5.2 Assessment of different types of audit risks

In the audit process, auditors assess different types of risks that can impact the reliability of the financial statements. These risks include inherent risk, control risk, and detection risk. Here’s an overview of how each type of risk is assessed:

1. Inherent Risk Assessment:
   • Inherent risk is the susceptibility of the financial statements to material misstatements before considering the effectiveness of internal controls.
   • Auditors assess inherent risk by considering various factors, such as the nature of the client’s business, industry-specific risks, complexity of transactions, and accounting estimates.
   • They evaluate the likelihood and potential magnitude of material misstatements arising from inherent risk.
   • Higher inherent risk indicates a greater likelihood of material misstatements and requires more extensive audit procedures.
2. Control Risk Assessment:
   • Control risk is the risk that the client’s internal controls fail to prevent or detect material misstatements in the financial statements.
   • Auditors assess control risk by evaluating the design, implementation, and operating effectiveness of the client’s internal controls.
   • They assess the strength of control activities, segregation of duties, monitoring procedures, and the control environment.
   • A higher control risk indicates a higher likelihood that internal controls may not be effective in preventing or detecting material misstatements.
3. Detection Risk Assessment:
   • Detection risk is the risk that auditors fail to detect material misstatements in the financial statements during the audit.
   • Auditors assess detection risk by determining the nature, timing, and extent of substantive procedures necessary to address the assessed risks.
   • They consider the sufficiency and appropriateness of audit evidence to be obtained through tests of details and substantive analytical procedures.
   • The level of detection risk is inversely related to the amount of substantive testing performed by auditors. Higher substantive testing reduces the likelihood of failing to detect material misstatements.