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Audit risk model

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Audit risk model

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

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