Subject : CORPORATE

 
   Title :        Audit Liability _ Part 5 _ Accountant's Risk Management _ Risk Analysis Checklists
   Author : Mark L. Cheffers  
   
 

Every professional faces risk of professional liability and litigation. These are generally attributable to client engagement risk, client financial risk, industry risk, firm risk and expectation gap. Before taking up any engagement, a professional should perform a thorough risk analysis in order to identify the suitability of taking up the work or modifying the scope of audit. Following checklists will prove to be very useful to every professional in mitigating his failure risk. - Editor

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*Mark L. Cheffers, CPA, ABV, is the founder of `www.AccountingMalpractice.com'. He is a former PWC manager, Harvard MBA and highly experienced litigation consultant.

 

 

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Do you prepare risk assessment checklists? _ In this article we outline over two hundred questions that should form part of your audit risk assessment analysis. These questions have been divided into five distinct areas. Those areas are represented below. Together they represent what we call the "Overall Risk Analysis & Profile" (ORAP), and should assist with planning and redflag identification by staff. The following does not include "Engagement Type Risk." Engagement Type Risks are based on the type of service or services being offered (see Appendix A).

ORAP Chart

I _ Client II _ Client

Engagement Financial

Risk Profile Risk Profile

Planning Process

III _ Industry IV _ Firm

Risk Risk Analysis

V _ Expectation

Gap

I. Client Engagement Risk Profile

Certain activities that have occurred at a client since the previous engagement pose risks to the firm. The following questions should be answered as part of every engagement, whether it is an audit, review or compilation.

# Question Yes _ No _ NA Comment

1. Is the company bucking the trend of the industry as a whole?

2. Has there been a recent turnover of board members?

3. Has there been a turnover in senior management?

4. Has the CFO or controller, or senior accounting personnel resigned for no specific reason?

5. Has there been a shift in duties within the accounting department?

6. Has the board asked for the resignation CFO or others in the accounting and finance area?

7. Is the relationship between you and the client strained?

8. In the past, has anyone from the engagement team been denied access to records, facilities, certain employees, customers, vendors, or others from whom audit evidence was sought?

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9. Has anyone from the staff received any tips or complaints about alleged fraud?

10. Is management's behavior unusual or intimi-dating?

11. In the past has anyone been denied access to certain members of management or the outside members of the audit committee?

12. In the past has anyone from the audit team had frequent disputes with management?

13. In the past has management placed undue time pressure to resolve complex or contentious issues?

14. In the past have there been unusual delays in receiving information?

15. In the past has management been unwilling to facilitate auditor access to key electronic files for testing the use of computer-assisted techniques?

16. In the past has audit staff been denied access to key IT operations staff and facilities, including security, operations, and systems development personnel?

17. Did management complain about the conduct of last year's audit team?

18. In the past has management complained or try to intimidate members of the audit team, especially in connection with the auditor's critical assess-ment of audit evidence or in the resolution of potential disagreements with management?

19. Has there been any evidence in the past that management is overriding normal ethical standards in order to achieve goals?

20. How does management treat the internal audit department _ do they respond adequately to their recommendations or concerns?

21. Is there evidence that non-financial management places excessive participation in or preoccupied with the selection of accounting principles or the determination of significant estimates?

22. Are there any known violations of securities laws against any member of senior management?

23. Has anyone from senior management ever been convicted of a crime?

 

 

 

 

 

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24. In the past has management failed to correct known reportable conditions on a timely basis?

25. In the past has management had an excessive interest in maintaining the company's stock price?

26. In the past has management committed to analysts, third parties, and creditors, aggressive or unrealistic forecasts?

27. In the past has management expressed an interest in employing inappropriate means to minimise reported earnings for tax-motivated reasons?

28. In the past has there been recurring evidence of attempts by management to justify marginal or inappropriate accounting on the basis of materiality?

