Professional Documents
Culture Documents
9th Edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
CHAPTER 7 PLANNING THE AUDIT: IDENTIFYING AND RESPONDING TO THE RISKS OF MATERIAL MISSTATEMENT
LEARNING OBJECTIVES
1.
2.
3. 4.
Define the concept of material misstatement and discuss the importance of materiality judgments in the audit context Identify the risks of material misstatement and describe how they relate to audit risk and detection risk Assess factors affecting inherent risk Assess factors affecting control risk
LEARNING OBJECTIVES
5.
6.
Use preliminary analytical procedures and brainstorming to identify areas of heightened risk of material misstatement Describe how auditors make decisions about detection risk and audit risk
LEARNING OBJECTIVES
7.
8.
Respond to the assessed risks of material misstatement and plan the procedures to be performed on an audit engagement Apply the frameworks for professional decision making and ethical decision making to issues involving materiality, risk assessment, and risk responses
Risk: Expresses uncertainty about events and/or their outcomes having a material effect on the organization According to ISA 315 the risks:
Are associated with operational and financial reporting decisions Are sometimes hard to quantify and are judgmental in nature Are present but the organization does not have material misstatements, thus making it difficult for auditors to know when a risk factor truly is leading to a material misstatement for their particular clients
7-6 Copyright 2014 South-Western/Cengage Learning
What conditions would cause these types of risks to lead to a material misstatement in the financial statements? (LO 1, 2, 3, 4, 5) What types of risks do these examples represent? (LO 2, 3, 4) How do these risks affect detection risk and audit risk? (LO 2, 7)
LEARNING OBJECTIVE 1
DEFINE THE CONCEPT OF MATERIAL MISSTATEMENT AND DISCUSS THE IMPORTANCE OF MATERIALITY JUDGMENTS IN THE AUDIT CONTEXT
ASSESSING MATERIALITY
Misstatement: An error, either intentional or unintentional, that exists in a transaction or financial statement account balance
Essential to understand materiality in the context of designing and conducting a quality audit
ASSESSING MATERIALITY
Materiality Magnitude of an omission or misstatement of accounting information that, in view of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement
ASSESSING MATERIALITY
According to ISA 320, Materiality in Planning and Performing an Audit
Auditors judgments about materiality should be made based on a consideration of information needs of users as an overall group
MATERIALITY GUIDANCE
Audit firms provide auditors with:
Specific written guidance Decision aids
MATERIALITY GUIDANCE
Performance materiality: Amount set by auditor at less than materiality level for financial statements as a whole or for particular classes of transactions, account balances, or disclosures
Used to:
Assess risks of material misstatement Determine the nature, timing, and extent of audit procedures
MATERIALITY GUIDANCE
Tolerable misstatement: Amount of misstatement in an account balance that the auditor could tolerate and still not judge underlying account balance to be materially misstated Clearly trivial amount (posting materiality) Inconsequential, whether:
Taken individually or in the aggregate Judged by any criteria of size, nature, or circumstances
7-16
LEARNING OBJECTIVE 2
IDENTIFY THE RISKS OF MATERIAL MISSTATEMENT AND DESCRIBE HOW THEY RELATE TO AUDIT RISK AND DETECTION RISK
Risk of material misstatement high - Auditor accepts less audit risk Risk of material misstatement lower - Auditor accepts more audit risk
7-21 Copyright 2014 South-Western/Cengage Learning
LEARNING OBJECTIVE 3
FACTORS FOR ASSESSMENT OF INHERENT RISK AT THE ASSERTION LEVEL AT A HIGHER LEVEL
Account represents an asset that can be easily stolen Account balance made up of complex transactions Account balance requires a high level of estimation to value Account balance subject to adjustments that are not in the ordinary processing routine Account balanced composed of a high volume of nonroutine transactions
7-25 Copyright 2014 South-Western/Cengage Learning
BUSINESS RISKS
Inherent risk at financial statement level that affects business operations and potential outcomes of organizational activities Factors affecting such risk
Overall economic climate Technological changes Competitor actions Geographic locations of suppliers
Management integrity was a fundamental problem leading to this fraud Assessing management integrity is no easy task
AUDITING IN PRACTICE - APPLICATION OF ACCOUNTING PRINCIPLES AND RELATED DISCLOSURES Auditor needs to:
Determine whether managements decisions are appropriate and consistent with financial reporting framework Develop expectations about appropriate disclosures that are necessary Compare those expectations to disclosures made by management in assessing inherent risks
LEARNING OBJECTIVE 4
CONTROL RISK
Relates to susceptibility that a misstatement will not be prevented or detected on a timely basis by internal control system Its assessment can be made at:
Overall financial statement level Account or assertion level
AUDITING IN PRACTICE - LACK OF OVERSIGHT AS A CONTROL WEAKNESS LEADS TO EMBEZZLEMENT Rita Crundwell and the City of Dixon, Illinois $50+ million fraud Auditors need to be aware of weak internal controls and negative consequences for a clients financial statements
Control risk assessment as high means a need to perform additional substantive procedures Assessment of control risk as low means a need to test those controls for operational efficiency
7-40 Copyright 2014 South-Western/Cengage Learning
LEARNING OBJECTIVE 5
USE PRELIMINARY ANALYTICAL PROCEDURES AND BRAINSTORMING TO IDENTIFY AREAS OF HEIGHTENED RISK OF MATERIAL MISSTATEMENT
BRAINSTORMING
A group discussion designed to encourage auditors to creatively assess client risks
Particularly those relevant to possible existence of fraud in an organization
Occur during the early planning phases of audit Repeated if actual fraud is detected Attended by entire engagement team and led by audit partner or manager
Considering client information, particularly with respect to the fraud triangle Integrating information from previous steps into an assessment of likelihood of fraud in engagement
LEARNING OBJECTIVE 6
DESCRIBE HOW AUDITORS MAKE DECISIONS ABOUT DETECTION RISK AND AUDIT RISK
Determining detection risk influences nature, amount, and timing of substantive audit procedures
Audit risk usually set at between 1% and 5% Detection risk ranges from 1% to 100%
LEARNING OBJECTIVE 7
RESPOND TO THE ASSESSED RISKS OF MATERIAL MISSTATEMENT AND PLAN THE PROCEDURES TO BE PERFORMED ON AN AUDIT ENGAGEMENT
AUDITING IN PRACTICE - THE CITY OF DIXON, ILLINOIS SUES ITS AUDITOR RELATED TO RITA CRUNDWELL EMBEZZLEMENT The lawsuit alleges:
Professional negligence Negligent misrepresentation Certain deficiencies in audit procedure