Introduction to Audit Risks

Introduction to Audit Risks

When you run a business, you are exposed to a lot of risks, and having audits is no exception. When the auditors from audit firms in Johor Bahru perform audits, audit risks are present due to various reasons. Audit risks refer to the risks where the auditors would issue an incorrect audit opinion to the financial statements that they have audited. As an instance, they issued an unqualified opinion after auditing the financial statements of a firm although there is a material misstatement or non-compliance with FRS (Also see FRS 1). This implies that the auditors failed to detect or identify the material misstatements of the financial statements. Another possibility could be the auditors have issued a qualified opinion as they have discovered an immaterial misstatement, but the correct opinion should be the unqualified opinion.

There are two primary sources of audit risks, which are from the auditors and the customers. Besides, there are three types of audit risks, which are the detection risks, control risks and the inherent risks.

Detection Risks

Detection risks refer to the risks that the auditors have failed to detect material misstatements in their customer’s financial statements, and they issued a wrong opinion to the financial statements that they have audited. This occurs due to the errors that the auditors have committed rather than the customer.

Typically, detection risks occur due to improper engagement management, low competency, inappropriate audit approach, poor audit planning, as well as an inadequate understanding of their customer. For instance, if the auditors do not have a proper audit planning, they are unable to identify all types of risks, and they use a wrong audit program to detect the risks. As a result, they are unable to detect material misstatements.

To reduce the detection risks and subsequently lower the audit risks, the auditors should establish the correct audit strategy, have a strategic audit plan, deploy the appropriate audit approach when they plan for the audit. Besides, they should also understand the audit objective and the audit scope clearly so that they can fix the audit approaches and design an audit program that suits their customer. Moreover, possessing a strong audit team may help in minimising detection risks too.

Control Risks

The control risks, which is also known as internal control risks, are the risks in which the current internal control of the company is unable to detect or protect it from misstatements and substantial errors.

Typically, the management of a company has to establish internal control over financial reporting and examine its efficiency and effectiveness. This helps in ensuring that their financial statements do not contain any material misstatements.

A weak internal control may bring risks to the auditors as this increases the probability of having a material misstatement in the financial statements. As a result, there is a high risk that the auditors are unable to detect all the misstatements. This indicates that when control risks (Also see What is a Test of Control?) increase, the audit risks will increase too.

The auditors need to understand and test the internal control over financial reporting of their customer before concluding whether they can rely on the controls or not. If the customer seems to possess a reliable internal control, the auditors may test the control to see if it is working correctly.

To reduce the control risks that occur due to poor internal control, the auditors may use some approaches. As an instance, they may perform a proper risk assessment at the stage of audit planning. This assessment helps the auditors to understand the customer’s internal control over financial reporting as well as the nature of the business.

Inherent Risks

Inherent risks are the risk that the internal control of the company is unable to detect or prevent. This risk occurs due to the complexity of its nature of business. In some occasions, the nature of the business may be associated with the complexity of the financial transactions, and this needs high-involvement judgement.

Typically, the inherent risk is high if the transactions are highly involved in human judgement. The external environment, such as political issues and climate change, may influence the inherent risks as well.

To deal with the inherent risks appropriately, the auditors should examine the risks and establish audit procedures. If the auditors know that their potential client is facing high inherent risk, and they know that they do not possess sufficient resources to deal with such a situation currently, they should not accept the audit engagement. Thus, this process helps the auditors in reducing inherent risks which will eventually lower the audit risks.

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