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    The Joint Influence of the Extent and Nature of Audit...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
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    Title:
    The Joint Influence of the Extent and Nature of Audit Evidence, Materiality Thresholds, and Misstatement Type on Achieved Audit Risk
    Practical Implications:

    This study challenges the audit practice to think about what makes sufficient, relevant, and reliable audit evidence. It provides evidence that decreased audit risk does not always occur when materiality is lowered, an increased quantity of audit evidence is obtained, and traditional audit tests are performed. The nature and persuasiveness of the audit evidence should be evaluated in order to obtain the desired level of audit risk. 


    For more information on this study, please contact David V. Budescu.
     

    Citation:

    Budescu, D.V., Peecher, M.E and I. Solomon. 2012. The Joint Influence of the Extent and Nature of Audit Evidence, Materiality Thresholds, and Misstatement Type on Achieved Audit Risk. Auditing: A Journal of Practice and Theory 31 (2): 19-41.

    Keywords:
    Audit risk, audit evidence, fraud, error, materiality, misstatement
    Purpose of the Study:

    The role of the auditors is to provide assurance on a company’s financial statements by obtaining sufficient evidence to support the audit procedures performed.  Although there are professional and regulatory standards to guide an auditor, it is ultimately the auditor’s judgment to determine if the amount of evidence that is obtained is of the right quality and quantity to support the opinion.  Through a simulation model, the authors seek to provide evidence that an achieved audit risk is influenced jointly by the nature and extent of audit evidence, materiality, and the types of financial misstatement that may occur.  Using the audit risk model, the authors address how auditors use of the audit risk model lead to lower levels of achieved audit risk and whether fraud is the only type of misstatement where use of the audit risk model is suspect. Below are the factors that the authors assess to evaluate their influence on achieved audit risk in their study: 

    • Quantitative materiality (six levels ranging from .5-5% based on typical materiality measurement)
    • Extent of the evidence (the amount of times the auditor will evaluate a set of audit procedures.  For example, an auditor may perform analytics, inquiries, walkthroughs, and sample items to test a specific account are viewed as one “venture” at the audit evidence for the account). 
    • Nature of the evidence (third-party external evidence, internal evidence from management’s financial reporting process, or internal evidence from management’s business process)
    • Type of misstatement type (Unintentional error due to management’s random error, unintentional error due to bias in management’s judgments, or intentional error due to fraud)
       
    Design/Method/ Approach:

    The authors perform a simulation to model how achieved audit risk depends on the extent and nature of audit evidence, materiality levels, and the type of misstatements that may distort the financial statements. Specifically, they use the revenue account for purposes of their simulation.  They also manipulate four factors (the independent variables):  quantitative materiality, evidence extent, evidence nature, and misstatement type. The dependent variable is the achieved audit risk, which is measured as the probability that the auditors’ expectation for revenue departs from the true value by at least material amount. 

    Findings:
    • Increasing the extent of testing decreases the audit risk only under certain conditions (i.e. when the bias in audit evidence is less than quantitative materiality).  In certain circumstances, increasing the extent of testing may increase the audit risk (i.e. when the bias in audit evidence exceeds quantitative materiality).
    • Reducing materiality levels to perform a more precise audit may or may not enhance the effectiveness of the audit procedures.  Depending on the nature of the audit procedures and the evidence that is gathered, it may decrease or increase the audit risk.
    • Quality of the internal controls of an organization may assist an auditor to better judge the extent in which evidence from management is may be distorted or contain an intentional or unintentional misstatement.
    • In the circumstances of fraud, an auditor should supplement more traditional audit tests with tests that provide evidence that is unlikely to be biased by management (i.e. external evidence).
       
    Category:
    Audit Quality & Quality Control, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Audit Scope & Materiality Judgements, Evaluation of Evidence