Perhaps the most important risk for auditors is the risk of a material misstatement [RMM], which is the risk of a material misstatement in the unaudited financial statements, or an underlying level of aggregation, after the application of management's control procedures.
Auditors obtain a sufficient understanding of the client entity in order to evaluate this risk at all three levels of aggregation ( i.e. the financial statement level, the account balance level and the class of transaction level). This evaluation of the risk of material misstatement includes the auditor's evaluation of the risk arising from fraud. Prior to the commencement of evidence gathering, auditors discuss the RMM with their audit team.
Auditors either evaluate this risk directly or evaluate the components of the risk (i.e. inherent risk and control risk) individually. At the financial statement level, particularly, when it is sometimes difficult to differentiate between the risk components, auditors may choose to evaluate RMM directly (in other words, auditors evaluate the combined inherent and control risks). However, the approach generally taken in these pages is to evaluate inherent risk and control risk individually at all levels of aggregation.
The risk of material misstatement is an important concept for auditors as, for a given acceptable level of audit risk, the greater the risk of material misstatement, the greater is both the quantity and quality of evidence that is required to be gathered and evaluated by the auditor. Additionally, the greater the risk of material misstatement, the greater is the degree of professional skepticism applied.
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