Risk Assessment

ISA 200 - Overall Objectives of the Independent Auditor and the Conduct of an Audit in
accordance with ISA
A> AUDIT RISK

1, Definition
- Audit risk: the risk that the auditor expresses an inappropriate audit opinion when the
FSs are materially misstated
- Components:
2, Components
Type of risk Definition Characteristics
Inherent Risk The susceptibility of an assertion Affected by the nature of the

about a class of transaction, account entity
balance or disclosure to a Eg: regulations, industry, complex
misstatement that could be material calculations/ accounting
either individually or when standards,...
aggregated with other
misstatements, before
consideration of any related
internal controls
Control Risk The risk that a material misstatement Affected due to inherent
that could occur in an assertion limitations of internal control
about a class of transaction, account Eg: human errors
balance or disclosure and that could
be material, individually or when
aggregated with other
misstatements, will not be
prevented or detected and
corrected on a timely basis by the
entity's internal control
Detection Risk The risk that the procedures - Sampling risk: The
performed by the auditor -> reduce auditor does not, and
risk to an acceptably low level will cannot, examine all
not detect a misstatement that available evidence and
exists and that could be material, only performs audit
either individually or when procedures on a sample of
aggregated with other misstatements items.
- Non-sampling risk: the
risk that the auditor's
procedures do not detect
material misstatement due
to factors other than the
sample tested.
Eg: lack of experience, time
pressure, financial constraints,
new client,...
3, Types of risk
- Risk at the FS level: pervasive to the FS and may affect any assertions. Eg: poor
management attitudes to internal control
- Risk at the assertion level: more specific and will take the form of specific issues. Eg: a
company that keeps inventory in multiple locations -> inherent risk - not all inv are
counted, control risk - entity’s system for accounting
ISA 320 - Materiality in Planning and Performing an Audit

B> MATERIALITY
1, Definition
- Material: info if its omission or misstatement could reasonably be expected to influence
the economic decisions of users taken on the basis of the FSs
- Aspects: Quantitative Materiality and Qualitative materiality
- Characteristic: Higher anticipated level of audit risk -> lower the value at which
materiality will be set
- Impact:
+ Nature, timing, and extent of audit procedures: lower M -> more work to assure
AR = AAR
+ Whether to use sampling techniques
+ Effect of misstatements in terms of whether to seek adjustments, any auditor’s
report modification
2, Calculation of materiality
3, Performance materiality
- Definition: the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the probability
that the aggregate of uncorrected and undetected misstatements exceeds materiality for
the financial statements as a whole".
Other refers to "the amount or amounts set by the auditor at less than the materiality level or
levels for particular classes of transactions, account balances or disclosures"
- To determine -> involves the auditor’s professional judgment
C> RISK ASSESSMENT

1, Understanding the entity and its environment
- Nature of the entity
- Industry, regulatory, and other external factors
- Objectives and strategies, and relating business risk
- Selection and application of accounting policies
- Financial performance
- Internal control
2, Understanding the entity’s system of internal control

- Control environment
- The entity’s risk assessment internal control
- The entity’s process for monitoring internal control
- The information system and communication
- Control activities
3, ISA 520 - Analytical Procedures

- Following types of comparisons:
+ Prior periods
+ Budgets and forecasts
+ Industry information
+ Predictive estimates, eg: expectations
+ Relationships between elements of financial information, eg: ratio analysis
+ Relationship between financial and non-financial information, eg: payroll costs to
the number of employees
- Common ratios for use:
D> ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
1, Significant risks

Risk Assessment

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ISA 200 - Overall Objectives of the Independent Auditor and the Conduct of an Audit in

accordance with ISA

A> AUDIT RISK

Inherent Risk The susceptibility of an assertion Affected by the nature of the

ISA 320 - Materiality in Planning and Performing an Audit

- To determine -> involves the auditor’s professional judgment

C> RISK ASSESSMENT

2, Understanding the entity’s system of internal control

3, ISA 520 - Analytical Procedures

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