Academic journal article International Journal of Management

An Empirical Examination of the Impact of Risk Factors on Auditor's Risk Assessment

Academic journal article International Journal of Management

An Empirical Examination of the Impact of Risk Factors on Auditor's Risk Assessment

Article excerpt

The primary objective of this study is to identify what factors affect the assessments of auditor risks including audit risk, business risk, and personal risk in under-researched area of Singapore. Factor analysis and logistic regression were applied as methods of analysis. The result shows that a single factor related to "the effectiveness of control activities" has significant explanatory power, and indicates that the client's control environment is influential in contributing to the assessments of auditors' risks.

Introduction

In today's expanding global economy, accounting firms serve not only local but also international companies. The increasingly complex business operating procedures and the largely complicated sets of investors' portfolios have caused the auditing profession to face a great deal of uncertainty. As to the argument by Vinten (1991), "Auditors need to achieve a via media (middle way) between abrogating risk-taking entirely and permitting totally uncontrolled and huge risk exposures" (p. 3). In addition, a phenomenon noted by Slice (1991), lawsuits against auditors are a continuing source of concern for members of the public accounting profession. A great effort, therefore, to investigate what gets public accountants into "trouble" with their clients and with third parties was made (Pierre and Anderson, 1984). The responses of the accounting profession to a reduction in the likelihood of audit failure and litigation allegation via risk factors assessed, more audit effort input and fee billed have been analyzed (Low et al., 1990; Mock and Wright, 1999; Bell and Carcello, 2000; Wright and Bedard, 2000). However, these issues are prevailingly taking into consideration within a Western world context. Whether the auditors from the non-Western world face the same litigation environment and whether the auditors replicate similar strategies to responding to such a threat still remain to be answered. For clarifying those questions, therefore, this study aims to identify what potential risks are associated with Singaporean auditors and how auditors assess them. Three potential risks identified in this study are audit risk, business risk and personal risk. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. Business risk is the risk to the audit firm from association with the client, consisting of the risk of potential litigation costs and the related effect on the audit firm's reputation. Personal risk is the risk of damage to the individual auditor's own personal reputation from being associated with the client.

This study is organized as follows. The theory and hypothesis development is provided in section II. section III sets out the research methodology which includes the description of independent and dependent variables, sampling approach and analysis methods. section IV presents the logistic results. A brief summary and discussion are provided in finally section.

Theory and Hypothesis Development

1. Control Environment

Empirical evidence suggests that correctly assessing the control environment is beneficial to assessing identified risks. Sullivan (1988) emphasized that fraudulent financial reporting is often found at the very top of the organisation - what the Treadway report (1992) called "the tone at the top" and what auditors call the control environment. A similar result was also found by Loebbeoke et al. (1989), the control environment was found to be one of the significant factors associated with management fraud. Where controls are weak, an important condition exists that can allow either management fraud, a defalcation, or an error to occur. The control environment also serves to enhance or mitigate the assessment of inherent risk and control risk (Haskins & Dirsmith, 1995; Marden et al., 1997). Accordingly, an incorrect evaluation of the control environment will lead to an incorrect assessment of inherent risk, control risk and fraud risk, and possibly result in audit errors, such as failing to detect material errors and misstatements in the financial statements and then forming an improper opinion. …

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