Identifying and Assessing the Risks of Material Misstatement

Assessment of Risks of Material Misstatement at the Financial Statement Level (Ref:

Para. 24 (a))

A98. 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 this nature are not necessarily risks identifiable with

specific assertions at the class of transactions, account balance, or disclosure

level. Rather, they represent circumstances that may increase the risks of material

misstatement at the assertion level, for example, through management override of

internal control. Financial statement level risks may be especially relevant to the

auditor’s consideration of the risks of material misstatement arising from fraud.

A99. Risks at the financial statement level may derive in particular from a weak control

environment (although these risks may also relate to other factors, such as

declining economic conditions). For example, weaknesses such as management’s

lack of competence may have a more pervasive effect on the financial statements

and may require an overall response by the auditor.

A100. The auditor’s understanding of internal control may raise doubts about the

auditability of an entity’s financial statements. For example:

• Concerns about the integrity of the entity’s management may be so serious as

to cause the auditor to conclude that the risk of management misrepresentation

in the financial statements is such that an audit cannot be conducted.

• Concerns about the condition and reliability of an entity’s records may cause

the auditor to conclude that it is unlikely that sufficient appropriate audit

evidence will be available to support an unqualified opinion on the financial

statements.

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A101. PSA 705, “Modifications to the Opinion in the Independent Auditor’s Report”

establishes requirements and provides guidance in determining whether there is a

be required in some cases, to withdraw from the engagement where this is legally

possible.

Assessment of Risks of Material Misstatement at the Assertion Level (Ref: Para. 24(b))

A102. Risks of material misstatement at the assertion level for classes of transactions,

account balances, and disclosures need to be considered because such

consideration directly assists in determining the nature, timing, and extent of

further audit procedures at the assertion level necessary to obtain sufficient

appropriate audit evidence. In identifying and assessing risks of material

misstatement at the assertion level, the auditor may conclude that the identified

risks relate more pervasively to the financial statements as a whole and potentially

affect many assertions.

The Use of Assertions

A103. In representing that the financial statements are in accordance with the applicable

financial reporting framework, management implicitly or explicitly makes

assertions regarding the recognition, measurement, presentation and disclosure of

the various elements of financial statements and related disclosures.

A104. Assertions used by the auditor to consider the different types of potential

misstatements that may occur fall into the following three categories and may take

the following forms:

(a) Assertions about classes of transactions and events for the period under audit:

(i) Occurrence—transactions and events that have been recorded have

occurred and pertain to the entity.

(ii) Completeness—all transactions and events that should have been

recorded have been recorded.

(iii) Accuracy—amounts and other data relating to recorded transactions and

events have been recorded appropriately.

(iv) Cutoff—transactions and events have been recorded in the correct

accounting period.
(v) Classification—transactions and events have been recorded in the proper

accounts.

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(b) Assertions about account balances at the period end:

(i) Existence—assets, liabilities, and equity interests exist.

(ii) Rights and obligations—the entity holds or controls the rights to assets,

and liabilities are the obligations of the entity.

(iii) Completeness—all assets, liabilities and equity interests that should have

been recorded have been recorded.

(iv) 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.

(c) Assertions about presentation and disclosure:

(i) Occurrence and rights and obligations—disclosed events, transactions,

and other matters have occurred and pertain to the entity.

(ii) Completeness—all disclosures that should have been included in the

financial statements have been included.

(iii) Classification and understandability—financial information is

appropriately presented and described, and disclosures are clearly

expressed.

(iv) Accuracy and valuation—financial and other information are disclosed

fairly and at appropriate amounts.

A105. The auditor may use the assertions as described above or may express them

differently provided all aspects described above have been covered. For example,

the auditor may choose to combine the assertions about transactions and events

with the assertions about account balances.

Considerations specific to public sector entities

A106. When making assertions about the financial statements of public sector entities, in
addition to those assertions set out in paragraph A104, management may often

assert that transactions and events have been carried out in accordance with

legislation or proper authority. Such assertions may fall within the scope of the

financial statement audit.

Process of Identifying Risks of Material Misstatement (Ref: Para. 25(a))

A107. Information gathered by performing risk assessment procedures, including the

audit evidence obtained in evaluating the design of controls and determining

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whether they have been implemented, is used as audit evidence to support the risk

assessment. The risk assessment determines the nature, timing, and extent of

further audit procedures to be performed.

A108. Appendix 2 provides examples of conditions and events that may indicate the

existence of risks of material misstatement.

Relating Controls to Assertions (Ref: Para. 25(c))

A109. In making risk assessments, the auditor may identify the controls that are likely to

prevent, or detect and correct, material misstatement in specific assertions.

Generally, it is useful to obtain an understanding of controls and relate them to

assertions in the context of processes and systems in which they exist because

individual control activities often do not in themselves address a risk. Often, only

multiple control activities, together with other components of internal control, will

be sufficient to address a risk.

A110. Conversely, some control activities may have a specific effect on an individual

assertion embodied in a particular class of transactions or account balance. For

example, the control activities that an entity established to ensure that its

personnel are properly counting and recording the annual physical inventory

relate directly to the existence and completeness assertions for the inventory

account balance.

A111. Controls can be either directly or indirectly related to an assertion. The more
indirect the relationship, the less effective that control may be in preventing, or

detecting and correcting, misstatements in that assertion. For example, a sales

manager’s review of a summary of sales activity for specific stores by region

ordinarily is only indirectly related to the completeness assertion for sales

revenue. Accordingly, it may be less effective in reducing risk for that assertion

than controls more directly related to that assertion, such as matching shipping

documents with billing documents.

Significant Risks

Identifying Significant Risks (Ref: Para. 27)

A112. Significant risks often relate to significant non-routine transactions or judgmental

matters. Non-routine transactions are transactions that are unusual, due to either

size or nature, and that therefore occur infrequently. Judgmental matters may

include the development of accounting estimates for which there is significant

measurement uncertainty. Routine, noncomplex transactions that are subject to

systematic processing are less likely to give rise to significant risks.

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A113. Risks of material misstatement may be greater for significant non-routine

transactions arising from matters such as the following:

• Greater management intervention to specify the accounting treatment.

• Greater manual intervention for data collection and processing.

• Complex calculations or accounting principles.

• The nature of non-routine transactions, which may make it difficult for the

entity to implement effective controls over the risks.