CHAPTER 9

 Risk Assessment is a systematic process of

evaluating the potential risks that may be
involved in a projected activity or
undertaking.
 Risk response is the process of developing
strategic options, and determining actions,
to enhance opportunities and reduce threats
to the project's objectives.
“We conducted our audits in accordance with
Philippine Standards on Auditing. Those
standards require that we comply with the
ethical requirements and plan to perform
the audit to obtain reasonable assurance
about whether the financial statements are
free of material misstatements.
 The phrase reasonable assurance is intended to inform
the users that auditors do not guarantee or insure
the fair presentation of the financial statements.

 Reasonable Assurance – level of confidence that

financial statements are not materially misstated
 Unqualified opinion – auditor’s judgment that FS
are fairly and appropriately presented in accordance
with GAAP
 The phrase free of material misstatement is intended
to inform the users that the auditor’s responsibility is
limited to material financial information. Materiality
is important because it is impractical for auditors to
provide assurance on immaterial amounts.
Risk-Based Audit Approach
 Begins with the evaluation of the types and likelihood
of misstatements in account balance and the adjusts
the amount and type of audit work, to the likelihood of
material misstatements occurring in account balances.
 Identification of the client’s strategy and the processes
for developing that strategy.
 Examination of the core business process and resource
management.
 Identification for each of the key processes, objectives,
inputs, activities, outputs, systems and transactions.
 Assessment of the risks that the processes will not
meet the goals and controls related to those risks.
 AUDIT RISK – auditor may give an unqualified
opinion on financial statements that are materially
misstated.
 ENGAGEMENT RISK – CPA firm is associated with a
particular client including loss of reputation, inability
of the client t pay the auditor, or financial loss because
management is not honest and inhibits the audit
process.
 FINANCIAL REPORTING RISK
- relate directly to the recording of transactions
and the presentation of financial data in an
organization’s financial statements.
 BUSINESS RISK
- risk that affect the operations and potential
outcomes of organizational activities.
AUDIT RISK
 By not accepting certain companies as client
 Setting audit risk at a level that the auditor believes
will mitigate the likelihood that the auditor will fail to
identify material misstatements.

