What is audit risk? Audit risk assessment

Audit risk components

Risk of material misstatement

Material misstatement risk refers to the possibility that the financial statements prepared by the auditee contain material misstatements. This risk is related to the auditee and not to the auditor, but the auditor needs to assess the level of this risk.

The risks of material misstatement can be categorized into:

• Inherent risk: The risk of misstatement that occurs when there is no internal control, such as the risk that an accountant records $200 as $2 million.

• Control risk: The possibility that internal control fails to prevent, detect and correct material misstatements in a timely manner, such as the risk that an accountant records 200 yuan as 2 million yuan and the accounting supervisor fails to discover and correct it immediately.

The risk of material misstatement can also be divided into:

• Risk of material misstatement at the financial statement level: This risk is related to the financial statements as a whole and may affect multiple assertions, such as the risk of management fraud;

• Risk of material misstatement at the recognition level: This risk is only associated with a single transaction, account balance or presentation recognition.

Check the risks

Detection risk refers to the risk that the auditor will fail to discover a material misstatement in the financial statements when performing substantive testing. This risk is only related to the auditor's work and depends on the rationality of the design of the audit procedures and the effectiveness of their implementation. Auditors can reduce detection risk through audit work, but it is impossible to reduce detection risk to zero. Auditors do not need to assess this risk, but they need to decide on an acceptable detection risk.

Acceptable audit risk

Acceptable audit risk refers to the risk that the auditor can accept that there are material misstatements in the financial statements and that the auditor issues an inappropriate audit opinion. This risk level is determined subjectively by the auditor based on his or her own risk tolerance. If the auditor decides to accept a lower audit risk, it will cost more to provide more assurance that there are no material misstatements in the financial statements.

Audit risk model

The mathematical model of audit risk is:

or:

The auditor calculates the acceptable detection risk based on the acceptable audit risk and the assessed risk of material misstatement and designs the nature, timing and extent of audit procedures accordingly.