Assignment on the Effective Use of the Audit Risk Model at the Account Level "

Abstract of 1. Study entitled " The Effective Use of the Audit Risk Model at the Account Level "

In this research study, the main focus is on audit risk failure. The audit risk factor has prime attention because of several factors such as business uncertainties, high financing costs, and economic weakness. It is founded that if the account level is increased when the risk is controlled, then it is expected by the auditors that the specific account is recommended to take this increment by the auditors without any amendment in the risk examine process. Audit mainly focuses on the reliability of reporting and guide to deal with investment decisions. In this study, it is also examined that the risk detection and risk evaluation by the auditors can improve the remunerations of auditor which is a positive change by the side of auditors. For accounts that are standard or center to the on-going activities of the organization, important levels of reviewer exertion are viable in accomplishing steady record level review hazard when account-level control chance is high.  Researchers claim that a positive relationship exists between audit adjustments and control risk factors. There may be a risk in the given criteria which have a negative impact on the performance of auditor, but they are most likely to reduce the risk in the files. It is explored that the probability of an ineffectual reaction to high record level control chance increments with customer unpredictability, reviewer customer misalignments, the nearness of an elementary level inward control shortcoming, and the planning of inside control shortcoming revelation. Research studies find that risk revision components are the disclosure of risk and false allegation of financial statements. The basic purpose of this article is to know about the audit implications on the accounts and to check that how the risk could be overcome by taking audit measures, and the document is concluded with the account level, which is used to control the risk in the accounts of the business.

2. Literature Review of Study entitled " The Effective Use of the Audit Risk Model at the Account Level "

1. Study entitled " The Effective Use of the Audit Risk Model at the Account Level "

Study aims to examine auditors effectively respond to an assessment of high control risk at the account level. Where the study was conducted on sample of comprised of accelerated filers subject to the provisions of Section 404 of SOX from 2004 through 2009 with available data in Compustat and Audit Analytics to construct the model variables. The result of study highlight there is a greater risk of an ineffective response to high control risk at the account  related to frequent or recurring non-routine processes , And define the reasons of likelihood of increase an ineffective response to high control risk at the account level that is include : client complexity, auditor-client misalignments, the presence of an entity-level internal control weakness, and the timing of internal control weakness reporting. (Andrew,2014)

2. Study entitled " Auditors’ perceptions of reasonable assurance the effectiveness of  the audit risk model " , Study aims to study perceptions for auditors’ of reasonable assurance in auditing work , the effectiveness of the audit risk model and the impact of education gender, official auditor certificate and job rank on this perceptions.  Where the study was conducted on sample of 269 people were including 150 administrators and 119 institute partners . Data has been collected by using questionnaires tool and in order to analyze the collected data, inferring and descriptive statistical methods have been applied. The results of study define there is significant differences between the auditors’ perceptions with different job rank, gender and qualified for official auditor certificate touching reasonable assurance in auditing work the effectiveness of the audit risk model.( Hashem , Javad & Hajar,2012)

3. Study entitled " Auditors’ perceptions of reasonable assurance the effectiveness of the audit risk model "  A research study conducted by Graham, Bedard, and Dutta in 2018 is aimed to investigate audit risk in a multicomponent audit setting. In the current environment, managing group audit risk is the highly critical and long-standing issue which is must be addressed to ensure efficient auditing system. The research study was conducted on small-sized organizations including 250 stores in the retail chain. In the research study, models were developed to support the examination of auditing risk. Research data was collected from the employees of these selected stores. According to the results of collected data, audit procedure get influence from misstatement pattern by managing group. Therefore, judgments of professional auditors are critical and difficult regarding the selection of appropriate auditing approach. Researchers have presented some recommendations about adding other factors and mathematical model in the auditing process to reduce risk factor associated with the auditing process in an organization (Graham, Bedard, & Dutta, 2018)

