Hong Kong Auditors Focus on Risk Assessment to Reduce Audit Risk
Auditing professionals in Hong Kong are increasingly recognizing the importance of risk assessment in reducing audit risk. According to the Hong Kong Standard on Auditing 200, one of the overall objectives of an auditor is to obtain sufficient and appropriate audit evidence to reduce audit risk to an acceptably low level.
Understanding Audit Risk
Audit risk is a function of material misstatement risks and detection risks, assessed at two levels: overall financial statement level and assertion level for classes of transactions, account balances, and disclosures. The assessment considers inherent risks and control risks, which are further broken down into detection risks.
The Audit Risk Model
The audit risk model provides a framework for auditors to manage total audit risk by adjusting detection risk. The equation is simple:
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Each component of the model has its own definition:
- Inherent Risk: Refers to the susceptibility of an assertion about a class of transaction, account balance, or disclosure to material misstatement before considering controls.
- Control Risk: Is the risk that a misstatement will not be prevented, detected, and corrected on a timely basis by internal control.
- Detection Risk: Is the risk that procedures performed by auditors will not detect a misstatement that exists and could be material.
Assessing Risks of Material Misstatement
In practice, auditors assess risks of material misstatement at the assertion level to determine the nature, timing, and extent of further audit procedures necessary to obtain sufficient and appropriate evidence. For instance:
- In auditing sales revenue for fast food stores, auditors consider inherent risk factors such as business risk and internal control effectiveness.
A Recent Example
A recent example illustrates how auditors can use the audit risk model to assess risks and adjust detection risk accordingly. In a cash-based sales environment, there is a higher chance of misappropriation, leading to an understatement of sales revenue due to incomplete recording. However, technology, such as electronic payments, reduces the inherent risk.
Assessing Internal Control System
In this case, auditors assessed the internal control system’s effectiveness in preventing misappropriation and omitting sale transactions recording. If deemed effective, auditors may adopt a combined approach by conducting more tests of controls and reducing the extent of substantive audit procedures.
Expert Insights
Dr. Josephine Wong, Teaching Fellow at the School of Accounting and Finance of Hong Kong Polytechnic University, emphasizes the importance of considering both inherent risk and control risk when assessing material misstatement risks. She highlights that auditors should not solely rely on internal control but rather adopt a combined approach to ensure adequate audit evidence.
Conclusion
In conclusion, Hong Kong auditors are increasingly recognizing the importance of risk assessment in reducing audit risk. By applying the audit risk model and considering both inherent and control risks, auditors can effectively manage detection risk and ensure that financial statements are accurate and reliable.