A financial audit is an important practice in any business. This is the activity of evaluating the financial transactions and financial status of the business. An audit may be conducted internally or by an external entity. When a financial audit is carried out, there is a factor called audit risk. This refers to the chances of making mistakes or overlooking mistakes during the audit. There is a formula used to calculate the audit risk:
Audit Risk (AR) = IR x CR x DR.
IR stands for inherent risk, which refers to the chances that something has been misstated and that there are no internal measures set up to lower the chances of this happening. CR stands for control risk. If there are internal controls set up to catch misstatements, there are still chances of mistakes slipping through - this is what the control risk refers to. DR stands for detection risk, and refers to the chances that a misstatement will not be detected by the auditor.
The audit risk is expressed in percentage form and is interpreted by the auditor depending on varying factors. Oftentimes, the audit risk is categorized as being low, medium, or high. What percentages fall under these three categories will also depend on the auditor. Some of the factors that come into play when calculating and analyzing the audit risk are experience and competence of the company’s personnel, the level of complexity of the financial transactions, the internal measures for control, and so on.
When conducting a financial audit, the audit risk must be below a certain threshold in order for the results to be deemed accurate and acceptable.