Case 3
For each of the business risk factors identified in question 1 above, indicate how each risk factor
might impact the risk of material misstatements in specific financial statement accounts or
disclosures.
Answer:
The market and competition, including demand, capacity, and price competition
Financial Statement Accounts/Disclosures that could be affected: cost of sales, revenue
Cyclical or seasonal activity
Financial Statement Accounts/Disclosures that could be affected: cost of sales revenue, inventory
Product technology relating to the entity’s products
Financial Statement Accounts/Disclosures that could be affected:
Energy supply and cost
Financial Statement Accounts/Disclosures that could be affected:
Regulatory factors
Financial Statement Accounts/Disclosures that could be affected: Cost of sales, revenues, taxes
payable, deferred taxes, tax expense Changes in government regulations and strict guidelines the
company will have to remit more taxes to the government and incur more cost.
PSA 315 (Redrafted), Identifying and Assessing the Risks of Material Misstatement
Through Understanding the Entity and Its Environment provides guidance on the
auditor’s consideration of an entity’s business environment and associated risks. Answer
the following questions:
o What is the auditor’s objective for understanding an entity’s business
environment?
Answer: The auditor must obtain an understanding of the entity and its environment to
assess the risk of material misstatement and to design the nature, timing, and extent of
further audit procedures to perform.
o Why does an auditor not have responsibility to identify or assess all business
risks?
Answer: Not all business risks give rise to risks of material misstatement. The auditor
needs to consider those business risks that could result in a material misstatement at
either the financial statement level or assertion level to classes of transactions, account
balances, and disclosures
o Provide some examples of business risks associated with an entity that an
auditor should consider when performing an audit.
Answer:
1. Operations in regions that are economically unstable, for example, countries with
significant currency devaluation or highly inflationary economies.
2. Developing or offering new products or services, or moving into new lines of
business
3. Expanding into new locations
4. Marginally achieving explicitly stated strategic objectives
5. Changes in the industry in which the entity operates.
6. Constraints on the availability of capital and credit
7. Loss of financing due to the company's inability to meet financing requirements.
8. Demand for the company's products or services have not been accurately
estimated
9. Demand for the company's products or services have not been accurately
estimated.
10. Company does not have the personnel or expertise to deal with the changes in the
industry.
o Provide some additional examples of business risks that might not lead to a
risk of material misstatements in the financial statements.
Answer:
Most business risks will eventually have financial consequences. However not all
business risks will give rise to material misstatements. A few examples of business risks
that might not lead to a risk of material misstatement in the financial statements may
include:
1. Employee stealing petty cash funds.
2. Employee use of company office supplies for personal benefit not company
benefit.
3. Employee running a personal side business from company facilities.