Audit risk is defined as the risk involved in the auditing process of financial statements of a company. It basically refers to the percentage of errors or flaws within an audit report. The formula used to represent audit risk is ‘Audit Risk (AR) = IR x CR x DR’. IR stands for Inherent risk in the formula representing probability or errors. CR in the formula is Control Risk representing the errors that are either left undetected by the internal control authorities or no control authorities were made for it. DR is detection risk, which represents the probability of the auditor not detecting the errors in his reports.
The audit risk for a specific audit has to be defined as low, medium or high. This classification can only be known after applying the audit formula on the situation. However, the audit risk formula only gives a generic understanding of the risk associated with the audits. It works as a basic plan to ensure the risk involved in auditing, but is never a sure-fire way of assessing it. There are numerous other factors involved in audits which are realized later on when the reports are actually being audited. These factors can play a vital role in determining the outcomes of the audit.
Planning to cut down the audit risk involves a number of strategies. The factors which are responsible for increasing and decreasing the audit risk are examined thoroughly. All the financial statements and account balances of a company are taken into consideration and examined for errors. Auditors assess the risk and the scope of the audit based on the following:
- The experience of personnel involved and the company’s reliability on them
- The simplicity of the Audited transactions
- The internal risk control framework if any
All of these factors are taken into account by the auditors to create a benchmark while developing the nature of the audit, its timings and extent.