 Not possible to ever completely eliminate audit risk,

but can be reduced by doing more work.
FINANCIAL REPORTING RISK
 Asset impairments
 Market-to-market accounting
 Warranties
 Pensions
 Estimates
 Competence and Integrity of management
 Incentives to misstate
 Management facing strong competition and weak
financial results may be motivated to circumvent a
weak internal control system or to take advantage of
complex financial instruments to achieve desired
financial reporting results that do not necessarily
portray economic reality.
 Audit firms have discovered that being associated with
companies with poor integrity creates risk that can
destroy the audit firm or significantly increase the cos
of conducting the audit.
Risk Assessment
 Performance of preliminary engagement activities to
decide whether to accept/continue an audit
engagement.
 Planning the audit to develop an overall audit strategy
and audit plan.
 Performance of risk assessment procedures to
identify/assess risk of material misstatement through
understanding the entity.
Risk Response
 Designing an overall responses and further audit
procedures to develop appropriate responses to the
assessed risk of material misstatement.
 Implementing responses to assessed risk of material
misstatement to reduce the risk to an acceptably low
level.
Reporting
 Evaluating the audit evidence obtained to determine
what additional audit work (if any) is required.
 Forming an opinion based on audit findings and
preparing the auditor’s report.
Performance of Preliminary
Engagement Activities
 Perform procedures required by PSA 220 regarding the
continuance of the client relationship and the specific
audit engagement.
 Evaluate compliance with ethical requirements,
including independence as required by PSA 220.
 Establish an understanding of the terms of
engagement as required by PSA 210.
Acceptance and Continuance of Client
Relationships and Audit Engagements
12. The engagement partner shall be satisfied that
appropriate procedures regarding the acceptance and
continuance of client relationships and audit engagements
have been followed, and shall determine that conclusions
reached in this regard are appropriate. (Ref: Para. A8-A9)
13. If the engagement partner obtains information that
would have caused the firm to decline the audit
engagement had that information been available earlier,
the engagement partner shall communicate that
information promptly to the firm, so that the firm and the
engagement partner can take the necessary action. (Ref:
Para. A9)
Client Selection and Retention
 The auditor maintains the necessary independence
and ability to perform the engagement.
 There are no issues with management integrity that
may affect the auditor’s willingness to continue the
engagement.
 There is no misunderstanding with the client as to the
terms of the engagement.
CPA firm assessment
 Competent to perform the engagement and has the
capabalities, including time and resources to do so.
 Can comply with relevant ethical requirements
 Considered the integrity of the client and does not
have information that would lead it to conclude that
the client lacks integrity
Preconditions
 Whether the financial reporting framework to be
applied are acceptable
 Agreement of management that it acknowledges and
understands its responsibility
Agreeable terms
 Objective and scope of the audit of financial
statements
 Responsibilities of auditor
 Responsibilities of management
 Identification of applicable financial reporting
framework
 Reference to the expected form and content of reports
by auditor…
Recurring Audits
 Auditor shall assess whether circumstances require the
terms of the audit to be revised and whether there is a
need to remind the entity of the existing terms of the
audit engagement.
 The auditor shall not agree to the change in the terms
of the audit engagement where there is no reasonable
justification for doing so.
Planning the Audit to Develop an
Overall Audit Strategy and Audit
Plan
 PSA 300 establishes standards and provides guidance
on the considerations and activities applicable to
planning an audit of financial statements. It states that
the auditor should plan the audit so that the
engagement will be performed in an effective manner.
Audit Planning
 Establishment of the overall audit strategy for the
engagement and developing an audit plan, in order to
reduce audit risk to an acceptably low level.
 Benefit from the their experience and insight and to
enhance the effectiveness and efficiency of the
planning process.
 The auditor considers the timing of certain planning
activities and audit procedures that need to be
completed prior to the performance of further audit
procedures.
 Analytical procedures to be applied as risk assessment
procedures
 Obtaining a general understanding of the legal
regulatory framework
 Determination of materiality
 Involvement of experts
 Performance of other risk assessment procedures
 Discussing the nature and timing of detailed audit
procedures with management may compromise the
effectiveness of the audit by making the audit
procedures too predictable.
Benefits of Audit Planning
 Helps ensure that appropriate attention is devoted to
important areas of the audit.
 Aids in identifying potential problems and resolving
them
 Ensure that the audit is properly organized, managed
and performed.
 Assists in the assignment and review of the team
members
 Coordinate the work to be done by auditors of
components and other parties.
Overall Audit Strategy
 PSA 300 requires that the auditor establishes the
overall strategy for the audit. It sets the scope, timing
and direction of the audit and guides the
development of the more detailed audit plan.
Process of Establishing Audit Strategy
 Identifying the characteristics of the engagement that
define its scope.
 Ascertaining the reporting objectives of the
engagement to plan the timing of the audit and the
nature of the communication required.
 Considering the important factors that will determine
the focus and direction of the engagement teams
efforts
 Considering the results of preliminary engagement
activities and, where applicable, whether knowledge
gained on other engagements performed by the
engagement partner for the entity is relevant
 Ascertaining the nature, timing and extent of
resources necessary to perform the engagement
Other Benefits
 Resources to deploy for specific audit areas
 Amount of resources to allocate to specific audit areas
 Period when resources are to be deployed
 How resources are managed, directed and supervised
 MATERIALITY
“Information is material if its omission or
misstatement could influence the economic decisions
of users taken on the basis of the financial statements.
Materiality depends on size of the item or error judged
in the particular circumstances of its omission or
misstatement. Thus, materiality provide a threshold or
cut-off point rather than being a primary qualitative
characteristic which information must have if it is to
be useful.”
 Quantitative
- peso amount of the error

 Qualitative
- causes of misstatement
Big things
come from
small things
Auditor to assume that users
 Have a reasonable knowledge of business and
economic activities
 Understand that prepared, presented and audited…
 Recognize the uncertainties
 Make reasonable economic decisions
 OVERALL MATERIALITY
- based on the auditor’s judgment as to the
highest amount of misstatement(s) that could be
included in the financial statements without affecting
the economic decisions taken by a user.
 SPECIFIC MATERIALITY
- materiality level for a particular classes of
transactions, account balances, or disclosures.
PERFORMANCE MATERIALITY
 Set at a lower amount than overall specific materiality

 Ensure that misstatements less than overall or specific

materiality are detected
 Provide a margin or buffer for possible undetected
misstatements
How to determine Materiality
 Auditors make a preliminary assessment as a whole by
determining the amount by which the believe the
financial statements could be misstated without
affecting users’ decision.

 A misstatement which is immaterial in quantity but

does not allow a client to meet a condition of a user,
may be considered material.
Other considerations
 When accepting new audit engagement, inquire about
the overall materiality used by the previous auditor.
 Ensure that experts employed or used by the audit
team are instructed to use an appropriate materiality
level in relation to the work they perform.
 Relationship Between
Materiality and Audit Risk