Patton et al. (1983) list a range of factors that might be used to measure the
relative riskiness of audit units: quality of the internal control system, competence
of management, time since last audit, liquidity of assets, complexity of transactions,
distance from main office, changes in accounting systems, unit size, and level of
employee morale. An effective optimizing model would incorporate some or all of
these factors in estimating the losses that accrue in the absence of auditing. It is
noteworthy that prior research has not attempted to incorporate actual risk data,
probably due to access and measurement difficulties. Rather, in applying the models
variations in risk have been calibrated for hypothetical audit units.
Drawing partly from the above list, the present study includes seven risk factors
likely to influence the rate at which a firm's assets are subject to loss in the
absence of auditing, that is. its risk (P,). These factors were drawn from a data base
derived from a survey of private (and family-controlled) companies. It is not
claimed that the seven risk factors account for all sources of risk; they are an
illustrative set of factors likely to influence the rate at which the net assets of the
firm decline in the absence of auditing.