Risk is defined as a threat which could mean that a bussiness fails to meet an ongoing business objective.Business risks represent problems which are faced by management of a business and these problems should be identified and assessed for their impact on the bussiness.Business risks has always direct impact on financial statements of the entity hence causig financial statement risks.1 Financial statement risk is the risk that components of financial statements could be misstated,through innacurate or incomplete recording of transactions or disclosure.Financial statement risk therefore represent potential errors or delibarate misstatements in the published accounts of the bussiness.2 2.0.Understanding of the client and its environment.
Obtain an understanding of the client and its environment is one of the important steps of audit process.An auditor must gather sufficient background information to assess the risks of material misstatement of the financial statements and to design the nature,timing and extent of further audit procedures.Risk assessment procedures used to gather this information and include inquiries of management,analytical procedures,observation and inspection,and other procedures.At this stage of the audit,the auditors are attempting to obtain an overall understanding of the client and its environment,including its objectives and strategies and related bussiness risks,the manner inwhich management measures and reviews financial performance,and the client’s internal control. The auditors’consideration of control risk involves analyzing the design and implementation of internal control to decide whether the internal control system appers adequate to prevent or detect and correct material misstatements. From the process of understanding the client’s environment, it is when an auditor may be in position to identify the risks associated from within and those associated
from outside that can have material misstatement in the financial statement. 2.1.Internal Control
Internal control is designed to provide resonable assurance of archieving objectives related to reliable financial reporting, efficiency and effectiveness of operations, and compliance with applicable laws and regulations. The nature and extent of the audit work to be performed on a particular engagement depend largely upon the effectiveness of the client’s internal control in preventing or detecting material misstatements in the financial statements. Before the auditors can evaluate the effectiveness of internal control, they need a knowledge and understanding of how it works,what control exist and who perfoms them, how various types of transactions are processed and recorded, and what accounting records and supporting documentation exist. The auditors must have a sufficient understanding of the design and implimentation of internal control to plan the audit. 2.2.External factors understanding.
In recent years larger firms have increased concern on risk anlysis as an approach to auditing.The more embracing concept is that of Bussiness risks.As we have already seen bussiness risk is the threat that an event or action will adversely affect a bussiness’s ability to achive its ongoing objectives, and can be split between external and internal factors. An understanding of these risks gives the auditor thorough understanding of the client’s bussiness and also suggests where misstatement may occur in the financial statements. The factor envinsioned here including industry conditions such as competitive environment,supplies and customer relationships, and technological developments.They also include the regulatory, legal,political environment and general economic conditions.These factor may subject the client to specialized risk that may in turn effect the audit. Many firm big firms to varying degrees have adopted a financial model to evaluate the client’s industry that considers the attractiveness and other characteristics of the industry. Concerning the overall attractiveness of the industry, auditor consider such factor as: Barriers to entry.
Strength of competitors.
Bargaining power of the suppliers of raw material and labor. Bargaining power of customers.3
In assessing bussiness risk the auditor should ask himself to what extent does these external environment factors can affect the firm? What is the client’s bussiness model? Who are its major customers and suppliers? What the types of transaction does the client engaged in? How are they accounted for? These are the type of questions that the auditors attempt to answer to obtain an understanding of the nature of the client. The auditors’ understanding of the nature of the client will include the client’s competitive position, organazational structure, governance processes,accounting policies and procedures, ownership, capital structure and product lines.Then the auditor turn their attention to the client’s critical bussiness processes and obtain an understanding of how these processes creat the value for the client’s customers. 2.3.0.Objective and Strategies and Related Bussiness Risks.
The client’s objectives are the overall plans of the entity as defined by management. Management attempts to archieve these objective by developing strategies, or operation actions.However, achieving management objectives is always subject to bussiness risks.As described in the previous section, these are the condition that threaten management’s ability to excute the strategies and achieve objectives. The auditors obtain an understanding of the client’s operation and financial strategies and attempt to identfy significant bussiness risk faced by the client.Significant risk that may be identified for a particular client might include risk related to competition, changes of government regulations, changes in technology, volatility of raw material prices, interruption of supplies of critical materials, changes in major markets, or increases in interest rates. In obtaining their understanding of these matters, the auditors are particulary interested in management’s risk assessment process.Well operating companies use formal processes for identifying business risks and devising ways to mitigate them. An understanding of this process can assist the auditors in identfying significant business risks and evaluating their audit
significance.Many of these business risk may create risk of material misstatement of the financial statement. 3.0.Types of Bussiness risks.
