Identifying and Assessing Risks of Material Misstatement

IDENTIFYING AND
ASSESSING RISKS OF
M ATE R I A L
M I S S T ATE M E N T
P R E S E N T E D BY: J O A N N E B I L L O N E S
RISK OF MATERIAL MISSTATEMENT

Refers to the risk that the financial statements are
materially misstated and do not present true
and fair view. The auditor shall identify and assess
the risks of material misstatement at:
The financial statement level; and
The assertion level for classes of transactions,
account balances, and disclosures.
FINANCIAL STATEMENT LEVEL

VS. ASSERTIONS LEVEL
F I N A N C I A L S TAT EM E NT
LEVEL
Refer to risks that relate

pervasively
to
the
financial statements as a
whole and potentially affect
many assertions.
A SS E RT I ON S L E VE L
Risks of this nature are

identifiable with specific
assertions at the class of
transactions, account balance,
or disclosure level.
Risks at FS level trickles
down and becomes risks at
assertion level
AUDITOR MUST
a) Identify risks throughout the process of obtaining
an understanding of the entity and its environment
b) Assess the identified risks and evaluate if FS or
Assertions level
c) Relate the identified risks to what can go
wrong at the assertion level
d) Consider the likelihood of misstatement
ASSESSING RISKS AT TWO LEVELS

F I N A N C I A L S TAT EM E NT
LEVEL
Factors affecting the risks:

Managements Integrity
Managements experience
and knowledge
Pressure on Management
Nature of entity
A SS E RT I ON S L E VE L
Factors affecting the

risks:
Susceptibility of account
Complexity of
transactions
Transactions not subject
to routine processing
AUDITORS RESPONSES TO RISKS

PROCESS OF IDENTIFYING RISKS OF MATERIAL MISSTATEMENT
(a and b)
Design and performance of audit procedures to obtain
sufficient, appropriate evidence
Use of information gathered as audit evidence to
support the risk assessment
Nature, timing and extent of further procedures are based
on, and are responsive to the assessed risks of material
misstatement at assertion level
AUDITORS RESPONSES TO RISKS

RELATING CONTROLS TO ASSERTIONS
(c and d)
Auditor may identify the controls that are likely to
prevent, or detect and correct, material misstatement in
specific assertions
Relate (some) controls to assertions in the context of
processes and systems in which they exist because controls
usually treat risks in groups
Determine if controls are either

indirectly related to an assertion
directly
or
M I S S TATE M E N T S
MISSTATEMENT DEFINED
As defined in PAS 450, Misstatement is a difference
between the amount, classification, presentation, or
disclosure of a reported financial statement item and
the amount, classification, presentation, or disclosure
that is required for the item to be in accordance with
the applicable financial reporting framework.
Misstatements can arise from error or fraud.
TYPES OF MISSTATEMENT
Misstatements may emanate from:
Error
Fraud
Noncompliance with Laws and Regulations
ERROR VS. FRAUD

RROR
EUnintentional
Examples:
Mathematical or clerical
mistakes in underlying
records and data
Oversight or
misinterpretation of facts
resulting in incorrect
estimates
Mistakes in application of
accounting policies
F R AU D
Intentional
Involves motivation and
perceived opportunity
May be:
Fraudulent financial
reporting
Misappropriation of Assets
(Defalcation)
TYPES OF FRAUD
F R AU D U L E N T FI N AN C I A L
R E P O RT I N G
Misstatement in FS
Management fraud
May involve:
Manipulation/falsification/alteration
of records or supporting documents
Misrepresentation or intentional
omission of vents or transactions
Recording of transactions without
substance
Intentional misapplication of
accounting policies
M I S AP P R O P R I AT I O N O F
A SS E T S (D EFA L C AT I O N )
Theft of assets
Employee fraud
Usually accompanied by false or misleading records to

conceal theft
May include:
Embezzling receipts
Stealing assets
Lapping of accounts receivable
NONCOMPLIANCE WITH LAWS AND

REGULATIONS
Noncompliance: omission or commission by an auditclient contrary to prevailing laws or regulations.
Examples:
Tax evasion
Violation of environmental protection laws
Inside trading of securities
AUDITORS
RESPONSIBILITY
AUDITORS RESPONSIBILITY:
ERROR AND FRAUD
PLANNING
Make inquiries of management
Design audit procedures based on risks
TESTING
Perform assessment procedures
Assess if fraud or error
COMPLETION
Obtain managements written representation for its responsibilities
EFFECT ON AUDITORS REPORT

Auditor may request revision of FS
Auditor may either qualify or disclaim his opinion
AUDITORS RESPONSIBILITY:
NONCOMPLIANCE
PLANNING
Obtain general understanding of legal and regulatory framework
Design procedures to identify noncompliance and evidences of compliance
TESTING
Evaluate possible effects on FS
Document findings, discuss with management, and consider implications
COMPLETION
Obtain managements written representation for its responsibilities
EFFECT ON AUDITORS REPORT

Auditor may request revision of FS
Auditor may either qualify or disclaim his opinion
SIGNIFICANT
RISKS
RISKS THAT REQUIRES SPECIAL

AUDIT CONSIDERATION
Significant risk is an identified and assessed risk of material
misstatement that, in the auditors judgment, requires special
audit consideration
Identifying significant risks:
risk of fraud
risk is related to recent
significant
economic,
accounting
or
other
developments
complex of transactions
significant transactions with
related parties
degree of subjectivity in the

measurement of financial
information
significant transactions that
are outside the normal
course of business or appear
to be unusual
CONDITIONS AND EVENTS

THAT MAY INDICATE RISKS
OF MATERIAL
M I S S TATE M E N T
Significant changes in the entity (e.g.,

acquisitions and reorganizations)
Significant changes in industry
Significant new products, services or lines of
business
New locations
Significant changes in IT environment
Operations in areas with unstable economies
High degree of complex regulation
END OF REPORT

Identifying and Assessing Risks of Material Misstatement

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What are the two levels of risks that an auditor must assess?

What are the two levels of risks that an auditor must assess?

What factors should an auditor consider when assessing risks at each level?

What factors should an auditor consider when assessing risks at each level?

IDENTIFYING AND

RISK OF MATERIAL MISSTATEMENT

FINANCIAL STATEMENT LEVEL

Refer to risks that relate

Risks of this nature are

ASSESSING RISKS AT TWO LEVELS

Factors affecting the risks:

Factors affecting the

AUDITORS RESPONSES TO RISKS

AUDITORS RESPONSES TO RISKS

Determine if controls are either

ERROR VS. FRAUD

Usually accompanied by false or misleading records to

NONCOMPLIANCE WITH LAWS AND

EFFECT ON AUDITORS REPORT

EFFECT ON AUDITORS REPORT

RISKS THAT REQUIRES SPECIAL

degree of subjectivity in the

CONDITIONS AND EVENTS

Significant changes in the entity (e.g.,

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