Client Risk Factors and Audit Resource Allocation Decisions

While contemporary auditing standards such as ISA 315 provide broad categories of client risks, prior research regarding audit resource allocation decisions has been based on individual client risks. This study contributes to the literature by using factor analysis to examine how individual client risks are categorized into broad risk factors and by examining the extent to which such broad risk factors are associated with audit engagement planning decisions. These issues are important because auditing standards direct auditors to consider risk patterns and interrelationships in addition to individual risks. Finally, we consider additional individual client risks that reflect those relevant to contemporaneous audit approaches and have not been examined in prior studies.

Based on archival data extracted from the working papers of 228 clients of a Japanese audit firm, we find that individual client risks empirically group together in a way that is similar to categories discussed in recent auditing standards. We also find significant relationships between audit resource allocation decisions and broad risk factors that have not been found in prior studies which use individual risk assessments in their models. Finally, we find that client risks that are emphasized in holistic audit approaches such as aggressiveness of forecasts and industry decline also have a significant impact on audit resource allocations.