What is Audit Risk?

Audit risk is the probability that the financial statements of the company contain an error that is material to the company even though the same has been verified and audited by the auditor of the company without any qualification concerning it.

In simple terms, Audit risk is defined as the risk of financial statements not being truly representative of an actual financial position of the organization or a deliberate attempt to conceal the facts even though audit opinion confirms that statements are free from any material misstatement. This risk can have a bearing on shareholders, creditors, and prospective investors.

This risk may arise due to any one or both of the two – Clients or Auditors.
This risk may be due to two reasons – mistakes/errors or a deliberate misstatement.

Types of Audit Risks

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#1 – Inherent Risks

Inherent chance is the chance that couldn’t be averted because of uncontrollable factors, and it’s also now no longer discovered in Audits.

Example: transactions regarding excessive-fee coins quantity bring a greater inherent chance

 then the transaction regarding excessive-fee cheques.

Sources of Inherent Risk:

Complex commercial enterprise transactions regarding by-product instruments;

Transactions requiring an excessive degree of judgment which might also additionally cause the chance of now no longer being identified;

Industry having common technological traits might also additionally divulge the corporations to era obsolescence chance.

A business enterprise that has already misreported positive figures withinside the beyond can be much more likely to misreport it again.

#2 – Control Risks

Control Risk is the chance of blunders or misstatements in monetary statements because of the failure of inner controls.

Example: Failure on the part of the control to manipulate and save your transaction completed through a team of workers who isn’t always legal to perform the one’s transactions withinside the first place.

Sources of Control Risk:

Failure of control to still right and powerful inner control

 for monetary reporting.


Failure to make sure right segregation of responsibilities amongst humans accountable for monetary reporting;

The non-lifestyles of the tradition of right documentation and filing;

#3 - Accounting risks

Accounting risk is the risk that the Statutory Auditor does not recognize errors or inaccuracies in the financial statements, thus giving an erroneous opinion on the company’s financial statements.

Example: Non-identification by the Statutory Auditors of the persistent miscommunication of the company’s financial statements.

Sources of detection Risk:

Poor audit planning, selection of incorrect audit procedures by the auditor;
Poor interaction and involvement with audit management by the auditor;
Misunderstanding of client’s business and complexity of financial statements;
Incorrect sample size selection.

Audit Risk Formula

Broadly, the risk is calculated by combining the three types of audit risk above.

The formula is: Audit Risk = Inherent Risk * Control Risk * Detection Risk Based on the above risk factors, auditors can arrive at the risk level and decide the strategy to address it.

How to minimize audit risk?

Have a strong audit team with sufficient knowledge of relevant activities and transactions;

The team has enough time to analyze the financial data;

Ensure strong engagement with client company management to understand company philosophy and practices;

Ensure proper and adequate sampling techniques;

Accurate assessment of the client’s internal control systems to determine whether the control is strong or weak;

Appropriate audit planning and selection of audit procedure;

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