Audit risk refers to the possibility that an error will go unnoticed during the auditing process, hence an auditor will end up giving an inappropriate opinion of the financial records. An auditor is required to plan carefully his auditing so that the risk is reduced when giving a report on the financial statements. However, even with a carefully planned auditing process, audit risk will always exist. Therefore, an auditor can only limit the risk to acceptable levels. This audit risk can be because of misstatement of materiality, lack of adequate controls to prevent the risk from happening or the auditor failing to detect the errors (Dauber et al, p. 53).
There are various reasons that lead to the increase in audit risk during boom periods; this can be explained as follows: First, most companies tend to start new ventures when the economy is doing well However, this can be an avenue for the management to form a front company or a shell company. This refers to a company that only exists on paper, has no employees or physical address and does not produce goods or services. They can legally incorporate the new venture; yet, it may have no operations. They will ensure that they comply with all the required statutory fillings including tax returns. After doing all this, they will direct some of the current company’s finances to the new venture as expenses. Therefore, if the auditor is not keen, he might not detect such a fraud on the company’s expenditure (Vona, p. 83-118).
Secondly, during boom periods companies experience increased business, such as increased orders that the current workforce cannot manage effectively. Therefore, most companies do hire more employees either on permanent or contractual basis. However, some officers at the company can take this opportunity to have ghost workers in the payroll. These can either be fictitious employees who are in the payroll who were never employed, or they can be former employees whose services were terminated yet their names are still in the payroll. Therefore, the auditor may fail to detect this hence misreporting on the true state or the company’s performance (Vona, p. 145-150).
Incapability of current controls can also be a cause for increased audit risk during economic growing period, in that as the company grows the set up controls, which previously worked effectively may be perforated. The reason behind this is that such controls could only manage a given level of transactions compared to the increasing levels. Therefore, an auditor relying on such controls to assess compliance to procedures risks giving an inappropriate verdict on the financial statements. For instance, new income avenues can be misclassified if they are contributing significantly to the company’s profitability yet they are not in the main line of the business (Collier & Agyei-Ampomah, p. 3-7).
During economic boom the chance of detection risk occurring is increased, which in turn elevates audit risk. When a business is growing rapidly, it will open new branches where there are different regulations from the current operation area. It might also acquire other entities that deal in other lines of business apart from its line. Therefore, an auditor carrying out auditing process on such a company might give an inappropriate opinion on its performance due to various reasons. These include choosing an auditing procedure that is not appropriate, selecting the right procedure but applying it wrongly or after choosing the right procedure and applying, it correctly ends up misinterpreting the results (Dauber et al, p. 59).