Risk Assessment

In gathering information about the client, the following risk indicators included in the table
below, are conditions and events that may indicate audit risk, significant risk and risk of
material misstatement.

Conditions and events that may indicate audit risks at the overall financial
statement level

The following table provides examples of conditions and events that may indicate the
existence of audit risk at the overall financial statement level. The examples provided cover
a broad range of conditions and events; however, not all conditions and events are
relevant to every audit engagement and the list of examples is not necessarily complete.
Refer to ISA 315, Appendix 2 for the list of these examples.

Risk Indicator Description of Risk Component

of Audit Risk
Operations in regions or The Financial Statements (FS) may be materially Inherent risk
countries with strict misstated as the entity might not comply properly
regulations/ different with the relevant laws and regulations possibly
regulations to Zimbabwe resulting in material misstatements of unrecorded
liabilities, expenses, etc. For instance ZSE regulations,
Environmental Laws (EMA), Labour Laws, etc.
Liquidity issues.  The FS may be materially misstated as the Inherent risk
 Operating losses. going concern assumption might not be
 Loss of significant properly accounted for and/or disclosed.
customers or  The FS may be materially misstated by
suppliers. engaging in fraudulent financial reporting to
 Constraints on hide going concern threat.
availability of capital
and credit.
 Changes or loss of
key personnel.
 Pending significant
litigation.
 Operations in
regions or countries
that are
economically
unstable.
Changes in the industry and  The FS may be materially misstated as the Control risk
management does not want entity might not comply with the changes to
to comply. the laws, eg, Companies Act, Code of
Corporate Governance etc., in the industry
within which it operates.
  Expanding into new  The FS may be materially misstated as the Control risk
locations/ control environment in other locations might
decentralisation of not be operating effectively.
the entity.
 Lack of personnel  The FS may be materially misstated as there Control risk
with appropriate might be errors occurring in the preparation
accounting and of financial records.
financial reporting
skills.
New client.  The FS may be materially misstated as the Detection
opening balances might be incorrect since we risk
were not auditors in prior years.
 The AFS may be materially misstated as
material misstatements could go undetected
as we are not familiar with the client.
 Management’s  The FS may be materially misstated as the Control risk/
integrity control environment might be compromised Inherent risk
questionable. by management who lacks integrity.
 Use of work of third  The FS may be materially misstated as the Inherent risk
party (component third party might not be competent and
auditor (ISA appropriately qualified in performing the work
600)/internal required for audit evidence.
auditors (ISA
610)/expert (620).
 Management  The FS may be materially misstated as Inherent risk
receives bonuses directors might engage in fraudulent financial
driven by profits. reporting, i.e. overstatement of revenue and
understatement of expenses to maximise
bonuses.
 Financials to be used  The FS may be materially misstated as Inherent risk
to obtain financing directors might engage in fraudulent financial
from the bank. reporting, i.e. overstatement of assets and
profits and understatement of liabilities and
expenses to ensure that financing will be
obtained.
 Tight dead line  The FS may be materially misstated as Inherent risk
management might not have sufficient time to
properly account and disclose post balance
sheet events (Subsequent events).
 The FS may be materially misstated as the
financial results might be incomplete due to
Detection
time pressure.
risk
 There is a risk that the auditor might not have
sufficient time to obtain the audit evidence
resulting in material misstatement going
undetected.
 Listed on a stock  The FS might be materially misstated as the Inherent risk
 exchange (ZSE) company might not comply with ZSE
regulations resulting in the delisting of the
company and affecting the going concern of
the company.
 Change of  The FS may be materially misstated as the Control risk/
accounting software financial data might not be properly Inherent risk
transferred from the old accounting system to
the new accounting system.
 History of errors or  The FS may be materially misstated as the Inherent risk
significant current financial statements might include
adjustment at year material misstatements.
end.
 Managers are the  The FS may be materially misstated as Inherent risk
owners of the entity. directors might engage in fraudulent financial
reporting to inflate the performance and
position of the entity.
 Entity required to  The FS may be materially misstated as errors Inherent risk
produce group might occur during consolidation as it involves
financial an intricate process possibly resulting in
statements / material misstatements.
Different accounting  The FS may be materially misstated as IFRS 3
policies in a group / might not be properly accounted for.
Different accounting  The FS may be materially misstated as the
systems/ reporting consolidation might not be properly done in
dates. terms of IAS 27.
 Related parties.  The FS may be materially misstated as related
parties might not be eliminated on
consolidation.
 The FS may be materially misstated as related
party transaction might not be accounted for
at arms length and disclosed properly.

Please note
 There are no marks allocated for the risk indicators unless you are required to list the
risk indicators.
 Marks are awarded for describing the risk as per the description column in risk
column in the table above.
 In questions, the risk indicator will be mentioned in the scenario to enable you to
discuss or describe the risk.

