The Effects of a Bust Economy on Audit Risk

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Assessing audit risk correctly and completely is important to the beginning of a successful audit. Not only should an auditor have an understanding of the individual risk factors of the company itself, but also how those risk factors are affected by external influences. A crucial external influence affecting audit risk is the state of the economy. When an economy enters a recession or an economy bubble bursts, there is a greater likelihood that inherent risk and control risk will increase. These increases are mainly driven by the sudden pressure placed on employees and management to keep the appearance of a positive financial status, which sometimes leads to fraudulent activity.

The affects of a declining economy predominantly affect inherent risk of the audit risk model because of the attraction to either inflate revenues or under report expenses to keep the company in a positive financial standing. Many high-tech related company’s experienced a devastating blow to their financials after the technology bubble burst of 2000, which was marked by two large fraud scandals. First, was Lucent Technologies Inc, a communication equipment provider, which began to inflate revenue of $1.2 billion after management became overwhelmed from the significant decrease in telecommunication equipment spending (Belson, 2004 para. 1). Included in the scheme was $125 of false sales to Winstar Communication (Belson, 2004 para. 1). Second, was MCI WorldCom, a long distance phone company, whose executives under reported its expenses between 2000 and 2002. The executives hid expenses by booking operating costs as capital investments, causing their cash flow to be overstated by over $3.8 billion (Romero & Berenson, 2002 para. 7).

Another factor incre...

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...lthy and still thriving in difficult economic times. These pressures generate an increase in inherent risk and control risk, which results in an increase in audit risk. Auditors should always be aware of how the economy has affected a client and keep an attitude of professional skepticism at all times in order to plan an audit to detect the heightened risk of fraudulent activity occurring.

Works Cited

Belson, K. (2004, 18 May). Technologies; Lucent fined $25 million by S.E.C in fraud case. The New York Times. Retrieved from http://www.nytimes.com.

Bilski, J. (2009, 17 July). Workers gone wild: 7 outrageous cases of employee fraud. CFO Daily News. Retrieved from http://www.cfodailynews.com

Romero, S., & Berenson, A. (2002, June 26). WorldCom says it hid expenses, inflating cash flow from $3.8 billion. The New York Times. Retrieved from http://www.nytimes.com

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