Audit risks

an inappropriate audit opinion

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.

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.

Material
Misstatement Through Understanding the Entity and its Environment
states:
'The objective of

the auditor is to identify and assess the risk of
material misstatement, whether due to fraud or error, at the financial
statement and assertion levels, through understanding the entity and
its environment, including the entity's internal control, thereby
providing a basis for designing and implementing responses to the
assessed risks of material misstatement.'

statements are materially misstated prior to audit and consists of

two components, inherent risk and control risk.

a class of transaction, account balance or disclosure to misstatement

that could be material, before consideration of any related controls.

the industry;

limitless, however, here are a few examples:
The car industry is

one of the first industries to suffer during an economic downturn due to the reluctance of the population to spend money or take out loans that they may struggle to pay back. For this reason, we could say that the car industry is inherently risky.
Financial institutions deal with complex financial instruments such as derivatives. These instruments can be incredibly difficult to account for and value and so are inherently risky.

industry where trends and tastes change rapidly. For companies such

as these, sales and inventory balances are inherently risky.
A company is heavily financed by debt. This is inherently risky as missed interest payments and repayments may lead to insolvency.
A company operates a profit related bonus scheme. Its profit figures are inherently risky as there is the incentive to management to manipulate them to achieve the bonus targets.

Examples of inherent risks

could occur and that could be material will not be

prevented, or detected and corrected on a timely basis by the entity's internal controls.

Could be higher or lower

performed by the auditor to reduce audit risk to an

acceptably low level will not detect a misstatement that exists and that could be material.

Detection risk comprises:
Sampling risk
Non-sampling risk

areas
increasing supervision levels
increasing the element of unpredictability in sample selection
changing

the nature, timing and extent of procedures
increasing the emphasis on substantive tests of detail
emphasising the need for professional scepticism.

is highly exposed to the economic climate, uses lots of

complex treasury
instruments such as interest rate swaps and futures and has a very poor system of internal controls

BakeMake Inc operates in a low risk industry, has few complex transactions and a highly sophisticated system of internal
controls.

only way we can bring audit risk down to an

acceptably low level is to lower detection risk. This means that the risk of the auditors not finding a misstatement needs to be low.
In practice this means that the auditors need to do more work:
less reliance on controls and more substantive testing;
larger sample sizes;
more experienced auditors.

risk can afford to be high. Be careful, however, as

this is a theoretical concept and under no circumstances will the auditors do no work! They can just do a different type of work:

More reliance on the strong internal controls and less detailed substantive testing.

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. Misstatements can arise from error or fraud.'

and other external factors (including the financial reporting framework)
the nature

of the entity, including:
– its operations
– its ownership and governance structures
– the types of investment it makes
– the way it is structured and financed
the entity's selection and application of accounting policies
the entity's objectives, strategies and related business risks
the internal controls relevant to the audit.

come from a wide range of sources.

Procedures as:
'Evaluations of financial information through analysis of plausible relationships

among both financial and nonfinancial data' and investigation of identified fluctuations, inconsistent relationships or amounts that differ from expected values.
Analytical procedures are fundamental to the auditing process.
Prior periods
Industry information
Financial ratios