Coordination Effects on Audit Risk Allocation in Group Audits

Abstract

Financial accounting is designed to provide decision-useful information. An auditor’s task is to assure the information provided by the management. In audit reality the items of a financial statement represent aggregated business cases. This aggregate can be influenced by several sources of errors. For the overall audit opinion, it is essential to consider potential de-pendencies between different sources of errors, especially in the context of (multinational) group audits.

Based on a simplified auditing model assuming two error sources we illustrate the crucial nature of correlated audit risks in the audit effort decision. Therefore, we compare the situation if an audit is carried out either as a well-coordinated audit or as a less coordinated audit and error-sources may correlate. The results provide evidence that in case of correlated error-sources neglecting the correlation might cause inefficiencies. This is reasoned by the fact that the same post audit (overall) expected damage is reached at higher costs when the insur-ance effect of correlation is neglected by determining the optimal level of audit effort. The overall assessment however strongly depends on the investor’s perspective and especially if investors and auditors have different loss functions the assessment might turn either way.

Keywords: audit task-sharing, audit risk, correlation of risks, joint audit, audit quality

JEL Classification: M42, M48