29. Is there a constant turnover of outside auditors?

30. In the past has there been evidence that management is disrespectful to regulators?

31. In the past has there been evidence that management is careless with its control over and recording of assets?

32. Has there been any sexual harassment, gender, age, discrimination or related claims filed against senior management?

33. Does management ensure that business policies and practices continue to be aligned with ethical principles?

34. Does management provide multiple channels for feedback through which people can ask questions, voice concerns, and seek resolution to ethical issues?

35. In past audits did the audit team find control weaknesses, which in and of itself were not material, but together with all other control weaknesses may indicate a lack of control?

36. In the past did the audit staff note whether there was inadequate segregation of duties or independent checks?

37. Do past work papers document whether there inadequate oversight by management over employees responsible for assets?

38. Is the company's job screening procedures inadequate?

39. In the past audits during the review of fixed assets were there many discrepancies noted?

 

 

 

 

 

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40. Has past audits of the company's purchasing department note whether there were many control issues noted?

41. Does management understand the IT technology in place, which would allow an employee to perpetrate a misappropriation?

42. Has past audit teams identified inadequate access controls over automated records?

43. Does the company outsource its internal audit function, and if so, who determines what the auditors will audit?

44. Had past audits revealed that the board disregards corporate counsel's suggestions?

45. Have past audits revealed that there were a signi-ficant number of documents missing?

46. In past audits did the audit team identify that there were only copies of documents available when documents in original form are expected to exist?

47. In the past had the client been unable to produce evidence of key systems development and programme change and testing and implementation activities for current-year system changes and deployments?

48. In the past did the audit team identify that there was missing inventory or physical assets of a material amount?

49. In the past had the audit team identify situations were there was unavailable or missing electronic evidence, inconsistent with the entity's record retention policies and/or procedures?

50. In the past had the audit team documented situations where the client provide inconsistent, vague or implausible responses (from manage-ment of employees) arising from inquiries or analytical procedures?

51. Does the company resist signing the engagement or representation letter?

52. Has the client dangled non-audit services in front of the auditor around the same time that decisions about reserves are being made?

53. Does the client consistently delay entry of auditors in the company?

 

 

 

 

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54. Does the client have material legal risks arising internally or externally?

55. Does management lack critical business skills?

56. Is there substantial volatility in the prospective client's revenue, income or share price?

57. Are there significant related party transactions?

58. Has it ever been alleged that the company's management engaged in earnings management schemes?

II. Client Financial Risk Profile

In order to complete the "Client Financial Risk Profile" you will need to:

(a) Review prior year's work papers. (b) Complete analytical calculations. (c) Interview management? (d) Review client documents.

# Question Yes _ No _ NA Comment

1. Is the company bucking the trend of the industry as a whole?

2. Is there a plausible explanation for their performance?

3. Using the press as an outlet has management "pumped" the performance of the company?

4. Are the company's ratios in line with past performance and/or industry standards?1

5. Are managements' discussions supportive of by the facts?

6. Is there a significant emphasis on share price?

7. Are there loan covenants or other agreements tied to the company's performance?

8. Is there an unexpected or unexplained relationship between sales volume obtained by the accounting records and production statistics maintained by operations personnel?

9. Is the company suffering from operating losses?

10. Does the company have recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth?

 

 

1. As exemplified by a change in inventory, accounts payable, sales or cost of salesfrom prior period to current period may be inconsistent; a comparison of bad debt write-offs to comparable industry data; and other various ratios applicable to the client's industry.

 

 

 

 

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11. Does the relationship of net income to cash flows from operations appear unusual? (Management may have been able to record fictitious revenues and receivables, but was unable to manipulate cash.)

12. Have there been any changes in accounting, statutory or regulatory requirements that would have a significant impact on the client's financial condition or profitability?

