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Lanfei Gao, Michael Andrews, and Shanaka DeSilva,. The Audit Risk Model. Audit Risk. The risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated First fundamental concept of audit procedures. Contents of Audit Risk.
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Lanfei Gao, Michael Andrews, and Shanaka DeSilva, The Audit Risk Model
Audit Risk • The risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated • First fundamental concept of audit procedures
Contents of Audit Risk Detailed level: • Account Balance • Class of Transactions Assertion • Material Misstatement Risk -Inherent risk -Control risk • Detection risk
Engagement Risk • An auditor’s exposure to financial loss and damage to professional reputation. • client and third party lawsuits • negative publicity
Audit Risk Model • Inherent risk (IR) – The likelihood that a material misstatement exist. • Control risk (CR)- Risk that the misstatement will not be prevented, or detected and corrected on a timely basis by the entity's internal control. • Risk Material Misstatement; RMM = CR x IR • Detection risk (DR) – Effectiveness of the audit procedure.
Audit Risk Model Audit Risk Model Equation: AR = RMM x DR • Requires professional judgment • Highly subjective • Not intended to be a precise formula
Limitations of the Audit Risk Model • The desired level of audit risk may not actually be achieved • It does not consider potential auditor error • Does not consider nonsampling risk
Thank You! • What are the components of the Audit Risk Model? • What is the Audit Risk Model Formula? • How is the Audit Risk Model used? • What are the Audit Risk Model’s Limitations? • Audit, Inherent, Detection, Control • AR = IR x CR x DR or AR = RMM x DR • Determine Audit Risk, Determine RMM, Solve for DR • Audit Risk Level may not be achieved, does not consider auditor error, does not consider nonsampling risk