Today, I would like to introduce to you a concept of audit: Audit Approach.

Did you think about it before? Do you have any question on how an auditor conducts an audit, and by which method?

In fact, there are different kinds of audit approaches and each of them has different effectiveness, resources required and different outcome.

By referring to a Technical Article published on accaglobal.com, by Brian Pine – an ACCA examiner, audit approaches are shared in more details hereinafter.

Audit approaches

There are 04 different audit approaches:

• The substantive procedures approach

• The balance sheet approach

• The system-based approach

• The risk-based approach

(i) The substantive procedures approach

This is also referred to as the vouching or the direct verification approach. In this approach, audit resources are targeted on testing large volume of transactions and account balances without any particular focus on specified areas of the financial statements.

This approach might be the most simples approach. In my observation, this method is often used in internal audit rather than an external audit where there are strict time frame and resource constraints.

(ii) The balance sheet approach

In this approach, substantive procedures are focused on balance sheet accounts, with only very limited procedures to be carried out on income and cash flow statement items. The justification for this approach is the notion that if the relevant assertions for all balance sheet accounts are tested and verified and profit/losses accounts will not be misstated.

Supporting for this approach, auditor might base on rule of Double-entry in accounting and therefore design directional tests in audit.

(iii) The system-based approach

This approach requires auditor to assess effectiveness of internal control system of an entity and then direct substantive procedures to those areas where it is considered that system objectives will not be met. Reduced procedures are carried out in those areas where system objectives are supposed to be met by procedures of internal control system.

(iv) The risk-based approach

In this approach, audit resources are directed toward those areas of financial statements that may contain misstatements (either by error or omission) as a consequence of risks faced by the business.

Currently risk-based approach is the audit approach applied by most jurisdictions. IAASB also applies risk-bases approach when developing ISAs. Risk-based approach can minimize the possibility of audit objectives not being met, at the most effective resources and time.

Application of Risk-based approach in ISAs

ISA 315, Identifying and assessing the risk of material misstatement throughout understanding of the entity and its environment, requires auditor to apply risk-based approach in carrying out an audit on financial statements. In so doing, it requires auditor to make risk assessments of material misstatements at the financial statement level and assertion level, based on an appropriate understanding of the entity and its environment including internal controls.

For this reason, this approach is often referred to as the “business risk approach”. When adopting this approach, risks can be categorized in 03 types of risks which may have impact to financial statements.

- Financial risks

- Compliance risks

- Operational risks

Those sections are often clearly addressed and monitored in an internal audit. In an external audit, these risks are addressed to the extent of its possible impacts to financial statements only.

Reference

­A risk-based approach to auditing financial statement – published by ACCA at accaglobal.com, written by Brian Pine