What is the equation for calculating audit risk?

The correct equation for calculating audit risk is determined by the relationship between inherent risk, control risk, and detection risk. Audit risk is fundamentally understood as the risk that an auditor may issue an inappropriate opinion on financial statements that are materially misstated.

The correct formula emphasizes that audit risk is a function of these three components: inherent risk, which is the susceptibility of an assertion to a misstatement due to error or fraud; control risk, which is the risk that a misstatement will not be prevented or detected by the internal controls; and detection risk, which is the risk that the auditor's procedures will fail to detect a misstatement that exists. When these factors are multiplied together, the resulting product reflects the overall audit risk, thereby reinforcing the interconnected nature of these risks in the audit process.

This equation highlights the concept that as inherent risk and control risk increase, the auditor must reduce detection risk through more stringent audit procedures to maintain the overall audit risk at an acceptable level. Thus, it captures the overall relationship between the risks inherent to the audit and the effectiveness of the detection methods employed by the auditor.