An Empirical Examination of the Impact of Risk Factors on Auditor's Risk Assessment

The primary objective of this study is to identify what factors affect assessments of auditor risks including audit risk, business risk, and personal risk in under-researched area of Singapore. Factor analysis and logistic regression were applied as methods of analysis. The result shows that a single factor related to the effectiveness of control activities has significant explanatory power, and indicates that client's control environment is influential in contributing to assessments of auditors' risks. Introduction In today's expanding global economy, accounting firms serve not only local but also international companies. The increasingly complex business operating procedures and largely complicated sets of investors' portfolios have caused auditing profession to face a great deal of uncertainty. As to argument by Vinten (1991), Auditors need to achieve a via media (middle way) between abrogating risk-taking entirely and permitting totally uncontrolled and huge risk exposures (p. 3). In addition, a phenomenon noted by Slice (1991), lawsuits against auditors are a continuing source of concern for members of public accounting profession. A great effort, therefore, to investigate what gets public accountants into trouble with their clients and with third parties was made (Pierre and Anderson, 1984). The responses of accounting profession to a reduction in likelihood of audit failure and litigation allegation via risk factors assessed, more audit effort input and fee billed have been analyzed (Low et al., 1990; Mock and Wright, 1999; Bell and Carcello, 2000; Wright and Bedard, 2000). However, these issues are prevailingly taking into consideration within a Western world context. Whether auditors from non-Western world face same litigation environment and whether auditors replicate similar strategies to responding to such a threat still remain to be answered. For clarifying those questions, therefore, this study aims to identify what potential risks are associated with Singaporean auditors and how auditors assess them. Three potential risks identified in this study are audit risk, business risk and personal risk. Audit risk is risk that auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. Business risk is risk to audit firm from association with client, consisting of risk of potential litigation costs and related effect on audit firm's reputation. Personal risk is risk of damage to individual auditor's own personal reputation from being associated with client. This study is organized as follows. The theory and hypothesis development is provided in section II. section III sets out research methodology which includes description of independent and dependent variables, sampling approach and analysis methods. section IV presents logistic results. A brief summary and discussion are provided in finally section. Theory and Hypothesis Development 1. Control Environment Empirical evidence suggests that correctly assessing control environment is beneficial to assessing identified risks. Sullivan (1988) emphasized that fraudulent financial reporting is often found at very of organisation - what Treadway report (1992) called the tone at top and what auditors call control environment. A similar result was also found by Loebbeoke et al. (1989), control environment was found to be one of significant factors associated with management fraud. Where controls are weak, an important condition exists that can allow either management fraud, a defalcation, or an error to occur. The control environment also serves to enhance or mitigate assessment of inherent risk and control risk (Haskins & Dirsmith, 1995; Marden et al., 1997). Accordingly, an incorrect evaluation of control environment will lead to an incorrect assessment of inherent risk, control risk and fraud risk, and possibly result in audit errors, such as failing to detect material errors and misstatements in financial statements and then forming an improper opinion. …