Types of Audit Risks

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What an audit risk? It is the risk that financial statements are factually incorrect even though the numbers to appear correct when vetted by financial officials. There are three main types of audit risk: inherent risks, detection risks and control risks.

Inherent Risks

An inherent risk is the type of audit risk that cannot be identified by a company’s internal auditors or other financial officers. In order to try to prevent the audit risk components, companies must have in place a series of procedures to, hopefully, detect any problems. Identifying these types of audit risks involves having a clear audit plan, audit approach and audit strategy. An audit plan is the guideline to adhere to strictly when conducting an internal audit. It lists evidence that needs to be gathered as well as the relevant numbers. The audit approach is a method of risk analysis that balances internal operations with expected external results. Finally, an audit strategy is used to develop the audit plan, dictating how all the parts fall into place as well as the timing and employees involved.

Detection Risks

A detection risk is a type of audit risk that results from poor planning. There is a chance an auditor will not identify and correct a misstatement in time before the audit. When a company’s financial teams aggregate materials there is the chance parts are gathered erroneously, either with missing information or with faulty mathematics. Navigating a detection risk require a deep understanding of the nature of the company and business in general. The depth and width of a company’s operation, its financial statements and the methodology of its financial reporting are all components of detection risks. Other components include classification testing, completeness testing, occurrence testing and valuation testing.

Control Risks

A control risk is a type of audit risk that investigates the accuracy of the numbers reported by a company’s employees. A company could accidentally commit fraud by assessing numbers incorrectly or reporting it erroneously. Identifying areas where there may be such problems is vital to recognizing control risks. If a control is weak, there is a great chance that the financial materials are incorrect, which in turn could mean the company’s auditors or other financial officers wouldn’t catch it.

Circumventing the three types of audit risk involves several components that must be dealt with by a steady hand: planning and strategizing thoroughly in every department in every step, exercising proper internal control over financial reporting and performing an excellent assessment of audit risks. Whether handled entirely in-house or coupled with the services of an accounting firm for an objective viewpoint, audit risks can be reconciled early and promptly to prevent a business being fiscally injured.