Auditing risks refer to the probability that the auditor may issue an unqualified report due to materially incorrect financial statements. It may come from two different sources: Clients and Auditors themselves. There are three types of audit risks, namely inherent risks, control Risks, and detection risks. All of these three risks are discussed below:
A business cannot control the inherent risk as it may occur due to the complex nature of business or transaction. This type of risk represents a worst-case scenario because the company cannot control it anyhow.
Firms operating in highly regulated sectors are more susceptible to higher inherent risks, especially when they do not have an audit department. The ultimate risk also depends on the financial exposure created by the inherent risk. For instance, if a firm releases forward-looking financial statements, either to internal investors or the public as a whole, this may increase the chances of inherent risk. These forward statements may include information on future funds from operations, expected debt levels, capital spending, and the annual increase in prices of the product.
Control risks are those audit risks that cannot be detected by the auditing department. Basically, it occurs when the auditing department is not efficient enough to safeguard against significant errors or misstatements in the financial statements. Apart from this, when the internal control is weak, the chances are that financial statements might be misstated, and auditors could not detect those misstatements.
There are certain ways that auditors can use to minimize the control risks that result from poor internal control. Most importantly, they should carry proper risk assessment at the planning stage. This would help them understand not only the nature of the business but also internal control activities that link to financial reporting.
Mostly, COSO (Committee of Sponsoring Organizations of the Treadway Commission) frameworks are used by most audit firms to assess internal controls.
Detection risks state the situation when auditor fails to detect the material misstatement in the financial statements and then issues an incorrect opinion to the audited financial statements. This type of audit risk may be caused due to improper audit planning, poor engagement management, low competency, wrong audit methodology, and lack of understanding of audit client. Unlike inherent risks, detection risks occur because of auditor rather than the client. And, the most common reason behind them is improper audit planning. To minimize detection risks, auditors should set right audit strategy and employ right audit approach.
Audit risk is fundamental to the audit process. A good understanding of the business operation, nature of the business, and the complexity of client’s financial statements can help auditors to mitigate these risks. Most auditors use a risk-based approach in order to minimize the chance of giving an inappropriate audit opinion.
Accountancy students are required to have a good understanding of what audit risk is, and why it is so important. For the exam purpose, it is important to understand that audit risk is a very practical topic and is therefore examined in an applied context. If you are facing problems in understanding the typical concepts of auditing that are required to solve the assignment questions, then seek help from auditing assignment help experts working with Instant Assignment Help.