Audit Risk vs. Risk of Material Misstatement

Attribute	Audit Risk	Risk of Material Misstatement
Definition	The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.	The risk that the financial statements are materially misstated due to error or fraud.
Responsibility	Primarily the responsibility of the auditor.	Primarily the responsibility of management.
Factors	Consists of inherent risk, control risk, and detection risk.	Consists of inherent risk and control risk.
Assessment	Assessed by the auditor based on the audit procedures performed.	Assessed by the auditor based on the understanding of the entity and its environment.

Introduction

Audit risk and risk of material misstatement are two key concepts in the field of auditing. Understanding the differences between these two risks is crucial for auditors to effectively plan and execute their audit procedures. In this article, we will compare the attributes of audit risk and risk of material misstatement to provide a comprehensive understanding of these concepts.

Definition

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. It is composed of two components: the risk of material misstatement and detection risk. On the other hand, the risk of material misstatement is the risk that the financial statements are materially misstated before the audit is conducted. It is also composed of two components: inherent risk and control risk.

Components

As mentioned earlier, audit risk consists of the risk of material misstatement and detection risk. The risk of material misstatement, on the other hand, consists of inherent risk and control risk. Inherent risk is the susceptibility of an assertion to a material misstatement, assuming that there are no related controls. Control risk, on the other hand, is the risk that a material misstatement could occur and not be prevented or detected by the entity's internal controls.

Relationship

There is a direct relationship between audit risk and the risk of material misstatement. As the risk of material misstatement increases, audit risk also increases. This is because a higher risk of material misstatement means there is a greater likelihood that the financial statements are materially misstated, leading to a higher risk that the auditor will issue an inappropriate audit opinion. Therefore, auditors must assess and address the risk of material misstatement to effectively manage audit risk.

Assessment

When assessing audit risk, auditors consider the risk of material misstatement as well as detection risk. The risk of material misstatement is assessed by evaluating inherent risk and control risk. Inherent risk is assessed based on factors such as industry conditions, complexity of transactions, and the entity's financial stability. Control risk is assessed by evaluating the effectiveness of the entity's internal controls in preventing and detecting material misstatements.

Management

Managing audit risk and the risk of material misstatement is a critical aspect of the audit process. Auditors must design their audit procedures to address the assessed risks and gather sufficient appropriate audit evidence to reduce detection risk. This involves performing substantive procedures to test the accuracy and completeness of the financial statements and evaluating the effectiveness of the entity's internal controls in mitigating the risk of material misstatement.

Conclusion

In conclusion, audit risk and risk of material misstatement are essential concepts in the field of auditing. While audit risk is the risk that the auditor expresses an inappropriate audit opinion, the risk of material misstatement is the risk that the financial statements are materially misstated before the audit is conducted. Understanding the components, relationship, assessment, and management of these risks is crucial for auditors to effectively plan and execute their audit procedures.