Changing interest rates(especially with highly geared companies) Change in exchange rates
Failure to modernise products,processes,labour relations,marketing Employees
Failure to modernise or achieve ISOs or e-commerce
The process of dealing with suppliers or customers
Excessive reliance on a dominant chief executive
Cashflow including overtrading
Reliance on one or few products,customers,suppliers
Lack of research and development4
Computer systems failures
This is the possibility that the company will fail to operate due to suppliers failure to supply the required raw materials. 3.4.Financial risk
This is the possibility that exchange rate fluctuations will cause a substantial cost on imported inventory or interest rates will rise and make the company’s loans too expensive maintain. 3.5.Compliance risk
This is the possibility the company will unwillingly break the laws and be fined. Any of these risks can damage a company and may impact on financial statements.The issue here is the going concern of the company. 3.6.Rationale of business risk approach:
Research showed that processing errors were rarely a cause of audit problems. Major audit problems( e.g companies failing shortly after a clear audit report)arise out of issues such as going concern,major fraud by top management,larger-scale system breakdown,failure to modernise products,lack of response to market forces etc. The investigation of bussiness risk enables the auditor to have a profound knowledge of the bussiness The approach focuses the audit on to the high risk areas
The approach adds value to the audit and enables the auditor to offer some commercial benefits to the audit. The previous emphasis on transactions and systems was expensive and uneconomic. The pace of change in bussiness and in computing and communications means that companies are much more at risk of failure than ever before.The global economy is more competitive and more unforgiving than national economies. Audit firms wish to be in a van of innovation to attract clients The bussiness,environmental,corporate governance issues and the nature of management control are all now more significant for bussinesses.They also translate more quickly into the financial statements. A need for audit firms to show product differentiation to potential clients. Risks associated with specific industries may affect the auditor’s assessment of client bussiness risk and acceptable audit risk and may even influence auditors against accepting engagements in riskier industries such as the financial services and health insurance industries. Certain inherent risks are typically common to all clients in certain industries.Familiarity with those risks aids the auditor i assessing their relevance to their clients.Examples include potential inventory obsolescence in the fashion clothing industry,accounts receivable collection inherent risk in the casulty insurance industry. Many industries have unique accounting requirements that the auditor must understand to evaluate whether the client’s financial statements are in accordance with generally accepted accounting principles.For example if the auditor is doing an audit of a city
government,the auditor must understand government accounting and auditing requirements.Unique accounting requirements exist for construction companies,railroad,charity and non profit organizations,financial institutions etc. Auditors’litigation in many cases result from the auditors’s failure to fully understand the nature of transactions in the client’s industry for example many auditng firms have ended up paying large amount of money to federal government related to audits of failed savings and loans. Volatility in economic conditions,technological changes,extent of competition and customers behaviour.To develop effective audit plans,auditors must have expertise to assess external environment risks. The client bussiness risk can arise from any of the factors affecting the client and its environment.The auditors’concern is the risk of material misstatements in the financial statements due to client bussiness risk.For instance acquisition and mergers if not carefully done may impair fixed assets and goodwill in the financial statements.After evaluating client bussiness risk,the auditor can then assess the risk of material misstatement in the financial statements and then apply the audit risk model to determine the appropriate extent of audit evidence.5 4.0.Auditor’s concern on Business risk.
In other words, the auditors try to relate each and identify risk to what can go wrong at the assertion level. As an example, if the auditors identify a risk of inventory obsolescence, this means that there is a risk that the inventory may be misstated with respect to the valuation assertion. In assessing this risk, the auditor will consider any control established by management to mitigate this risk. Then, the auditors consider whether this risk could result in a material misstatement of inventory and cost of goods sold, and the likelihood that the material misstatement could actually occur. Finally they use all risk assessments to plan and perfom the audit. The auditors’concern is to assess the adequacy of management’s use of going concern assumption in preparation of financial statements and whether these risks may impact the future plans of the entity. 5.0.Conlusion
Researches has indicated that the bussiness failure and collapses of companies is due to risks especially those caused by control and bussiness