4. Study entitled " Managing Group Audit Risk in a Multicomponent Audit Setting " The study aims to examine the causes of audit risk in the companies listed at the stock exchange. Companies listed on stock exchanges try to control falsification and manipulation of financial statements of a company by the internal and external auditing system however still some factors cause to increase auditing risk. The research study is aimed to discuss these factors as causes for auditing risk. The samples are drawn from the workforce and professionals of selected listed companies. Research data is collected from secondary and primary research resources. According to research findings, auditing risk causes mainly relates to subjects that concern with financial information generation and presentation to the stakeholders. Companies conduct frauds and manipulate information under the pressure of management and corporate governance that constitutes the auditing risk. The researcher recommended that auditing team should pay attention to frequent changes in the financial outcomes of the company and abnormal stock changes thus auditing risk can be controlled (Sun, 2018)

5.  study entitled "Audit risk- part I" is not a new topic, but it definitely received a lot of attention for many reasons: (i) economic weakness (ii) high financing costs(iii) business uncertainties which increased the possibility of business failures. But what is more risker reason to draw more attention is because of the development of audit technology.  Based on (Lynford E, 2019) Many companies use traditional statistical theory to quantify sampling risk objectively quantification, such as adverse conditions, impending legislation, or errors initiated by mangers and their intentions. Then, why is it difficult to implement audit technology? The belief of increasing audit risk is substantial, as KPMG studied " Audit "2025” is that four in five respondents—80%—say auditors should use bigger samples and more sophisticated technologies for gathering data and performing analysis in their daily work. So it recommended to use more technology and pave the way of it in time with employees and within the organization in general. 

6. study entitled "Audit risk- part III"(SAS47) Defined internal control as that the risk that occur in an account balance or a class of transactions, and that could be material when aggregated with error in other balances and classes, will not be prevented or detected on a timely basis by the system of accounting control". (Lynford E, 2019) observe that is hard to risks related with both routine processing matter and characteristics of account balances. Basically, it's expensive for internal control system to control some risk like gold inventory and inventory in general is risker than land or building, nevertheless, it doesn't mean that the internal control is FRAIL, it's insufficient hence the expensive ness of the producer. (Lynford E, 2019) suggested to the need for the inherent risk alongside with internal control. Inherent risk could assess, the internal control evaluation of the procedure, sampling and audit planning to solve some of the sophisticated operations.

7. Study entitled" The Concept of Audit Risk" According to the IAASB Glossary of Terms, audit risk is defined as follows: “The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of material misstatement and detection risk”. Audit risk is the risk faced by auditors that they will fail to disclose material errors in the financial statements. There is a correlation relationship between audit risk and materiality, hence the high probability of failure and error in most material areas. The audit risk is related to the financial statement as in seeing if the information is realistic and objective or not.  The risk of revision has two components: "1) risk that the financial statements contain false allegations; and 2) risk that the auditor will not disclose them". At this extent the auditor varies the circumstances to them, as the nature, timing and extend of the audit procedure. If the evaluation of the material risk is to be high, then a great, reliable samples of evidence should be collected. It recommended for the external auditor to consider two components to detect all types of audit risk: 1) risk assessment during collecting the evidence and 2) the business risk- all the economic aspects of the audit assessment.  (Nikolovsk et al., 2019)

8. The study entitled " Misstatements in Financial Statements: The Relationship between Inherent and Control Risk Factors and Audit Adjustments". This research study investigates whether audit adjustments differ efficiently with inherent and control risk factors. It depends on proprietary information from an enormous recent sample of audit adjustments discover in a financial statement that done by a Big 4 audit firm in Germany. The audit risk model (ARM) indicates that there is a positive relationship between misstatements and different inherent and control risk factors. According to the research finding, there is a different systematically between the number of audit adjustments and inherent risk and control risk factors. In particular, in integrity, respectability, and competence of the customer's administration, substance level control quality, economic state, and internal control framework are related to the number and relative size of the audit. As a result, the study proposes that the inherent and control risk elements are strongly connected with the income-influencing adjustment. (Schmidt, 2014)

9. The study entitled “ The audit risk model, business risk and audit-planning decisions." The research characterizes the cases under which the audit risk model does, and does not, identifies audit‐planning including investment and pricing decisions. The samples that present in the study are audit partners and managers. The auditors evaluated the element of the audit risk model and explanation the investment and fee did not include a risk premium. According to the research finding, when the risk of error is high, the audit risk model will provide a useful guide to deal with that risk. In addition, the study shows the capacity of the audit risk model (ARM) to characterize auditor conduct, and the tendency of auditors to charge a risk premium that base on the nature of the risk presents in the audit. (Richard W. Houston, 1999)

