Audit Risk

Summary

This video explains the concept of audit risk, which refers to the risk that an auditor gives an inappropriate opinion on financial statements that contain material misstatements. The video breaks down audit risk into three components: inherent risk, control risk, and detection risk. It discusses how these risks interact, with inherent and control risks being independent of the auditor, while detection risk is dependent on the audit procedures. The video highlights the inverse relationship between financial statement risk and detection risk and elaborates on how auditors use this to plan audit procedures and gather sufficient evidence to ensure accurate audit outcomes.

Takeaways

• 😀 Audit risk refers to the possibility that an auditor expresses an inappropriate opinion on financial statements that contain material misstatements.
• 😀 The three main components of audit risk are Inherent Risk, Control Risk, and Detection Risk.
• 😀 Inherent Risk is the susceptibility of an account or transaction to misstatements, assuming there are no controls in place.
• 😀 Control Risk is the risk that internal controls fail to prevent or detect material misstatements in a timely manner.
• 😀 Detection Risk is the risk that audit procedures fail to detect material misstatements in the financial statements.
• 😀 Audit risk is calculated by multiplying Inherent Risk, Control Risk, and Detection Risk.
• 😀 The combined level of Inherent Risk and Control Risk is also known as financial statement risk.
• 😀 There is an inverse relationship between financial statement risk and detection risk—if financial statement risk is high, detection risk should be low, and vice versa.
• 😀 The auditor sets acceptable levels of detection risk based on assessments of Inherent and Control Risks.
• 😀 After applying controls and audit procedures, the remaining undetected errors are referred to as audit risk.
• 😀 Audit procedures are designed to provide reasonable assurance that financial statements are free from material misstatements, reducing residual audit risk.

Q & A

What is audit risk?

Audit risk is the risk that an auditor expresses an inappropriate audit opinion on financial statements that contain material misstatements. It is the risk that the auditor fails to give an appropriate opinion during an audit assignment.

What are the components of audit risk?

The components of audit risk are inherent risk, control risk, and detection risk. The combined level of inherent risk and control risk is referred to as financial statement risk.

How is audit risk mathematically calculated?

Audit risk is calculated as the product of inherent risk, control risk, and detection risk. Mathematically, audit risk equals inherent risk multiplied by control risk multiplied by detection risk.

How are audit risk and detection risk related?

Audit risk and detection risk are related to the auditor and depend on the audit procedures applied. Detection risk refers to the risk that the auditor's procedures fail to detect material misstatements.

What is inherent risk?

Inherent risk is the susceptibility of an account balance or class of transactions to material misstatement, assuming no internal controls are in place.

What is control risk?

Control risk is the risk that material misstatements, either individually or when aggregated, will not be prevented or detected in a timely manner by the entity's internal control system.

What is detection risk?

Detection risk is the risk that the auditor’s substantive procedures will fail to detect a material misstatement that exists in the financial statements.

How do inherent risk and control risk relate to financial statement risk?

Inherent risk and control risk are collectively known as financial statement risk, which represents the risk that material misstatements exist in the financial statements before applying audit procedures.

How does the relationship between financial statement risk and detection risk work?

There is an inverse relationship between financial statement risk and detection risk. When financial statement risk is high, auditors should plan for a lower acceptable level of detection risk. Conversely, when financial statement risk is low, a higher level of detection risk can be accepted.

What is the effect of high inherent risk and high control risk on detection risk?

If there is high inherent risk and high control risk, the auditor should maintain the lowest acceptable level of detection risk to reduce the overall audit risk to an acceptable level.

What does the term 'sufficient appropriate audit evidence' refer to?

Sufficient appropriate audit evidence refers to the amount and quality of audit evidence required to support the auditor’s opinion, which depends on the assessment of financial statement risk and planned detection risk.