Audit risk is the probability of losses due to an auditor's failure. This is typically a low probability, high impact risk associated with large financial failures. For example, the Enron scandal in 2001 that led to the dissolution of Arthur Andersen, considered one of the big-five accounting firms at the time. The following are the basic types of audit risk.
An inherent risk is the risk of material misstatements due to fraud or incompetence. In the context of an audit, this is a risk of misstatements in the audit itself.
Control Risk The risk that internal controls are missing or fail. For example, transactions that aren't verified.
Detection RiskThe risk that misstatements aren't detected by the audit process.
Governance RiskThe risk that governance bodies will fail to act upon risks and misstatements reported in an audit.
Residual RiskResidual risk is the risk that remains after you make an effort to manage risk. In the case of an audit, this is the sum of the risks above.
Notes Inherent risk is often defined in creative and indirect ways because nobody wants to mention fraud or incompetence. For example, "the risk that would occur without controls."
This is the complete list of articles we have written about financial risk.
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