How Auditing Reduce Information risk | Auditing Course
Channel: Farhat Lectures. The # 1 CPA & Accounting Courses
Date: 2023-08-28

In this video, I explain, how audit reduce information risk.

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List the causes of information risk, and explain how this risk can be reduced.

As society becomes more complex, decision makers are more likely to receive unreliable information. There are several reasons for this: remoteness of information, biases and motives of the provider, voluminous data, and the existence of complex exchange transactions.

Remoteness of Information
In a global economy, it is nearly impossible for a decision maker to have much firsthand knowledge about the organization with which they do business. Information provided by others must be relied upon. When information is obtained from others, the likelihood of it being intentionally or unintentionally misstated increases.

Biases and Motives of the Provider
If information is provided by someone whose goals are inconsistent with those of the decision maker, the information may be biased in favor of the provider. The reason can be honest optimism about future events or an intentional emphasis designed to influence users. In either case, the result is a misstatement of information. For example, when a borrower provides financial statements to a lender, there is considerable likelihood that the borrower will bias the statements to increase the chance of obtaining a loan. The misstatement could be incorrect dollar amounts or inadequate or incomplete disclosures of information.

Voluminous Data
As organizations become larger, so does the volume of their exchange transactions. This increases the likelihood that improperly recorded information is included in the records—perhaps buried in a large amount of other information. For example, if a business overpays a vendor’s invoice by $2,000, it is unlikely to be uncovered unless the company has instituted reasonably sophisticated procedures to find this type of misstatement. If many minor misstatements remain undiscovered, the combined total can be significant.

Complex Exchange Transactions
In the past few decades, exchange transactions between organizations have become increasingly complex and therefore more difficult to record properly. The increasing complexity in transactions has also resulted in increasingly complex accounting standards. For example, the correct accounting treatment of the acquisition of one entity by another poses relatively difficult accounting problems, especially as it relates to fair value estimations. Other examples include properly combining and disclosing the results of operations of subsidiaries in different industries and properly valuing and disclosing derivative financial instruments.

Reducing Information Risk
After comparing costs and benefits, business managers and financial statement users may conclude that the best way to deal with information risk is simply to have it remain reasonably high. A small company may find it less expensive to pay higher interest costs than to incur the costs of reducing information risk.

For larger businesses, it is usually practical to incur costs to reduce information risk. There are three main ways to do so.

User Verifies Information
The user may go to the business premises to examine records and obtain information about the reliability of the statements. Normally, this is impractical because of cost. In addition, it is economically inefficient for all users to verify the information individually. Nevertheless, some users perform their own verification. For example, the IRS does considerable verification of business and individual tax returns to determine whether the tax returns filed reflect the actual tax due the federal government. Similarly, if a business intends to purchase another business, it is common for the purchaser to use a special audit team to independently verify and evaluate key information of the prospective business.