The Effect Of Risk Based Auditing On Financial Performance In Commercial State Corporations In Nigeria

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The Effect Of Risk Based Auditing On Financial Performance In Commercial State Corporations In Nigeria

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PROJECT TOPIC AND MATERIAL ON THE EFFECT OF RISK BASED AUDITING ON FINANCIAL PERFORMANCE IN COMMERCIAL STATE CORPORATIONS IN NIGERIA

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  • Name: The Effect Of Risk Based Auditing On Financial Performance In Commercial State Corporations In Nigeria
  • Type: PDF and MS Word (DOC)
  • Size: [70 KB]
  • Length: [56] Pages

 

 

 

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Audits serve a fundamental purpose in promoting confidence and reinforcing trust in financial information. Risk Based Audit approach is the method the auditor follows to determine the audit procedures to be performed, based on risk; or the indication that the transactions or classes of transactions, accounts or balances and/or disclosures is misstated to enable the auditor to achieve the audit objective. The evaluation and consideration of the risk based audit approach is a normal consequence of striving for improvement and the development of the services that the auditing profession provides (Lutta, 2012).

Risk Based Audit enhances transparency, accountability and responsiveness to public expenditure policy priorities and it virtually covers all aspects of the public financial management (Lutta, 2012). A risk based audit approach is designed to be used throughout the audit to efficiently and effectively focus the nature, timing and extent of audit procedures to those areas that have the most potential for causing material misstatements in the financial report (Institute of Chartered Accountants of Australia, 2011).The risk based audit approach is an essential component in the performance of an audit and part of the audit profession’s defence against legal liability. This improves the standing of the audit profession as the audit was legalised (Rapa and Kauffman, 2005).

Risk Based Audit is superior to traditional audit approaches for two reasons. First, it focuses on risks, the underlying causes of financial surprises, not just the accounting records. Second, the Risk based Audit shifts the focus from inspecting the quality of the financial information that is recorded in the financial statements to building quality into the financial reporting process and adding value to the Bank’s operations (Gibson, 2003).

The Risk Based Audit, which focuses on both recorded and unrecorded risk, improves financial statement and the financial statement reporting process. The Risk Based Audit focuses on business risk and the process for controlling these risks. The higher the risk area, the more audit time and client controls are required. Besides focussing on the level of risk, the risk based method helps to evaluate and build value into the financial reporting process and the clients business and activities. This knowledge is gained through the way the client operates their business, management, internal and external environments. The knowledge gathered can help to design the audit program that includes the most effective combination of tests responsive to each client’s unique circumstances. For this reason, the risk based approach is then superior to traditional auditing methods (Gibson, 2003).

1.1.1 Risk Based Audit

It is a process, an approach, a methodology and an attitude of mind rolled into one. The simplest way to think about risk based audit conceptually is to audit the things that really matter in an organisation. Risk based audit is developed after considering certain complexities surrounding an audit. Major complexities are, firstly, the expectation gap, secondly, responsibilities of the auditor, thirdly, provision of reasonable assurance, and fourthly, the practical implementation of the standards

(Gibson, 2003).

The basic premise of RBA is that auditors should devote more resources to accounts that are likely to be misstated and fewer resources to those that are less likely to be misstated (Bell et al. 2005; Rittenberg & Schweiger, 2005; Knechel, 2007). This approach is expected to lead to more effective and efficient audits (Public Company Accounting Oversight Board, 2007). However, if auditors do not accurately assess misstatements risk at the account level, audit resources will be misallocated, resulting to undetected misstatements (Kinney, 2005; O’Donnell & Schultz, 2005).

Risk based approach requires the auditor to first understand the entity and its environment in order to identify risks that may result in material misstatement of the financial report. Next, the auditor performs an assessment of those risks at both the financial report and assertion levels. The assessment involves considering a number of factors such as the nature of the risks, relevant internal controls and the required level of audit evidence (ICAA, 2011).

The result of the assessment effectively categorises the audit into a) areas of significant risk of material misstatement that require specific responses and b) areas of normal risk that can be addressed by standard audit work program. Having assessed risks, the auditor then designs appropriate audit responses to those risks in order to obtain sufficient audit evidence on which to conclude. Risk assessment continues throughout the audit and the audit plan and procedures are amended where a reassessment is necessary (ICAA, 2011).

1.1.2 Financial Performance

Financial performance is a measure of an organization’s policies and operations in monetary terms. It is a general measure of a firm’s overall financial health over a given period of time and can be used to compare similar organizations across the same industry or compare industries or sectors in aggregation. There are many different ways of measuring a firm’s financial performance. It may be reflected in the firm’s return on investment, return on assets, value added among others and is subjective measure of how a firm can use assets from its primary mode of business and generate revenues.

There are many different ways to measure financial performance, but all measures should be taken in aggregation. Line items such as revenue from operations, operating income or cash flow from operations can be used, as well as total unit sales. Furthermore, the investor may wish to look deeper into financial statements and seek out margin growth rates or any declining debt (Lutta, 2012).

In public sector, the nature of financial position is a function of the resources and obligations the public sector entity is held accountable for managing and maintaining in order to meet its multiple public interest objectives in both the short and long terms. The financial performance is determined by a comparison of actual versus budgeted annual results. The resultant surplus or deficit provides cumulative information about the financial performance of the public entity (Mutua, 2012).

1.1.3 The Effect of RBA on Financial Performance in Commercial State

Corporations

The risk based audit approach provides the auditor with an approach to conduct the audit as efficiently and effectively as possible, benefitting both the audit team and the entity. The basic premise of RBA is that auditors should devote more resources to accounts that are likely to be misstated and fewer resources to those that are less likely to be misstated thereby improving financial performance (Bell et al. 2005; Rittenberg & Schweiger, 2005; Knechel, 2007). This approach is expected to lead to more effective and efficient audits (Public Company Accounting Oversight Board, 2007).

Focusing on critical risks by auditors align audit priorities with those of the shareholders resulting in adding value to the entity. According to Griffiths (2006) RBA directs scarce audit resources at checking the responses to the risks that present a serious threat to an organization and that regulations are now requiring directors to ensure these risks are properly managed. High quality RBA ensures that critical risks are accurately identified and properly evaluated and reported by the auditors. Good use of RBA results to effectiveness and therefore improving returns to the citizen and investors. As opposed to general audit of business processes in an organization, RBA appeals to an auditor to carefully consider the significant processes in an entity and focus efforts there. Use of RBA ensures that no potentially risky area is left out.

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