Risk-Based Approach in Audit

Risk-based approach is the technique that auditors use in performing the audit, in which they focus on analyzing and managing different types of risks that could lead to material misstatement. In this approach, auditors direct their attention to those key risk areas of financial statements that may contain misstatement.

Using this approach, auditors need to perform risk assessment of material misstatement on financial statements based on their understanding of the client’s business and control environment.

In this case, auditors first need to identify the risks that the client exposes to when obtaining an understanding of the client’s business and its environment including an internal control system that it has in place. This is also known as “top-down” approach of identifying risks, in which “top” refers to the client’s day-to-day operations and “down” refers to the client’s financial statements.

Once auditors have identified and assessed the risks of material misstatement in financial statements, they can plan the audit procedures to respond to the assessed risks so that they can minimize their audit risk to an acceptably low level.

In short, in risk-based audit approach auditors need to:

• Identify key risks in day-to-day business operation
• Assess the impacts that those risks can have on financial statements
• Plan audit procedures according to the assessed risks

Risk-based audit approach not only helps auditors to manage and minimize the audit risk, but it also helps to reduce audit work on some levels while maintaining the audit quality. This is due to in this approach, auditors need to focus on the risky areas that could lead to material misstatement only. Hence, they don’t need to spend much time on the low-risk areas; and their audit objectives can still be met.

Though there is no perfect audit approach that can give auditors a 100% guarantee to meet audit objectives, the risk-based audit approach can help auditors to minimize the possibility of audit objectives not being met in their audit engagement, regardless the size, location and complexity of the client. That’s why the risk-based audit approach is the audit approach that auditors use the most in the auditing of financial statements.