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STUDENT HANDOUTS
AUDITING THEORY AFRICA, DY
AT 109—IDENTIFYING AND ASSESSING RISKS OF MATERIAL MISSTATEMENT (ROMM) OCTOBER 2021 LECPA REVIEW

LEARNING OBJECTIVES

1. Explain the concept of risks of material misstatement 4. Describe the process of identifying and assessing ROMM.
(ROMM). 5. Identify examples of ROMM relating to specific accounts
2. Explain the concept of significant risks. and disclosures in the financial statements.
3. Explain the concept of “risks for which substantive
procedures alone do not provide sufficient appropriate
audit evidence.”

REVIEW NOTES

ROMM of F/S [LO 1]
ROMM refers to risk that the F/S are materially misstated prior
to audit. The auditor shall identify and assess the ROMM at the:
• F/S level; and
• Assertion level for classes of transactions, account balances,
and disclosures to provide a basis for designing and
performing FAP.
transactions, account balances, and disclosures in the F/S. This
exercise requires professional judgment taking into account
both quantitative and qualitative factors.
Quantitative consideration involves comparison of an account’s
amount with general materiality, though some auditing firms
use performance materiality. The account is quantitatively
material if it exceeds materiality.

F/S Level Qualitative consideration takes into account the possibility of

ROMM at F/S level refer to risks that relate pervasively (widely)
to the F/S as a whole, and potentially affect many assertions.
Examples include:
• Weak control environment, including management override
of internal control.
• Going concern problem.
• Fraud risks.
• Declining economy.
Assertion Level
The ROMM at assertion level refer to risks that are confined to
one or a few assertions for classes of transactions, account
balances, and disclosures in the F/S. Examples are:
• Risk of theft of cash relating to existence assertion.
• Risk of delayed recording of accounts payable relating to
completeness assertion.
material misstatement, based on auditor’s knowledge such as
accounts that involve accounting estimates (e.g., allowance for
bad debts, retirement obligations, etc.) or suspicious accounts
(miscellaneous accounts, related party transactions, etc.).
Immaterial accounts and disclosures are usually scoped out of
any further audit. However, before scoping out account or
disclosure, consider:
• Possible accumulation of immaterial misstatements that
could be material; and
• Whether the F/S area is understated due to fraud or error.
Significant Risk [LO 2]
Significant risk is a ROMM that, in the auditor’s judgment,
requires special audit consideration. Factors to consider
whether a ROMM is significant risk are shown below.

The ROMM at assertion level consist of inherent risk and control

risk. Hence, audit risk at assertion level is expressed through this
model: AR = f(IR x CR x DR).

Inherent risk is the susceptibility of an assertion to a

misstatement that could be material before consideration of
any related controls.

Control risk is the risk that a misstatement that could occur in

an assertion will not be prevented, or detected and corrected, on
a timely basis by the entity’s internal control.

Identifying Material Accounts and Disclosures

As the audit is focused on areas that have a chance of material
misstatement, the auditor needs to identify material classes of
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AUDITING — THEORY | AT 109—IDENTIFYING AND ASSESSING ROMM ARC – ACCOUNTANCY REVIEW CENTER

In all audits, PSAs presume the following to have significant risks Step 3: Consider Likelihood and Magnitude of Misstatement
resulting from fraud risks:
The likelihood of misstatement refers to the probability of
1. Revenue recognition occurrence of risk. The auditor could evaluate this probability
2. Management override of internal control as high, moderate, or low. The magnitude of misstatement
refers to the impact of misstatement if it could be material. The
Risks for which Substantive Procedures (SPs) Alone Do Not auditor uses performance materiality as in evaluating
Provide SAAE [LO 3] magnitude of misstatement.

These risks may include risks of inaccurate or incomplete Assessed Level of Inherent Risk
processing for routine transactions (e.g., revenue, purchases,
Assessing the level of inherent risk is usually expressed as high,
and cash receipts or payments), which are subject to highly
moderate, or low.
automated processing with little or no manual intervention.
The factors that should be considered in assessing the
The auditor shall obtain an understanding of the controls over
susceptibility of an assertion to material misstatement include:
such risks and perform TOC to obtain sufficient appropriate
audit evidence. 1. Higher size
2. Greater liquidity
For example, risk of incorrect recording of purchases of “Apps” 3. Higher volume
from Google’s Playstore and Apple’s App Store which involve 4. Complexity
highly consistent processing due to automation. 5. Subjective estimates

Process of Identifying and Assessing ROMM [LO 4] Assessed Level of Control Risk and Tests of Controls
1. Identify, assess, and relate risks to F/S
2. Relate risks to what can go wrong (WCGW) at the assertion
level and relevant controls
3. Consider likelihood and magnitude of misstatement

Step 1: Identify, Assess, and Relate Risks to F/S

The auditor’s understanding of the entity is central to
identifying and assessing the ROMM. The auditor uses this
understanding to identify the entity’s business risks which may
relate ROMM of F/S.

