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

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

How to Use the Audit Risk Model

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