Question

7. Explain the Audit risk, its function, components, its importance and departmental responsibility of audit risk?

Answer 1

Audit risk, function

Audit risk is the risk that financial statements are materially incorrect, even though the audit opinion states that the financial reports are free of any material misstatements.

The purpose of an audit is to reduce the audit risk to an appropriately low level through adequate testing and sufficient evidence.

Over the course of an audit, an auditor makes inquiries and performs tests on the general ledger and supporting documentation. If any errors are caught during the testing, the auditor requests that management propose correcting Journal entries.

At the conclusion of an audit, after any corrections are posted, an auditor provides the written opinion as to whether the financial statements are free of material misstatements.

Components

The two components o audit risk are risk of material misstatement and detection risk.

Risk of material misstatement: is the risk that the financial reports are materially incorrect before the audit is performed. The risk of material misstatement is even higher if there is believed to be insufficient internal controls which is a fraud risk

Detection risk: is the risk that the auditor's procedures do not detect a material misstatement. Example - Auditor needs to perform a physical count of inventory and compare the results to the accounting records. If test sample for inventory count is insufficient to extrapolate out the entire inventory, detection risk are high.

Importance of audit risk

Audit risk is fundamental to audit process because auditors cannot and do not attempt to check all transactions. Hence the importance of risk based approach towards auditing is critical. Auditors should direct audit work to the key risks, where it is more likely that errors in transactions and balances will lead to a material misstatements in the financial statements.

Departmental responsibility of audit risk

An audit department is a unit within a company that is responsible for evaluating operational procedures, risk management, control functions, and government processes.

Chief functions are:

- Determine compliance with policy and procedures

- Assess the quality of internal controls

- Evaluate the quality of risk management

- Review the effectiveness and security of IT systems

- Verify physical assets and inventory

Etc.