5.0 Audit risk assessment

Audit risk assessment is a systematic process performed by auditors to evaluate and understand the risks associated with an audit engagement. It involves identifying and assessing the risks of material misstatement in the financial statements, both at the overall financial statement level and at the assertion level for specific account balances, transactions, and disclosures. The goal of audit risk assessment is to determine the nature, timing, and extent of audit procedures required to address those risks appropriately.

The process of audit risk assessment typically involves the following steps:

1. Understand the Entity and Its Environment:
   • Gain an understanding of the client’s industry, business operations, and regulatory environment.
   • Identify the client’s objectives, strategies, and key performance indicators.
   • Assess the client’s internal control environment and the effectiveness of internal controls.
2. Identify and Assess Inherent Risk:
   • Identify the risks that could result in material misstatements in the financial statements.
   • Consider factors such as the complexity of transactions, accounting estimates, related-party transactions, and industry-specific risks.
   • Assess the likelihood and potential magnitude of material misstatements arising from inherent risk.
3. Assess Control Risk:
   • Evaluate the effectiveness of the client’s internal controls in preventing or detecting material misstatements.
   • Identify key control activities and consider their design and operating effectiveness.
   • Assess the likelihood and potential impact of control failures on the financial statements.
4. Determine Detection Risk:
   • Consider the level of detection risk required to achieve the desired level of assurance.
   • Determine the nature, timing, and extent of substantive procedures necessary to reduce detection risk to an acceptable level.
   • Evaluate the sufficiency and appropriateness of audit evidence to be obtained.
5. Plan Audit Procedures:
   • Develop an overall audit strategy and plan, taking into account the identified risks and the nature of the client’s business.
   • Determine the appropriate combination of tests of controls and substantive procedures.
   • Document the planned audit procedures and the rationale for their selection.