Chapter 10

Identifying and Assessing the

Risks of Material
Misstatements Through
Understanding the Entity and
Its Environment
PSA 315 (Redrafted), “Identifying and Assessing
the Risks of Material Misstatements through
Understanding the Entity and Its Environment
deals with the auditor’s responsibility to identify and assess the risks of
material misstatements in the financial statements, through
understanding of the entity and its environment, including its internal
control. The standard presents an overview of the requirements
such as:
I. Risk assessment procedures and sources of information about the
entity and its environment, including its internal control
II. Understanding the entity and its environment, including its internal
control
III. Identifying and assessing of the risks of material misstatements
IV. Material weakness in internal control
V. Documentation
 I. RISK ASSESSMENT PROCEDURES

Inquiries of Analytical Observation

management and procedures and inspection
others within the
entity

II. UNDERSTANDING THE ENTITY AND ITS

ENVIRONMENT INCLUDING ITS INTERNAL CONTROL

Industry, Nature of Objectives and

regulatory and the entity strategies and
other regulatory related business
factors risks

Measurement and Understanding

review of the the client’s
entity’s financial internal control
performance
 III. IDENTIFYING AND ASSESSING THE RISK OF
MATERIAL MISSTATEMENT
Matters to be considered by the auditor in identifying and assessing
the risk of material misstatements:

Whether the risk is a risk of fraud.

Whether the risk is related to recent significant economic, accounting

or other developments and, therefore, requires specific attention.

The complexity of transactions.

Whether the risks involves significant transactions with related parties.

The degree of subjectivity in the measurement of financial information

related to the risk especially those involving a wide range of
measurement uncertainty.

Whether the risk involves significant transactions that are outside the
normal course of business for the entity, or that otherwise appear to
be unusual..
IV. MATERIAL WEAKNESS IN INTERNAL CONTROL

The auditor must identify the following risks:

Risks of material misstatement that the auditor identifies

and which the entity has not controlled, or for which the
relevant control is inadequate.

A weakness in the entity’s risk assessment process that

the auditor identifies as material, or the absence of a risk
assessment process in those cases where it would be
appropriate for one to have been established.
 V. DOCUMENTATION

The discussion among the engagement team regarding the susceptibility

of the entity’s FS to material misstatement due to error or fraud

Key elements of the understanding obtained regarding each of the

aspects of the entity and its environment

The identified and assessed risks of material misstatement at the FS

level and at the assertion level

The risks identified and related controls evaluated as a result of the

requirements in paragraph 24 of PSA 315 (Redrafted)

The risks identified and related controls evaluated as a result of the

requirements in paragraphs 26-29 of PSA 315 (Redrafted)
Activity: Watch video on
1. “Audit Risk Model” – 11:00
2. “Assessing Inherent Risks” – 3:58
3. “Assessing Control Risks” – 3:44