Audit Risk
Define risk in auditing.
AUDIT RISK MODEL
AUDIT RISK = INHERENT RISK x CONTROL RISK x DETEECTION RISK
AR = IR x CR x DR
DR = AR/ (IR x
CR)
Risk
Auditors accept some level of risk
in performing the audit.
An effective auditor recognizes that
risks exist, are difficult to measure,
and require careful thought to respond.
Responding to risks properly is critical
to achieving a high-quality audit.
Risk and Evidence
Auditors gain an understanding of the
client’s business and industry and
assess client business risk.
Auditors use the audit risk model to further
identify the potential for misstatements
and where they are most likely to occur.
Illustration of Differing
Evidence Among Cycles
Sales and Acquisition Payroll and
collection and payment personnel
cycle cycle cycle
Inherent
A Medium High Low
risk
Control
B Medium Low Low
risk
Acceptable
C Low Low Low
audit risk
Planned
D Medium Medium High
detection risk
Illustration of Differing
Evidence Among Cycles
Inventory and Capital acquisition
warehousing and repayment
cycle cycle
Inherent
A High Low
risk
Control
B High Medium
risk
Acceptable
C Low Low
audit risk
Planned
D Low Medium
detection risk
Describe the audit risk model
and its components.
Audit Risk Model for Planning
PDR = AAR ÷ (IR × CR)
where: PDR = Planned detection risk
AAR = Acceptable audit risk
IR = Inherent risk
CR = Control risk
Consider the impact of
engagement risk on
acceptable audit risk.
Impact of Engagement Risk on
Acceptable Audit Risk
Auditors decide engagement risk and use
that risk to modify acceptable audit risk.
Engagement risk closely relates to client
business risk.
Factors Affecting Acceptable
Audit Risk
The degree to which external users
rely on the statements
The likelihood that a client will have
financial difficulties after the
audit report is issued
The auditor’s evaluation of
management’s integrity
Methods Practitioners Use to
Assess Acceptable Audit Risk
Methods Used to Assess
Factors Acceptable Audit Risk
External users’ Examine financial statements
reliance on Read minutes of the board
financial Examine form 10K
statements Discuss financing plans
with management
Methods Practitioners Use to
Assess Acceptable Audit Risk
Methods Used to Assess
Factors Acceptable Audit Risk
Likelihood Analyze financial statements
of financial for difficulties using ratios
difficulties Examine inflows and outflows
of cash flow statements
Management See Chapter 8 for client
integrity acceptance and continuance
Consider the impact of several
factors on the assessment
of inherent risk.
Factors Affecting Inherent Risk
Nature of the client’s business
Results of previous audits
Initial versus repeat engagement
Related parties
Nonroutine transactions
Judgment required to correctly record
account balances and transactions
Makeup of the population
Factors related to fraudulent financial reporting
Factors related to misappropriation of assets
Discuss the relationship of
risks to audit evidence.
Relationship of Factors Influencing
Risks to Risks and Risks to
Planned Evidence
Acceptable audit risk
D D I
Factors I Planned I Planned
Inherent
influencing detection audit
risk
risks risk evidence
I D
Control risk
D = Direct relationship; I = Inverse relationship
Relationship of Factors Influencing
Risks to Risks and Risks to
Planned Evidence
Auditors can change the audit
to respond to risks
The engagement may require
more experienced staff
The engagement will be reviewed
more carefully than usual
Audit Risk for Segments
Both control risk and inherent risk are
typically set for each cycle, each
account, and often even each audit
objective, not for the overall audit.
Tolerable Misstatement, Risks,
and Balance-related Audit
Objectives
It is common to assess inherent and control
risk for each balance-related audit objective
It is not common to allocate materiality
to objectives
Measurement Limitations
One major limitation in the application of the
audit risk model is the difficulty of measuring
the components of the model.
Relationships of Risk to
Evidence
Planned Amount of
Acceptable Inherent Control detection evidence
Situation audit risk risk risk risk required
1 High Low Low High Low
2 Low Low Low Medium Medium
3 Low High High Low High
4 Medium Medium Medium Medium Medium
5 High Low Medium Medium Medium
Tests of Details of Balances
Evidence Planning Worksheet
Auditors develop various types of worksheets
to aid in relating the considerations affecting
audit evidence to the appropriate
evidence to accumulate.
Discuss how materiality and risk
are related and integrated into
the audit process.
Relationship of Tolerable
Misstatement and Risks to
Planned Evidence
Acceptable
audit risk D D I
Planned I Planned
Inherent detection risk audit evidence
risk I
I D I
Control
risk
Tolerable
misstatement
D = Direct relationship; I = Inverse relationship
Audit Risk Model for Planning
AcAR = IR × CR × AcDR
where: AcAR = Achieved audit risk
IR = Inherent risk
CR = Control risk
AcDR = Achieved detection risk
Audit Risk Models for Planning
Evidence and Evaluating Results
D Inherent
Acceptable Achieved risk
Compare
audit audit
risk risk
D Control
risk
Substantive Achieved
audit D detection
evidence risk
D = Direct relationship
I = Inverse relationship I
Revising Risks and Evidence
The auditor must revise the original
assessment of the appropriate risk.
The auditor should consider the effect
of the revision on evidence requirements,
without the use of the audit risk model.
End of Chapter 9