3 Components of Assessing Audit Risks

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Each year, your audit team conducts a new risk assessment before they begin fieldwork. Why is this? Auditors don’t want to express an incorrect opinion on the accuracy and integrity of your company’s financial statements, as giving the seal of approval on financials containing material misstatements can lead to shareholder lawsuits, increased regulatory attention and more. To better understand your audit team’s approach, gain insight into the three main components of an audit risk assessment.  

1. Control Risk 

Sometimes, a company’s internal controls are not sufficient in preventing or detecting material misstatements. Control risk increases when a business fails to implement and enforce effective internal controls, as well as when third parties override them without the company’s knowledge. Control risk can be decreased if the company implements good internal controls the auditors can test and rely upon. 

2. Inherent Risk 

This component refers to the susceptibility of the financial statements to a material misstatement, whether the company has strong internal controls or not. Inherent risk is measured on a scale referred to as the spectrum of inherent risk. There is a greater inherent risk in certain transactions and industries; for example, businesses operating in developing countries face a greater threat of corruption and bribery by government officials, no matter the internal controls they implement. Inherent risk is also increased when accounting transactions are complicated or involve a high degree of judgment and subjectivity.  

3. Detection Risk 

Detection risk is increased when there’s a high chance the audit procedures performed will not detect material misstatements. If control risk and inherent risk are high, an auditor may test a bigger sample of transactions to lessen detection risk.  

While control risk and inherent risk are the results of a company’s industry and actions, detection risk is managed by the audit team to reduce it to an acceptable level.  

Collaboration is Key 

Your audit team is not just responsible for attesting to your company’s financial statements, they also verify that your financial statements “present fairly, in all material respects, in accordance with accounting principles generally accepted in the United States of America (US GAAP).”  

Unmodified (or “clean”) audit opinions involve detailed audit procedures, like confirming the balances of accounts receivable with customers and conducting test counts of inventory in the company warehouse. Overall, the more demanding the audit team’s procedures, the lower the likelihood of failing to detect a material misstatement.  

With audit season in full swing for calendar year-end entities, be sure to contact your Doeren Mayhew audit team to discuss changes in business operations, accounting methods and industry conditions that may impact audit risk. We’re here to help and will adjust our audit procedures accordingly to ensure your financial statements are prepared with the highest level of quality and efficiency.  

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