Conditions and events which may affect risk at the assertion level
To demonstrate conditions and events which may affect risk at the assertion level we will
use the following example. Please note that these conditions and events evident from the
example below can be found in ISA 315, Appendix 2.

Recap: Please recap or revisit assertions.

Example
You are a first year trainee accountant of ABC Ltd (ABC). The audit senior on the job has
provided you with the following information which you will require in the audit of ABC.
 Revenue comprises of sales made to local and foreign customers.
 Foreign customers are invoiced in their respective currencies.
 During the year, ABC entered into a forward exchange contract (FEC) for the goods
ABC sold to one of their once off foreign customers to protect itself against foreign
currency fluctuations.
 The normal credit terms are 30 days.
 ABC provides for credit losses at 2% of the trade receivables balance.
 Management of ABC receives a bonus based on profit for the year.
 At year-end, trade receivables were factored to enable ABC with quick cash flow that
was required.

REQUIRED:
a. Identify the significant account balance(s) and/or class(es) of transactions in the
above scenario of ABC Ltd.
b. Describe the risk of material misstatement of the identified account balance(s)
and/or class(es) of transactions.
c. Present your answer using assertions.

Suggested Solution

a. Significant class of transactions: Revenue

b. Risk of material misstatement at the assertion level.

Conditions or Risk indicator Risk (b) Assertion

events (c)
affecting risk at
assertion level
Appendix 2 (ISA Foreign customersThere is a risk that Accuracy
315) are invoiced in revenue from
Complexity of the their foreign
foreign customers
underlying currencies. might not be
transaction translated at the
correct exchange
rate
Susceptibility of Management There is a risk that Cut-off
the account to receives bonus revenue might be
misstatement based on profit for recognised in the
the year. incorrect period in
order to inflate the
revenue figure for
bigger bonuses.
Susceptibility of Management There is a risk that Occurrence
the account to receives bonus management
 misstatement based on profit for might record
the year. fictitious sales in
order to inflate the
revenue figure for
bigger bonuses.

Please Note:

1. The first two columns were not required. They are included in the suggested solution
to demonstrate to you how conditions or events can affect risk at the assertion level.
2. The assertions at risk for the relevant class of transaction (statement of
comprehensive income line item) revenue, in this instance are accuracy, cut-off and
occurrence.
3. Completeness and classification are not at risk at ABC Ltd, hence they are not
addressed in the suggested solution.
4. For a complete split of assertions between classes of transactions, account balances
and presentation and disclosure refer to ISA 315 par A111.
5. The solution continues with allowance for credit losses and trade receivables.

a. Significant account balance: Trade receivables.

Significant class of transactions: Allowance for credit losses.

b. Risk of material misstatement at the assertion level.

Conditions or Risk indicator Risk (b) Assertion
events affecting (c)
risk at assertion
level
Appendix 2 (ISA Foreign customers There is a risk that trade Valuation
315) are invoiced receivables might not be
Susceptibility of in their foreign translated at the correct
the account to currencies. closing rate at year-end.
misstatement
Completion of Once-off FEC for There is a risk that FEC gains/ Valuation
unusual and goods sold to losses might not be accurately
complex foreign customers. accounted for resulting in
transaction. misstatement of trade
And/Or receivables account.
Complexity of the
underlying
transaction
making up the
account balance.
And/Or
Transaction not
subject to routine
processing.
 Susceptibility of Management There is a risk that fictitious Existence
account to receive bonuses debtors could be recorded in
misstatement. based on net the financial records in order
profit for the year. to inflate the revenue figure
for bigger bonuses.
Degree of Allowance for There is a risk that allowance Valuation of
judgement credit losses. for credit losses is Trade
involved. understated receivable
to inflate the trade and
receivables Accuracy and
account and put ABC in a completeness
better light than it is. of allowance
for credit
losses
Completion of Trade receivables There is a risk that the trade Rights and
unusual are factored. receivables account does not obligation
transaction belong to ABC Ltd since
debtors have been factored.
Exam technique
1. Present your answer using assertions even when not required to do so. This will
enable you to generate points.
2. Use ISA 315 par A111 when answering a risk question at the assertion level. This will
enable you to address the correct risk for a class of transaction, account balance
and/or disclosure.
3. When you are required to describe the risk at the assertion level, use the
information in the scenario. For instance, if you were to write “there is a risk that
trade receivables might be valued incorrectly”, your answer would be incomplete as
you did not link it to the scenario as stated in the required. You would have to link
your answer to forex valuation and the impact of provision for credit losses when
addressing the valuation assertion as stated in the suggested solution above.
4. When you are required to describe the risk at the assertion level, do not confuse the
required for an audit procedures question: