Audit and Risk Management

Audit and risk management are both focused on ensuring compliance, proper governance, and effective operations, and they are closely related functions within an organization. They work in tandem to minimize potential risks and enhance the entity’s overall performance although they have distinct purposes.

The following post explains in detail how audits contribute to identifying, mitigating and monitoring risks.

Understanding Risk Management

Risk management can be defined as the process of identification, evaluation and prioritization of risks, followed by the minimization, monitoring and control of the probability of the risks occurring. It includes identifying, assessing and controlling financial, operational, compliance and strategic risks to an entity's earnings. Potential problems are identified before they arise with the help of risk management.

A. The different types of risks are explained below

1. Financial Risks: Financial risks refer to money flowing in or out of a business. This may be due to sudden financial losses. There may be various factors for the financial losses – market conditions, changes in interest rates, economic conditions, frauds, misstatements, etc.
2.  Operational Risks: Risk that a business will suffer losses due to failures or errors in its operational processes. This can arise due to human error, supply chain disruptions, etc.
3. Compliance Risks: Risks that a business may suffer losses due to non-compliance of applicable legal laws, standards and regulations. This can arise when the business does not comply with labour laws, environmental laws, consumer protection laws, etc.
4. Strategic Risks: Risks that a business may suffer losses because it is unable to deliver expected outcomes. This can arise due to poor decision-making, changes in the competitive landscape, etc.

B. Types of Audits that address Risks

1. Financial Audits: Financial audits are conducted by external auditors and are the most common type of audits for entities. Being conducted by an independent auditor, the financial statements depict financial stability and ensure confidence in investors, as the auditor obtains reasonable assurance that the financial statements are accurately reported and free from material misstatement.

2. Operational Audits:  The entity’s goals, planning process procedures and results are analyzed with the help of these audits. This is done by reviewing an entity’s internal processes and systems to assess its effectiveness and efficiency. This helps in identifying gaps and inefficiencies which may lead to operational risks. Recommendations are provided to prevent disruptions of any kind.  

3. Compliance Audits: Compliance audits ensure that the entity complies with the laws, regulations and industry standards. They prevent non-compliance of laws and regulations avoiding penalties and reputational damage to entities.

4. IT & Cybersecurity Audits: An IT audit deals with the auditor evaluating an entity’s IT infrastructure, policies and operations and assessing for vulnerabilities in the information systems. This helps to prevent strategic risks by protecting against data breaches and ensuring business continuity.

C. How do Audits Support Risk Management?

Audits assist in risk management in the following ways :

1. Risk Identification: Hidden and emerging risks across various areas are identified and uncovered with the help of internal audits. This is usually the case when the auditor understands the workflow process for each department and tries to understand the issues faced by the staff in the workflow process.
2. Risk Assessment: The risk assessment process during internal audits takes place when the auditor identifies and assesses both the likelihood and impact of various risks on the entity. Apart from this, the internal controls are also identified and evaluated to determine how adequate they are in reducing risks to ensure residual risks are at manageable levels in the entity.
3. Risk Mitigation: Once the auditor has completed the risk identification and assessment processes and now knows the level of internal controls in the entity, they provide their recommendations to avoid the impact of the risks identified by strengthening the internal controls. This can be in the form of updating policies, enhancing monitoring, new controls to be implemented, etc.
4. Ongoing Monitoring: Regular audits ensure that new risks faced by the entity are identified and assessed on a timely basis. Apart from this, regular follow-ups by the auditors ensure that the recommendations have been implemented by the entity and its management.

Real-world examples of how entities have mitigated risks effectively through audits

Example 1: Mitigating Financial Risk 

A financial services company was facing immense financial risks due to deficit controls over its complex financial transactions. As a part of their normal procedure, their internal audit team conducted the risk assessment procedures and recognised weaknesses in their procedures.

Actions Taken:

• Put in place enhanced internal controls for transaction approvals and reconciliations.
• High-risk transactions were closely monitored and frequent audits were conducted regularly.
• Staff were trained on the enhanced internal controls and risk management procedures put in place.

Outcome: Strengthened controls and improved financial reporting by reducing the discrepancies financially and incidents of fraud. This led to greater confidence by stakeholders and regulators in the Company leading to a more sturdy risk management framework.

Conclusion

Audits identify potential threats, assess their impact, and provide recommendations to mitigate them. This way they have a key role in strengthening the risk management system. Regular audits can help address risks, safeguard an entity’s reputation and increase stakeholder confidence. This is why audits should not be seen as a burden but as a tool for continuous improvement and adaptability.

To learn more about The Role of Audits in Risk Management, book a free consultation with one of the Flyingcolour team advisors.

Disclaimer: The information provided in this blog is based on our understanding of current tax laws and regulations. It is intended for general informational purposes only and does not constitute professional tax advice, consultation, or representation. The author and publisher are not responsible for any errors or omissions, or for any actions taken based on the information contained in this blog.