Audit Risk Model

Definition

The Audit Risk Model determines the total amount of Risk associated with an Audit of Financial Statements, and describes how this risk might be managed. The conceptual relation posits:

$\mbox{Audit Risk} = \mbox{Control Risk} \times \mbox{Detection Risk} \times \mbox{Inherent Risk}$

The factors are respectively:

• Control Risk. The risk caused by the failure of existing controls or the absence of controls, leading to incorrect financial statements.
• Detection Risk. The risk caused by the failure of the Auditor to discover a material misstatement in the financial statements.
• Inherent Risk. The risk caused by an error or omission arising from factors other than control failures. This risk is most common when accounting transactions are quite complex, there is a high degree of judgment involved in accounting for transactions, or the training level of the accounting staff is low

Issues and Challenges

• Intrinsic meaurement difficulty
• Assumption of conditionally independent risks