e-Vision: Business Models, Business Risks and Audit Risk

Assessment

J. Efrim Boritz andTheophanis Stratopoulos

University of Waterloo

e-Vision Company Background

e-Vision is a medical imaging software developer facing several challenges to its business model arising from environmental changes

First Challenge • HIPAA of ‘96 in the US created stringent privacy requirements for all

health care industry participants ... HIPAA fully in place as of January ’05 and many US competitors are already in compliance.

• Early ‘05, a major OEM who advanced half the funds for a $5 million contract for the delivery of a toolkit for its MRI scanners has requested that all company personnel be trained in HIPAA requirements as well as procedures and documentation to ensure the training was tracked and will be maintained. The customer has the right to audit the company’s development practices under ISO 9000:2000.

• Company’s goals are to increase market share in the US, retain OEM customers. The company has added HIPAA requirements to the specifications for all new systems so that new products will be HIPAA compliant in ‘06. The company has been encouraging all its employees to complete an internally developed course on HIPAA.

Learning objectives

Tracing from …

• environmental changes, to • business strategy changes, to • internal process changes, and ultimately to• financial statement impacts …

is a complex and challenging task.

Graphic Teaching Aid

Help students see the linkages between … • environmental changes, • strategic responses, • internal processes and • financial statement accounts

Help them perform task more effectively

Graphic Teaching Aid

Scenario 1Legend

Elements :

Relationships:Intra- or Inter-categorylinkages such asexistence, causality,and change over time

RelevantStrategicGoals

InternalProcesses &Resources

Environment/External Factors:Competitors, regulators,economy customers,markets, etc.

Relevant StrategicGoals:Organizationalobjectives of theorganization

Internal Processes& Resources:Products, services,business processes,resources (e.g., human,financial, information),etc.

Impact onAccounts:Account classes orspecific accounts

Environment/ExternalFactors

Impact onAccounts?

Regulatory agency (HIPAA)created stringent privacy requirements for all health care industry participants. HIPAA is fully in place asJanuary 2005.

Major OEM Customer Request for HIPAATraining and Training Tracking System;Customer has right to audit codevelopment practices; has alreadyadvanced half of $5 M contract

Many Competitorsalreadyin compliance withHIPAA

Retain OEM customers

Company has addedHIPAA requirementsto new systemspecifications so thatnew products will beHIPAA-compliant in2006.

Employeesencouraged to takeinternal HIPAAcourses

Revenue General &Admin

Cost of Sales

Increase Market ShareIn the US

R & DInventory

Implementation Guidance

1.Pre: Outline the principles of Strategic Auditing and ask students to review the case (Approximately 15-20 minutes)

2.During - General Information: Audit risk assessment and business models. Business risk implications associated with industry structure and company’s strategy. Review financial statements. (Approximately 30 minutes)

3.During - Case Discussion: Select simplest possible combination for first challenge and make it more complicated as you move to the subsequent challenges. (Approximately 40 to 50 minutes or 20 to 25 minutes per challenge)

4.Post: Assign one of the other challenges – with desired degree of difficulty - as a homework assignment.

Classroom Testing

• Objective: Evaluate the effectiveness of the case.

• Tool/Method: A pre and post questionnaire. Matched pairs.

• Target Audience: Arts/Public accounting and Math/Public accounting students in a co-op program (with 8 months prior co-op work experience) taking an audit class prior to an 8-month co-op term

• Condition: Instructor was not involved in the development of the case and had access only to teaching notes

Classroom Testing (Pre & Post)

Question- Five point Likert scale (1 = strongly disagree, … 5 = strongly agree).

- Questions were asked before and after the completion of the case

Arts/Public Accounting

Math/Public Accounting

Average(Pre-Post)

t-score (p-value)

Average(Pre-Post)

t-score (p-value)

Understanding a audit client’s business strategy is essential for performing effective audit

-.03-.5

(.62)-.16

-2.60(.01)

External auditors should focus more on the risk of errors in judgment and application of GAAP than on the risk of poor strategic business decisions made by client

.12.97

(.34).87

5.59(.00)

Risks arising from a change in a client’s business strategy are important in the long-run but unlikely to create audit risk of the current period

.10.72

(.48).08

.51(.61)

Classroom Testing (Post)

Question- Five point Likert scale (1 = strongly disagree, … 5 = strongly agree).

- Questions were asked after the completion of the case

Arts/Public Accounting

Math/Public Accounting

Averaget-score

(p-value)Average

t-score (p-value)

The e-vision case enhanced my understanding of how strategic business risks affect the risk of material misstatement

3.789.11(.00)

3.665.05(.00)

The diagram enhanced my understanding of how strategic business risks affect the risk of material misstatement

3.534.6

(.00)2.94

-.45(.83)

Teaching Notes

• The degree of difficulty of the case, can be modified to the experience of your students.

• For example provide the relationships linking the external factors to relevant strategic goals to internal processes and provide a list of relevant as well as irrelevant accounts. (See next slide)

Graphic Teaching Aid

Scenario 1Legend

Elements :

Relationships:Intra- or Inter-categorylinkages such asexistence, causality,and change over time

RelevantStrategicGoals

InternalProcesses &Resources

Environment/External Factors:Competitors, regulators,economy customers,markets, etc.

Relevant StrategicGoals:Organizationalobjectives of theorganization

Internal Processes& Resources:Products, services,business processes,resources (e.g., human,financial, information),etc.

Impact onAccounts:Account classes orspecific accounts

Environment/ExternalFactors

Impact onAccounts?

Regulatory agency (HIPAA)created stringent privacy requirements for all health care industry participants. HIPAA is fully in place asJanuary 2005.

Major OEM Customer Request for HIPAATraining and Training Tracking System;Customer has right to audit codevelopment practices; has alreadyadvanced half of $5 M contract

Many Competitorsalreadyin compliance withHIPAA

Retain OEM customers

Company has addedHIPAA requirementsto new systemspecifications so thatnew products will beHIPAA-compliant in2006.

Employeesencouraged to takeinternal HIPAAcourses

Revenue General &Admin

Cost of Sales

Increase Market ShareIn the US

R & DInventory

Teaching Notes

Teaching notes, based on personal interviews with audit partners and senior audit managers from the Big-4 firms, cover the following areas:

1. General Evaluation– Company Background– Strategy– Financial Statement Analysis– Stock Market

2. Detailed Evaluation of Each of the 4 Challenges

References• Martin, R. and F. Phillips. 2006 “Aerospace Lighting, Inc. (ALI):

Linking Business Strategy to Audit Planning.” Issues in Accounting Education, 21(3), pp. 313-321.

• Ballou, B. and W Robert Knechel 2002. Ceskoslovenska Obchodni Banka, a.s.: Applying business risk audit techniques. Issues in Accounting Education; Aug 2002; 17, 3, 289-312.

• Bell, T., F. Marrs, I.Solomon and H. Thomas. 1997. Auditing Organizations Through a Strategic-Systems Lens. Montvale, NJ: KPMG Peat Marwick LLP.

• Bell, T.B., M. E. Peecher, and I.Solomon. 2002. The strategic-systems approach to auditing. In Cases in Strategic-Systems Auditing eds. T.B. Bell and I.Solomon,1-34.