Outline the factors that an auditor would have to consider when determining the level of acceptable audit risk they would be willing to take when conducting an audit.
Critically evaluate the importance of these factors and include in your discussion factors that would be influenced by:
1. User reliance on financial statements
2. Likelihood of financial difficulties
3. Management of the firm being audited
Inherent, Control, and Detection Risks
Since a business is vulnerable to various risks, the role of auditors can be very helpful in detecting and mitigating such risks. Furthermore, it also assists in attaining a true and fair view of the company. Moreover, an auditor also assists in minimizing the likelihood of errors and frauds by verification and vouching methods. For such purpose, it is relevant that the company attains a qualified opinion. Nevertheless, this report primarily emphasizes upon audit risks and relevance of specific traits that play a role in operating the audit process. Such audit risks generate when irregularities and errors derive due to the auditor’s incapability in assessing the financial statements. The reason behind such incapability can be too much dependence on financial statements, financial hurdles, etc. On a whole, this report highlights such traits through an enhanced analysis.
Inherent risk refers to a kind of risk that cannot be mitigated even after careful planning and prior consideration of risk. Besides, since every business is prone to several types of risks, it has become problematic to keep such risks controlled. Furthermore, financial frauds have been increasing over time and therefore, proper audit practices have become the hour of need. In relation to auditing, various factors must be taken into account, as even it is not invulnerable to risks (Livne, 2015). In this case, the role of auditors becomes very significant as they can assist in offering an enhanced judgment. For this, auditors are bound to maintain enhanced relationships with the management in order to evaluate the financial statements effectively, thereby terminating the likelihood of errors and frauds. In addition, they must make appropriate inquiries in order to determine the efficacy of financial information (Hoffelder, 2012). On a whole, an auditor assists in procuring an enhanced judgment regarding the truthfulness of financial statements.
An auditor would be willing to take acceptable audit risk in order to provide an unqualified opinion in the event of material misstatement of financial statements. Moreover, his judgment and evaluation play a key role in establishing an effective report accommodated with professional and honest opinions (Livne, 2015). It is the auditor’s duty to not only plan and operate audit procedures but also to create effective stakeholder value during the auditing process. However, due to such responsibility, an auditor is burdened with a residual risk of offering an unqualified opinion. This is because whether financial statements are free from biases and errors, it majorly depends on his opinion. As per Fazal (2013) if an auditor fails to offer an effective opinion resulting from the discovery of errors and frauds in the upcoming future, he as well as the firm becomes duly liable for various kinds of criminal charges and other penalties. However, in relation to audit firms, they subscribe to several incompetence insurances in order to sustain the risk and its legal consequences. Nevertheless, auditors must undertake prior caution while interacting with the management on matters related to frauds and errors in the financial statements, as it can hamper the integrity and reliability of such financial data. In addition, auditors must not hesitate in communicating with higher authorities after discovering involvement of the management in the fraud.
Audit Reports and Judgment
In the event of the issuance of an unqualified report, auditors must take into account best outcome attributes while utilizing his intellectual knowledge and experience. However, there are scenarios when audit reports can depict a faulty judgment. For example, issuance of qualified judgment without a substance, issuance of unqualified judgment wherein qualification is sensibly justified, issuance of a judgment wherein the scope of financial statements does not necessitate such an opinion, etc (Roach, 2010). The complete audit procedure can be segregated into a series of segments that are incorporated with audit risks. These segments comprise of Detection risk, Control risk, and Inherent risk. In simple words, an audit risk is a multiplication of all such risks, and it is the auditor to use their judgments to make sure that these risks do not exceed their specified limits.
Control risk generates because of absence or incapability of operational measures in the company. Therefore, companies must implement proper internal control sin order to safeguard from frauds and errors. Moreover, this evaluation must be carefully implemented for small firms, as they do not pursue task specialization and control attributes to minimize the influence of the risk. Inherent risk is the risk of significant misstatements present in the financial statements because of errors of commission or omission, and control failures. Detection risk is the risk that auditors fail to interpret even after repetitive signals, thereby resulting in misrepresentation or fraud. Therefore, it is upon the auditor to implement effective audit processes in order to detect such misrepresentation. Besides, such failure to comply with specific processes arises because of restrictions prevalent in relation to the selection of samples (Gilbert et. al, 2005). Hence, enhancing the number of sample transactions can assist in reducing such failure. These risks form part of the risk model of audit risk wherein auditors investigate the control and inherent risks together with understanding the operational effectiveness and the environment of the company as a whole. There may also be some external factors that can make the auditors review their judgment on the risks prevalent in the company for which audit process is conducted.
