We use a risk based approach to audit a company's year-end financial statements, but the term " risk based audit approach" can sound like the latest in business buzzwords similar to holistic, innovative and mission critical.

The substance behind the term "risk based approach" comes from Canadian Auditing Standards, the standards Canadian accountants apply when performing an audit. In fact, the standards dedicate a section to risk assessments: "CAS 315 Identifying and Assessing the Risks of Material Misstatement."

Internal and External Risk Assessments

What does a risk based audit approach mean? We do a risk assessment during the planning phase of an audit looking for both financial reporting risk and business risk. Financial reporting risk is when a company's financial statements don't reflect the company's operations and users of the statements rely on the inaccurate portrayal to make decisions.

We also assess the company's business risk starting with an external review of the company's industry, its regulations and its use of technology. After an external review we move into internal review.

Every analysis of the company's operational risk includes an assessment of the company's ability to continue as a going concern. We ask the basic question: will the company be able to make it beyond the following fiscal year? Moving from big picture to the smaller details we look for issues that could cause a company to fail. What would the possible catastrophe look like?

Most businesses are healthy, but Canadian Auditing Standards require a going concern assessment for all companies. The exercise is used to both identify the rare company that could become insolvent and to identify a company's risks. We perform the analysis at the start of an audit and at its end (to consider any new information uncovered during the audit itself).

We use the assessment to design the audit including the procedures used to test the company's balances and transactions. High risk balances and transactions are tested in greater detail with low risk balances receiving less testing. Using a risk based approach results in efficiencies when performing the audit.

Risk Assessment by Management

A risk based audit results in efficient and effective audits, but a risk assessment can also be a valuable tool for business owners and managers. When was the last time you sat down and performed a risk assessment of your business? Or asked yourself the question: what could cause the business to fail in the next year? Being proactive about risks can mean identifying and minimizing risks early.

Five years ago, if a cable TV company performed a risk assessment they would have identified early signs of an industry in upheaval. Changing technologies matched with changing demographics were moving television to online streaming and Netflix had entered the Canadian market in 2010. If we looked around today these signs are obvious; however, it's only within the last year that the largest cable providers have responded with their own online streaming services.

Better Public Company Risk Disclosure

Financial Reporting & Assurance Standards Canada has an open project looking at changing the Auditors' Reporting Standards for public companies. The project looks to add a section on significant matters in in the Auditors' Report attached to audited public company financial statements. If the changes go through this will give users of public company financial statements a clearer view of items that impact a risk based audit approach. Canada is considering the change to align reporting standards to expected changes in International Standards.

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