Identifying and Assessing Risks

of Material Misstatement
Identifying and Assessing Risks of Material
Misstatement
The auditor considers the risk at two levels:
1. The overall financial statement level
2. The assertion level for classes of transactions, balances and
disclosures
• For this purpose, the auditor should:
1.) Identify risks throughout the process of obtaining an understanding
of the entity and its environment
2.) Assess the identified risks, and evaluate whether they relate more
pervasively to the financial statements as a whole and potentially affect
many assertions
3.) Relate the identified risks to what can go wrong at the assertion
level
4.) Consider the likelihood of misstatement, and whether the potential
magnitude is material
Risks of material misstatement at the financial statement level
- refer to risks that relate pervasively to the financial statements
as a whole and potentially affect many assertions.
Risks of material misstatement at the assertion level
refer to the risks for specific assertions, classes of transactions,
account balances and disclosures which needed to be considered
because such consideration directly assists nature, timing and extent of
further audit procedures to obtain sufficient appropriate audit
evidence.
Two components of risks of material misstatement
at the assertion level
1.) Inherent Risk
2.) Control Risk
Use of Assertions
Explicitly
Implicity
Assertions used by the auditor to consider
the different types of potential misstatements
3 categories
1.) Assertions about classes of transactions and events for the period
under audit
2.) Assertions about account balances at the period end
3.) Assertions about presentation and disclosures
Assertions about classes of transactions and
events for the period under audit
1.) Occurrence- transactions and events that have been recorded have
occurred and pertain to the entity
2.) Completeness- all transactions and events that should have been
recorded have been recorded
3.) Accuracy- amount and other data relating to recorded transactions
and events have been recorded appropriately
4.) Cutoff- transactions and events have been recorded in the correct
accounting period
5.) Classification- transactions and events have been recorded in the
proper accounts
Assertions about account balances at the
period end
1.) Existence- assets, liabilities and equity interest exist
2.) Rights and obligations- the entity holds or controls the right to
assets and liabilities are the obligations of the entity
3.) Completeness- all assets, liabilities and equity interests that should
have been recorded have been recorded
4.) Valuation and allocation- assets, liabilities and equity interests are
included in the financial statements at appropriate amounts and any
resulting valuation or allocation adjustments are appropriately
recorded
Assertions about presentation and disclosures
1.) Occurrence and rights and obligations- disclosed events,
transactions and other matters have occurred and pertain to the entity
2.) Completeness- all disclosures that should have been included in the
financial statements have been included
3.) Classification and understandability- financial information is
appropriately presented and described, and disclosures are clearly
expressed
4.) Accuracy and valuation- financial and other information are
disclosed fairly and at appropriate amounts.
Identifying significant risks
Significant risks
- refers to an identified and assessed risk of material
misstatement that, in the auditor’s judgment, requires special audit
consideration.
Significant risks often relate to:
a.) Non-routine matters
- are transactions that are unusual, due to either size or nature
and that therefore occur infrequently
b.) Judgmental matters
- may include the development of accounting estimates for
which there is significant measurement uncertainty.
Risks that require Special Audit consideration
In exercising judgement as to which risks are significant risks, the auditor
shall consider at least the following:
a.) Whether the risk is a risk of fraud
b.) Whether the risk is related to recent significant economic, accounting or
other developments and, therefore, requires specific attention.
c.) The complexity of transactions
d.) Whether the risk involves significant transactions with related parties
e.) The degree of subjectivity in the measurement of financial information
related to the risk esp. those involving wide range of measurement
uncertainty
f.) Whether the risk involves significant transactions that are outside
the normal course of business for the entity or those that appear
unusual
.
• When the auditor has determined that a significant risk exists, the
auditor shall obtain an understanding of the entity’s controls
including control activities, relevant to that risk
Documentation
The auditor shall document the following matters:
a. The discussion among the engagement team and the significant
decisions reached
b. Key elements of the understanding obtained regarding each of the
aspects of the entity and its environment and of each of the
internal control components; the sources of information from
which the undertaking was obtained, and the risk assessment
procedures performed
c.) The identified and assessed risks of material misstatement at the
financial statement level and at the assertion level
d.) The risks identified, and related controls about which the auditor
has obtained understanding
Auditor’s Responses to
Assessed Risks
At the financial level
Includes the following:
1. Emphasizing the audit team the need to maintain professional
skepticism
2. Assigning more experienced staff or those with special skills
3. Providing more supervision
4. Incorporating additional elements of unpredictability in the
selection of further audit procedures to be performed
5. Making general changes to the nature, timing or extent of audit
procedures
At the assertion level
Further audit procedures include:
1.) Performing test of controls
2.) Performing substantive procedures
Responding to the Assessed Risks at the
Assertion level
1.) Nature
The auditor’s assessed risks may affect both the type of audit
procedures to be performed and their combination
2.) Timing
The auditor may perform tests of controls or substantive procedures at
an interim date or at the end of the period.
3.) Extent
It is determined after considering the materiality, the assessed risk and
the degree of assurance the auditor plans to obtain.
Test of Controls
• Are designed to evaluate the operating effectiveness of controls in
preventing, detecting and correcting material misstatements at the
assertion level
Performance of test of controls
Test controls are performed to obtain evidence about the effectiveness
of the

