Moving beyond the traditional: Embracing the risk-based mindset
Previously, risk assessments relied heavily on understanding a client's internal controls (ICs) to determine control risk. A standardized approach was employed, often testing the existence and documentation of control procedures.
While internal controls remain crucial, SAS 145 ushers in a new era of risk-based thinking. The focus has shifted to identifying and evaluating the specific risks that could lead to material misstatements at the assertion level. This creates a more tailored testing approach.
Consider a manufacturing company with a history of significant inventory write-downs. Under the traditional approach, auditors might have simply verified the existence of documented procedures for cycle counts. However, under SAS 145, analysis is on the inherent risk of inventory misstatements. Factors like the complexity of the inventory (think high-value electronics vs. standard office supplies) or reliance on third-party logistics providers would influence our risk assessment.
Next steps might include designing targeted procedures to assess the effectiveness of controls mitigating those specific risks. For example, observing physical inventory counts more closely, focusing more on high-risk inventory items, or performing additional testing of inventory valuation methods.
A sharper focus on inherent risk
SAS 145 provides a clear definition of inherent risk as the susceptibility of an account balance, transaction type, or disclosure to a material misstatement, absent any controls. This concept empowers auditors to prioritize their audit efforts more effectively.
For instance, a public company in the highly competitive tech industry might have a higher inherent risk for revenue recognition than a private company in a more stable industry. This would influence the nature, extent, and timing of our revenue audit procedures. This might mean performing more extensive analytical procedures on sales data, scrutinizing customer contracts for potential side agreements, or dedicating additional resources to testing the valuation of complex software licenses.
Leveraging technology and data analytics
The rise of data analytics, AI, and other technologies presents exciting opportunities under SAS 145, providing the opportunity to gain deeper insights into potential risks by leveraging data mining techniques and continuous auditing tools. For example, analyzing trends in sales returns or customer complaints for a retail client might reveal areas with a higher inherent risk of fraudulent sales.
Similarly, data visualization tools can help us identify unusual patterns in financial data, prompting further investigation. Imagine a sudden surge in accounts receivable aging for a company in a declining industry – this could be a red flag for potential bad debt. How AI, data analytics and other emerging technologies are likely to impact how auditors deal with the standard is examined standard in this article.
