Audit Risk Presentation

Welcome
 The key purpose of the audit process is to form and express an understanding of an opinion, on
whether the financial statements presented are true, accurate, and holds a fair view. Therefore, audit
risk would refer to the probability of the financial statement not present either a true, accurate and a
fair view after the audit process is concluded (Cushing & Loebbecke, 1983, p. 3). Therefore, audit risk
means the possibility of a material misstatement, becoming unnoticed even after the audit is
concluded. The audit risk can be recognized from the standpoint of the auditor and the management.

From the auditors standpoint, the risk involves three components inherent risk, control risk and
detection risk. From the management standpoint, the management is concerned with upholding such
responsibilities as protecting the assets out of the resources of the organizational shareholders, setting
up and presenting financial statements from the books of account preserved by the organization, and,
avoiding mistakes and errors in auditing. This paper will discuss auditors view of a point about how
they express an inappropriate opinion on the financial statements in regards to the Audit Risk Model.
 According to Houston, Peters, and Pratt (1999, p. 12), Audit Risk
Model is presented as below:

Audit Risk = Inherent Risk x Control Risk x Detection Risk

From the equation above, the audit risk is depicted as the product
of a range of risks, which are met in the performance of the audit
process (Botez, 2015, p. 117). To maintain the general audit risk
process of actions below the satisfactory boundary, the auditor has
to evaluate the degree of risk that pertains each component of
audit risk.
 The three elements of the audit risk are
explained as follows:
 Inherent Risk is a risk that involves a material misstatement in the financial statements,
that perhaps results from an audit mistake of either omission or error due to various
factors other than the shortcomings of controls. The factors that result in a misstatement
emanating from the absence or shortcomings of controls are regarded distinct in the
evaluation and assessment of control risk (Botez, 2015, p. 118).

The risk is usually regarded higher, especially to such extents where a high level of
decision making and estimation, or generally where the organizational business
transactions are largely complicated and complex. Inherent risk is usually common
where accountants have to employ larger than normal level of decision making and
estimation, or where it involves complex financial instruments.
 Inherent risk is frequently observed in the various financial services sector. The reasons
for such observation originates from the fact that financial services sector involves
complexity and dynamism in controlling the financial institutions, great networks of
associating organizations and the improvement of imitative products and other complex
instruments.

Most financial organizations have venerable and complex relationships with various
parties. A holding company may be engaged with numerous distinct entities at once,
where each entity controls and manages special-purpose vehicles and other off-balance
sheet entities. Every level in the organizational structure may have excess client and
investor association. Other related parties are also disreputably less transparent than
distinct entities. Business relationships mostly involve auditors, and their engagement
generates inherent risk with the overwhelming complexities and new aspects.
 According to the International Standards of Auditing (ISAs) (cited in Mock et al., 2013),
Control Risk is the material misstatement in the financial statements that results from the
absence, failure or shortcomings in the performance of significant controls of an
organization.

Control risk entails the misstatement that exists in a contention likeliness because the
misstatement may not either prevent the risk from entering the organizational financial
information or being detected and corrected by the internal control system of the
organization.

Organizations ought to have sufficient internal controls in considerations, to avoid and

detect such instances of fraud and error. This risk is regarded to be high, especially
where the audit process may not have sufficient internal controls to avoid and detect the
instances of fraud and error to be realized in the financial statements.
 A customer in a mining company was considering to invest in latest project in Florida.
The customer was willing to incorporate a better understanding of various political and
business environment in the state before considering its final judgment in poorly defined
separation of duties. The client specifically got concerned about the political risks that
may affect the business in Florida, that includes risks posed by violence, corruption and
nationalization.

The evaluation process of these risks might be considered higher, for instance where the
business is involved in a poorly defined separation and segregation of duties.
Consequently, it should be noted that the financial statements are prepared and
presented by individuals, who may not have the required technical know-how of the
organizational finance and accounting.
 Detection risk entails the risk in the financial statements that the auditors may fail to
notice a material misstatement. It, therefore, means that the auditors have to apply audit
processes to detect any misstatement in the financial statement, that may occur due to
either a mistake or fraud. Omission or misapplication of essential audit processes may
lead to a material misstatement that remains unnoticed by the auditor. Such detection
risk as the employment of sampling for selecting transactions constantly exists because
of the inherent confines of the audit (Botez, 2015, p. 121).

Detection risk result from poor planning of the audit process. For instance, when the
audit is poorly planned, it, therefore, means that all types of risks that are defined by the
audit program that was designed to detect the risks is also poorly and incorrectly
deployed. The results will conclude that the material misstates are not detected
eventually.
 Stephanie is an auditor at a well-known auditing company. She
has the responsibility to audit the companys financial statements.
Over the last few days, the organizational manager took a fake call
that instantly impacted the company at risk. The accountant
manipulated the financial information to prevent the companys
investors from selling the company's stock. However, Stephanie
did not detect the misstatements in the companys financial
statements, and, hence, the interpretation of the audit information
was wrong. Consequently, Stephanie had to reduce the risk by
implying much stricter audit processes.
 The audit risk model is employed by the auditors in
various companies and organizations to assist in the
general regulation of risks involved in an audit
engagement. The auditors eventually examine the
inherent and control risks that affect the audit
engagement while expanding the understanding of the
organizations and its environment. Detection risk
forms the residual risk after regarding both the two
risks that involve the overall audit risk. The risk model
establishes the entire amount and degree of risk that is
associated with an audit and describes how these risks
should be mitigated and managed. The auditors
involved in risk management must review each of the
subsidiary levels of the risks to establish the total
amount of the audit risk.
 BOTEZ, D., 2015. Study Regarding the Need to Develop an Risk Model. Audit financier, 13(125).

Cushing, B.E., and Loebbecke, J.K., 1983. Analytical approaches to audit risk: A survey and analysis.

Auditing: A Journal of Practice & Theory, 3(1), pp.23-41.

Houston, R.W., Peters, M.F. and Pratt, J.H., 1999. The audit risk model, business risk and audit-
planning decisions. The Accounting Review, 74(3), pp.281-298.

Mock, T., Bdard, J., Coram, P., Espahbodi, R. and Warne, R., 2013. Comment letter to respond to the
IAASB invitation to comment on its Exposure Draft, Reporting on Audited Financial Statements:
Proposed New and Revised International Standards on Auditing (ISAs).