The Environment Of The Audit Risk Model Accounting Essay

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

The environment of the audit risk model lends itself enthusiastically to this task. Through the evaluation of the accounting industry the model can become a practical and dynamic tool for controllers in both their discovery of possible irregularities and allotment of resources. A key challenge faced by auditors and those who standardize them in performing this role is the proper allotment of discovery resources. To overcome this obstruction, auditors make use of the audit risk model to competently apportion their resources while still upholding efficiency (David Piercey, 2011). The audit risk model is made up of intrinsic, control and detection risk to establish the overall audit risk concerned in the performance of an audit. Inherent and control risk categorize the specific characteristics inside the industry and client that make it more likely to misstate their financial outcomes. The audit risk is defined as the probability that an auditor will be unsuccessful in adjusting the opinion to replicate that the financial statements are significantly misstated (Snyder & Jongward, 2007).

As a prognostic tool, the audit risk model gives auditors a sensible measure of the areas of financial statements that are more susceptible to deceitful financial reporting. Once recognized, the auditor can then use this tool to guide their focus to superior risk areas. The intrinsic risks inside the profession come about from the anxieties between an audit firm's obligation to guard investor's interests, its business obligation to generate profits from audits and the surroundings in which audit firms are retained and paid by the companies that they are charged with watching. As a consequence, it is expected that the audit firms themselves will be subject to outside controls intended to make sure they attain the proper balance of interests when performing the helpful service they provide. Even in the face of regulatory and professional principles to make sure correct and impartial audits there remains the risk that forces outside the audit firm may support mistaken audit opinions (Snyder & Jongward, 2007).

The contemplation of audit risk is a major focus for balancing the trade-offs between competence and effectiveness in audits. "The model described in SAS No. 47 (AICPA 1984) constitutes a decision aid that decomposes a global risk assessment into component risks that are used as inputs to the model. On the one hand, the standards define the components to be conditionally dependent. Likewise, control risk is defined as the risk that a material misstatement that could occur, will not be prevented or detected, by the entity's internal control structure. Thus, the wording of the standard indicates that the component risk assessments should not be made independently" (Dusenbury, Reimers & Wheeler, 2000).

The audit risk model operationalizes a risk based approach to choosing the quantity of detailed testing necessary for an audit to be successful. Because detailed testing is expensive, conducting such tests only to the degree necessary for an audit to be effective can increase audit efficiency. The audit risk model decomposes the auditor's risk of wrongly concluding that no material misstatement exists into three major components-client inherent risk, client control risk, and auditor detection risk. The auditing standards demonstrate the model multiplicatively as follows: the standards suggest that appraisals of these risks establish the degree of most audit work. First, the auditor selects a satisfactory level of overall audit risk (AR) to be very low. Then, the auditor reviews the inherent riskiness (IR) of the client's accounts, cycles, or financial statement assertions. Next, the auditor documents an understanding of client controls and assesses control risk (CR). Control risk may be assessed twice-once before the tests of controls are executed and then again after the auditor has the results of the tests of controls, if performed. The auditor joins inherent risk and control risk to solve for the amount of detection risk (DR) that can be tolerated, given the targeted AR level. Optimally, the DR part may be split into APR and TDR components in recognition of the two major classes of substantive procedures (Dusenbury, Reimers & Wheeler, 2000).

Auditing standards show that intrinsic, control and analytical procedures risks may be joined to establish the extent of substantive, detailed testing. The standards portray each component risk independently; however, the audit risk model will not generate proper results unless the components are measured in relation to each other. That is, knowledge about one part of the risk model must be weighed in order to correctly assess the risks associated with another. This relationship is known as being conditionally dependent (Dusenbury, Reimers & Wheeler, 2000).

After tackling unparalleled disputes in the last decade, accounting firms have begun wide-ranging efforts to progress the basic financial statement audit and to increase external comfort beyond the traditional audit. The reassessment of audit methods has fashioned a new importance on evaluating business and procedure risks in the performance of an audit. Present inclinations in auditing are forming new tests for the profession, leading to the advancement of new techniques and services (Eilifsen, Knechel & Wallage, 2001).

