11/24/2023

RISK ASSESSMENT

Arnel N. Moran

Related Readings: PSA 315

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Risks Related to an Audit Firm

Business risks – factors that could adversely affect an entity’s

ability to achieve its objectives and execute its strategies.

Engagement risk – risk that the practitioner expresses an

inappropriate conclusion when the subject matter information is
materially misstated.

Audit risk – engagement risk in an audit engagement.

Audit Risk Model

Components of Audit Risk

Risk of material misstatement
a. Inherent risk – susceptibility to material misstatement, in the
absence of controls.
b. Control risk – failure of controls to prevent, detect or correct
material misstatements on a timely basis.
c. Detection risk – the failure of the auditor to detect material
misstatements

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Audit Risk Model

AR = IR x CR x DR

𝑨𝒄𝒄𝒆𝒑𝒕𝒂𝒃𝒍𝒆 𝑨𝒖𝒅𝒊𝒕 𝑹𝒊𝒔𝒌

Planned detection risk=
𝑰𝒏𝒉𝒆𝒓𝒆𝒏𝒕 𝑹𝒊𝒔𝒌 𝒙 𝑪𝒐𝒏𝒕𝒓𝒐𝒍 𝑹𝒊𝒔𝒌

Risk Assessment

Risk assessment is the process of obtaining an understanding of

the entity and its environment, including its internal control, to
identify and assess the risk of material misstatement, whether due
to fraud or error, at the financial statement and assertion levels.
(PSA 315)

The auditor uses professional judgment to determine the extent

of understanding required.

Information obtained may be used as evidence.

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Risk Assessment Procedures

1. Inquiry of management and others within the entity
 Auditor may also inquire employees other than management and those charged with
governance
2. Analytical procedures
 Helps identify the existence of unusual transactions or events, and amounts, ratios, and trends.
3. Observation and inspection
 Support inquiries of management and others, and may also provide information about the
entity and its environment
4. Other considerations
 information obtained from acceptance or continuance process
 Information obtained from other engagements for the entity
 Changes in information obtained from prior periods, if the entity intends to use that
information
5. Discussion among the engagement team
 The engagement partner and other key members shall discuss the susceptibility of the FS to
material misstatements

Understanding the Entity and its Environment

The auditor shall obtain an understanding of

1. Relevant industry, regulatory, and other external factors
2. Nature of the entity
3. Entity’s selection and application of accounting policies
4. Entity’s objectives and strategies

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Understanding the Entity and its Environment

Industry factors
 Market and competition, seasonal activity, product technology, and energy
supply and cost.

Regulatory factors
 Accounting principles and practices, regulatory framework, legislation and
regulation, taxation, government policies, and environmental requirements.

Other external factors

 General economic conditions, interest rates and availability of financing,
and inflation.

Understanding the Entity and its Environment

Nature of entity
 Operations – revenue sources, geographic dispersion, key customers
and suppliers, and research and development activities.
 Ownership and governance structures
 Investment plans – acquisitions or divestitures and capital investment
 Structuring and financing – subsidiaries and associates, debt
structure and related parties
 Financial reporting

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Understanding the Entity and its Environment

Accounting policies
Evaluate whether these policies are appropriate and consistent with
the applicable financial reporting framework
 Method of accounting significant unusual transactions
 Effect of significant accounting policies in controversial or emerging
areas
 Changes in accounting policies
 Financial reporting standards and laws and regulations that are new to
the entity

Understanding the Entity and its Environment

Objectives and Strategies

1. Objectives
 Overall plans for the entity to conduct its business
2. Strategies
 Approaches by which management intends to achieve its objectives

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Understanding the Entity and its Environment

Financial performance
 Key performance indicators and key ratios, trends and operating
statistics
 Period-on-period financial performance analysis
 Budgets, forecasts, variance analysis, and segment reports
 Employee performance measures and incentive compensation
policies
 Comparison of an entity’s performance with that of competitors

Understanding the Entity’s Internal Control

The auditor shall obtain an understanding of internal control relevant to

the audit.

Components of Internal Control: (CRICM)

 Control environment
 Entity’s risk assessment
 Information system and communication
 Control activities
 Monitoring of controls

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Identifying and Assessing Risks of Material

Misstatements

The auditor shall identify and assess the risks of material misstatements
at
a. Financial statement level
b. Assertion level for classes of transaction, account balances, and
disclosures

To provide a basis for designing and performing further audit procedures

Identifying and Assessing Risks of Material

Misstatements

Management assertions
Assertions – representations by management, explicit or otherwise, that are
embodied in the financial statements.
 Classes of transactions (COCAC)
 Account balances (CRVE)
 Presentation and disclosure (COCA)

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Identifying and Assessing Risks of Material

Misstatements

Significant risks
The auditor shall determine whether any of the risks identified are, in the
auditor’s judgment, significant risks.

The auditor shall consider

 Risk of fraud
 Recent development
 Complexity of transactions
 Significant related party transactions
 Degree of subjectivity
 Significant unusual transactions

Identifying and Assessing Risks of Material

Misstatements

Documentation
The auditor shall document
 The discussion among the engagement team;
 Key elements of understanding obtained;
 Identified and assessed risk of material misstatements at financial
statement level and at the assertion level; and
 Risks identified and related controls.