Academic journal article Journal of Accountancy

The Audit Risk Model

Academic journal article Journal of Accountancy

The Audit Risk Model

Article excerpt

The interdependence of component risks.

Are the risks assessed for the audit risk model judged independently or are they conditional on values of the other risks?

Auditing standards indicate that inherent, control and analytical procedures risks may be combined to determine the extent of substantive, detailed testing. The standards depict each component risk individually; however, the audit risk model will not produce proper results unless the components are considered in relation to each other. That is, knowledge about one component of the risk model must be weighed in order to properly assess the risks associated with another (this relationship is known as being "conditionally dependent").

For example, imagine that firm A and firm B have identical control structures with respect to an audit objective or account, but that firm A is inherently riskier than firm B. If auditors consider only features of the internal controls as the basis to assess control risk, then they will assess A and B control risk as the same. However, to use the risk model properly, the assessed control risk of firm A should be higher than the control risk of firm B. To oversimplify, if there is inherently a higher probability of more material misstatements in firm A than in firm B, then the same control structure has a higher risk of failing to detect/correct misstatements in firm A than in firm B. Assessing these component risks interdependently calls for subtle, highly skilled judgment.

In a series of cases, we looked at inherent, control and analytical-procedures risks from auditors in firms where each of these risks was separately assessed. …

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