The audit risk model, business risk and audit-planning decisions

This study identifies conditions under which the audit risk model does, and does not, describe audit-planning (investment and pricing) decisions. In a n experiment, audit partners and managers examined one of two cases where a material misstatement-error or irregularity-was discovered. The auditors a ssessed the elements of the audit risk model, assessed business risk and pr ovided recommendations for the audit investment and fee, When the likelihoo d of an error was high, the audit risk model dominated business risk in the explanation of the audit investment, and the fee did not contain a risk pr emium. When the likelihood of an irregularity was high, business risk domin ated the audit risk model in the explanation of the audit investment, and t he fee contained a risk premium. These results suggest that the ability of the audit risk model to describe auditor behavior and the inclination of au ditors to charge a risk premium depend upon the nature of the risks present in the audit. In the presence of errors, the audit risk model adequately d escribed audit-planning decisions; in the presence of irregularities it did not.