Audit practice has develop in recent years due to unparalleled market forces including market infiltration, commodity based pricing, demands to decrease substantive testing, focus on value-added declaration and rising expenses from teaching, technology, and legal actions. As a result, a lot of large accounting firms have come to the conclusion that the audit process needed new skills, methods, and service deliverables. "Initial efforts to redesign the audit process focused on: (1) reducing or shifting costs, and (2) increasing the value of the audit, leading to changes in staffing and recruiting, specialization by industry, reduced reliance on substantive testing, increased emphasis on qualitative and analytical evidence, and mounting investments in technology assets. Small changes in audit practice eventually became radical and pervasive, as can be seen in KPMG's BMP audit methodology, Arthur Andersen & Co's Business Audit and Ernst & Young's Audit Innovation efforts, among others" (Eilifsen, Knechel & Wallage, 2001, p.198).

Bad choices, information collapses, or deceitful action can consequence when workers, administration, or other stakeholders take inappropriate or useless measures that unfavorably affect a company. Issues can also come about from unsuccessful reactions to strategic risks, such as a failure to recognize and appropriately respond to alterations in the business environment, or misalignments between strategic goals and business procedures. Control procedures inside a company work to ease these troubles. External reassurance is the guarantee that the audit can be measured to be a dedicated form of power, and the command for auditing or other types of outside assurance is provisional upon the business risks facing a company and the techniques accessible to manage them. The degree to which the outside auditor is viewed as a resource of declaration depends on the auditor's capability to decrease vital risks. Subjective evidence advocates that the conventional financial statement audit is losing worth because the information associated with the auditor's report is not appropriate or practical. Furthermore, since owners have a lot of dissimilar types of control accessible for managing risk, the external audit may please regulatory necessities without supplementing organizational power (Eilifsen, Knechel & Wallage, 2001).

The auditor's test is to make the most of the value of the center audit service, while increasing the worth of external guarantee. Auditors should advance their attainment of client knowledge to offer a more effectual audit established on more complete and pertinent audit proof. Some dispute that auditing should develop to a strategic systems outlook of the company and center on the company's goals, pressures, and reactions to risks. Logic suggests that a lot of considerable business risks have direct associations to audit fears. Financial statements are authenticated with a methodical understanding of client business risk that supports audit findings about financial statement affirmations. The auditor's extended acquaintance can also be used to augment the scope and worth of declaration given to the client and stakeholders (Eilifsen, Knechel & Wallage, 2001).

This importance on understanding the client's business and connected risks is gaining reception as auditors move away from the self preventive spotlight on financial reporting and focus more on strategic risks, business procedure sand controls, business processing, and the evaluation of accounting approximations. Even though familiarity about business circumstances and procedures is significant, the auditor must also be familiar with that outstanding business risks typically have insinuations for the accomplishment of the audit. An organization that does not sufficiently watch its strategic risks or fails to act in response to recognized risks is more likely to have trouble succeeding. High enduring business risks may signify flaws in the control atmosphere, potentially high control risks for exact processes, or point to declarations that may be misstated. Residual business risks can be examined for their association to precise financial declarations and audit goals. The auditor then plans substantive tests to assess whether the declarations in question are significantly misstated. Because of the widespread knowledge attainment used to evaluate business risks and their relations to audit risks, only restricted substantive testing may be needed for a lot of declarations or objectives. In addition, high remaining risks indicate regions of client need that the outside accountant may aid in advance or develop reassurance to the client (Eilifsen, Knechel & Wallage, 2001).

 Auditors have been shown to adjust the elements of the audit risk model (ARM) and increase the audit investment in response to increasing risk that client financial statements contain material misstatements. There is also evidence that auditors respond to business risk--the risk of loss or injury to an auditor's professional practice due to client relationships--by increasing the investment in the audit and/or charging fees above the amounts required to cover the costs of conducting audits. While this research suggests that auditors react to both audit and business risk, it does not identify the conditions under which audit decisions reflect business risks not captured by the ARM. In such cases, the ARM, a standard of professional audit practice, fails to describe audit behavior (Houston, Peters & Pratt, 1999).

The ARM primarily addresses the risks associated with issuing unqualified audit opinions on client financial statements that contain material misstatements. Business risk, on the other hand, is present even when auditors comply with generally accepted auditing standards (GAAS) and render appropriate audit opinions. The primary costs associated with business risk relate to litigation, whether the exposure leads to auditors being held liable for client stakeholder losses. Other costs relate to sanctions imposed by regulatory bodies, impaired reputation and failure to collect fees. Business risk encompasses more than the risks associated with issuing unqualified opinions on materially misstated financial statements. A client with a weak internal control system experiencing financial difficulty, for example, introduces two kinds of risks: the risk of a material misstatement and the risk of financial failure. The ARM reflects only the first; business risk encompasses both (Houston, Peters & Pratt, 1999).