The Audit Risk Model, Business Risk, and Audit Planning Decisions

Posted: 4 May 1999

See all articles by Richard W. Houston

Richard W. Houston

University of Alabama

Michael F. Peters

University of Maryland

Jamie H. Pratt

Indiana University - Kelley School of Business - Department of Accounting

Abstract

This study identifies conditions under which the audit risk model does, and does not, describe audit planning (investment and pricing) decisions. In an experiment, audit partners and managers examined one of two cases where a material misstatement ? error or irregularity ? was discovered. The auditors assessed the elements of the audit risk model, assessed business risk, and provided recommendations for the audit investment and fee. When the likelihood of an error was high, the audit risk model dominated business risk in the explanation of the audit investment, and the fee did not contain a risk premium. When the likelihood of an irregularity was high, the results were reversed. Business risk dominated the audit risk model in the explanation of the audit investment, and the fee contained a risk premium. These results suggest that both the ability of the audit risk model to describe auditor behavior and the inclination of auditors to charge a risk premium depend upon the nature of the risks present in the audit. In the presence of errors, the audit risk model adequately described audit-planning decisions; in the presence of irregularities it did not.

JEL Classification: M40, M49

Suggested Citation

Houston, Richard W. and Peters, Michael F. and Pratt, James H., The Audit Risk Model, Business Risk, and Audit Planning Decisions. The Accounting Review, Vol 74, No 3, July 1999. Available at SSRN: https://ssrn.com/abstract=163219

Richard W. Houston (Contact Author)

University of Alabama ( email )

Culverhouse School of Accountancy 310 Alston, Box 870220
Tuscaloosa, AL 35487
United States
205-348-8392 (Phone)
205-348-8453 (Fax)

Michael F. Peters

University of Maryland ( email )

Department of Accounting Van Munching Hall
College Park, MD 20742-1815
United States
301-405-7118 (Phone)
301-405-0359 (Fax)

James H. Pratt

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2657 (Phone)
812-855-8679 (Fax)

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