Question

What would be an example of inherent risk in a company like DHHS? Give an explanation of detection risk? What then is audit risk?

Answer 1

->> Audit risks come from two main different sources: Clients and Auditors themselves. The risks are classified into three different types: Inherent risks, Control Risks and Detection Risks.

Audit risk can be presented by the risks model as the combination of inherent risks, control risks and detection risks. As mention above, inherent risks and control risks are control by clients whereas detection risks are control by auditors.

Audit risk = inherent risk x detection risk x control risk

In financial and managerial accounting, inherent risk is defined as the possibility of incorrect or misleading information in accounting statements resulting from something other than failure of controls. Examples of inherent risk are most common where accountants have to use a larger than normal amount of judgment and approximation, or where complex financial instruments are involved.

• Control Risks:

Control risk or internal control risk is the risk that current internal control could not detect or fail to protect significant error or misstatement in the financial statements. Basically, managements are required to set up and assess the effectiveness and efficiency of internal control over financial reporting to make sure that financial statements are free from material misstatements.

• Detection Risk:

Well detection risk is the risk that auditor fail to detect the material misstatement in the financial statements and then issued incorrect opinion to the audited financial statements. The common cause of detection risk is improper audit planning, poor engagement management, wrong audit methodology, low competency and lack of understanding of audit client. Detection risk is occurred because of auditor part rather than client part.