Client-Acceptance Decisions: Simultaneous Effects of Client Business Risk, Audit Risk, Auditor Business Risk, and Risk Adaptation

Abstract

Little is known about how audit partners make the client-acceptance decision. In this paper, a model is developed and tested that characterizes the client-acceptance decision as a process of risk evaluation and risk adaptation. The model proposes that auditors will evaluate client-related risks (e.g., financial viability, and internal control) and use that evaluation to determine if the audit firm will suffer a loss on the engagement via a lack of engagement profitability or future litigation. The model proposes that auditors will adapt to the client-acceptance risks by using three strategies: (1) screening clients based on their risk characteristics; (2) screening clients based on the audit firm's risk of loss on the engagement; and (3) more proactively adapting using strategies including adjusting the audit fee, making plans about necessary audit evidence, making plans about personnel assignment, and/or adjusting the amount of data collected during the client-acceptance process. To test the model, an experiment was conducted using 137 highly experienced audit partners as participants. The results show that the partners considered the relationships between client-related risks and used their evaluation of those risks to evaluate the audit firm's risk of loss on the engagement. In terms of risk adaptation, partners screened clients based on the clients' risk characteristics and based on the audit firm's risk of loss on the engagement. Contrary to prediction, the partners did not use more proactive risk-adaptation strategies (e.g., adjusting the audit fee, making plans about necessary audit evidence, etc.) to make less “acceptable” clients more acceptable. It appears that avoiding risk, rather than proactively adapting to risk, is descriptive of how audit partners currently make the client-acceptance decision.

The application of business risk audit methodology within non-Big-4 firms

“…The respondents generally agreed that the business risk audit methodology reduced risks for auditing firms because of the ability to better understand their clients, which allowed material risks to be more easily identified and addressed. This finding concurs with the findings of previous studies that indicate that the business risk audit methodology can reduce both business risk and audit risk by creating a stronger framework in which auditors focus not simply on the financial statements of client firms but the larger interactions that occur (Johnstone, 2000;Bell et al, 1997;Eilifsen et al, 2001). …”

“…However, they expressed the idea that the business risk audit methodology had the advantage of reducing the risk of not identifying material risks in the operations and actions of their clients, which concurs with the findings of previous studies and opinions of others in the auditing industry Johnstone, 2000;Bell et al, 1997;Eilifsen et al, 2001). …”

“…With the information presented to them, clients can also more easily implement controls and activities that will reduce the risks that are present that could harm their operations. (Johnstone, 2000). The information analysed as part of the primary data analysis regarding the motivations for adopting the business risk audit methodology, the advantages and disadvantages of BRA, and the aftermath of the BRA approach for auditors in the United Kingdom, Canada and the United States has revealed important differences between the three countries.…”

“…Instead, much of what is to be communicated is expressly stated and listed. In some respects, it appears that these guidelines are actually intended to set the foundation of the business risk audit between the auditor and the entity so that there is no confusion about what is to take place or how it will take place (Johnstone, 2000).…”

Client acceptance decisions of Dutch auditing partners

“…In this context, recent scholarship has drawn attention to the relatively neglected issue of client-acceptance decisions (Gendron 2002;Johnstone 2000;Johnstone and Bedard 2003). Due to continued fee pressure and litigation risk, issues related to the risks of doing business with new prospective clients have acquired an increasingly central position in the risk-containment efforts of auditing firms during the past decade (Johnstone 2000).…”