Assessment of audit risk

Knowledge of the client’s business from a preliminary analytical review can help auditors identify problem areas and make broad risk assessments. However some more technical risks need to be assessed. These are known as inherent risk, internal control risk, detection risk, and audit risk.

Inherent risk is the probability that material errors or irregularities have entered the data processing system used to develop financial statements. Inherent risk is a characteristic of a client’s business, the major types of transactions, and the effectiveness of its accountants. Auditors do not create or control inherent risk. They can try to assess it.

Internal control risk is the probability that the client’s internal control procedures will fail to detect material errors and irregularities, provided any enter the data processing system in the first place. Auditors do not create or control internal control risk. They can only evaluate a company’s control system and assess the probability of failure to detect errors and irregularities. An auditor’s assessment of internal control risk is based on the study and evaluation of internal control.

Detection risk is the probability that the audit procedures will fail to produce evidence of material errors and irregularities, provided any have entered the data processing system in the first place and have not been detected and corrected by the client’s internal control procedures. In contrast to inherent and internal control risk, auditors are responsible for performing the evidence gathering procedures that manage and control detection risk. These audit procedures represent the auditor’s opportunity to detect material errors and irregularities that can cause financial statements to be misleading.

In an overall sense, audit risk is the probability that an auditor will give an inappropriate opinion on financial statements. For example, the worst manifestation of this risk is giving an unqualified opinion on financial statements that are misleading because of material errors and irregularities the auditor failed to discover. Such a risk always exists, even when audits are well planned and carefully performed. The risk is much greater in poorly planned and carelessly performed audits.

VII. Task 1. Read the text and answer the questions: What is the role of evidence? How are different kinds of evidence classified?