1.) design of the accounting and internal control systems

2.) operation of the internal controls throughout the period

Nature of tests of Control
• Test of control generally consist of one or a combination of the
following evidence techniques:
a.) Inquiry
b.) Observation
c.) Inspection
d.) Reperformance
Timing of tests of controls
• The auditor shall test controls at a point in time or over a period in
time, for whichever the auditor intends to rely on those controls

• The auditor usually perform test of controls during an interim visit in

advance of period end.
• Auditors cannot rely on the results of such tests without considering
the need to obtain further evidence relating to the remainder of the
period.
In determining to test whether or not to test the remaining period, the
following factors must be considered:
a.) The result of the interim tests
b.) The length of the remaining period
c.) Whether changes have occurred in the accounting and internal
control systems during the remaining period.
Using audit evidence obtained during an
interim period
The auditor shall:
a.) Obtain significant changes to those controls subsequent to the
interim period
b.) Determine the additional audit evidence to be obtained for the
remaining period
Using audit evidence from a previous audit
The auditor shall establish the continuing relevance of that evidence by
obtaining audit evidence about whether significant changes in those
controls have occurred subsequent to the previous audit.
• If there are changes that affect the continuing relevance of the audit
evidence from the previous audit, the auditor shall test the controls in the
current audit.
• If there have not been changes, the auditor shall test the controls at least
once in every third audit.
Extent of tests of controls
• The auditor cannot possibly examine all transactions related to
certain procedures. In an audit, the auditor should determine the size
of a sample sufficient to support the assessed level of control risk
Using the results of tests of control
• Based on the results of the tests of control, the auditor, the auditor
should evaluate whether the internal controls are operated as
intended

The conclusion reached as a result of the evaluation is called the

Assessed level of control risk.
Substantive procedures
• Are designed to detect material misstatements at the assertion level

This reflects that:

i.) The auditor’s assessment of risk is judgmental and so may not
identify all risks of material misstatement
ii.) There are inherent limitations internal control
Nature and Extent of Substantive Procedures
Depending on the circumstances, the auditor may:
1.) Performing only substantive analytical procedures will be sufficient
to reduce audit risk to an acceptably low level
2.) Only tests of details are appropriate
3.) A combination of substantive analytical procedures and test of
details are most responsive to the assessed risks
Timing of Substantive Procedures
Audit evidence from a previous audit’s substantive procedures provides
little or no audit evidence for the current period.

Exception:
It may be appropriate to use audit evidence from a previous audit’s
substantive procedures if that evidence and the realted subject matter
have not fundamentally changed.
Using audit evidence obtained during an interim period
The auditor may determine that it is effective to perform
substantive procedures at an interim date and to compare and
reconcile information:
a.) identify amounts that appear unusual
b.) Investigate any such amounts
c.) Perform substantive analytical procedures or test of details to test
the intervening period
Documentation
The auditor shall document:
a.) The overall responses to address the assessed risks of material
misstatement at the financial statement level and the nature, timing
and extent of the further audit procedures performed
b.) The linkage of those procedures with the assessed risks at the
assertion level
c.) The results of the audit procedures including the conclusions where
these are not otherwise clear.
You can also split your
content
White Black
Is the color of milk Is the color of coal,
and fresh snow, the ebony, and of outer
color produced by the space. It is the
combination of all the darkest color, the
colors of the visible result of the absence
spectrum. of or complete
absorption of light.

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