Audit risk – is the risk that the auditor gives an in appropriate audit opinion when the financial statement are materially misstated. An audit in accordance with ISAs is designed to provide reasonable assurance that the financial statements taken as whole are free from material misstatements. The concept of reasonable assurance implies that there is risk that audit opinion will be inappropriate when the financial statements are materially misstated.Audit risk can be reduced to an acceptable low level by designing and performing audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusion on which to base an audit opinion.
Audit risk therefore considers two base risks:
- that the financial statements were materially misstated prior to audit (control & inherent risks)
- and that the auditor will not detect such material misstatement (detection risk)
Business risk on other hand is the risk that entity will not be able to achieve its objectives and execute its strategies. Such risks results from the way the entity is managed, its operating environment, products, customer base, legal and regulatory regimes and the very fact that it operates in a dynamic and adaptive environment.
Management should have risk assessment procedures on place to be able to recognize business risks and take appropriate action (e.g through risk management procedures and controls) to minimize the impact of such risks.
Relationship of audit risk and business risk.
Business risk is much broader than the risk of material misstatement of financial statements (Audit risk), but as most business risks will eventually have financial consequences, there will be a ‘cascading’ impact on the financial statements and consequentially audit risks.
Embodied within business risk controls will be those controls that directly or indirectly, relate to financial reporting, operation and compliance.
Audit risk takes into account the risks that are inherent within the entity, how such risks are managed and their impact on the financial statements.