There are 3 main types of audit risk – inherent risk, control risk and detection risk. These are the factors that influence the audit strategy and how auditors approach an assignment.
Inherent risk is the first type of audit risk that is affected by the nature of the company. It is not something that auditors can reduce because they cannot control it. The only way to deal with it is by planning the audit procedures according to their assessment of the inherent risk.
Control risk is the second type of audit risk that is affected by a company’s internal control and how they manage their financial reporting process. It is important for auditors to understand and assess the internal control over financial reporting before they start their audit.
Detection risk is the third type of audit risk that is affected by if audit procedures fail to identify material misstatements in the financial statements. Detection risk is often caused by poor audit planning, poor engagement management, wrong audit methodology, low competency and a lack of understanding of the audit client.
Detection risk is a major concern for many auditors, especially when the audit team does not fully understand the client’s business and the financial reports that they’re assessing. Typically, detecting risk is reduced by assessing client-specific risks at the beginning of an audit and by implementing audit programs that are designed to uncover any material misstatements that might exist.
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