Audit Risk Model

Question 1

Risk Model

Answer 1

Audit Risk Model

The audit risk model helps auditors identify and quantify the main elements of overall audit risk.

Definition: Audit Risk
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

Components of Audit Risk
1. Inherent Risk (IR): Risks arising from errors or omissions in financial statements.
2. Control Risk (CR): Risks that internal controls fail to prevent or detect material misstatements.
3. Detection Risk (DR): Risks that audit procedures fail to detect material misstatements.

Audit Risk Model Formula
AR = IR × CR × DR

Where:

• AR = Audit Risk
• IR = Inherent Risk
• CR = Control Risk
• DR = Detection Risk

Risks are expressed as proportions (e.g., 10% = 0.10).

Example
If the audit risk is 5%, the auditor accepts a 5% risk that the audited item will be misstated and a 95% probability that it is materially correct.