Audit Risk Assessment: Essential Strategies for Today’s Auditors

Financial risk assessment in auditing focuses on catching inaccuracies in financial reports before they cause problems. Because investors and other stakeholders rely on these records to make decisions, the goal is to ensure a company’s financial statements truly reflect its financial health.¹

In this post, you’ll learn about different types of audit risks, how they can impact a business if left unchecked and the latest strategies and audit risk tools to help mitigate them.

Understanding Audit Risk and Its Components

Financial audit risk is the possibility that an auditor concludes that a company’s financial reports are accurate when, in reality, mistakes exist that could affect stakeholders, such as investors or creditors. It occurs when errors or omissions are reflected in the reports but are not caught during an audit. This results in an inaccurate representation of an organization’s financial position.²

Why is mitigating audit risk important? Inaccuracy in financial statements can cause serious trouble for an organization. Not only can it erode public trust in a business, but it can also lead to regulatory issues with government agencies. The Securities and Exchange Commission (SEC), for example, says that investors expect companies to be completely honest and accurate in their financial reports. If organizations don’t meet that standard, the agency promises to hold them accountable.³

Types of Audit Risks

There are three types of audit risk:²

• Inherent risk: Inaccurate information appears in financial reports due to the nature and operations of the company, such as transaction complexity or accounting estimates.
• Control risk: A company’s internal controls fail to prevent the financial errors or fraud.
• Detection risk: Financial mistakes go unnoticed throughout the auditing process.

These risks are usually assessed separately, but sometimes they build on each other. Together, they determine the overall financial risk in auditing.

The Impact of Audit Failure

In 2019, the SEC started investigating Kraft Heinz, a food and beverage company. In 2021, the SEC charged Kraft for improperly recording around $208 million in cost savings in its financial statements over several years.

According to the regulatory watchdog, Kraft didn’t have proper internal accounting controls in its procurement department. As a result, finance personnel repeatedly missed signs that expenses were being accounted for incorrectly. The company’s Chief Operating Officer (COO) even signed off on faulty financial reports that ultimately hurt investors.

The SEC treated this discrepancy as accounting misconduct. To settle the charges, Kraft paid $62 million. The Chief Procurement Officer (CPO) and COO, who were charged along with the company, paid a combined civil penalty of $400,000. The CPO was banned from serving as an executive at any public company for five years.³

Key takeaways from this case show that poor risk management in auditing can lead to the following:

• Regulatory scrutiny
• Costly fines
• Reputational damage
• Personal consequences for business leaders
• Negative impacts on investors

Audit Risk Assessment Strategies

The main role of internal auditors in risk management is to provide assurance that management presents a true and fair view of a company’s financial position. Achieving that requires knowing, prioritizing and mitigating the risks that could cause financial misstatements. The following risk assessment strategies can help:

Understand the Business Environment and Identify Risks

Auditors rely on what they know about a business, its industry and its operational environment to spot risks that could lead to mistakes in financial statements.⁴ The following risk assessment procedures support the development of this knowledge:⁵

• Analysis: Identifying trends, patterns and anomalies in financial data that auditors can use to assess the reasonableness of an organization’s financial statements
• Inspection: Examining regulatory requirements, physical assets like inventory lists or checking records, such as invoices, to verify information accuracy and existence of assets
• Observation: Checking the performance of risk mitigation procedures in day-to-day operations to assess their effectiveness and whether they are actually being followed
• Inquiry: Obtaining relevant information from people responsible for governance or management in the organization being audited

Use a Risk Matrix

Financial audits might reveal multiple risks. Some require more attention than others during risk evaluation in auditing. With a risk matrix, you visually map out financial threats based on how likely they are to happen and how much damage they could cause. This makes it easier to prioritize risks.⁶

Evaluate Internal Controls

Internal controls are the systems and processes that businesses put in place to make sure their financial information is accurate, reliable, timely and compliant with relevant regulations. Auditors evaluate them to ensure they operate effectively and align with applicable regulations.⁷

Managing Internal and External Audit Risks

An organization’s in-house audit department conducts internal audits to evaluate the effectiveness of internal controls and ensure they adhere to relevant regulations. Because of the internal nature of these audits, financial markers generally want more objective audits. Internal teams working together with independent auditors can increase objectivity and reduce financial audit risks.⁸

On the other hand, external audits are done by third parties. The independent nature of these audits enhances their credibility. However, external auditors often face the challenge of incomplete or inaccurate data because they depend on the information the company provides. Full access to the necessary financial records can help solve this problem and reduce external audit risks.^{8, 9}

Tools and Technologies for Audit Risk Mitigation

Technology can help make audit risk management more efficient. Tools for audit risk mitigation include the following:

• AI-powered data analytics tools: Analytics tools can sift through large quantities of financial data to reveal hidden patterns that signify irregularities.¹⁰
• Automation tools: Automation workflows in enterprise resource planning systems and accounting software automate repetitive, error-prone accounting processes to increase audit accuracy and save time.¹¹

Lead the Field as an Expert Auditor With DePaul University

If you are interested in advancing your career in auditing, consider pursuing an online Master of Science in Accountancy (MSA) from DePaul University. Through the MSA curriculum, you’ll be able to expand your knowledge of financial record management, auditing and consultancy and hone the skills needed to put that knowledge into practice. If you are ready to take the next step in your accounting journey, explore more information about the online MSA program and review the admissions process today.