The engagement risk is affected by the seriousness, final, and urgent use by the final user. For instance, in relation to credit appraisal procedure, if the financial statements are utilized for the same, the encouragement of the management will be immense in order to affect the auditor, and such an auditor will possess an additional exertion to comply with the same standards to establish a favorable judgment. Moreover, this can result in window-dressing of the financial statements (Parker et. al, 2011). In simple words, the risk of final usage enhances the risk of appropriate investigation that can play a role in establishing biases in the auditor’s mind, as for whether to take into consideration every variation or allow some slides if the final user is for the public.
Engagement, Continuity, and Client Management Risks
It is the auditor’s duty to detect and scrutinize areas that may be relevant to continuity issues, and in order to fulfill these criteria, necessary evidence must be gathered. Moreover, the going concern principle is applicable for every commercial organization unless specified in any other situation. Therefore, in the event of any doubt in the financial statements, the management measures must be taken into account to mitigate such fraudulent information (Parker et. al, 2011). Besides, the management may also misguide such data, thereby necessitating an analytical and experienced auditor to examine the planning process in order to offer a valuable suggestion (Cappelleto, 2010). Moreover, such auditor must not let his personal biases interfere with the circumstances and facts of the scenario.
Management integrity plays a key role in controlling the risk of an auditor. Moreover, the best method to document this can be the form of continuance or acceptance of the client. Furthermore, the attitude of the management towards implementing various plans and policies, follow-ups, implementing standards, and their efficacies play a relevant part in simplifying the job of an auditor. This can also facilitate in setting up a tone for the workforce of the company that they can adhere to, thereby measuring and minimizing the component risks. Moreover, the well-being of an auditor is also very important in this scenario because such auditor makes certain steps to ensure that the management does not deviate from the effectiveness of strong internal control measures (Manoharan, 2011). This can, in turn, allow the auditor to minimize his own biases and opinion issues while offering a qualification on the audit procedure. Therefore, proper use of an auditor’s judgment and opinion can play a part in minimizing the loopholes. Besides, according to various researchers, auditing standards can be efficiently maintained by the enhanced support of the decisions offered by the auditors, ultimately proving of immense benefit to the people in the organization (Manoharan, 2011). In addition, during the performance of an audit procedure, when an auditor undertakes his strategy with uncertainties, it results in a high-quality audit process as it assures that all unspecific scenarios are being taken into consideration.
Depending upon the size of a firm, an audit strategy varies accordingly based on factors like effectiveness level of the management and complications. This is because few large firms often utilize immense procedural rules and regulations in order to influence the exact same data that cannot be hidden or manipulated by a smaller firm from their auditors (Lapsley, 2012). Besides, the risk of an audit process is not only undertaken by the auditor but also by the company themselves. Nevertheless, this can assist an auditor to be cautious regarding financial information incorporated in the financial statements. Moreover, an auditor must not accept procured details when other information opposes with the prior one. In addition, the process of investigation must not be undertaken prior to such step. Therefore, when management and auditors do not work together, various scandals are likely to happen. Hence, in order to safeguard from such possibilities of fallen auditing standards, it is significant for auditing firms to establish frameworks that are efficient in nature and facilitates in determining processes for all audit reports.
Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ,Melbourne
Fazal, H 2013, What is Intimidation threat in auditing?, viewed 15 April 2017, https://pakaccountants.com/what-is-intimidation-threat-in-auditing/.
Gilbert, W. Joseph J & Terry J. E 2005, The Use of Control Self-Assessment by Independent Auditors, The CPA Journal, vol.3, pp. 66-92
Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.
Lapsley, I. 2012, Commentary: Financial Accountability & Management, Qualitative Research in Accounting & Management, vol. 9, no. 3, pp. 291-292.
Livne, G 2015, Threats to Auditor Independence and Possible Remedies, viewed 15 September 2016, https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full.
Manoharan, T.N. 2011, Financial Statement Fraud and Corporate Governance, The George Washington University.
Parker, L, Guthrie, J & Linacre, S 2011, The relationship between academic accounting research and professional practice, Accounting, Auditing & Accountability Journal, vol. 24, no. 1, pp. 5-14.
Roach, L 2010, Auditor Liability: Liability Limitation Agreements, Pearson.
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