Client Business Models, Process and Entity Business Risks, and the Risk of Material Misstatement of Revenue

• In Event: Materiality

Abstract

Recent studies have investigated aspects of implementing risk-based auditing procedures (see the summary in Kochetova-Kozloski and Messier 2011). Addressing a previously untested yet fundamental theoretical dimension, this research tests for the impact of different client business strategies on process-level business risk judgments and their association with the risk of material misstatement (RMM) assessments of revenue. I propose and test a judgment model of the generation and impact of process-level business risk, i.e., the risk that a process will not produce the level of effectiveness necessary to achieve one or more strategic objectives (Bell et al. 2002, 8-9). Graduate accounting students with auditing experience who had studied the applicable risk-based auditing and business process concepts demonstrated understanding of the predicted relationships. The results indicate (with a few exceptions) that: (1) the participants generated higher process-level business risk assessments for the processes that were critical success factors given the different business strategies; (2) their process-level business risk and RMM judgments manifested the predicted associations; (3) for the client that implemented a product differentiation business strategy, judgments of business risk mediated the association of levels of process performance (operating risk) and the RMM of revenue; and, (4) the participants correctly assessed the higher overall entity-level business risk for the product differentiation versus the cost leadership type of business strategy. Overall, especially for the product differentiation strategy, the participants provided business risk and RMM judgments that are consistent with the model reported here and theories of risk-based auditing (Bell et al. 2002, 2005, 2007; Knechel 2007).

Author

• William F Wright, University of Illinois at Urbana–Champaign