Audit risk model

1. The Audit Risk Model
Lanfei Gao, Michael Andrews, and Shanaka DeSilva,

2. 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

3. Contents of Audit Risk
Detailed level:
–Account Balance
–Class of Transactions
Assertion
– Material Misstatement Risk
-Inherent risk
-Control risk
– Detection risk

4. Engagement Risk
•An auditor’s exposure to financial loss and
damage to professional reputation.
– client and third party lawsuits
– negative publicity

5. 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.

6. Audit Risk Model
Audit Risk Model Equation:
AR = RMM x DR
•Requires professional judgment
–Highly subjective
•Not intended to be a precise formula

7. How to Use the Audit Risk Model

8. 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

9. 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