What is audit risk?
Even though the audit opinion indicates no substantial misstatements in the financial reports, audit risk is the possibility that the financial statements are materially inaccurate.
Recognizing Audit Risk
An audit aims to lower audit risk to a suitable level by using sufficient evidence and proper testing. Creditors, investors, and other interested parties rely on the financial statements, so audit risk could put a certified public accounting (CPA) firm that does audit work at risk of being sued. An auditor investigates and tests the general ledger and accompanying paperwork during the audit process. The auditor asks management to suggest correcting journal entries if any inaccuracies are discovered during testing.
Following the posting of any corrections, an auditor issues a written opinion at the end of the audit stating whether or not there are any severe misstatements in the financial statements. Auditing companies carry practical malpractice insurance to control audit risk and possible legal responsibility.
Forms of Risk in Audits
The risk of a substantial misstatement and the risk of discovery are the two parts of audit risk. Consider the following scenario: a CPA company is evaluating the risk of auditing the inventory of a big sports goods business, and the store requires an audit.
The Danger of Serious Misrepresentation
The possibility that the financial reports are significantly inaccurate before the audit is carried out is known as the significant misstatement risk. The term “material” in this context refers to a sum of money that is significant enough to influence a reader of a financial statement; the precise percentage or sum of money is arbitrary. A shareholder reviewing the financial accounts may view a $100,000 error in the sports goods store’s inventory balance as a significant amount. If inadequate internal controls are thought to exist, there is an increased chance of considerable misrepresentation, which is also a risk of fraud.
Risk Detection
The danger that a significant misrepresentation may go undiscovered by the auditor’s processes is known as the detection risk. As an illustration, an auditor must physically count the inventory and compare the results to the accounting documents. The purpose of this effort is to demonstrate that inventory exists. The detection risk is increased if the auditor’s test sample for the inventory count is too small to extrapolate to the complete inventory.
Conclusion
- Even though the audit opinion indicates no substantial misstatements in the financial reports, audit risk is the possibility that the financial statements are materially inaccurate.
- A certified public accounting (CPA) company conducting audit services may be legally liable for audit risk.
- Auditing companies carry practical malpractice insurance to control audit risk and possible legal responsibility.
- The risk of a substantial misstatement and the risk of discovery are the two parts of audit risk.
