Business Risk

yep..its business risk

In recent years, larger firms have extended the concepts of risk analysis as an approach to auditing.The new more and embracing is that of business risk.A definition of business risk is "The threat that an event or action will adversely affect a business's ability to achieve its ongoing objectives and can be split between external and internal factors"

External risks

Risks arising from outside the company include: (may embedded in audit case study in Q's)

• Changing legislation (e.g. the use of genetically modified foods).


• Changing interest rates(especially with highly geared companies).


• Changing exchange rates (e.g strong £ and the high price of British exports).


• Public opinion, attitudes, fashions.


• Price wars initiated by competitiors (e.g. Giant vs Tesco)


• Enviromental matters

Internal risks Risks arising from inside the company include:

• Failure to modernise products, processes,labour relations, marketing


• Employees


• Board Members


• Cash flow including overtrading


• Gearing


• Inappropriate acquisitions


• Internal controls


• Fraud


• Computer systems failures


• Lack of R&D

The client's approach to risk

The potential effect of the risks on the financial statements depends on how the client deals with risk. Possible actions are:

1. Do nothing and hope for the best.


2. Develop internal controls.There is much emphasis on internal controls in the corporate governance and management of risk is a large part of it.


3. Develop quality controls over production of goods, production of services, staff recruitment.


4. Diversify. acquisitio, new products, multiple sourcing.


5. Train staff


6. Risk reduction. raising staff awareness of risk, tighter discipline in all areas.


7. Transfer risk. by insurance, subcontracting, outsourcing


8. Avoidance. e.g. manufacturing in countries where the market is, instead of exporting, and thus avoiding exchange rate risks and government import restrictions.

Question for such approach to risks can be found in December 2002 Question 6 of ACCA 2.6

Designing the audit

• Agree the assignment in a letter of engagement


• Discuss and review the business risks with directors/management


• Plan the audit accordingly


• Carry out audit


• At final review stage of the audit, consider business risks and any possible impact on misstatements in the financial statements.


• Report.

IN the exam:

When devising substantive tests, think about the financial statement assertions that need to be met (CODRACE / PERMCOV / COMPARE). Also think about the audit procedures you can perform (AEIOU).

Examples for receivables

Cutoff - test a sample of GDN's immediately before and after year end and ensure that the receivable and sale has been recorded in the correct period. Also ensure that the inventory is not included.

Existence - circularise a sample of receivables to confirm the amount owed to the client.

Analytical Procedures - calculate receivable days for the year and compare to the credit terms given to customers. You could also compare with prior year or industry average.

Receivables provision - review the aged receivables listing and compare the amount of receivables > say 90 days to the provision to see if adequate.

Payables examples:

Cutoff - test a sample of GRN's immediately before and after year end and ensure that the payable and purchase has been recorded in the correct period. Also ensure that the inventory has been included.

Completeness - test a sample of after date payments, trace to GRN & Invoice, if it relates to a purchase before year end ensure it is included in the payables listing.

Analytical Procedures - calculate payables days and compare to the average terms given by suppliers or to prior year.

Test supplier statement reconciliations by comparing the balance on the supplier statement to the payables balance on the payables listing and if any discrepancies exist ensure there is a valid explanation from the client (eg cash in transit).