4 years ago · 3 min read Show
Why assess audit risk? So you don’t get lost in the woodsWhy assess audit risk? So you don’t get lost in the woods Picture this: You’ve finally made it through busy season. You’ve booked a family trip to a remote cabin in the mountains to unplug and relax. Your out-of-office message has been turned on and you’ve planned plenty of outdoorsy activities for you and your family. You’ve written out a packing list and checked off every item: Clothes? Check. Hiking boots? Check. Bug spray? Check. Snacks and entertainment to ward off your kids’ boredom- and hunger-related complaints during the long car ride? Check. The car’s all packed, everyone’s buckled in and your GPS is set up on the dashboard. Now that you’re ready to embark on a journey to the middle of nowhere, you reach for your GPS… …and throw it out the window. Probably not the best way to get where you need to go, right? Even if you’re too proud to ask for directions when you’re on a road trip, when planning your audit, it should be a different story. Why does risk assessment matter?The goals of identifying, assessing and responding to risk are at the core of every audit. Identifying and assessing a client’s specific risks drives the audit procedures you should perform and helps you avoid inefficient over-auditing. Even more seriously, this process helps you avoid a failure to obtain sufficient appropriate audit evidence to support your opinion. Put plainly: Risk assessment is crucial for a quality audit. However, data collected by the AICPA Peer Review Program in 2016 show that many firms need to improve compliance with AU-C Section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement or AU-C Section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained. Many auditors believe they can perform a quality audit without properly considering their client’s risks of material misstatement, but that’s simply not true – and it’s leading to violations of professional standards. The audit risk modelTo understand why risk assessment is so important, we must start with the audit risk model, displayed below: Audit risk is the risk that the firm will issue the wrong audit opinion when the financial statements are materially misstated. Our objective as auditors is to reduce audit risk to an acceptably low level. Audit risk is composed of:
Inherent and control risk combine to form the risk of material misstatement, or RMM. These risks exist independent of the auditor and cannot be reduced through substantive procedures. So, if RMM is moderate or high, how do we reduce audit risk to an acceptably low level? We do this by manipulating the only risk that we can control: detection risk. Detection risk is influenced by the nature, timing and extent of your audit procedures. For example, if you wanted to reduce detection risk, you might:
Without first properly assessing inherent and control risk, you would have no basis for assessing detection risk and no way to plan the nature, timing and extent of your procedures. You might as well be throwing darts blindfolded – or driving aimlessly through the mountains with no map or GPS. Regardless of the amount of testing you perform, if you don’t identify and assess your client’s specific risks, you’ll fail to comply with Generally Accepted Auditing Standards (GAAS). The result will be what the Peer Review Program calls a “materially non-conforming engagement.” Peer reviewers are in the process of being retrained on this concept. That means even if your reviewer took a different stance in the past, going forward, engagements that are not built around identifying, assessing and responding to the client’s risks will be considered non-conforming. Resources to helpKeep an eye out for future blog posts in which we’ll discuss risk assessment and response in further detail. Additionally, the AICPA has a free toolkit at aicpa.org/riskassessment to help you perform more effective risk assessments, appropriately link your risk assessments to your audit procedures and comply with the standards. The toolkit includes resources such as an audit risk assessment tool with accompanying video guides, a staff training workshop, an internal inspection aid and an aid for identifying controls at smaller entities. Proper risk assessment drives your audit procedures, so it’s crucial to get it right. And when you’re literally driving on your next road trip, don’t toss your GPS out the window when you leave. Audit risk is a type of risk that applies to any company. The purpose of an audit is to provide assurance that the financial statements are free from material misstatement, whether due to fraud or error. It doesn’t matter if you’re trying to get a loan, raise capital for your business, sell shares to investors, or even if you’re just trying to figure out where all your money is going – understanding audit risk will help you take appropriate steps in order to mitigate the risk. Auditors typically use substantive tests and analytical procedures when performing audits. These approaches can be applied separately or together. It all depends on the circumstances, the auditor’s judgment as well as what information they have about a company before beginning their work. In both cases, the auditor’s goal is to judge whether accounts give a reasonable view of the organization’s financial status. This will be doubly important when performing a sustainability audit. Why is audit risk important?Audit risk is important because it’s one of the factors that determines the level of assurance that can be provided with an audit. The higher the level of audit risk, the lower the level of assurance we can give. This is why it’s so important to understand the different types of audit risk and how they can affect your company.
