Evaluation and Response to Risk in International Accounting and Audit Systems: Framework and German Experiences

Abstract

This paper presents arguments with respect to the evaluation and response to risk, placing an emphasis on German corporate governance. It starts by discussing opportunities and limitations of the audit risk approach in detecting accounting and economic risks. Hereafter individual responses to material risks are analyzed by considering potential shortcomings arising from systematic deviations from rational behavior.

In the main part, it will be argued that German corporate governance stresses internal reporting duties, some of which could serve as models for future international standards on auditing. By internalizing the information flows regarding substantial risks, negative effects of publicizing this kind of information can be reduced (e.g. self-fulfilling prophecies and litigation risks). This also facilitates a more open communication with monitoring parties. But to ensure the effectiveness of such an internal control, it is essential that the reporting duties of the auditor and the management towards the board members are legalized and put into compulsory form.

In an appendix, legislative responses to audit failures in Germany since 1870 until today are summarized. Legal requirements and their development regarding the statutory audit in general, auditor independence, the auditor's report and the audit opinion are presented.

Keywords: corporate governance, behavioral economics, accounting, disclosure, Germany, statutory audit, law and economics, biases and heuristics

JEL Classification: G34, G39, M41, M49