Definition
Audit risk is the risk that auditors might issue a clean audit report when financial statement are materially misstated.
The material misstatement in the financial statement is expected to misguide users of the financial statement. So, audit risk is the expected failure of the auditor to perform audit and obtain sufficient & appropriate audit evidence. Audit risk is also called the risk of material misstatement.
Audit risk assessment
Audit risk can be assessed from the following three most relevant sources.
- Business understanding of audit client.
- Internal control understanding.
- Understanding applicable accounting framework and related provisions.
Business understanding leads to identifying industry-related regulation, norms, framework, reporting structure, competition, market size, market share, and other important factors. The auditors can understand the business by inquiring management, studying the current market, studying competitor financial statement, and market journals etc.
Internal control understanding is obtained by performing a test of control and walkthrough testing. So, if there is some major deficiency in the internal control leading to misstatement, the level of assurance required can be increased.
Understanding the applicable accounting framework is a strength of the auditor. They need to ensure correct accounting treatment for transactions. So, the reported figures in the financial statement stand true and fair.
Depending on the risk, auditors design audit procedures. So, if the assessed risk of material misstatement is higher, the auditor needs to plan extensive audit procedures. On the other hand, if the assessed risk of material misstatement is low, the auditors can plan limited audit procedures.
Also read, Tracing and vouching
Further, it should be noted that auditors can issue clean audit reports when they have sufficient and appropriate audit evidence to cover assessed risk of material misstatement. Otherwise, the audit report needs to be revised.
Conclusion
Audit risk is the risk that an auditor might issue a clean audit report when there is a material misstatement in the financial statement. The audit risk can be assessed by understanding the business, understanding applied internal controls, and ensuring correct accounting treatment is applied.
To issue a clean audit report, auditors need to ensure they have covered the risk of a material misstatement by applying audit procedures and collecting audit evidence.