The entity’s business risk is broader than the ROMM of F/S,

though the former includes the latter, as shown in below.

Risk of Material Misstatement (Combined Inherent Risk x

Control Risk)
Inherent Risk Control Risk ROMM (IR x CR)
Low Low Low
Low Moderate Low
Low High Moderate
Moderate Low Low
Step 2: Relate Risks to WCGW at the Assertion Level and Moderate Moderate Moderate
Relevant Controls Moderate High High
High Low Moderate
The auditor relates identified risks to assertion level as further
High Moderate High
audit procedures (FAP) are performed at assertion level. The
auditor performs this step by considering WCGW at assertion High High High
level and the relevant controls that are likely to address WCGW

DISCUSSION QUESTIONS

ROMM of F/S [LO 1] b. a risk that may relate to the inaccurate or incomplete
1. A risk of material misstatement is recording of routine and significant classes of
a. an identified and assessed risk of material transactions or account balances, the characteristics of
misstatement that, in the auditor’s judgment, requires which often permit highly automated processing with
special audit consideration. little or no manual intervention.
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c. the risk that the financial statements are materially
misstated prior to audit.
d. the risk that relate pervasively to the financial
statements as a whole, and potentially affect many
assertions that could be considered material.
2. Which of the following is(are) risks of material
misstatement levels an auditor is required to identify and
assess?
a. at the assertion level for each material account and
disclosure consisting of two components: inherent risk
and control risk.
b. at the financial statement level as a whole potentially
affecting many assertions.
c. either a or b.
d. both a and b.
3. Which of the following is most likely a risk of material
misstatement at the assertion level?
a. Weak control environment.
b. Going concern problem.
c. Declining economy.
d. Delayed recording of accounts payable.
4. The auditor uses the understanding of the entity and its
environment, including internal control, to identify and
assess risks of material misstatement. The process of
identifying and assessing risks of material misstatement
include
a. Evaluating whether the risks relate more pervasively to
the financial statements as a whole and potentially
affect many assertions
b. Identifying material account balances, class of
transactions, and disclosures in financial statements.
c. Relating the risks identified to financial statements
assertions.
d. All of the above.
5. It refers to an account or disclosure that has a reasonable
possibility of containing a material misstatement regardless
of the effect of internal controls.
a. Significant account or disclosure
b. Pervasive account or disclosure
c. Significant assertion
d. Pervasive assertion
6. In determining which financial statement accounts and
disclosures are material, an auditor shall consider
a. Quantitative factor by using the materiality levels.
b. Qualitative factors taking into account the possibility of
material misstatement.
c. Both a and b.
d. Neither a nor b.
7. A __________ is a management assertion that has a
reasonable possibility of containing a material
misstatement without regard to the effect of internal
controls.
a. Relevant assertion
b. Pervasive assertion
c. Risky assertion
d. Fraudulent assertion
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Significant Risk [LO 2]
8. Significant risks are assessed risks of material misstatement
that, in the auditor’s judgment, require special audit
consideration. The auditor is _______ to determine
whether any of the risks identified are, in the auditor’s
judgment, a significant risk.
a. encouraged c. required
b. not permitted d. allowed
9. Which of the following is required of the auditor when the
assessed risk of material misstatement is judged to be a
significant risk?
a. To obtain an understanding of the entity’s controls,
including control activities, relevant to significant risks.
b. To perform test of controls.
c. To be audited by test of details substantive procedures
in all cases.
d. All of the above.
10. Which of the following risks of material misstatement may
least likely be judged as significant risk?
a. The risk is a risk of fraud.
b. The risk is related to recent significant economic,
accounting or other developments.
c. The risk relates to complex, unusual and subjective
transactions.
d. The risk involves significant transactions with unrelated
parties.
11. PSA 240, The Auditor’s Responsibilities Relating to Fraud in
an Audit of Financial Statements, presumes which of the
following to have significant risks relating to fraud?
a. Improper revenue recognition.
b. Management override of internal control.
c. Both a and b.
d. Neither a nor b.
Risks for which SPs Alone Do Not Provide SAAE [LO 3]
12. Statement 1: Risks for which substantive procedures alone
do not provide sufficient appropriate audit evidence may
include risks of inaccurate or incomplete highly automated
processing for routine and significant classes of transactions
such as an entity’s revenue, purchases, and cash receipts or
cash payments.
Statement 2: The auditor may not obtain an understanding
of relevant controls over risks for which substantive
procedures alone do not provide sufficient appropriate
audit evidence.
a. True, True c. True, False
b. False, False d. False, True
Process of Identifying and Assessing ROMM [LO 4]
13. Determine the most logical order of assessing the risks of
material misstatements as indicated in PSA 315?
I. Consider the likelihood of misstatement, including the
possibility of multiple misstatements, and whether the
potential misstatement is of a magnitude that could
result in a material misstatement.
II. Assess the identified risks (if it is a significant risk), and
evaluate whether they relate more pervasively to the
financial statements as a whole and potentially affect
many assertions;
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III. Identify risks throughout the process of obtaining an a. b. c. d.