13. Has there been a rapid change in technology?

14. Is the company vulnerable to product obsoles-cence?

15. Has there been a rapid change in product offer-ings?

16. Are there difficulties in obtaining the capital necessary to stay competitive?

17. Does the company report estimated financial results that may be deemed highly tentative, and the entity's stability could be compromised if the estimates are proved to be incorrect?

18. Are there significant related party transactions that are either audited by another CPA or un-audited?

19. Do operations exist in tax-haven jurisdictions for no apparent reason?

20. Is the organisational structure unduly complex for no apparent reason?

21. Can the client's operations be characterised by unusual growth or profitability?

22. Is the client's stability dependent on pending transactions?

23. Are sales or profitability incentive programmes unrealistic?

24. Is the stability of the client unusually sensitive to:

l Interest rates

l Debt service requirements

l Debt covenants

25. Has management personally guaranteed any of the company's debts and is the financial condition of the company deteriorating?

 

 

 

 

 

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26. Is there evidence that that there is a displeasure or dissatisfaction with the company or the way employees are treated?

27. Are there considerable amount of related party transactions?

28. Have past audits revealed discrepancies in the accounting records that were quantitatively of small amounts but qualitatively significant?

29. In past audit had it been noted that there were transactions (significant) not recorded in a completely or timely manner or they were improperly recorded as to amount, accounting period, classification or entity policy?

30. Have past audits revealed that there were last-minute adjustments that significantly affected the financial results?

31. In past audits were there cases where there were unsupported or unauthorised balances or transactions?

32. Had the past audit revealed that employees have access to systems and records inconsistent with their authorised duties?

33. In the past were there a significant number of adjusting journal entries?

34. In past audit had the auditors identified large stale dated transactions within company prepared reconciliations?

35. In past audits had the company prepare new general ledger accounts that appear not to substantiate the intent of the account?

36. In the past three years has the client been issued a going-concern opinion?

37. What is the current (liquidity) ratio as compared to the past three years?

38. What is the Quick or acid-test ratio as compared to the past three years?

39. What is the gross profit ratio as compared to the past three years?

40. What is the operating margin as compared to the past three years?

41. What is the net income ratio as compared to the last three years?

 

 

 

 

 

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42. What is the total return on assets ratio as compared to the last three years?

43. What is the return on equity ratio as compared to the last three years?

44. What is the debt to asset ratio as compared to the last three years?

45. What is the debt to equity ration as compared to the last three years?

46. What is the "times to interest earned ratio" as compared to the last three years?

47. What is the Inventory turnover rate as compared to the last three years?

48. What is the average age of inventory as compared to the last three years?

49. What is the accounts receivable turnover as compared to the last three years?

50. What is the "days sales in accounts receivable" as compared to the last three years?

51. What is the asset turnover as compared to the last three years?

52. Has the client employed the services of another accounting firm for consultation on a complex transaction?

53. Has the client suddenly established numerous subsidiaries for what appears to be a logical decision?

54. How does the client's actual results compare to budgeted?

55. Have prior audits discovered unrecorded liabi-lities?

56. Is the company in need for capital?

57. Does the client's credit review, if any, contain derogatory information?

58. Are there any structural variables that are depressing profitability?

59. Is there negative evidence that will impact future profitability?

60. How does your client compare to its peer group?

 

 

 

 

 

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61. What differentiates your client from its larger competitor? And, is the differentiation shrinking?

62. Have the prospective client's financial statements ever been restated?

63. Is the firm or anyone in the firm under investi-gation?

III. Industry Risk Assessements

In order to complete this section it will take some research (unless your firm specialises in a particular industry and maintains current information on the area). Sources for information might include: purchasing an industry study; from trade associations; from trade magazines; company documents (e.g., MD&A); government resources; business articles; interview with an industry specialist; and, companies such as Bizminer.com, Moody's, to name a few. Most firms that specialise in a certain area will usually maintain a clipping file from newspapers, magazines, and trade journals, which can be easily accessed.

