The risk of substantially inaccurate financial statements, even if the audit opinion indicates that the financial reports are free from errors, is known as audit risk. Irrespective of how thoroughly auditors planned and executed their audit work, there is always the possibility of audit risk. Auditors, on the other hand, can help to mitigate the risk. Furthermore, if the audit is well-planned and conducted, the audit risk will be minimal.
The objective of an audit is to minimize the audit risk to a manageable level by doing thorough checks and gathering substantial evidence. Audit risk may result in legal liability for a certified public accounting firm undertaking audit work since investors, creditors, and other stakeholders look at financial statements. An auditor conducts investigations and tests on the general ledger and accompanying documentation during an audit.
The auditor recommends that managers consider amending journal entries if any inaccuracies are detected during the testing. After such corrections have been made, an auditor would issue a written opinion at the end of an audit on whether the financial statements are free of significant misrepresentation. Auditing firms carry malpractice insurance to reduce audit risks and possible legal liability.
Audit risk can be categorized into three parts. The first one is control risk, which would be the risk that a client’s control systems would fail to recognize or avoid a possible material misrepresentation. The second type is the detection risk, which refers to the possibility that the audit methods used will fail to identify a significant mistake. The third type is the inherent risk, which refers to the possibility of major misstatements in a client’s financial statements.