understanding of the entity and its environment, Higher size Yes Yes Yes No
including relevant controls that relate to the risks, and Greater liquidity Yes Yes Yes Yes
by considering the classes of transactions, account Higher volume Yes No Yes No
balances, and disclosures in the financial statements Complexity No Yes Yes Yes
IV. Relate the identified risks to what can go wrong at the Subjective estimates No No Yes Yes
assertion level, taking account of relevant controls
that the auditor intends to test; 20. Inherent risk (relating to existence assertion) is often low
a. I, II, III and IV c. III, II, I and IV for an account such as:
b. III, II, IV and I d. IV, III, I and II a. Accounts receivable.
b. Marketable securities.
Step 1—Identify, Assess, and Relate Risks to F/S c. Cash.
14. Which statement is correct regarding business risk? d. Inventory.
a. The risk of material misstatement of the financial
statements is broader than business risk, though it Control Risk
includes the latter 21. Control risk should be assessed in terms of
b. The auditor should identify or assess all business risks a. Specific controls.
c. All business risks give rise to risks of material b. Types of potential fraud.
misstatements c. Financial statement assertions.
d. A business risk may have an immediate consequence d. Control environment factors.
for the risk of misstatement for classes of transactions,
account balances, and disclosures in the assertion level 22. Assessing the level of control risk is based on the
or the financial statements as a whole a. Susceptibility of an assertion to material misstatement.
b. Effectiveness of the design and implementation of
15. A potential business risk created by new products may most internal control.
likely include c. Both a and b.
a. Increased product liability d. Neither a nor b.
b. Increased legal exposure
c. The entity does not have the personnel or expertise to 23. Which of the following is an example of control risk?
deal with the changes in the industry. a. Client has perishable inventory which may be
d. Loss of financing due to the entity’s inability to meet overvalued
financing requirements. b. Client has a high number of cash sales which may mean
income is not completely recorded
16. Which of the following conditions and events least likely c. Lack of a finance director
indicate the existence of risks of material misstatement? d. The client is in a highly regulated industry and therefore
a. Changes in the supply chain. at risk of unrecorded fines and penalties
b. Expanding into new locations.
c. Inquiries into the entity’s operations or financial results 24. After obtaining an understanding of an entity’s internal
by regulatory or government bodies. controls, an auditor may assess control risk at the maximum
d. Consistency of the entity’s IT strategy and its business for some assertions because the auditor:
strategies. a. Believes internal control activities are unlikely to be
effective.
Step 2—Relate Risks (Inherent Risk) to WCGW at the Assertion b. Determines that internal control is not well-
Level and Relevant Controls (Control Risk) documented.
17. Why do assertions of financial statements have risks of c. Performs tests of controls to restrict detection of risk to
material misstatement? an acceptable level.
a. Because assertions have susceptibility to material
d. Identifies control activities that are likely to prevent
misstatement due to their complexity and uncertainty.
material misstatements.
b. Because a misstatement that could occur in an
assertion will not be prevented, or detected and
25. Which of the following assessed level of control risk tests of
corrected, on a timely basis by the entity’s internal
controls are not performed?
control.
a. High.
c. Both a and b.
b. Moderate.
d. Neither a nor b.
c. Low.
d. Below maximum.
Inherent Risk
18. Auditors often assess which of the risks for assets and
Step 3—Consider Likelihood & Magnitude of Misstatement
income accounts of financial statements?
26. While assessing the risks of material misstatement auditors
a. Overstatement. c. Either a or b.
identify risks, relate risk to what could go wrong, consider
b. Understatement. d. Both a and b.
the magnitude of risk and
a. Assess the risk of misstatement due to illegal acts.
19. The factors that suggest susceptibility of an assertion to
b. Consider the complexity of the transactions involved
material misstatement include:

