Audit Risk – Factors Affecting Audit Risk and Beyond
Keywords – Audit Risk – Factors Affecting Audit Risk – Residual Risk
Financial statements often carry certain errors. The extent of such material errors is classified as audit risk.
In other words, audit risk is the acceptance that audits may contain some errors even after being reviewed and approved by an auditor.
With the tightening of business regulations, auditing practices have been forced to adapt too.
Applying an audit risk model then allows auditors to comply by the rules, while also remaining flexible enough to carry on with the business and use parameters that have been in use already.
In addition, with a careful application of audit risk, you can not only calculate your overall risk, but also modify it to keep specific factors in check.
It is also important to specify that audit risk only calculates risk related to auditing. Therefore, audit risk should not be synonymised with business risk as a whole. We will discuss business risk, and other specific forms of business risk, in coming blogs.
Audit risk is generally comprised of three main errors:
- Detection – that a calculation or statement error was not accounted for.
- Control – that the auditing mistakes have crossed control.
- Material or Inherent – that the statements were declared misstated deliberately.
The overall audit risk is calculated as a product of the three individual errors, i.e.
Audit Risk = Detection Risk x Control Risk x Material Risk
The specifics of each error are calculated or interpreted by an auditor.
For example, after reviewing the financial statements, the auditor may conclude that the material error is 50%, along with a 20% control error.
At that point, depending on the industry; specifically competitiveness and scale of a business for instance; the overall acceptable risk is stated. The acceptable audit risk percentage lowers as a sector gets more competitive and scaled.
For example, if an acceptable audit risk for your business is 5%; the acceptable detection risk is:
50% x 20% x DR = 5%
=> DR = 5% / (50% x 20%)
=> DR = 50%
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And, if you would like to look into other blogs that tackle auditing, you may also like: