control risks pertaining to an audit engagement while gaining an understanding of the entity and its environment.
Detection risk forms the residual risk after taking into consideration the inherent and control risks pertaining to the audit engagement and the overall audit risk that the auditor is willing to accept.
Where the auditor's assessment of inherent and control risk is high, the detection risk is set at a lower level to keep the audit risk at an acceptable level. Lower detection risk may be achieved by increasing the sample size for audit testing. Conversely, where the auditor believes the inherent and control risks of an engagement to be low, detection risk is allowed to be set at a relatively higher level.
It is a very good question; there is a big difference between Business Risk and Audit risk.
However Audit risk is very limited but failure of NOT addressing the other risks appropriately put business at bigger regulatory and financial issues.
Audit risk has traditionally been defined as risk that an auditor will make wrong or misleading assessments. By following a systematic approach and practicing in accordance with the International Standards for the Professional Practice of Internal Auditing, published by the IIA, auditors can reduce such risk by following risk based approach in their audit function.
audit risk also includes the risk that internal audit is working on the wrong projects and/or completing its work in an inappropriate manner.
The risk that an auditor will not discover errors or intentional miscalculations (i.e. fraud) while reviewing a company's or individual's financial statements. There are two general categories of audit risk – risk regarding assessment of the financial materials and risk regarding the assertions produced by evaluation of the financial materials. Companies request an audit in order to provide confidence to investors that their financial statements and reporting are accurate. In order to insure against potential litigation arising from missed financial improprieties, such as material misstatements, auditors will typically carry malpractice insurance.
Audit risk is a risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
Audit risk is made up from inherent risk, control risk and detection risk
which of the following is not generally considered a catagory of audit risk