During the audit process, auditors have to be increasingly wary of the inherent risks that are involved in the audit process. Risk identification tends to be an important part of the audit engagement process because of the fact that it involves potential changes to the disclosure of opinion that auditors have to put forth when it comes to the audit of these financial statements.
In this regard, it can be seen that engagement risks can be defined as one of the most important risks that need to be considered when it comes to designing audit processes and procedures for the engagement parties.
Engagement risk is defined as the overall risk that is associated with an audit engagement process. As a matter of fact, this specific risk is mainly associated with conducting the process of the audit itself, more so than anything else.
From the perspective of the auditor, it is highly important to consider this type of risk, because of the detrimental impact this kind of risk can have on the audit team, and the company, as a whole.
Engagement risks tend to increase when the client is in a relatively weaker position and is in need of obtaining funding from external sources in order to survive. Alternatively, this phenomenon can also be defined as a position where the company cannot be safely declared as a going concern.
Hence the existing risk that the company faces in this regard is quite substantial and needs to be accounted for in this regard.
The point of concern in this regard is the fact that since the company is likely to default or go bankrupt in the near future, it might also result in the auditor facing litigation because of not having declared the company as not going concerned.
Additionally, it can also be seen that these features and factors tend to exist within the audit process, because of the existing business uncertainty that is true in any case of the business itself. Hence, these engagement risks are inherent need to be identified and dealt with, before the engagement process begins.
Examples of Engagement Risks
Speaking of engagement risks, it can be seen that these are the risks that the auditor is exposed to as a result of taking on the audit process of a certain client. Some examples of engagement risks are mentioned below:
- A high-risk client: This means when the company is exposed to a certain level of risk, which highlights their going concern phenomenon, it is important for the auditor to identify that so that they are not litigated in the future when the company defaults or becomes bankrupt.
- Existing repute: The existing reputation of the company is also an important phenomenon which can be used to assess the underlying engagement risk. Mostly with companies who have been involved in unfair and unethical practices in the past, have a shaky reputation in the industry. Hence, this results in a higher degree of engagement risk for the auditor in this regard.
- Red flags: In certain cases, there is ambiguity about the overall financial position of the company. These red flags can be identified using the Annual Reports and the Financial Statements. Before taking on a client, it is also a good idea to look at these red flags, in order to minimize these engagement risks to an acceptable level.
Engagement Risks and Audit Process
In the cases where the auditor is deemed to be risk averse, it can be seen that they would be increasingly reluctant to work with clients that have a higher engagement risk.
On the contrary, a relatively new auditor, or an audit firm might agree to take on a client with higher engagement risk, because it would then be set off with the help of the payoffs they will get as a result of this.
However, it must be realized in this regard, that audit procedures need to be expanded in order to offset the inherent engagement risk that is involved with a particular client.
Therefore, it can be concluded that engagement risks tend to be one of the most important risks for any audit process. This is mainly because of the potential they have in negatively impacting and subsequently jeopardizing the name, and repute of the auditor.
Regardless of the fact that these risks are inherent in most business cases, yet it can be seen that they can be improved upon if the client is properly scrutinized before signing the audit engagement contract.