Referring to the identification of areas with high audit risk, this entails pinpointing specific accounts or audit segments where material misstatements are more likely to occur. Once these areas are identified, the overall audit effort is strategically allocated to ensure a concentrated focus on the highest-risk sections. When auditors assess the audit risk for a company audit assignment, several factors come into consideration:
Inherent risk:
- The nature of the business, its products or services, and its market position.
- The present and likely future financial position of the company.
- Auditors’ previous experience with the company.
- Circumstances that could pressure management to manipulate results.
- Susceptibility of the company’s assets to fraud.
- Existence of related party or unusual transactions.
- The potential material impact of errors on the financial statements.
Control risk: a) The quality and effectiveness of management and the degree of supervision exercised. b) The existence and quality of internal controls. c) The competence of accounting staff. d) The nature of accounting records. e) The existence and effectiveness of the internal audit department, if applicable.