Research Implications of the Auditing Standard Board's Current Agenda

This commentary provides insights into auditing standards issues derived from our work with the Auditing Standards Board (ASB) over the last six years. Our roles as the academic members of the ASB included bringing to the ASB's attention research bearing on the issues being addressed and stimulating research related to ASB projects. In this commentary we focus on promising areas of research likely to be helpful to ASB standard setting over the next few years. We ask researchers to bring to our attention current efforts and to consider performing research related to the areas discussed in this paper. Our discussion is structured around recommendations to the ASB included in the Report and Recommendations of the Panel on Audit Effectiveness (2000) (the Panel). Chairman Arthur Levitt of the Securities and Exchange Commission initiated formation of the Panel to assess whether independent audits of public companies' financial statements adequately serve and protect the interests of investors. These recommendations are having a significant effect on the ASB's agenda and will likely shape its agenda over the next several years. Specifically, we address the following four areas in which academic research seems particularly useful: (1) 1. The audit risk model and linkage of risks to audit procedures 2. Fraud risk assessment 3. Going-concern considerations 4. Analytical procedures THE AUDIT RISK MODEL AND LINKAGE The Panel made a number of recommendations regarding the current audit risk model, which describes the components of the risk that the auditor will unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements (AICPA 2000, AU 312.02). At the account level, audit risk consists of: * Inherent risk--the susceptibility of an assertion to a material misstatement, assuming there are no related controls; * Control risk--the risk that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by internal control; and * Detection risk--the risk that the auditor will not detect such misstatements. Mathematically, the model is often viewed (2) as: Audit Risk = Inherent Risk * Control Risk * Detection Risk It is interesting to note that the ASB deviated somewhat from this model in Statement on Auditing Standards (SAS) No. 82 on the consideration of fraud in a financial statement audit. SAS No. 82 requires the auditor to identify risks indicated by various factors and design "focused tests" that are reactive to those risks. This process of reacting to identified risks is not well articulated with the overall audit risk model. While concluding that the audit risk model is "appropriate," the Panel (2000, 10) indicated that the model needs "enhancing and updating." In its recommendations to the ASB, the Panel (2000, 14) states that auditing standards should be made more "specific and definitive" without necessarily paying blind homage to the existing audit risk model. The members of the Panel clearly believe that the existing audit risk model and the related auditing standards do not provide sufficient guidance to direct auditor judgment. Another impetus to reexamine the audit risk model appears in the recently issued report of the Joint Working Group (JWG) composed of members from the American Institute of Certified Public Accountants, the Auditing Practices Board of the United Kingdom and the Republic of Ireland, and the Canadian Institute of Chartered Accountants. The JWG was formed by these organizations to: * study the methodologies of the large auditing firms; * understand what drives the development of the methodologies; and * consider the effect of their development on the way audit firms apply the audit risk model. (JWG 2000) In discussing the implications of their study of firm methodologies, the JWG researchers question whether current audit methodologies are well described by existing auditing standards (JWG 2000,22). …