How Can I Screen My Audit Clients?
Sarah Corning is the managing partner for a large office of a major audit firm. The audit firm has developed an analytical model that is used to evaluate the risk of potential audit clients. The audit firm has learned that the audits of certain types of clients are more likely to result in a failure to detect material misstatements, exposing the audit firm to lawsuits. The analytical model includes factors such as industry, past volatility in the company’s stock price (for publicly traded companies), asset mix, assessment of the character of management, the strength of the company’s internal controls, and so forth. The model rates potential clients on a scale from 1 to 5, with 1 being the safest clients and 5 being the most risky. Some of Sarah’s partners have advocated a policy of rejecting all potential clients with ratings of 5. Comment on this proposal.