Industry and Corporate Risk

Introduction

Organizations today face several business risks that can have an effect on their financial statements. The audit risk model is a tool that auditors use to help identify those risks. To better understand how the audit risk model can help identify risks, we will examine how the model can be applied to the Coca-Cola Corporation and the limitations of using the model.

Components of the Model

The audit risk model is composed of the equation, audit risk (AR) equals inherent risk (IR) times control risk (CR) times detection risk (DR). Audit risk is the risk that the auditor may fail to modify their opinion on misstatements in the financial statements. Inherent risk is the risk of an assertion being made on material misstatements, assuming that there is no problem with related internal controls. Control risk is the risk that material misstatements could occur in an assertion that are not detected or prevented by the existing internal controls. Detection risk is the risk that the auditor will not detect a material misstatement in the assertion (Messier, 2003, pg. 94).

In the process of assessing the auditee risk, the auditor must determine the entity’s business risk. This can be done by evaluating the nature of the entity, industry, regulatory, and other external factors, management, governance, objective and strategies, measurement and performance, and business processes (Messier, 2003, pg. 98).

Examples of possible business risks can be found in the Coca-Cola Corporation. Coca-Cola faces different regulatory practices since it has operations in countries outside of the United States. These operations include North America, Africa, Asia, Europe, Eurasia, and Middle East, and Latin America. Another business risk for Coca-Cola is that the nature of the business can be seasonal. The demand for the product can fluctuate from one location to another and may fluctuate over time within a single location. Coca-Cola also acquired ownership or licensing rights to products in Croatia, Argentina, Mexico, and Bahrain in 2004, which create new business risks. The company also uses two different units of measurement to figure sales. The measurements are gallons and cases of finished products. The difference in measurement can cause errors in measurement, therefore possibly creating another business risk (Coca-Cola, March 4, 2005, pg. 2, 4).

Applying the Model

The use of the audit risk model should be applied at the account balance or class of transaction level. There are three steps to applying the model, the steps include setting a planned level of audit risk, determining inherent and control risk, and solving the risk equation in order to determine the appropriate level of detection risk (Messier, 2003, pg. 95).

The first step, setting a planned level of audit risk, may be done in quantitative or qualitative terms. This is done so that at the completion of the audit, the auditor may issue an opinion on the financial statements at an acceptable level of audit risk. The second step, determining inherent and control risk may be done together or separately since they are considered