10. The study entitled “ Audit Risk Management and Its effect on The Audit of The Financial Statement." The audit risk is one of the most intricate classifications in the audit filed. which help to decide the auditor’s opinion related to the reliability of reporting. Nowadays the assessment of audit risk is mandatory on auditing. The study aims to improve the comprehensive approach of audit risk management. The result of the study showed that to vindicate the assumption, the researcher proposes his comprehensive approach to audit risk management. The comprehensive approach depends on statues of audit repeated that is done by the audit risk management procedures. The approach deal with the audit risk model that can be managed through impact its determinants and the path of the audit institutions apply it for the purpose of saving a lot of time to evaluate the control risk factors. In addition, the research seeks to develop the audit risk management logic chart. (SABAURI, 2018)

3. Part 1

1.      Identify the risks that are relevant to the audit and classify them as financial statement- or assertion-level risks.

	Risk	Financial Statement Risk	Assertion-level risks
1	Hypermarket liquidated cash accounts in order to provide enough cash flow to support itself. There is a risk of unrecorded such liquidations.
2	Hypermarket has become increasingly dependent on their local bank credit line to fulfill their duty. LOC renewal depends on keeping a rapid ratio of 0.5.
3	Hypermarket has historically engaged the auditor to assist with the preparation of the financial statements, but the bookkeeper assumed this task in the year under audit.
4	No internal control
5	Not have account receivable
6	Not have investors account
7	No segregation duties
8	No internal auditors observed
9	Hypermarket has no recorded controls and the auditor does not plan to reduce the scope of audit procedures by relying on the controls ' operational efficiency
10	The local economy has contributed to flight of the workforce, resulting in lower demand and net losses.

	Risk	Assertions affected
1	Hypermarket liquidated cash accounts in order to provide enough cash flow to support itself. There is a risk of unrecorded such liquidations.	Valuation, allocation, and accuracy
2	Hypermarket has become increasingly dependent on their local bank credit line to fulfill their duty. LOC renewal depends on keeping a rapid ratio of 0.5.	Completeness, valuation
3	Hypermarket has historically engaged the auditor to assist with the preparation of the financial statements, but the bookkeeper assumed this task in the year under audit.	Accuracy Completeness, understandability
4	No internal control	Valuation, allocation, and accuracy
5	Not have account receivable	Completeness, Valuation, allocation, and accuracy, Rights and Obligations
6	Not have investors account	Completeness, Valuation, allocation, and accuracy, Rights and Obligations
7	No segregation duties	Valuation, allocation, and accuracy
8	No internal auditors observed	Completeness, cutoff, existence and occurrence
9	Hypermarket has no recorded controls and the auditor does not plan to reduce the scope of audit procedures by relying on the controls ' operational efficiency	Completeness, Existence and occurrence, Valuation, allocation, and accuracy
10	The local economy has contributed to flight of the workforce, resulting in lower demand and net losses.	Understandability and classification

 3.      Determine which risks would qualify as “significant risks” and document why.

	Risk	Significant risks	Reasons
1	Hypermarket liquidated cash accounts in order to provide enough cash flow to support itself. There is a risk of unrecorded such liquidations.
2	Hypermarket has become increasingly dependent on their local bank credit line to fulfill their duty. LOC renewal depends on keeping a rapid ratio of 0.5.
3	Hypermarket has historically engaged the auditor to assist with the preparation of the financial statements, but the bookkeeper assumed this task in the year under audit.
4	No internal control	ü	It will  affect the achievement of the objectives, bad designed business processes, integrity and ethic risk, errors of human bean.
5	Not have account receivable
6	Not have investors account
7	No segregation duties	ü	Increase of fraud by employees and managers.
8	No internal auditors observed
9	Hypermarket has no recorded controls and the auditor does not plan to reduce the scope of audit procedures by relying on the controls ' operational efficiency
10	The local economy has contributed to flight of the workforce, resulting in lower demand and net losses.	ü	This risk puts pressure  and stress on the company

 4.      Assume that the controls described in the narrative have been appropriately designed and implemented. Identify the risks that are relevant to the audit and classify them as financial statement- or assertion-level risks.

