Do you know someone who suffers from risk assessment averseness? Patients with this illness possess an extreme dislike for thinking before acting. They live in the land of the objective–bank confirmations, vouching, and searching for unrecorded liabilities. They disdain the subjective–inquiring about processes, observing segregation of duties, thinking about inherent risk. To them, auditing is science, not art. It’s concrete. You hear them say “that front-of-file stuff is just to make peer reviewers happy.” After all, “there’s work to do.” And they know what to do. It’s all there in the prior year file.
There is only one cure for this thought-borne disease. It’s understanding the advantages of risk assessment and planning.
Let’s start with the audit risk model. How is it defined?
Put simply, it is:
Risk of Material Misstatement = Inherent Risk X Control Risk
This is the framework for gaining an understanding of:
The audit standards require that we understand the entity and its environment. I like to start by asking management the question, “If you had a magic wand that you could wave over the business and remove one problem, what would it be?” The answer tells us a great deal about the entity’s risk. I want to know what they think and feel. The visceral is a flashing light saying, “Important!” And believe me, every business owner or manager worries about something. Your clients understand their businesses. This is where they live. The wise auditor taps into that knowledge.
Risks can be thought of as threats to objectives. Your client’s fears tell you what the objectives are.
Other questions that can be entertained include:
Now let’s delve into accounting controls.
In every audit, we must understand the client’s internal controls. “But my client has no controls.” Really? It is doubtful that a client has no controls. They may have few, but almost every entity has some controls. Here are a few questions to consider:
These are examples of what we need to understand before we plan the audit. Why? Because risk is a function of processes. Understanding informs us. It directs us.
Remember this: Numbers are the narrative.
And this: To change the story, change the figures.
And for auditors: See if the story is true–or if it changed (whether by accident or intentionally).
How do we do this?
We look for indicators of false numbers (false stories). Do the accounting processes allow for false numbers?
As a kid, I once stole five dollars from my father. His internal control of laying his billfold down on his dresser every night did not work well. When he asked who took the money, I changed the story from one of fact to fiction (also known as a white lie). I tried to change the narrative.
My father inquired, but he also observed, and my reaction gave me away.
Auditors are to use the following in performing risk assessments:
Inquiry alone is never sufficient. Combine observation and inspection with inquiries.
And what is the purpose? To know where risks lie.
We’ll pick up here in my next post about risk assessment. Feel free to share this article with those you know who suffer from audit risk assessment averseness. Friends don’t let friends audit without thinking.
What unique risk assessment procedures do you use? Since this is an art, there are myriad ways to gain an understanding of clients and their processes–and I’m always looking to learn more.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses.He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events.Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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