Auditing is integral to every business and organization to ensure financial stability. Every business wants its auditing report to be precise, compliant and transparent. To ensure such a level of accuracy and reliability of your financial statements, the Risk-Based Auditing Approach is one of the most effective methods available.
Auditing could be for an entire organization or a particular function or a production phase. Risk-based auditing ensures that the internal audit process focuses its efforts on providing advisory and assurance services based on the top risks of the organization.
In this article, you will learn more about Approaches in Auditing world and how Risk Based Auditing approach is more effective.
Types of Auditing Approaches
An important aspect in deciding the outcome of the audit is the approach that the auditing firm uses to complete a given audit assignment. Audit failure is more likely if auditors don't use the right auditing approach, which might result in a damaged reputation and even expensive litigation against the company.
Hence, audit firms take 4 different types of audit approaches to tackle this complexity.
- Balance sheet approach
- Systems-based approach
- Substantive procedures approach
- Risk-based approach
Balance Sheet Approach: The balance sheet approach is a type of financial auditing method where auditors focus their attention on the balance sheet (also called statement of financial position) accounts, rather than on the income statement (also called profit and loss statement) accounts.
In this approach, Auditors check the balance sheet accounts to ensure that the financial statements are accurate. By doing so, they can reduce the risk of errors or misstatements in the income statement accounts.
System-based Approach: The system-based auditing approach helps auditors to gain a better understanding of the organization's financial reporting systems and identify any areas of risk or opportunities for improvement.
This approach focuses on the systems and processes used by an organization to generate financial information, rather than just looking at individual transactions.
Substantive Procedures approach: This approach is an important tool for ensuring the integrity of financial reporting and promoting transparency and accountability in organizations.
It involves testing and verifying the amounts and disclosures presented in financial statements through procedures such as reviewing documentation, testing samples of transactions, etc.
Risk Based Auditing Approach: This approach involves identifying the areas of the financial statements that are most susceptible to material misstatement, and then designing audit procedures that are tailored to address those risks.
By focusing on the areas that present the highest risk, auditors can more efficiently allocate their resources and efforts to areas where there is the greatest likelihood of detecting errors or fraud.
What is Risk-based Auditing?
Risk-based auditing is an approach to auditing that focuses on identifying and prioritizing areas of risk within an organization, and then designing an audit plan to address those risks. It is a method of auditing that is driven by the level of risk associated with a particular area or process within the organization.
This conventional audit approach is focused on transactions to create financial statements such as the balance sheet. This auditing approach is used to identify risks with the greatest impact. Strategic risk analysis would include political and social risks, such as the effect of regulations and sociological change.
Risk-based audits begin by assessing the risks faced by a business or the company and attempt to correct and redefine the controls based on the urgency and the possibility of a loss of the risks.
In simpler terms, Risk-based auditing provides auditors a prominent role in minimizing the risks. Beyond just assessing the problems, they gradually become a part of creating effective controls and maintaining efforts in risk management.
Objective of Risk-based Auditing Approach
The objective of Risk-Based auditing approach is to provide assurance that the financial statements of an organization are factually accurate and reliable. It also aims to improve the efficiency and effectiveness of the audit process by focusing on the areas of highest risk. By doing so, auditors can allocate their resources and efforts more efficiently, which can ultimately lead to a more cost-effective audit
A Risk-based audit approach begins with a risk element for the audit plan. In this approach, the goal of the department is to present the risks of the highest priority.
Most audit departments assume they are risk-based, however, the audit plan is designed from an audit discipline comprising departments or processes.
An ideal risk-based audit approach begins with an evaluation of the top risks of the management. All audits in the plan help to communicate those risks and provide results to the senior management.
What are the benefits of a risk-based approach in auditing?
The Risk-based audit approach helps auditors to work on the organizational risks on time and provide awareness to management in solving issues regularly. For a better understanding, the usage of data is vital.
When the risk-based audit approaches are linked to service-delivery principles, you can claim that the internal audit should not implement a single approach for all sizes.
