The main goals of this chapter are to: Understand the concept of audit risk, learn the form and components of the audit risk model, understand how to use the audit risk model, understand the auditor's risk assessment process, learn how the auditor assesses the risk of material misstatement, understand the fraud risk assessment process, learn how to respond to the results of the risk assessments, learn how to evaluate the results of the audit tests. | Chapter 4 Risk Assessment McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Audit Risk The risk that an auditor expresses an unqualified opinion on materially misstated financial statements. Financial statement level Individual account balance or class of transactions level LO# 1 4- The Audit Risk Model Audit Risk = IR × CR × DR Inherent risk and control risk: Risk of material misstatement Nonsampling risk Sampling risk Detection risk: Risk that auditor will not detect misstatements Inappropriate audit procedure Fail to detect when using appropriate audit procedure Misinterpreting audit results LO# 2 4- Engagement Risk An auditor’s exposure to financial loss and damage to professional reputation. Client and third party lawsuits Negative publicity LO# 2 Local audit failure 4- Using the Audit Risk Model Set a planned level of audit risk such that an opinion can be issued on the financial statements. Assess the risk of material misstatement (IR x CR). Use the audit risk equation to solve for the appropriate level of detection risk: AR = IR × CR × DR DR = AR IR × CR Auditors use this level of detection risk to design audit procedures that will reduce audit risk to an acceptable level. LO# 3 4- Limitations of the Audit Risk Model Preliminary Assessment Level of Risk Actual or Achieved Level of Risk LO# 3 + / – The audit risk model is a planning tool, but it has some limitations that must be considered when the model is used to revise an audit plan or to evaluate audit results. The desired level of audit risk may not actually be achieved. It does not consider potential auditor error. There is no way of knowing what the preliminary level of risk actually was. 4- The Auditor’s Risk Assessment Process Figure 4-2 An Overview of the Auditor’s Assessment of Business Risks and the Risk of Material Misstatements LO# 4 4- Errors are unintentional misstatements: Mistakes in . | Chapter 4 Risk Assessment McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Audit Risk The risk that an auditor expresses an unqualified opinion on materially misstated financial statements. Financial statement level Individual account balance or class of transactions level LO# 1 4- The Audit Risk Model Audit Risk = IR × CR × DR Inherent risk and control risk: Risk of material misstatement Nonsampling risk Sampling risk Detection risk: Risk that auditor will not detect misstatements Inappropriate audit procedure Fail to detect when using appropriate audit procedure Misinterpreting audit results LO# 2 4- Engagement Risk An auditor’s exposure to financial loss and damage to professional reputation. Client and third party lawsuits Negative publicity LO# 2 Local audit failure 4- Using the Audit Risk Model Set a planned level of audit risk such that an opinion can be issued on the financial statements. Assess the
