1. Overview

• Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated.

• A material misstatement is defined as an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the  judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.

  • Factual Misstatements: Factual misstatements are misstatements about which there is no doubt.

  • Judgmental Misstatements: Judgmental misstatements are differences arising from the judgments of management, including those concerning recognition, measurement, presentation, and disclosure in the financial statements (including the selection or application of accounting policies that the auditor considers unreasonable or  inappropriate).

  • Projected Misstatements: Projected misstatements are the auditor's best estimate of misstatements in populations, involving the projection of misstatements identified in audit samples to the entire population from which the samples were drawn.

3. Audit risk and materiality

Audit risk and materiality should be considered together in designing the nature, extent, and timing of audit procedures and in evaluating the results of those procedures.

There is an inverse relationship between audit risk and materiality. The risk of a very large misstatement may be low, whereas the risk of a small misstatement may be high. Also, the more material a misstatement is, the less likely it is that the auditor will not detect it.