Audit Risk Assessment and Detection of Misstatements in Annual Reports: Empirical Evidence from Nigeria

Likewise, more substantive works will be required in order to reduce audit risk to an acceptable level. The management that is fairly ignorant towards their subordinates and daily activities can give rise to the levels of inherent risk. If not being proactive, the management can always miss out on material misstatements arising out in the general nature of the business, which in turn gives rise to IR.

Likewise, this can be done when auditors obtain sufficient appropriate audit evidence to reduce audit risk to an acceptable level. Control risk is the risk that the client’s internal control cannot prevent or detect a material misstatement that occurs on financial statements. It is the second one of audit risk components where auditors usually make an assessment by evaluating the internal control system that the client has in place. Risks of material misstatement at the financial statement level may be especially relevant to the auditor’s consideration of the risk of material misstatement due to fraud. The discussion that follows describes audit risk in terms of three component risks. Fn 12 The way the auditor considers these component risks and combines them involves professional judgment and depends on the audit approach. Unlike inherent risk and control risk, auditors can influence the level of detection risk.

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audit risk models consisting of amounts derived from accounting estimates pose greater risks than do accounts consisting of relatively routine, factual data. For example, technological developments might make a particular product obsolete, thereby causing inventory to be more susceptible to overstatement. These latter factors include, for example, a lack of sufficient working capital to continue operations or a declining industry characterized by a large number of business failures. Detection Risk is the risk that the auditors fail to detect a material misstatement in the financial statements.An auditor must apply audit procedures to detect material misstatements in the financial statements, whether due to fraud or error. Detection risk is the risk that auditors fail to detect material misstatements that exist on the financial statements. Detection risk is considered the last one of the three audit risk components. Fn 2 In addition to audit risk, the auditor is also exposed to loss or injury to his or her professional practice from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on.

• If auditors believe that the client’s internal control can reduce the risk of material misstatement, they will assess the control risk as low and perform the test of controls to obtain evidence to support their assessment.
• This is often the danger of a cloth misstatement within the financial statements arising thanks to error or omission as a result of factors aside from the failure of controls .
• Hence, business risk is a much broader concept than audit risk.
• Inherent risk is the risk that a client’s financial statements are susceptible to material misstatements in the absence of any internal controls to guard against such misstatement.
• If the sporting goods store’s inventory balance of $1 million is incorrect by $100,000, a stakeholder reading the financial statements may consider that a material amount.

Control risk is defined as the risk which tends to surface when the internal controls in place have failed, and the financial statements have missed highlighting the failures of internal controls. The audit risk corresponds to the risk that arises when there is material misstatements on the financial statements, whereas audit opinions present a fair picture. The detection risk corresponds to the risk where the auditor displays an inability to catch material misstatements.

What is the Audit Risk Model?

Inadvertently signing off on financial statements that contain material misstatements can open a Pandora’s box of risks — from shareholder lawsuits to increased regulatory oversight. In making risk assessments, the auditor should identify the controls that are likely to prevent or detect and correct material misstatements in specific relevant assertions. Risk assessment for financial reporting is management’s process for identifying, analyzing, and responding to the risks relevant to the preparation of financial statements in conformity with generally accepted accounting principles in the United States. Testing performed by the auditor to reduce detection risk to an acceptable level is referred to as substantive testing. Substantive testing encompasses several types of testing, including substantive tests of transactions, substantive analytical procedures, and tests of details of balances. Substantive tests of transactions are used to determine whether all six transaction-related audit objectives have been satisfied for each class of transaction.

• The UK Auditing Practices Board announced in March 2009 that it would update its auditing standards according to the clarified ISAs, and that these standards would apply for audits of accounting periods ending on or after 15 December 2010.
• Accordingly, the auditor controls audit risk by adjusting detection risk according to the assessed levels of inherent and control risks.
• Testing performed by the auditor to reduce detection risk to an acceptable level is referred to as substantive testing.
• Describe the major components of an audit program for cash receipts and cash management controls.
• The auditor is required to obtain an understanding of the entity and its environment, including the entity’s internal control systems.