The audit risk model identifies the aggregate amount of risk related to an audit and explains how this risk can be managed. The aggregate amount of risk is computed by finding the product of the control risk, detection risk, and inherent risk. The three types of risks constitute the audit risk model. The model allows the auditor to determine the type and quantity of evidence they will need for each distinct assertion (Whittington & Pany, 2018). It depicts the type of evidence that needs to be gathered for every transaction class, relevant disclosure, and account balance. It is best identified during the planning phase and has little value with regard to assessing audit performance.
Inherent risk is the potential of material misstatement of an assertion prior to the consideration of the customer’s internal control. The variables that impact this risk are associated with the nature of the audit client and environment or the nature of the specific financial statement element. The control risk is the risk of occurrence of a material misstatement in a vital assertion and not be recognized or prevented in a timely manner by the client’s internal control (Whittington & Pany, 2018). The detection risk is the threat that the auditor’s procedures will fail to recognize a material misstatement existent in a relevant assertion. It is determined by the effectiveness of audit procedures and their use by the auditor.
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The inherent risk is based on the auditor’s assessment of the client. The auditor has to assess the nature of the client and the firm's environment in identifying the inherent risk. Business characteristics, for instance, going concern issues, may indicate a high inherent risk. The control risk will also require the auditor's assessment of the client, specifically their internal controls. The detection risk is a component determined by the auditor. The auditor will determine this risk by identifying whether their audit procedures are effective.
Reference
Whittington, R., & Pany, K. (2018). Principles of auditing and other assurance services . New York: McGraw-Hill Education.
