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The Risk-Based Audit Model

The document discusses the risk-based audit model. It distinguishes between risk-based and accounts-based audits, with risk-based audits beginning with assessing risks of misstatement and adjusting audit work accordingly. The stages of risk-based audits are described as risk assessment, risk response, and reporting. Audit risk is defined as the risk of an unqualified opinion on materially misstated statements, and is determined by engagement risk, business risk, and financial reporting risk. Setting audit risk involves considering materiality, costs, client selection, expectations, and focusing on risky accounts.

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Joshel Mae
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788 views

The Risk-Based Audit Model

The document discusses the risk-based audit model. It distinguishes between risk-based and accounts-based audits, with risk-based audits beginning with assessing risks of misstatement and adjusting audit work accordingly. The stages of risk-based audits are described as risk assessment, risk response, and reporting. Audit risk is defined as the risk of an unqualified opinion on materially misstated statements, and is determined by engagement risk, business risk, and financial reporting risk. Setting audit risk involves considering materiality, costs, client selection, expectations, and focusing on risky accounts.

Uploaded by

Joshel Mae
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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The Risk-based Audit Model

 Distinguish between the risk-based audit process and the accounts-based audit process.
 Describe the activities in the risk-based audit process.
 Explain the factors to consider in implementing the audit risk model.
 Explain the limitations of the audit risk model.

The Risk-based Audit Process

Risk-based Versus Accounts-based

A risk-based audit model is an audit approach that begins with an assessment of the types
and likelihood of misstatements in account balances and then adjusts the amount and type of
audit work to the likelihood of material misstatement occurring in account balances.

In a risk-based audit, the audit team views all activities in the organization first in terms of risks
to strategies and objectives, and then in terms of management's plans and processes to
mitigate the risk. The auditors obtain an understanding of the client's objectives. The risks are
identified and the auditors determine how management plans to mitigate the risk and whether
those plans are in place and operating effectively.

An account-based audit is an approach wherein the auditor obtains an understanding of


control and assesses control risk for particular types of errors and frauds in specific accounts
and cycles.

Under the PSAs which are risk-based, specific audit procedures vary from one engagement to
the next. the following stages are, however, involved in every engagement.

Stages of the Risk-based Audit Process

PHASE I. Risk Assessment

This phase involves the following activities:

A. Performance of preliminary engagement activities to decide whether to accept/continue an


audit engagement.

B. Planning the audit to develop an overall audit strategy and audit plan.

C. Performance of risk assessment procedures to identify/assess the risk of material


misstatement through understanding the entity.

PHASE II. Risk Response

This phase covers the following activities:

A. Designing overall responses and further audit procedures to develop appropriate


responses to the assessed risk of material misstatement.

B. Implementing responses to the assessed risk of material misstatement to reduce audit


risk to an acceptable low level.

PHASE III. Reporting

This phase involves the following activities:

A. Evaluating the audit evidence obtained to determine what additional audit work (if any) is
required.

B. Forming an opinion based on audit findings and preparing the auditor's report.
Understanding the Audit Risk Model

Audit risk is the risk that the auditor may give an unqualified opinion on materially
misstated financial statements. It is determined and managed by the auditor. 

Engagement risk deals with whether the auditor wants to be associated with a particular
client including loss of reputation, the inability of the client to pay the auditor, or financial loss
because management is not honest and inhibits the audit process.

Business risk is a risk that affects the operations and potential outcomes of organizational
activities.

Financial reporting risk relates to the recording of transactions and the presentation of the
financial data in an organization's financial statements.

The following considerations are important in integrating the concepts of materiality and risk in
the conduct of an audit.

1. Audits involve testing or sampling and thus cannot provide absolute  (100%) assurance that
the financial statements are free of material misstatements without inordinately driving up the
cost of audits.

2. Not all clients are worth accepting. Since audits rely on testing and to some extent on the
integrity of management, there are some clients that an audit firm should not accept because
the engagement risk is too high.

3. Competition for clients among audit firms is high. Clients choose auditors based on a number
of factors including fees, service, industry, knowledge, personal rapport, and ability to assist the
client.

4. Auditors should understand society's expectations of financial reporting to reduce audit risk to
an acceptably low level and therefore minimize lawsuits that the users may possibly bring forth.

5. Risky areas of the business must be identified by the auditors to determine which account
balances are more prone to material misstatements, how the misstatements might occur and
how a client might be able to cover them up.

6. Auditors need to develop approaches and methodologies to allocate overall assessments of


materiality to individual account balances because some account balances may be more
important to users.

The relationship between engagement risk and audit risk may be presented as follows:

  Engagement Risk
High Moderate Low
      Set within professional standards
but can be higher than companies
 Audit risk  Do not accept Set very low (1%) with higher engagement risk (5%)

 Setting the audit risk at 1% is equivalent to performing a statistical test using a 99%
confidence level. Audit risk set at 1% implies that the auditor is willing to take a 1%
chance of issuing an unqualified opinion on materially misstated financial statements.
 Audit risk set at 5% implies that the auditor is willing to take a 5% chance of issuing an
unqualified opinion on materially misstated financial statements.
 High levels of audit risk are appropriate for clients with lower levels of engagement risk.

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