So, why does audit risk matter?In a word: money. Whether you’re a small business or a multinational conglomerate, material misstatement in your financial statements can have a big impact on your bottom line – and that’s not good news for anyone. And if you’re trying to raise money by selling shares or issuing debt, a poor audit report can make it very difficult to do so. In short, understanding audit risk is essential for anyone who wants to make informed decisions about their business. By knowing what risks are out there and what you can do to mitigate them, you can help ensure that your company stays financially healthy – no matter what the economy throws at it. What are the 3 types of audit risk?In auditing, there are three primary types of risk: inherent risk, control risk, and detection risk. With inherent risk, we assume that there will always be an inherent possibility of material misstatement, whether due to fraud or error. Control risk is the chance that a control doesn’t work effectively and thereby fails to prevent or detect a material misstatement on a timely basis. Detection risk is the likelihood that when there’s a material misstatement in the financial statements, it will not be detected in a timely manner. How can a company reduce the “Detail” type of audit risk?The detail type of audit risk is the risk that results from a lack of sufficient evidence to support the mathematical accuracy and correctness of transactions recorded in a company’s accounts. This type of audit risk can be reduced by ensuring that there is enough detail to account for every transaction, inflows and outflows. For example, a business could ensure all their revenue comes from customers by obtaining a credit report on every customer to ensure they are not buying products or services from an unknown source. If a company can’t obtain sufficient detail about the source of their revenue, there is a higher likelihood that there may be missing transactions in their accounts which could lead to misstatements.
How can a company reduce “Materiality” type of audit risk?The materiality type of audit risk is the risk that a misstatement in financial statements, either due to fraud or error, will be large enough to influence a company’s decision-makers. This type of audit risk can be reduced by ensuring that all transactions are properly recorded and classified in the financial (Comptroller) statements. For example, a business could ensure that all expenses are categorized correctly so that there is a clear understanding of how much money the company is spending in each category. If a company can’t ensure that their transactions are recorded and classified correctly, there is a higher likelihood that there may be large misstatements in their financial statements. What is meant by inherent risk?Let’s break it down. Inherent risk is the “default” level of risk in an audit, often referred to as a firm’s acceptable level of risk. Inherent risk is high when the company being audited has unreliable financial data or operates in a volatile industry with a lot of operational or accounting uncertainties. It is generally accepted that there will be some material misstatement in financial statements given the existence of inherent risk. Why does inherent risk exist?Inherent risk exists because there are too many interrelated variables in financial information to make it completely accurate. For example, the failure of a customer to pay an invoice on time or an executive making poor business decisions can cause material misstatements in an audited entity’s financial statements. What is a control risk?A control risk is the risk that a control does not work effectively and thereby fails to prevent or detect a material misstatement on a timely basis. The design of controls, their operational effectiveness, and the business processes they support are all considered when assessing risk by auditors.Controls might be as basic as a locked door or as sophisticated as an automated system that checks transactions for conformity with corporate standards. A good example of a control risk is the embezzlement of cash by a bookkeeper. If the company has a good control in place, such as reconciling bank statements to the general ledger on a regular basis, then the risk of this type of fraud is reduced. What is a detection risk?Detection risk is the likelihood that when there’s a material misstatement in the financial statements, it will not be detected in a timely manner. Detection risk is also known as “auditor’s risk” because it’s the primary concern for auditors. Detection risk is influenced by the effectiveness of controls designed to prevent or detect material misstatements. Detection risk has a direct impact on materiality, which influences the extent of audit evidence required to achieve an acceptable level of assurance regarding the financial statements. 5 examples of detection risk?
What are the 5 main risk types that face businesses?The five main types of risk that businesses face are Strategic Risk, Compliance Risk, Operational Risk, Financial Risk and Reputational Risk. Each of these types of risks are important to understand because they can impact your business. Sometimes these risks intersect or happen simultaneously, so it’s necessary to learn about them all to ensure that you protect the success of your company. Caveats and disclaimersAt ESG | The Report, we believe that we can help make the world a more sustainable place through the power of education. We have covered many topics in this article and want to be clear that any reference to, or mention of audit risk vs detection risk, risk of material misstatement vs risk assessment, sufficient appropriate audit evidence from audit procedures, audit risk model, financial statement assertion regarding reasonable assurance, financial statement assertions, a control risk assessment or the mention of perform risk assessment, audited financial statements and the financial statement level, statements are materially misstated, accounting principles and/or procedures performed to detect material misstatements, or the client’s internal control, to obtain evidence, misstatement and substantive testing of a client’s business, the planning stage, incorrect opinion or overall risk assertion level in the context of this article is purely for informational purposes and not to be misconstrued as investment or any other legal advice or an endorsement of any particular company or service. Neither ESG | The Report, it’s contributors or their respective companies or any of its members gives any warranty with respect to the information herein, and shall have no responsibility for any decisions made, or action taken or not taken which relates to matters covered by ESG | The Report. Thank you for reading, and we hope that you found this article useful in your quest to understand ESG and sustainable business practices. We look forward to living in a sustainable world. |
Why is control risk important in auditing?
Pos Terkait
Copyright © 2024 ketajaman Inc.
