Assessing the Risk
of Material
Misstatements
Fraud and Error
Misstatements in the financial statements can
arise from either fraud or error.
>Fraud is intentional
>Error is unintentional
Take note that auditors are only concerned with
fraud and errors that could MATERIALLY misstate
the financial statements.
Components of Fraud
The three components of fraud are:
1. Incentive or pressure to commit fraud
2. Opportunity to commit fraud
3. Rationalization of the fact
Types of Fraud
Two types of intentional misstatements (fraud)
that are relevant to audit:
1. Fraudulent financial reporting
2. Misappropriation of assets
Fraudulent Financial
Reporting
This involves intentional misstatements including
omissions of amounts or disclosures in financial
statements to deceive financial statement users.
>commonly done by the MANAGEMENT
Fraudulent Financial
Reporting
May be accomplished by the following:
1. Manipulation, falsification, or alteration of
accounting records or supporting documentation
2. Misrepresentation in, or intentional omission
from, the financial statements of events,
transactions, or other significant information
3. Intentional misapplication of accounting
principles relating to amounts, classification,
manner of presentation, or disclosure
Misappropriation of Assets
It involves the theft of an entity’s assets and is
often perpetrated by employees in relatively small
and immaterial amounts.
>often accompanied by false or misleading
records or documents in order to conceal the fact
Misappropriation of Assets
Can be accompanied in a variety of ways such as:
1. Embezzling receipts
2. Stealing physical assets or intellectual property
3. Causing an entity to pay for goods and services
not received
4. Using an entity’s assets for personal use
Who is Responsible for
Fraud?
The primary responsibility for the prevention and
detection of fraud rests with both those charged
with governance and management of the entity.
>An auditor is responsible for obtaining
reasonable assurance that the financial
statements are free from material misstatements,
whether caused by error or fraud.
Risk Assessment
Procedures
The audit procedures performed to obtain an
understanding of the entity and its environment,
including the entity’s internal control, to identify
and assess the risks of material misstatement,
whether due to fraud or error, at the financial
statement and assertion levels.
Risk Assessment
Procedures
The auditor should perform risk assessment
procedures to provide a basis for the identification
and assessment of risk of material misstatements
of the financial statements and assertion levels:
a) Inquiries of Management and others within the
entity
b) Analytical Procedures
c) Observation and Inspection
Inquiries
Although much of the information the auditor
obtains by inquiries can be obtained from
management and those responsible for financial
reporting, inquiries of others within the entity,
such as production and internal audit personnel,
and other employees with different levels of
authority, may be useful in providing the auditor
with different perspective in identifying risks of
material misstatements.
Inquiries
A. Inquiries directed towards those charged with
governance
B. Inquiries directed toward internal audit
personnel
C. Inquiries of employees
D. Inquiries directed toward in-house legal counsel
E. Inquiries directed towards marketing or saes
personnel
Analytical Procedures
May be helpful in identifying existence of unusual
transactions or events, and amounts, ratios, and
trends that might indicate matters that have
financial statement and audit implications.
>The main premise of analytical procedure is that
there is a plausible relationship for each account.
Observation and Inspection
Observation and inspection may support inquiries of
management and others, and may also provide
information about the entity and its environment.
Examples of such audit procedures include observation
or inspection of the following:
The entity’s operations.
Documents (such as business plans and strategies),
records, and internal control manuals.
The entity’s premises and plant facilities.
Reports by management and those charged with
governance.
Discussion Among the
Engagement Team
Provides an opportunity for more experienced
engagement team members, including the
engagement partner, to share their insights based
on their knowledge of the entity.
Allows the engagement team members to exchange
information about the business risks to which the
entity is subject and about how and where the
financial statements might be susceptible to
material misstatement due to fraud or error.
Significant Risks
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.
Significant Risks
Although risks relating to significant non-routine or
judgmental matters are often less likely to be
subject to routine controls, management may have
other responses intended to deal with such risks.
Accordingly, the auditor’s understanding of
whether the entity has designed and implemented
controls for significant risks arising from non-
routine or judgmental matters includes whether
and how management responds to the risks.
Risks for Which Substantive
Procedures Alone Do Not Provide
Sufficient Appropriate Audit
Evidence
In respect of some risks, the auditor may judge that it is
not possible or practicable to obtain sufficient appropriate
audit evidence only from substantive procedures. Such
risks may relate to the inaccurate or incomplete recording
of routine and significant classes of transactions or
account balances, the characteristics of which often
permit highly automated processing with little or no
manual intervention. In such cases, the entity’s controls
over such risks are relevant to the audit and the auditor
shall obtain an understanding of them.
Revision of Risk
Assessment
The auditor’s assessment of the risks of material
misstatement at the assertion level may change
during the course of the audit as additional audit
evidence is obtained. In circumstances where the
auditor obtains audit evidence from performing
further audit procedures, or if new information is
obtained, either of which is inconsistent with the
audit evidence on which the auditor originally
based the assessment, the auditor shall revise the
assessment and modify the further planned audit
procedures accordingly.
Thank you!