There are many inherent limitations that affect the internal control system. These inherent limitations aFirstly, Management is responsible for maintain internal control and ensure that all employees follow the policies. One of the major factors that affect internal control is a management override. Management overrides the ability of management to manipulate financial information that prepares fraudulent financial statements. Management override may lead to financial statement risk because the management they have the power to manipulate the accounting records and transactions and violation of a company’s accounting policy.

Secondly, estimation errors that may lead to financial statement risk. The person that involve in the internal control system could make simple mistakes or didn’t understand how to use this system. if there is incorrect or misjudgment in the data entry that may lead to mistakes to the financial statements.

Thirdly, none-compliance with accounting principles in the preparation of financial reports that influence the auditor's opinion. This will affect the internal control of WHC.

Finally, collusion is two or more people conspire with each other to circumvent the system. This may lead to financial statement risk and affect the internal control of WHC.

 5.      Based on the information provided, assess Inherent Risk (IR), Control Risk (CR) and the Risk of Material Misstatement (RMM) for each class of transaction, account, balance or disclosure. 

	Risk	(RMM)	(IR)	(CR)
1	Hypermarket liquidated cash accounts in order to provide enough cash flow to support itself. There is a risk of unrecorded such liquidations.			✓
2	Hypermarket has become increasingly dependent on their local bank credit line to fulfill their duty. LOC renewal depends on keeping a rapid ratio of 0.5.			✓
3	Hypermarket has historically engaged the auditor to assist with the preparation of the financial statements, but the bookkeeper assumed this task in the year under audit.			✓
4	No internal control			✓
5	Not have investors account			✓
6	No segregation duties			✓
7	No internal auditors observed
8	Hypermarket has no recorded controls and the auditor does not plan to reduce the scope of audit procedures by relying on the controls ' operational efficiency			✓
9	The local economy has contributed to flight of the workforce, resulting in lower demand and net losses.		✓

4. Part 2

      4.1 Liquidity Ratios

Industry Average: 1.5

The current ratio : measures a firm’s ability to pay off its short-term liabilities with its current assets, The higher  current ratio, the more favorable  than a lower current ratio because it shows that the company can pay all current debt .

Industry Average: 0.8

=0.64

The acid-test ratio :compares short-term assets with short-term liabilities to see if a company has enough cash to pay its  liabilities.

Activity Ratios

Industry Average: 7.20 times

Accounts receivable turnover is the number of times a year a business collects receivable from its average accounts. The ratio is used to assess a company's ability to provide its customers with credit efficiently and collect funds from them in a timely manner. A poor turnover rate is an incentive to accumulate disproportionately old receivable accounts that unnecessarily tie up working capital. This is also very possible that a disproportionate amount of bad debt is suggested by a low turnover level.

Industry Average: 4.12 times

Inventory turnover is a measure indicating how many times during a given period a company sold and substituted stock. Then a company can divide the days by the inventory turnover formula in the period to calculate the days it takes to sell the inventory.

Industry Average: 0.64 times

The  calculates the value of the profits or earnings of a company compared to the value of its assets. The turnover ratio of capital can be used as a measure of how well a company uses its resources to generate revenue. The higher the ratio of asset turnover, the more efficient a business would be. When, on the other hand, a company has a low asset turnover ratio, this means that it does not use its resources efficiently to generate sales.

Industry Average: 9.7 times

      4.3 Profitability Ratios

Industry Average: 17.39%

4.32  

Industry Average: 9.4%

Return on investment is one of the key financial metrics that calculate and measure the gain from an investment relative to its cost. If the return on investment is high, WHC will gain compare to its cost

      4.4 Long term debt paying ability Ratios

Long term debt paying ability Ratios analyze how will the WHC pay its debt. debt ratio is an index of a firm’s long-term debt-paying ability. If the debt is increase on WHC that is mean more financial risk.