# Question Yes _ No _ NA Comment

1. What is the general strength of the economy?

2. Is the industry susceptible to sudden downturns?

3. Is the industry experiencing difficulties?

4. What is the outlook for the industry according industry analysts?

5. Has demand been sequentially decreasing?

6. Do the suppliers have the bargaining power in the industry?

7. Is the industry subject to sudden technological changes, which can quickly affect the profitability or competitiveness of the industry?

8. Are there any negative industry trends that will impact your client and to what extent?

9. Is there a threat of entry to your client's market that would materially affect your client's business?

10. Do you know your client's competition and whether a change in strategy occurred that would impact your client's business?

11. Are there any foreseen problems with your client's suppliers that would affect future sales?

12. Are there any laws or regulations pending that would have a material impact on your client?

 

 

 

 

 

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13. What is the intensity of the competition and what is your client doing to maintain its market share?

14. Is there a threat of substitute products or services that will materially affect your client?

15. Are there any threats to the industry's distribution channel?

16. Is there a probability that unionisation will occur?

17. Has your client obtained a market analysis of the companies products, and, if so, are there any negative factors?

18. Is the geographic or market area saturated?

19. Have there been any demographic shifts that will impact the industry?

20. Is the projected industry growth in the client's area and target market large enough to support the client's growth?

21. Have the number of competitors increased from the prior year?

22. Does the industry have a well-known business cycle, and, if so, what direction do profits appear to be heading in?

23. What stage of the life-cycle is the industry currently in?

24. Is the industry susceptible to single suppliers, investors, and/or creditors?

25. Is the industry experiencing a "newer line" of products? If so, does your client have the capacity, capability, resources and management to retool?

26. Have there been any demographic shifts in custo-mers that will impact the industry negatively?

27. Is the industry changing where the bargaining power lies with the buyers?

28. Is there a threat of foreign competition?

29. Is the industry experiencing forward integration?

30. Are there barriers to exit?

31. Is there disagreement among industry analysts as to the state of the industry?

32. Do any geo-political forces threaten the industry?

33. Are there any environmental issues that threaten the industry?

 

 

 

 

 

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IV. Firm Risk Analysis

Before accepting any engagement a firm should evaluate the risks of accepting the engagement. Firm risks relate to the firm's abilities and limitations.

# Question Yes _ No _ NA Comment

1. Does the firm have the requisite expertise to handle the engagement?

2. Do the firm's employees have the requisite experience to handle the engagement?

3. Does the firm have the resources (human, cash-flow, research, equipment, etc.) to handle the engagement?

4. Are there any independence issues?

5. Are there any conflicts?

6. Is the firm unduly exposing itself to potential litigation?

7. Is the prospective client involved in any lawsuit or other litigation where the accountant might be implicated?

V. Expectation Gap Risks

The "expectation gap" is the gap that exists between the conduct required by the professional standards and that expected of a financial professional by the public and more skeptical jurors.

# Question Yes _ No _ NA Comment

1. Has the client submitted a list of those who will be potentially relying on the audited financial statements?

2. Does the firm's audit plan include items which third parties may be interested in, e.g., loan covenants?

3. Are there any newly proposed audit standards?

4. Has the firm taken the necessary steps to document their efforts regarding the detection of fraud in the financial statements?

5. Are the prospective client's financial statements such that transparency cannot be obtained?

Conclusion

The effectiveness of using the above questions or ORAP may not be immediately calculable in terms of a percentage decrease in risk of an audit failure; however in the context of a lawsuit, these questions will certainly help the practitioner to

 

 

 

 

 

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establish his defense by demonstrating what items were considered by the auditor and his resolution thereof.

Risk is not a constant thing or exact set of questions. As new issues arise and case law is established, as the expectation gap changes, etc., so does the accountant's risk. The leopard may indeed not be able to change his spots, but risk should be viewed as an ever-evolving species..

