Audit approaches are the methods or techniques that auditors use in their audit assignments.
Both internal and external audits apply audit approaches to conduct their audit activities differently based on the nature of engagement, scope, nature of the client’s business, and audit risks.
Selecting the right audit approach is important. It can help the auditor to improve audit performance in terms of efficiency and effectiveness.
The right audit approach could also help auditors to focus on the high risks areas and pay less effort on the low risks areas. Different audit firms might use different audit approach to perform their audit testing.
Risks based approach is the popular approach. This is because this approach could help the auditor to work in the key concerning areas and minimize the audit risks. We will talk in detail later in this article about risks based approach.
There are four essential audit approaches that are normally used by auditors both internal and external.
We say four essential here because there are many other approaches that are also used by auditors, but these four are the most useful as per experiences. Here are the four essential audit approaches:
Substantive Procedures Audit Approach:
This approach is generally used where the financial reporting system or internal controls over financial reporting are not reliable.
Auditors will not perform their testing on the entity’s internal control on financial reporting. They will jump to the substantive testing by focusing on the large or material transactions.
This approach is also called a vouching approach which means auditors select (five methods of audit sampling) the large and significant amounts of transactions and then check whether the transactions selected have enough reliable supporting documents.
Auditors will also check whether accounting recognition and classifications are complying with the accounting standard and framework being used to prepare the audit financial statements.
The disadvantages of this approach are that it’s required to test a large number of transactions where the audit resources will require more than others.
And the benefit of this approach is it could help auditors to minimize the risks that internal control over financial reporting could not detect. Check here for a detailed explanation of the substantive audit approach.
Balance Sheet Audit Approach:
The concept of a balance sheet audit approach is that auditors believe that once the account balance in the balance sheet is correctly recorded, then the accounting transactions in the income statements will also be correctly recorded.
In this approach, the auditor will focus their testing on high values balance sheet items where the transaction in the income statements will be less focused on.
In this approach, auditors assessed that if the items or accounting balance in the statement of financial position is correct, the transaction in the income statements is unlikely materially misstated.
Existence, Valuation, Right, and Obligation are the main financial assertion in balance sheet items.
And as long as these assertions are correct, their related assertion is highly likely correct as well.
For example, if the right, valuation, existence of assets are confirmed to be correctly recorded in the balance sheet for both periods. There is less change than depreciation if incorrectly recorded.
Noted: The balance sheet audit approach is applicable to be used in the situation where the company has just started its business with large balance sheet items and fewer transactions.
System Based Approach:
The system-based approach is different from the substantive-based approach. In the substantive-based approach, the auditor is not relying on the client’s internal control over financial reporting so they don’t test. They go to vouching for all material transactions in stat.
However, in the system-based audit approach, auditors first understand that there is a strong internal control system being used based on their understanding from the entity’s management team.
Yet, before relying on the system or internal control, auditors will need to perform a full understanding of the client’s internal control over financial reporting.
Once they perform an understanding of internal control, auditors will then need to perform testing and validate those internal controls. This is to ensure that they are strong enough to produce the correct financial reporting.
If auditors concluded that the internal control over financial reporting is strong, they also need to perform substantive testing but the volume of transactions is not that large as the substantive approach.
Risk-based Audit Approach:
Risk-based on the audit approach is probably the one that you heard the most and also the most use of the approach.
The main concept of risks based approach is: reduce audit risks, do fewer works, and meet the objectives. That is why this approach is mostly used by auditors.
Risks based approach principally performs by understanding the client’s business, environments, and internal control. Auditors will then need to assess the possible risks areas and material misstatement that could possibly happen to the financial statements.
Once the risk areas are identified, the auditors will design the auditor’s program and resources to detect those risks.
By doing so, auditors will not spend so much time testing the areas that have fewer risks and still meet the objective.
The following are the two examples of audit approaches used by the big four audit firms:
The capture below is the example of PWC’s Audit Approach;
The capture below is the example of the Deloitte Audit Approach;
Written by Sinra