Factors Considered By Auditors In Determining Acceptable Level Of Audit Risk

Discussion

Discuss about the Factors Considered by Auditors in Determining Acceptable Level of Audit Risk.

Auditors when performing the audit of financial statements in accordance with generally accepted accounting standards need to consider and evaluate several factors for determining acceptable level of audit risk. Audit risk arises when auditors is incapable of appropriately modifying his or her opinion on financial statements that have been materially misstated. For determining the acceptable level of audit risk by auditor when conducting audit of financial statements, several factors are considered by auditors such as reliance of users on financial statements, management of firms being audited and likelihood of financial difficulties (Backof 2015). Auditors in relation to relevant assertions concerning classes of transactions, account balances and several disclosures of overall financial statements consider audit risks. Auditors in such a way that the audit risk is reduced to lower level should perform the audit. Auditors in considering audit risk at overall financial statement level consider risks of material misstatement. In the event of organizations having high exposure to legal liability, the acceptable level of audit risk would be set at lower level compared when the organization has little exposure to such liability (Byrnes 2015). We have taken the organization Boral Limited for discussion of several factors influencing the audit risk by auditors.

Below are discussed three factors that would be considered by auditors in determining acceptable level of audit risk.

User reliance on financial statements- The degree to which external users rely on the financial statements is one of the factors that is considered by the auditors. It is considered appropriate by auditors to decrease the audit risk to acceptable level when heavy reliance are placed in financial statements by the external users. The reliance of external users on financial statement is indicated by distribution of ownership, amount and nature of liabilities and business size of clients. It is certainly possible that a great harm would result when the users are placing heavy reliance on financial statements. This happens when the significant misstatement in the financial statements remains undetected (Dictionary 2014). Cost of additional evidence is easily justified by auditors when there is a substantial loss resulting from material misstatement. Size of client will affect the acceptable level of audit risk and total revenues or total assets measure it. Many users relies on statements of publicly held corporations compared to closely held corporations. Actual and potential creditors are likely to more extensively use the statements having large amount of liabilities (Cannon and Bedard 2016). Opposite happens when there are few liabilities.

User Reliance on Financial Statements

Likelihood of financial difficulties- The likelihood that the clients are having financial difficulties after issuing of then audit report is another factors that is considered by auditors in determining acceptable level of audit risk. Various indicators for identifying the financial difficulties of any organizations by auditors are previous year loss and profits figure, liquidity position, competence of management, methods of financial growth and nature of operations activities carried out by clients. Auditors can respond to audit risks by other ways that he would change to respond to audit risks (Kneche and Salterio 2016). Acceptable level of audit risk would be reduced if it is believed by auditors that there is a high chance of loss or financial failure. An organization would have problem in paying off bills in future if there is shortage of cash and working capital. The likelihood and significance of steadily declining position should assessed by auditors. There is a greater risk of financial difficulty if client has greater reliance on debt as financing means and is witnessing declining operating success. It might happen that auditors decide upon the medium acceptable audit risk for audit as a whole but for inventory, they might decide to reduce acceptable audit risk too low for inventory (Griffith et al. 2015).

It is essential for the auditors to recognize the future problems that the organization such as Boral limited is likely to encounter if they are facing increasing losses or declining profits. It can be seen from the annual report of Boral limited that the profits in the year 2016 has fallen as compared to year 2015. In this regard, there is need on part of auditors to realize the solvency issues likely to be encountered by the organization. Boral limited is making use of higher amount of debt in the year 2016 and there is improvement in debtor management of the company. This poses a greater risk of financial difficulties as it is accompanied by falling operating profit. Concerning this, auditors needs to evaluate that whether fixed assets are being utilized for financing short and long-term loans (Kumar and Sharma 2015). This is so because large amount of cash flow during short time would force the company into bankruptcy.

For potential difficulties, one of the things that are constantly alert is competent management. Effects of short-run problems are minimized by modifying the operating methods of organizations. As a part of evaluation of ability of Boral limited to continue as a going concern, it is necessary for organization to assess the ability of management (William et al. 2016).

Likelihood of Financial Difficulties

Management of firm being audited- evaluation done by auditors regarding the integrity of management is another factor. Under this factor, the organization considered for evaluation of auditing risks is Boral limited. Management integrity is the management inspiration and honesty for reporting financials of business in a truthful way. Management integrity acts a mirror image that demonstrates the worthiness of business. Few things influence the nature of audit evidence in event of auditors questioning the integrity of management. Some of the factors concerning integrity of management of the company are relationship with previous or current auditors, relationship with labor unions and employees and frequency of turnover of key internal audit and financial personnel. Business affairs of company with low integrity are conducted in such manner that it will result in conflicts with regulators, shareholders and customers (Kogan et al. 2014). It is likely that auditor would assess the lower acceptable audit risk if the organization has questionable integrity and this would be a part of continuing and new client investigation. Assessment of integrity of management influences the risk of material misstatement and is related to preliminary risk assessment of the auditors.

Usually, there is an inverse relationship between the likelihood of material misstatement and auditor’s assessment of management integrity. A business affair of organizations having low integrity is often conducted in such a manner that would result in conflict with regulator, shareholders and customers. Audit risk structure of client is a key determinant of audit risk structure of organization. Auditors into the judgment of their audits should incorporate this particular risk component. Auditors from the management generate a great deal of audit evidence (Lobo and Zhao 2013). Auditors can assess the credibility of management-supplied evidence by carefully evaluating the integrity of management. High management integrity is related to low risk assessment and low management integrity is related to high-risk assessment. One of the primary driver of assessment of risk of auditor risk whether the material misstatement is identified by auditors in prior year audit. Auditors respond low management integrity by more persuasive evidence for supporting the assertions of audit. It is depicted that extent and timing of audit procedures does not form the basis of management integrity. In the event of lower integrity of management, for the verification of independent data auditors are required to go outside the clients rather than making simple analysis of client’s information. Auditors are likely to discover misstatements when auditors that management is of lower integrity assess it. The likelihood that the financials of the organization are misstated is indicated by the management integrity (Pizzini et al. 2014).

Management of Firm Being Audited

Boral limited had some issues with labor unions regarding safety concerns and some queries were raised about workers regarding. The safety issues was not raised by Boral limited in a timely manner and safety issues raised by workers was fail to addressed. The formal structure of safety concern of the workers was not functioning properly. Boral limited has also concern regarding the formulation of number of resolution that aimed at improving the accountability, transparency and effectiveness of the safety policies of Boral (van Buuren et al. 2017).

In the regard, the integrity of Boral limited becomes questionable and the auditors are likely to assess a lower acceptable audit risk.

Conclusion:

For the assessment of acceptable audit risk, there are various factors considered by auditors relating to engagement risk. Organization will suffer from harm even if the audit is finished the risk. An auditor mainly considers three factors for assessment of acceptable level of audit risk. From the above discussion, it can be concluded that Boral limited had lower management integrity in the previous years for which the auditors have lower level of acceptable audit risk. This is so because the management of integrity of organization becomes questionable. 

Reference:

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