UNDERSTANDING THE

ENTITY AND ITS

ENVIRONMENT

FRAUD ERROR AND NON-

COMPLIANCE
CAUSES OF MISSTATEMENTS
OF THE FINANCIAL
STATEMENTS
1. Errors
2. Fraud
a. Fraudulent financial reporting (management
fraud)
b. Misappropriation of assets (employee fraud)

Assessing the Risks of Material Misstatements

Fraud Risk Factors

1. Incentives/Pressures
2. Opportunity
3. Attitudes/Rationalizations

Assessing the Risks of Material Misstatements

Degree of assurance between
material fraud and material errors

1. Fraud is harder to detect than errors

2. Fraud may involve sophisticated and carefully
organized schemes designed to conceal it
3. Fraud may be accomplished by collusion

Assessing the Risks of Material Misstatements

Responsibilities of Those charged
with governance and of
management
1. Prevention and detection of fraud
2. Place a strong emphasis on fraud prevention, which may reduce
opportunities for fraud to take place, and fraud deterrence, which could
persuade in individuals not to commit fraud because of the likelihood
detection and punishment
3. To ensure , through oversight of management, that the entity establishes
and maintains internal control to provide reasonable assurance with regard
to reliability of financial reporting, effectiveness and efficiency of operations
and compliance with applicable law and regulations
4. To establish a control environment and maintain policies and procedures to
assist in achieving the objective ensuring, as far as possible, the orderly and
efficient conduct of the entity’s business

Assessing the Risks of Material Misstatements

Inherent Limitations of an Audit in
the context of Fraud
1. There is an unavoidable risk that some material misstatements of the financial statements
will not be detected, even though the audit is properly planned and performed in accordance
with PSAs
2. The risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting a material misstatement resulting from error because fraud may involve
sophisticated and carefully organized schemes designed to conceal it, such as:
• Forgery
• Deliberate failure to record transactions
• Intentional misrepresentation being made to the auditor 
3. The risk of the auditor not detecting a material misstatement resulting from management
fraud is greater than for employee fraud, because management is frequently in a position to
directly or indirectly manipulate accounting records and present fraudulent financial
information
4. The subsequent discovery of a material misstatement of the financial statements resulting
from fraud does not, in and of itself, indicate a failure to comply with PSAs

Assessing the Risks of Material Misstatements

Responsibilities of auditor for
detecting material misstatements
due to fraud
1.An auditor conducting an audit in accordance with PSAs obtains
reasonable assurance that the financial statements taken as a whole
are free from material misstatement, whether caused by fraud or error
2.An auditor cannot obtain absolute assurance that material
misstatements in the financial statement will be detected because of
such factors as of the following:
• use of judgment
• use of testing
• inherent limitations of internal control
• the fact that much of the audit evidence available to the auditor is
persuasive rather than conclusive in nature

Assessing the Risks of Material Misstatements

Responsibilities of auditor for
detecting material misstatements
due to fraud
3. The auditor should maintain an attitude of professional
skepticism throughout the audit, recognizing the possibility
that a material misstatement due to fraud could exist,
notwithstanding the auditor’s past experience with the
entity about the honesty and integrity of management and
those charged with governance

4. Members of the engagement team should discuss the

susceptibility of the entity’s financial statements to material
misstatement due to fraud
Assessing the Risks of Material Misstatements
RISK ASSESSMENT
PROCEDURES

These are the procedures to obtain an

understanding of the entity and its
environment, including its internal control.

Assessing the Risks of Material Misstatements

Risk Assessment Procedures
includes

(a)Inquiries of management and

others within the entity;
(b) Analytical procedures; and
(c) Observation and inspection.

Assessing the Risks of Material Misstatements

Inquiries of Management and
Others Within the Entity

(a) Inquiries directed towards those charged with

governance
(b) Inquiries directed toward internal audit personnel
(c) Inquiries of employees involved in initiating, processing
or recording complex or unusual transactions
(d) Inquiries directed toward in-house legal counsel
(e) Inquiries directed towards marketing or sales personnel

Assessing the Risks of Material Misstatements

Observation and Inspection as
Risk Assessment Procedures
 Observation of entity activities and operations.
 Inspection of documents
 Reading reports prepared by management
 Visits to the entity’s premises and plant facilities.
 Tracing transactions through the information system
relevant to financial reporting (walk-throughs).

