Audit Risk Model (Audit, Inherent, Control & Detection Risks)

Summary

In this educational video, CPA expert Savant from the CPA Recipe channel delves into the audit risk model, explaining how auditors provide a reasonable level of assurance, which is less than 100%. He discusses the components of audit risk, including inherent risk, control risk, and detection risk, and how they contribute to the overall audit strategy. Savant uses the audit risk model formula to illustrate how auditors aim to minimize risk to an acceptable level, ensuring the financial statements are materially correct and reducing the chance of issuing an incorrect opinion.

Takeaways

• 😀 The video discusses the audit risk model, which is crucial for understanding how auditors approach financial statement audits.
• 🔍 The speaker, a certified public accountant and former auditor, emphasizes the importance of minimizing audit risk to an acceptable level.
• 📊 Audit risk is defined as the risk that an auditor may issue an incorrect opinion on the financial statements.
• 📈 The audit risk model is represented by the formula: Audit Risk = Risk of Material Misstatement (Inherent Risk x Control Risk) x Detection Risk.
• 📋 Inherent risk is the susceptibility of financial statements to material misstatement due to factors like the nature of the business and accounting treatments.
• 🛡️ Control risk is the risk that material misstatements will not be prevented or detected by the entity's internal controls.
• 🔎 Detection risk is the risk that the auditor's procedures will not detect material misstatements that exist in the financial statements.
• 🔑 The auditor's objective is to express an opinion with a minimal risk of being wrong, aligning with the acceptable audit risk level.
• 🔍 The video explains that auditors use professional judgment to assess inherent and control risks, which are influenced by the client's business environment and internal controls.
• 📝 The speaker provides examples of how to assess risk components, such as revenue recognition and complex accounting measurements like pension liabilities.
• 🎯 The video concludes with a focus on the overall audit strategy, which involves determining the nature, timing, and extent of audit procedures to achieve the desired level of assurance.

Q & A

What is the main topic discussed in the video?

The main topic discussed in the video is the audit risk model, which is a framework used by auditors to assess and minimize the risk of providing an incorrect opinion on financial statements.

Who is the presenter of the video?

The presenter of the video is Savant from the CPA Recipe, a certified public accountant and former external auditor.

What does the acronym 'CPA' stand for?

CPA stands for Certified Public Accountant, a professional credential for accountants who have met certain qualifications and passed a rigorous examination.

What is the level of assurance an auditor provides during an audit?

An auditor provides a reasonable level of assurance, which is less than absolute or less than 100 percent. This means there is always some degree of risk that the financial statements might be materially misstated.

What is the significance of the phrase 'legend wait for it dairy' used in the video?

The phrase 'legend wait for it dairy' is used as a humorous and catchy way to engage the audience and create a memorable moment in the video. It does not have a direct relation to the content of the audit risk model discussion.

What are the three factors affecting audit risk according to the audit risk model?

The three factors affecting audit risk are the risk of material misstatement (Inherent Risk and Control Risk) and Detection Risk. These factors are used in the formula: Audit Risk = Inherent Risk x Control Risk x Detection Risk.

What is meant by 'Inherent Risk' in the context of the audit risk model?

Inherent Risk refers to the susceptibility of an account or financial statement to material misstatement due to factors such as the nature of the account, the complexity of the accounting treatments, and the volume of transactions.

How is 'Control Risk' defined in the audit risk model?

Control Risk is the risk that a material misstatement that could occur in a financial statement will not be prevented or detected on a timely basis by the entity's internal controls.

What is 'Detection Risk' and how does it relate to the audit process?

Detection Risk is the risk that the auditor's procedures will not detect a material misstatement in the financial statements. It is influenced by the nature, timing, and extent of the audit procedures performed by the auditor.

Why is it important for auditors to minimize audit risk?

Minimizing audit risk is important because it helps to ensure the credibility and reliability of the audit opinion. Reducing audit risk to an acceptable level minimizes the chances of issuing an incorrect opinion, which could damage the auditor's reputation and potentially lead to legal consequences.

How does an auditor determine the overall audit strategy to reduce audit risk?

An auditor determines the overall audit strategy by assessing the inherent risk, control risk, and planning the nature, timing, and extent of the audit procedures to address the detection risk. This involves professional judgment and may include analyzing financial trends, performing tests of controls, and conducting substantive testing.