Tailor the Audit to a Low-Risk Situation

By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

After looking at major financial statement accounts or classes of transactions, if you decide the risk of material misstatement is relatively low, you design your audit procedures accordingly. Here are three characteristics of company transactions that indicate low risk:

  • Like transactions are handled in the same way: For example, all customers who purchase on account are set up in the accounts receivable subsidiary ledger, and the invoice amount due is immediately booked.

    The accounts receivable subsidiary ledger is a listing of all customers and is usually ordered alphabetically by customer name or by customer account numbers. The ledger also reports the current amount each customer owes. A consistently applied accounting policy results in lower audit risk.

  • You encounter many recurring transactions: These types of transactions take place every month. For example, each month the company makes an accrual for payroll earned but not paid.

  • The transactions are easy to measure: Revenue and expense transactions the company records when they occur are easy to measure. You sell a suit, for example, and immediately record revenue for the sale price of the suit. In contrast is revenue recorded under percentage of completion — a method of recognizing construction revenue and expenses in stages that can be subjective and open to error.

Many audit firms assign less experienced auditors to work low-risk engagements and save the big guns for the tough cases. You’re more likely to have the pleasure of working these easier engagements early in your career, as a staff associate.

Also, in low-risk situations, sample sizes (the number of records you look at) are set at normal levels. Normal levels of any audit criteria are usually set as firm policy, meaning that your senior associate tells you what size samples to use.

Professional skepticism is also set at normal levels, which simply means you’ll be more apt to take transactions at face value. In other words, you assume the transactions are correct unless you discover otherwise.