Risk-Based Audit of Financial Statements Note: A higher risk of material misstatement will require the

auditor to perform more effective and extensive audit

Identifying and Assessing Risks of Material procedures.
Misstatements (RoMM) through Understanding the
4. Determine the acceptable level of Audit Risk
Entity and its Environment

Audit risk is the risk that the auditor gives an inappropriate

Risk assessment procedures are audit procedures performed
audit opinion when the financial statements are materially
to obtain an understanding of the entity and its environment,
misstated.
including the entity’s internal control, to identify and assess the
risks of material misstatement, whether due to fraud or error, at
the financial statement and assetion levels. Components of Audit Risk

Inherent Risk Control Risk Detection Risk

1. Obtain an understanding of the following:
i. Entity and its environment (the entity’s organizational • the susceptibility of an • is the possibility that • the risk that the
ABCOTD to a misstatement will auditor's
structure, ownership and governance, and its business misstatement before
consideration of any not be prevented or substantive
model, IT integration; industry, regulatory, and other related controls detected and procedures will not
corrected on a detect a
external factors; the measures used to assess the • Examples: timely basis by the misstatement that
Susceptibility to theft or accounting and exists in an
entity’s financial performance) fraudulent reporting, internal control ABCOTD that could
Complex accounting or systems be material
ii. Applicable financial reporting framework and calculations, Need for
judgment
accounting policies
iii. Entity’s system of internal control

The main purpose of the risk assessment procedures is to

enhance the understanding of the entity in order to The determination of acceptable level of audit risk is a matter of
specifically identify the applicable further audit professional judgment to be made by the auditor.
procedures (e.g. test of controls and substantive testing) and
to appropriately respond to the different risks assessed
5. Identify Detection Risk to determine the nature, timing and
related to the audit.
extent of further audit procedures

Detection risk is the function of the effectiveness of audit

procedures. When the auditor implements effective audit
procedures, detection risk will be low since there is a greater
possibility that the misstatement will be detected.

SCENARIO

Through the understanding of the entity obtained by the auditor

during planning actvities, there was ann increase in the assessed
level of control risk. How will this affect the different components
of audit risk?

The above scenario will require for a decrease in dectection

risk in order to maintain the acceptable level of audit risk.

Since the auditor only assesses the levels of IR and CR, the only
2. Consider Materiality way to maintain the acceptable level of audit risk when there is
Information is material if its omission or misstatement could an increase in CR is to change DR.
influence the economic decisions of users taken on the basis of
Lower DR Higher DR
the financial statements.
Nature More effective Less effective
procedures may be procedures may be
The concept of materiality is applied by the auditor in evaluating
applied applied
the effect of identified misstatements on the audit and of
uncorrected misstatements on the FS, and in forming the opinion Timing Procedures will be Procedures will be
of the auditor’s report. performed closer or performed at interim or
nearer to year-end several dates
Note: The lower materiality set will generally require the auditor Extent Larger sample size will Smaller sample size will
to perform more effective and extensive audit procedures. be tested be tested

3. Identify and Assess RoMMs

Using the unerstanding of the entity and its environment,
including its internal control, the auditor identifies and assesses
the risk of material misstatement at the following levels:

• risk of revenue overstatement due to cut-

Assertion off [assertion] error
• risk of understatement of trade payables
Level due to unrecorded purchase invoices
[completeness]

Financial
• risk that entity is not a going concern
Statement • significant risks of management fraud
Level