Let us look at the key benefits of risk-based auditing:
1. Consistency: Having a consistent and extensive approach, an organization can easily adjust to changing situations. Modifying the audit schedule according to the risk framework helps you change the techniques quickly based on the business objectives.
2. Clarity: A risk-based audit approach helps auditors to detect the risks correctly and enables management to put suitable internal controls rightly for optimum performance, thus resulting in a better understanding of the risks, and allowing the organization to manage the better way.
3. Accuracy: Grading and aligning the risks with the risk-based audit approach allow you to allocate business activity and funds to critical areas requiring utmost attention, developing a unique risk management audit schedule rather than depending on external plans and suggestions.
Steps to Take Risk-based Auditing Approach
A Risk-based audit has a major advantage- it could be modified and adjusted to blend with the risk management process and specific requirements of your company.
Let us look at the important steps to create and execute an effective audit approach.
1. Understand the Business & risks
The risk-based audit demands that you understand the strategies, goals, and objectives of the company. As an auditor, you or the audit committee must have deep knowledge about the business, such as its strength, weaknesses, and challenges so that the auditors could focus on the most crucial risk areas.
Especially, the risks in the banking and financial services sector include both conventional types of risk, such as operational, legal/regulatory, reputational, liquidity, market, operational, and reputational risk, as well as non-conventional types of risk, such as performance risk measurement, human resource development and retention, customer loyalty and retention, product/service development, and ethics/integrity.
Once you have a clear understanding of the risk, you must evaluate those risks to assess the possibility of occurrence, its impact on the organization, and efforts taken to minimize the risks. This information should be noted in the risk register of your company to easily share and distribute among the employees.
2. Involve the management
As an auditor, you should work closely with the senior management to organize business strategy and risks with your auditing and monitoring plan. The management could then help you conduct risk assessments more accurately for various business areas.
One of the vital factors that make risk-based auditing different from the traditional approach is the involvement of the management. Your team knows the business risks better than anybody else, and with this knowledge, you could develop an effective auditing system that suits every business!
3. Preliminary Risk Assessment
The purpose of preliminary risk assessment is to determine the degree of risk and sufficiency of controls in the various functional processes of a business unit. To identify the areas of highest risk, the evaluation focuses on the company profile, management structure, organizational changes, and specific management and audit committee issues.
The risk assessment determines how well the control design for each function mitigates inherent risk. The internal auditor then examines the outcomes of this evaluation and awards a low, moderate, or high-risk rating to the particular business processes.
There are three types of risk one should keenly focus on in a business while taking a risk based auditing approach. They are,
- Financial Risk
- Business Risk
- Operational Risk
4. Assess your risk maturity
Risk appetite describes how much risk exposure your company would accept. Risk tolerance refers to the degree to which your company could change from the existing risk appetite.
You need to identify and understand the risk management strategies, with the risk appetite along with organizational process stages. You also should determine the tolerance of the management and board to identify the starting point for independent risk assessments.
5. Develop an Audit Plan
An audit plan for a projected time period is produced based on the preliminary risk assessment, which sets the auditable business processes inside a risk matrix based on low to high risk. Every year, during the update phase of the risk assessment process, the three-year audit plan should be reviewed, and any necessary revisions should be made based on any new or altered risk factors.
6. Execution of Internal Audit Program
Once the audit plan is finalized, the audit fieldwork can begin. The audit process is guided by a standard audit program, which establishes which audit procedures should be done depending on the risk assessment level. During audit fieldwork and prior to the exit meeting, any potential audit concerns should be thoroughly reviewed with operational employees and line management.
7. Report and Communication
When the draft is complete, the report should include findings and suggestions that are classified as high, moderate, or low risk. At this point, there shouldn't be any disputes about the report's facts because everyone should have agreed on them throughout the fieldwork and risk assessment phases.
Then, the final report is issued with the findings and recommendations of the internal auditor included, as well as the Management Action Plan (MAP). This report should be sent to the relevant operating, senior, and executive management, as well as audit committee members.
Risk-based Auditing Services
Our team helps you determine the type of risk-based audit approach and minimize the organizational risks through related processes.
Need help with risk-based auditing? Call BMS.