Audit Risk

What Is Audit Risk?

Audit risk is the risk that financial statements are materially wrong, even however the audit assessment states that the financial reports are free of any material misstatements.

Understanding Audit Risk

The purpose of a audit is to reduce the audit risk to a suitably low level through adequate testing and adequate evidence. Since creditors, investors, and different stakeholders depend on the financial statements, audit risk might carry legal liability for a certified public accountancy (CPA) firm performing audit work.

Throughout an audit, a auditor makes requests and performs tests on the overall ledger and supporting documentation. Assuming any errors are discovered during the testing, the auditor demands that management propose adjusting journal passages.

At the finish of an audit, after any rectifications are posted, an auditor gives a written assessment with respect to whether the financial statements are free of material misstatement. Auditing firms carry malpractice insurance to oversee audit risk and the expected legal liability.

Types of Audit Risk

The two parts of audit risk are the risk of material misstatement and detection risk. Expect, for instance, that a large outdoor supplies store needs an audit performed, and that a CPA firm is evaluating the risk of auditing the store's inventory.

Risk of Material Misstatement

Material misstatement risk is the risk that the financial reports are materially mistaken before the audit is performed. In this case, "material" alludes to a dollar amount that is sufficiently large to change the assessment of a financial statement reader, and the percentage or dollar amount is subjective. Assuming the outdoor supplies store's inventory balance of $1 million is wrong by $100,000, a stakeholder perusing the financial statements might look at that as a material amount. The risk of material misstatement is even higher on the off chance that there is accepted to be inadequate internal controls, which is likewise a fraud risk.

Detection Risk

Detection risk is the risk that the auditor's procedures don't recognize a material misstatement. For instance, an auditor needs to perform a physical count of inventory and compare the outcomes to the accounting records. This work is performed to demonstrate the presence of inventory. Assuming that the auditor's test sample for the inventory count is inadequate to extrapolate out to the whole inventory, the detection risk is higher.

Features

• Audit risk might carry legal liability for a certified public accountancy (CPA) firm performing audit work.
• Audit risk is the risk that financial statements are materially wrong, even however the audit assessment states that the financial reports are free of any material misstatements.
• The two parts of audit risk are risk of material misstatement and detection risk.
• Auditing firms carry malpractice insurance to oversee audit risk and the likely legal liability.