AA - Planning & risk assessment

Audit Risk

TERMINOLOGY USED:

Audit risk is the risk of the auditor giving an inappropriate opinion on the financial statements, i.e. there are
material misstatements present in the financial statements.

Misstatement is:

1) a difference between the amount, classification, presentation or disclosure of a reported financial statement
item; and the amount, classification, presentation or disclosure that is required for the item to be in
accordance with the applicable financial reporting framework (ISA 450);
2) the difference between what is in the financial statements and what should be in the financial statements in
accordance with the applicable financial reporting framework.

Note: Material misstatement not identified by the auditor leads to incorrect decisions made by users and affects
the auditor’s reputation.

AUDIT RISK MODEL:

In order to calculate audit risk, the auditors use the audit risk model: AR=IR*CR*DR, where:
AR - Audit risk;
IR - Inherent risk - is the risk of a material misstatement in the financial statements due to the nature of the
client, whether it be the business itself or the industry which they operate within;
CR - Control risk - is the risk of a material misstatement in the financial statements due to poor client controls;
DR - Detection risk - is the risk of a material misstatement in the financial statements due to the auditor not
spotting the error.
Note: Inherent risk and Control risk cannot be changed, but must be identified to decide what should be the level
of Detection risk.
If Inherent risk and Control risk are high, then Detection risk must be low, meaning that:
- More audit procedures would be needed;
- More time should be spent on the audit;
- Sample sizes should be increased;
- More experienced audit staff should be used.

If Inherent risk and Control risk are low, then Detection risk can be high, meaning that:
- Smaller samples of transactions can be tested;
- Less time will be spent on the audit.

If audit risk is assessed correctly, the audit opinion will be appropriate at the end of the process.