OUR LADY OF THE PILLAR COLLEGE CAUAYAN

COLLEGE OF ACCOUNTANCY
OPERATIONS AUDITING

MODULE 3C:
RISK ASSESSMENT IN AUDIT PLANNING- Identifying risks and assessing
their impact and probability
Having identified the audit universe of auditable objects the next step in the process is to identify specific risks.
The objective is for IA to obtain a thorough understanding of the risks facing the organization and their potential
impact and probability, so that this knowledge can be used when scoring generic risk factors to select audit
objects for examination.

Good practice is that risk identification and risk assessment (scoring for impact and probability) should be carried
out in two phases. The reason is that the first phase (risk identification) is very similar to “brainstorming” where
the objective is to capture all risks. The second phase is about applying realistic judgements on the importance
and probability of risks identified. It can be complicated to combine these two different ways of thinking about
risk.

Identifying events that may give rise to risks and opportunities across the audit universe

The approach to identifying events will be different if management already has an entity risk management
process which identifies events and assesses risks.

• Where a risk management process is in place IA will need to (a) examine risk registers to understand the events
that managers have identified and then review these to determine whether the risk assessment has identified all
the key risks; (b) review the way that management have scored events and the actions put in place to address key
risks; (c) consider the effectiveness of risk mitigation actions in terms of its impact on residual risks; and (d)
identify high levels of residual risk that need to be factored into strategic and annual work plans.

• Where no risk management process is in place IA will need to carry out a separate exercise to identify events
that give rise to risks and opportunities. This is more difficult and time consuming than reviewing management’s
own risk assessments. It is important that the process includes interaction with management to obtain their
views on key events and risks impacting the organization. It will also be necessary to score events identified in
terms of probability and impact to create an overall risk score.

Identifying risks

Even where management has not carried out formal risk assessments there will often be other documentary
sources that can help IA unit to identify individual risks. These include:

• Operational plans for the organization;

• Earlier reports by internal or external audit;

• Annual report of the organization;

• Major reviews of functions or activities carried out by management or by external bodies

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 OUR LADY OF THE PILLAR COLLEGE CAUAYAN
COLLEGE OF ACCOUNTANCY
OPERATIONS AUDITING

The most common method of identifying risks will be by interview and discussions with management. This should
always be done, as management’s views on risk are very important.

To identify risks it can be useful to brainstorm the different types of events that may generate risks for the
organization. An example is provided below of common types of events that generate risk.

Assessing risks in terms of impact and probability

Once all relevant events (risks) have been identified they need to be assessed and scored. Inherent risk should be
assessed in terms of impact and probability. The impact defines the financial or non-financial consequences for
the organization should the risk occur. The probability defines the chances that the risk may occur. Assessing
impact of risks is more complex than assessing probability but both are important elements of a risk assessment.

It is recommended not to score the risks in a pure mathematical way. It is more practical to assess and score
them according to predetermined criteria for impact and probability. Good practice often suggests using three
scoring levels, but this may lead to an over-scoring in the middle category. A four point scales may therefore be
the most appropriate (particularly for assessing impact). There is no defined rule here. Auditors are free to
choose whichever scoring system they feel is more appropriate. The example below uses four categories and
three could also be used.

Criteria for assessing impact

There could be many criteria for assessing risk impact but those limited to four or five considered to be the most
important. The following criteria for assessing impact are commonly used and should be considered:

• Financial impact. The monetary consequences for the organization should the risk occur.

• Impact on reputation. The consequences with regard to the reputation of the organization, minister or even at
a higher level the reputation of the entire country in the eyes of rating agencies, international development
partners, etc.

• Regulatory impact. The occurrence of the risk may result in frozen budgets or programs or even in fines (e.g.
EU funds).
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 OUR LADY OF THE PILLAR COLLEGE CAUAYAN
COLLEGE OF ACCOUNTANCY
OPERATIONS AUDITING

• Impact on mission/achievement of objectives/operations. The extent to which the mission of the organization
may be impacted by the occurrence of the risk.

• Impact on people. Unplanned loss of key people and skills can significantly impact organization.

For each risk impact criteria the auditor needs to define what would represent different levels of impact (Very
High, High, Medium, and Low). This will ensure that risks are scored in a common way. The example below
provides general advice on scoring three criteria

Criteria for assessing probability

The auditor needs to consider the probability of an event occurring. For example, an earthquake could have a
very high impact but they not occur very often. The impact of loss of people or skills may not be very high but it
may occur very often. The criteria for assessing probability are often very similar and the following could be
considered as an option.

Scoring risks for impact and probability

Having developed criteria for assessing (scoring) impact and probability these need to be applied to all the risk
identified. This can be done in different ways:

• Score sheets can be developed and used by individuals to assess risks and then the results of individual scores
combined to develop an average across a group of people.

• Scoring can be done in a meeting where each individual presents his or her view and a consensus score is
agreed.

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 OUR LADY OF THE PILLAR COLLEGE CAUAYAN
COLLEGE OF ACCOUNTANCY
OPERATIONS AUDITING

Whichever method is used remember that people assess risks in different ways. Some people are by nature risk
averse and others are risk takers. If one person assesses a risk as high and the other as low, the result should not
simply be medium. A consensus needs to be reached.

Combining assessment criteria into a risk matrix

Decisions will need to be taken on combining the scores for risk impact with risk probability. Many organizations
use a matrix and agree in advance which combinations of probability and impact represent low, medium, high
and very high risk.

An example of a typical matrix is shown below. This would need to be modified to reflect the actual method of
scoring impact and probability. Different decision can also be taken on which combinations to classify as low
medium or high.

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