Assessing the Risks of Material Misstatemen

 Analytical Procedures

PSA 520 requires the auditor to use analytical procedures in planning

and overall stages of audit.
1. Develop Expectations regarding Financial Statements using
Prior years financial statements
Anticipated Results
Industry averages
Nonfinancial Information
Typical Relationship among financial statement account balances
2. Compare the expectations with the financial statements under audit.
3. Investigate significant difference
Assessing the Risks of Material Misstatemen
The Use of Analytical
Procedures
Planning the Audit - assist in determining the
nature, timing and extent of
other audit procedures.
Substantive Test - to obtain corroborative
evidence about particular
assertions related to account balances
Overall Review - completion phase; to
confirm conclusion
reached with respect to
the fairness of the financial
statements
Assessing the Risks of Material Misstatemen
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.
• Assists the engagement team members to gain a better understanding of the
potential for material misstatement of the financial statements in the specific areas
assigned to them and to under- stand how the results of the audit procedures that
they perform may affect other aspects of the audit, including the decisions about
the nature, timing, and extent of further audit procedures.
• Provides a basis upon which engagement team members communicate and share
new information obtained throughout the audit that may affect the assessment of
risks of material misstatement or the audit procedures performed to address these
risks.
Assessing the Risks of Material Misstatemen
SIGNIFICANT RISKS THAT
REQUIRE SPECIAL AUDIT
CONSIDERATION
Significant Risk
An identified and assessed risk of material
misstatement that, in the auditor's professional
judgment, requires special audit consideration.

The determination of significant risks, which arise

on most audits, is a matter for the auditor’s
professional judgment.
Assessing the Risks of Material Misstatemen
SIGNIFICANT RISKS THAT
REQUIRE SPECIAL AUDIT
CONSIDERATION
The auditor should consider:
1. whether the risk is a risk of fraud;
2. whether the risk is related to recent significant economic,
accounting, or other developments and, therefore, requires specific
attention;
3. the complexity of transactions;
4. whether the risk involves significant transactions with related parties;
5. the degree of subjectivity in the measurement of financial
information related to the risk, especially those measurements
involving a wide range of measurement uncertainty; and
6. whether the risk involves significant transactions that are outside the
normal course of business for the entity or that otherwise appear to
be unusual. Assessing the Risks of Material Misstatemen
RISKS FOR WHICH SUBSTANTIVE
PROCEDURES ALONE DO NOT
PROVIDE SUFFICIENT AUDIT
EVIDENCE
Substantive Procedures/Tests
These are the activities performed by the auditor
to detect material misstatement or fraud at the
assertion level.

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.
Assessing the Risks of Material Misstatemen
REVISION OF RISK
ASSESSMENT
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
Assessing the Risks of Material Misstatemen
COMMUNICATING WITH THOSE
CHARGED WITH GOVERNANCE AND
MANAGEMTENT
Objectives
a. Communicate clearly with those charged with
governance the
responsibilities of the auditor
b. Obtain from those charged with governance
information relevant to the audit;
c. Provide those charged with governance with timely
observations arising from the audit that are significant and
relevant to their responsibility to oversee the financial
reporting process; and
d. Promote effective two-way communication
Communication with those charged with governance
Those charged with governance
and management

Those charged with governance-The person(s) or

organization(s) with responsibility for overseeing the
strategic direction of the entity and obligations related to
the accountability of the entity
Management- The person(s) with executive responsibility
for the conduct
of the entity’s operations
* The auditor shall determine the appropriate person(s) within the
entity’s
governance structure with whom to communicate.

Communication with those charged with governance

Matters to be Communicated

The Auditor’s Responsibilities in Relation to the Financial Statement

Audit
a. auditor’s responsibility in forming and
expressing opinion
b. The audit of the financial statements does not
relieve management or those
charged with governance of their responsibilities

Communication with those charged with governance

Planned Scope and Timing of the
Audit
Significant Findings from the Audit
a. The auditor’s views about significant qualitative aspects of the
entity’s accounting practices, including accounting policies, accounting
estimates and financial statement disclosures
b. Significant difficulties, if any, encountered during the audit
c. Unless all of those charged with governance are involved in
managing the entity:
1. Material weaknesses of internal control that have come to the
auditor’s attention and have been communicated to management
2. Significant matters, if any, arising from the audit that were
discussed, or subject to correspondence with management
3. Written representations the auditor is requesting
d. Other matters, if any, arising from the audit that, in the auditor’s professional
judgment, are significant to the oversight of the financial
reporting process
Communication with those charged with governance
Planned Scope and Timing of the
Audit
Auditor Independence
a. complied
with relevant ethical requirements regarding independence
b. 1. All relationships and other matters between the firm,
network
firms, and the entity that, in the auditor’s professional judgment,
may reasonably be thought to bear on independence (i.e. total
fees charged during the period covered by the
financial statements for audit and non-audit services
b.2. The related safeguards that have been applied to eliminate
identified threats to independence or reduce them to an
acceptable
level.
Communication with those charged with governance
The Communication Process

 Establishing the Communication Process

The auditor shall communicate with those charged with
governance the form,
timing and expected general content of communications
 Forms of Communication
The auditor shall communicate in writing with those
charged with governance
regarding significant findings from the audit when, in the
auditor’s professional
judgment, oral communication would not be adequate.

Communication with those charged with governance

The Communication Process

 Timing of Communications
 Adequacy of the Communication Process
 Documentation

Communication with those charged with governance