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    Client business models, process business risks and the risk...
    research summary posted November 14, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
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    Title:
    Client business models, process business risks and the risk of material misstatement of revenue
    Practical Implications:

    The importance of understanding the operation of a client’s business and its competitive environment to achieve an effective audit is well-known. More specifically, the PCAOB requires that an auditor understand the company’s objectives and strategies and those related business risks that might reasonably be expected to result in risks of material misstatement. Valid understanding also is necessary to both interpret results from analytical procedures and to engage in effective professional skepticism for management’s assertions. The author’s results reveal a previously unreported level of understanding of process-oriented business risks and their association with the RMM of revenue for essentially new staff auditors. 

    Citation:

    Wright, W. F. 2016. Client business, models, process business risks and the risk of material misstatement of revenue. Accounting, Organizations and Society 48: 43-55. 

    Keywords:
    business risk auditing, risk-based auditing, risk assessment, analytical procedures, strategic management, and business models.
    Purpose of the Study:

    There are undeniable benefits for financial auditors to understand a client’s business strategy, strategic objectives and critical business processes, as well as understanding the business risks of a client’s business model during the reporting period. In fact, an inadequate understanding of business risks can result in an audit failure. While business risk auditing continues to be a central framework for auditing, whether auditors can achieve the necessary in-depth understanding of the business risks generated by different strategies and business models remains unclear.  Current research tests for understanding of the theory of business risk auditing, but this author tests the premise that informed graduate students acting as surrogates for staff auditors will understand and implement in their judgments the process risk implications of different business strategies and business models. This should prove important because the existing literature indicates inconsistent results on auditor’s ability to conduct an effective strategic analysis. 

    Design/Method/ Approach:

    The author conducted a 2x2 randomized between subjects design. The participants were all accounting Masters students who were a few weeks from their graduation. These participants were presented with an array of facts, until ultimately deciding which business strategy applied and assessing the performance and the associated business risk of each of the five processes of the case. 

    Findings:
    • The author finds that, with a few exceptions, surrogates for entry-level auditors made the subtle yet important distinctions among process-level business risks given the requirements of two different business strategies.
    • The author finds that the participants were able to report risk assessments for the critical Production process such that the indirect effect of process-specific business risk mediated the direct relationship between judgments of process performance and the RMM of revenue.
    • The author finds that the participants were able to make the distinction between the two different business strategies and could correctly indicate that there is no significant difference in the RMM of revenue for the two strategies when product generation performance was relatively high and business risk was relatively low. 
    Category:
    Client Acceptance and Continuance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Business Risk Assessment (e.g. industry - IPO - complexity)