The Issue of Business Risk - Literature review Example

Introduction The large scale corporate scandals such as Enron and WorldCom and the current economic crisis has resulted into the debate regarding theeffectiveness of the audit as the valid tool to critically analyze and expose the illegal and imprudent management and accounting practices that have resulted into the losses for the shareholders. The development of approaches such as Business Risk Audit was one of the manners in which audit community as a whole attempted to bring in a new and more refined approach to audit in order to overcome the traditional weaknesses of the audit tools and also cope with the increasing complexities of the modern business. This new approach was based on assessing the risk in business as well as process level risk while performing the audit and as such the fundamental process of performing audit took a new turn to accommodate the changes that are perceived to take place in the 21st century. There are many studies including Humphrey, Jones and Khalifa that assess the impact of this approach on the actual audit engagements and as such discussed at length as to what is being done and what is required further to make this practice more effective to cater to the needs of the modern business practices. Further studies also indicated the overall effectiveness with which this new methodology has been implemented by the audit firms while conducting the audits. This literature review will provide a comprehensive presentation of the available literature on the issue of business risk. Business Risk Approach in Auditing Business Risk Approach was believed to be initiated by the large firms that were under constant criticism from various quarters for their failure to critically assess and identify the failures of the firms like Enron. Thus business risk approach is not considered as feasible for the smaller firms that may not have the required expertise and depth to conduct appropriate business risk audit of their clients. The trends in the audit industry indicated that there is gradual increase in the costs of executing the existing practices because the overall complexities of doing business have increased to manifold in the current times. The greater cost on the imparting necessary knowledge and skills to audit staff as well as the more focus on the use of more value-added services, audit, as a profession integrated critical changes into itself to cater to the more challenging requirements of the new business entities that become more vulnerable to the risk owing to more volatile nature of the business. (Eilifsen, Knechel, & Wallage, 2001) Business risk is generally described as the risk that the business will to achieve its intended objectives. According to ISA 135- The auditor is entitled to obtain the information about the objectives and strategies of the entities in order to identify the business risks that may result into the material misstatement into financial statements. (Gray & Manson, 2007). It is critical to understand that auditors always included the risk assessment into their overall risk assessment however, the business risk approach is relatively more advanced concept underlying the fact that audit can add value by understanding and analyzing the financial statements and express their opinion. This approach towards audit therefore requires a complete change into the methodologies used to adapt this approach in most appropriate manner. Business risk approach to audit, in its essential sense, considers broader issues other than just assessing the true and fair nature of financial statements. This approach therefore not only enhances the scope of the audit but also provide auditors an opportunity to effectively check whether the intended objectives of the management are achieved or not. This new approach therefore is considered as the most important innovation in the field of audit and is considered as the Audit for Tomorrow as the various approaches adapted under this broader methodology encompassed almost every aspect of the business and how the decisions of its managers affect the value of the shareholders. Thus business risk approach is considered to allow the business managers to assess as to where they are actually standing and how and what need to be done. (Jones, Khalifa, & Robson, 1995). This approach is therefore completely radical and different approach than the traditional audit which focused mostly on the financial statements. Traditionally auditors used to perform analytical procedures in order to assess the client activities and their impact on the financial statements. Auditors often attempted to correlate this with the fluctuations into the financial statements and any abnormal fluctuation could have easily been identified as a precursor of the nature of the activities of the management. However, latest approaches to audit require auditors to integrate the business risk into their assessment of the activities of the firm also. The most important argument that is being given in this perspective is the argument that the integration of the business risk will allow auditors to spot the mismatches in the financial statements more accurately than using the more conventional methods of auditing. (Kotchetova, O’Donnell, & Webb, 2006). The major differences between the traditional audit process and the risk based audit process is mostly engrained into the fact that the conventional audit is transactional based and does not contribute towards creating value whereas the risk based audit is based on the risk and often creates or assists in creating value for the firms. Thus the business risk approach is something which assists the management in clearly evaluating their performance against the set criteria to achieve the organizational objectives. The traditional process of assessing the business risk involves the identification of the business objectives that the firm has set for it and then to identify the business risks that may hamper the obtainment of such objectives. What is also critical to note that since management objectives keep on changing therefore the overall assessment process also keeps on changing according to the given circumstances that may keep on changing? Auditors however, provide this service as a consultancy exercise to the firm as auditors have more superior as well as more objective knowledge about the firm and its activities. This approach also requires the auditors to focus on those areas that are of high business risk and warrant more critical scrutiny of the operational significance of such risks. (Gray & Manson, 2007). Auditors often tend to obtain more in-depth knowledge about the business and based on their understanding, they may be able to identify the residual business risk that may be of critical importance for the firms and as such may impact the overall conduct of the audit. Thus the auditing while adapting the business risk approach shall be viewed in large social context wherein the role of audit shall also be seen as the catalyst for ensuring the corporate governance and compliance of the modern businesses with the prudent business practices and policies in order to safeguard the interests of the various stakeholders. This approach therefore may offer a rare glimpse of hope to the regulators that the auditors can effectively become one of the change agents for bringing in the institutional change within any economy to ensure that the markets perform smoothly and at an acceptable level of risk. Studies by Curtis & Turley (2006) indicate that the gaps between the actual implementation of the approach and the perceived methodologies for business risk are however, higher. (Curtis & Turley, 2006). Thus to implement these approaches and techniques in the real world business settings is relatively more complicated and require further refinement of the techniques as the existing techniques are considered as only in their infancy. Conclusion The above discussion of literature review indicates that there was a general need for a radical change in the auditing process as the conventional and more traditional methods failed to offer the desired results and insulate the companies from the effects of taking excessive risks. The business risk approach in audit was one of the most critical and important innovation that outlined a much broader role of the auditors in the whole auditing process besides ensuring that the audit firms play their part in indicating the management about the actual progress being done by the firm in achieving their intended objectives. The business risk approach therefore is critical due to the fact that it engages both the businesses as well as the auditors to play their part in identifying the residual business risk inherent in the business operations and adapt a more holistic approach. This approach required that the firms must focus on the overall business processes and shall not limit themselves to only transactional based approaches to conduct the audit. The business risk approach therefore is considered as the solution for achieving the required degree of assurance with regards to the overall risk adaptability of the firms. Later studies however, also indicate that there are still some gaps between the implementation because this new approach is itself into its infancy stage thus it is important that the continuous and more robust approach must be adapted to achieved the desired objectives out of the business risk. Bibliography 1. Curtis, E., & Turley, S. (2006). The business risk audit – A longitudinal case study of an audit engagement. Accounting, Organizations and Society , 32 (4), 439-461. 2. Eilifsen, A., Knechel, W. R., & Wallage, P. (2001). Application of the Business Risk Audit Model: A Field Study. Accounting Horizons , 15, 15-26. 3. Gray, I., & Manson, S. (2007). The Audit Process: Principles, Practice and Cases. London: Cengage Learning EMEA. 4. Jones, J., Khalifa, R., & Robson, K. (1995). Business Risk Auditing and the Auditing Profession: Status, Identity and Fragmentation . Retrieved Feb 10, 2010, from http://www.competition-regulation.org.uk: http://www.competition-regulation.org.uk/conferences/mcrcarr03/chumphrey.pdf 5. Kotchetova, N., O’Donnell, E., & Webb, A. (2006). The Influence of Business Risk Assessments on Audit Planning Decisions:A Descriptive Model with Experimental Evidence. Retrieved Feb 09, 2010, from http://aaahq.org: http://aaahq.org/audit/midyear/07midyear/papers/Kotchetova_TheInfluence.pdf Read More