Risk

Risk

Risk

Appendix A _ Types of Services

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1. Taxation

(a) e-Tax Transformation

2. Auditing

3. Review Services

4. Compilation Services

5. Actuarial Services

6. Litigation & Forensic Accounting Support Services :

(a) Risk Advisory Services

(b) Litigation Services

(c) Intellectual Property Services

(d) Dispute Resolution Services

(e) Investigations

(f) Forensic Accounting

7. Financial Forecasts & Projections

8. Financial Planning

9. Trustee Services

10. Real Estate Advisory Services

11. Environmental Advisory Services

12. Cyber-Crime & Cyber-Security

13. Business Valuation Services

14. Internal Auditing Services

15. Operational Performance Services

(a) Procurement Through Payables Diagnostic

(b) Cash Management Review

 

 

 

(c) Order Management Process Review

(d) Inventory Planning and Control

(e) Online Banking Process Review

(f) Consumer Credit Review

(g) Commercial Credit Review

(h) Asset Liability Management Process Review

(i) Derivatives Trading and Operations Process Review

(j) Treasury/Funding Process Review

(k) Consumer Loan Collections Process Review

(l) E-Business Process Controls Review

16. Consulting Services :

(a) e-Business

(b) e-Integration

(c) e-Outsourcing

(d) Customer Management

(e) Supply Chain Management

(f) Knowledge Management

(g) Finance

(h) Human Resources

(i) B2B e-Market Consulting

17. Assurance Services :

(a) Information Risk

(b) Management Assurance

 

 

 

 

 

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28. Professional Committee Appointment Services

29. Technology Risk Services

30. Compensation & Benefits

31. Business Process & Improvement

32. Information Technology Services

33. Audit Committee Services

34. Financial Recovery Services (Bankruptcy, Turnaround, Workout)

35. Financial Management Solutions In Marital Dissolution

36. Insurance Claim Services

37. Securities & Professional Liability Services

38. Transfer Pricing

39. Temporary Financial Services (Financial system design and implementation, financial forecasting, projections, and budgeting, Financial analysis, Financial project management, Treasury functions, Cash flow modeling and management, External audit preparation, Internal control design and implementation, Internal audit assistance, Inventory and costing systems, Recurring accounting assistance, Lender reporting and analysis.)

40. Third Party Reviews

41. Estate Planning

42. Royalty Compliance

43. Succession Services

44. Cost Segregation Services

45. Claims Resolution Services

46. Insurance Brokerage

47. Early Warning Assessment of Portfolio

48. Due Diligence Analysis for Under-writing Purposes

49. Market Feasibility Analysis

 

 

(c) Quality

(d) Reliability

(e) Compliance

(f) Regulatory

(g) Operational Effectiveness

(h) Value Management

18. Corporate Finance :

(a) M&As

(b) Sales Disposals

(c) Debt & Equity Financing

(d) Valuation & Appraisals

(e) Leveraged Management Buyouts

(f) Flotation & Public Offerings

(g) Privatisation

19. Corporate Recovery :

20. Transaction Services :

(a) Pre-Deal Evaluation

(b) Bid Services

(c) Transaction Services (Due Diligence)

(d) Strategic and Commercial Intelligence

(e) Vendor Initiated Due Diligence

(f) Vendor Assistance

(g) Transaction Structuring

(h) Stock Exchange Reporting

(i) Contract Assistance

(j) Integration

21. Strategic Services

22. Fixed Assets Valuation Services

23. Real Estate Valuation Services

24. Software Support Services

25. Quantitative Economics & Statistics

26. Lease Consulting Services

27. Employee Benefit Services

   

Disclaimer : The views in this article are author's point of view. www.manupatra.com may or may not subscribe to the views of the author. This article is not intended to substitute the legal advice. No portion of this article may be copied, retransmitted, reposted, duplicated or otherwise used, without the express written approval of the author.
The Copyright of the article is with the author.