What Is a Financial Risk Audit? (Including Types and Tips)

By Indeed Editorial Team

Published 24 October 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Audits help businesses learn more about how well it's doing financially and what they can do to improve. Although there are many types of audits, a business can find it especially beneficial to engage an auditor to assess it for potential risks. If you're a risk auditor or if the idea of joining this field interests you, learning more about auditing for risks could help you excel in this role. In this article, we define risk audits, list the types of risks you might audit for and provide some tips to improve your competency in performing this type of audit.

What is a risk audit?

A risk audit involves the examination of a financial statement, project or business to determine any potential threats. This process is an excellent way of assessing the effectiveness of an organisation's risk management system. For financial statements, auditors perform this type of risk assessment specifically to identify and rectify any misstatements. An auditor typically employs the following procedures to audit for risks:

  • Inquiry: The auditor has meetings with the company's financial personnel to obtain information about the company's practices.

  • Inspection: Auditing inspections involve ensuring that a business is compliant with various obligations and policies.

  • Observation: The auditor observes the company's employees as they perform internal control activities, reviews the information gathered and compiles a report.

  • Analytical procedures: These procedures help an auditor establish the reason for any discrepancies between expected and reported amounts.

Related: What Is an Internal Audit? Role and Career Information

Types of risks

Here are the different types of risks you might encounter during a risk audit:

Inherent risk

Inherent risk is an assessed level of raw or untreated risk in a process. In financial statements, the usual cause of this type of risk is an error of omission. It's important to find any inherent risks that a company might have, as these risks can mislead investors. Since detecting these risks can be quite challenging, a common approach is to engage several auditors to check all the financial statements thoroughly. Here are some examples of mistakes and situations that can cause inherent risk:

  • Human error: In business, human error can result in the omission of a transaction. For example, a company's bookkeeper might fail to record a transaction with a regular vendor or record the wrong amount.

  • Complex organisational structure: The structure of some organisations may become very complex because they gain many associates, subsidiaries, holdings and joint ventures. Accordingly, recording and reporting transactions become more complicated, and mistakes can occur.

  • Non-routine transactions: These types of transactions include activities that only occur periodically, such as checking physical inventory or calculating depreciation costs. Because of the rarity of these events, it's easy for an inexperienced employee to make a mistake by recording the wrong amounts or not recording them at all.

Related: What Is a Job Audit? (Definition and How to Conduct One)

Control risk

Control risk is the chance of a misstatement occurring in a financial statement either because there weren't any measures in place to detect such misstatements, or the measures didn't work. Often known as internal controls, these measures can involve frequent monitoring of processes, conducting risk assessment activities and compiling and submitting reports. When an organisation lacks these measures, these are some of the control risks that can occur:

  • Cybersecurity risks: Businesses that don't have effective cybersecurity are more vulnerable to hackers and online fraud. For example, a hacker might order a product without making a payment, causing the company to suffer a loss.

  • Integrity and moral risks: A company without internal controls risks entering into contracts with parties who provide misleading information about their assets or credit capacity. Without safety measures, the company has no means to screen its employees, partners or clients and relies only on good faith.

  • Fraud: Without control aids, such as multi-factor authentication, businesses may find it challenging to verify the identity of employees, vendors, clients and customers. The consequences of being a victim of fraudulent activity can include loss of reputation, brand image and gross revenue.

  • Poor business design and practices: These can include approving documents without properly reviewing them, neglecting to update internal controls periodically and allocating duties inefficiently.

Related: How to Be a Good Auditor (With Skills and Tips to Improve)

Detection risk

This risk pertains to the inability of an auditor to detect a misstatement in a financial statement. Usually, auditors examine a statement for inherent and control risks first, leaving detection risk as the final component in the procedure. Here are examples of detection risks:

  • Improper planning and usage: This can include failing to define all potential threats and therefore deploying auditing software or an auditing procedure incorrectly.

  • Low competency level: An inexperienced or ill-prepared auditor might be more prone to making this error. For example, an auditor with doesn't know everything about a client is more likely to make an inaccurate judgement and determine that there aren't any misstatements.

  • Incorrect auditing methodology: Choosing an inappropriate auditing strategy can result in the auditor failing to find a mistake. An example of this could be checking the accuracy of the invoice instead of the occurrence of the sale.

  • Close auditor-auditee relationship: This type of auditing risk has a higher likelihood of occurring when the auditor and the audited entities are familiar with each other. If the employees of a business and the auditor are close friends, for example, this can lead to a relaxed auditing process that results in the overlooking of potential threats.

Related: What Does an External Auditor Do? (Plus Duties and Certifications)

Tips for risk auditing

Here are some tips that can help you do well when auditing for risks:

Be impartial

To conduct a thorough audit, it's important that you're not biased regarding the findings. More experienced auditors may sometimes find it challenging to adopt a neutral position, which can affect the quality of their work. It's a good idea to remember that your main duty is to identify any misstatements and determine the severity of the risks. Frequently reminding yourself of your role and function can make it easier to recognise any biases that might otherwise affect the quality of your work.

Related: FAQ: What Does a Compliance Auditor Do? (With Salary)

Be thorough

It's not possible for an auditor to detect every single risk and error. This is particularly true for detection risk. Auditors typically check only a representative sample of a company's transactions instead of attempting to analyse all of them. Despite this, aim to detect as many potential risks as you can. Increasing the size of the sample that you assess is one way to ensure that you're being thorough in your duties.

Related: 40 Auditor Interview Questions (Plus Sample Answers)

Communicate your findings clearly

The final stage of an auditing process typically involves a review. Here, the auditor shares information about the risks they've found and gives advice for managing them. The auditor might produce a written report, but there's also usually a closing meeting that involves senior management, shareholders and the board of directors. Prepare thoroughly before you share the information you've gathered. Regardless of whether you're delivering a written report or a presentation, ensure that all the figures are accurate.

You can prepare for a presentation by rehearsing in front of a mirror or with a few of your colleagues. Try to be concise and keep your language simple to make sure that everyone understands your message clearly.

Related: How to Write an External Auditor Resume (With Example)

Outline potential consequences

Finally, be sure to highlight the potential consequences that might arise if your client doesn't resolve the risks you've found. You may do this during the closing meeting by preparing a brief presentation. In addition to the potential consequences that might affect the company, you can also suggest a plan of corrective action. Having a realistic timeframe for such a plan can help persuade your audience of its feasibility and encourage them to adopt it.

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