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AUDITING — THEORY | AT 109—IDENTIFYING AND ASSESSING ROMM
c. Consider the likelihood that the risks could result in
material misstatements
d. Determine materiality levels
27. The likelihood of misstatement refers to the probability of
occurrence of risk. The auditor could evaluate this
probability as
a. High.
b. Moderate.
c. Low.
d. Any of the above.
28. The magnitude of misstatement refers to the impact of
misstatement if it could be material. In evaluating
magnitude of misstatement, an auditor most likely uses
a. Materiality for the financial statements as a whole.
b. Materiality for particular financial statement accounts
and disclosures.
c. Performance materiality.
d. Clearly trivial misstatement.
Combined Inherent Risk x Control Risk
29. Combining the assessed levels of inherent risk and control
risk gives result to
a. Assessed level of risk of material misstatement
(ROMM) at the assertion level.
b. Acceptable level of detection risk at the assertion level.
c. Acceptably low of audit risk at the assertion level.
d. All of the above.
30. Assume that control risk = 0.70, inherent risk = 0.80, and
audit risk = 0.05. If a material misstatement occurred and
was not corrected by the auditee’s internal controls, what
is the risk that the misstatement would not be detected by
the audit procedures?
a. 0.02 c. 0.09
b. 0.07 d. 0.50
ROMM: Cash
31. Which of the following risks of material misstatement
relating to cash pertains to valuation assertion?
a. Cash is overstated because of recorded fictitious,
overstated receipts, or has been stolen.
b. Cash is overstated because the entity has lost right to
recorded cash.
c. Cash is understated because not all bank accounts and
receipts have been recorded.
d. Cash is misstated because bank accounts denominated
in a foreign currency have been translated using the
incorrect exchange rate.
ROMM: Receivables
32. Which of the following risks of material misstatement
relating to receivables pertains to valuation assertion?
a. Receivables account is overstated due to unrecorded
receipts.
b. Receivables account is overstated because the entity
does not have the rights to collect them.
c. Receivables account is understated because shipments
to customers were not billed and recorded as sales.
d. Receivables account is overstated due to inadequacy of
allowance for doubtful accounts as a result of
deteriorating economic conditions.
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ROMM: Investments
33. Which of the following risks of material misstatement
relating to investments pertains to valuation assertion?
a. Investments are overstated due to inclusion of
investments that do not exist or have already been
disposed of.
b. Investments are misstated because of inaccurate
recording or valuation.
c. Investments are overstated because the company does
not have the rights over the investments.
d. Investments are understated because acquisitions are
not recorded as assets.
ROMM: Inventories
34. Which of the following risks of material misstatement
relating to inventories pertains to valuation assertion?
a. Inventory account is overstated because it includes
fictitious or stolen inventory.
b. Inventory account is overstated because it includes
already sold inventory or inventory held on
consignment.
c. Inventory is overstated because obsolete or damaged
inventory is still valued at cost even though net
realizable value falls below cost.
d. Inventory is understated because not all inventory
counted has been included in the record.
35. Mason also holds around P2 million of aircraft spares which
are included within inventory. Mason sells the aircraft
spares to amateur flying associations. Aircraft spares which
are not sold after three years are scrapped. Approximately
a quarter of this value is made up of specialist equipment
taken out of aircraft when it was replaced by newer or more
advanced equipment. Such specialist equipment is
transferred from non-current assets to inventory without
adjustment, and continue to be recognised at amortised
cost. Which of the following summarises the key audit
concern arising from the matter described?
a. Accuracy, valuation and allocation of inventory
b. Accuracy, valuation and allocation of non-current
assets
c. Completeness of non-current assets
d. Existence of inventory
36. Failure to record the acquisition of goods is a violation of
which audit objective?
a. Accuracy c. Authorization
b. Occurrence d. Completeness
ROMM: Properties
37. Which of the following risks of material misstatement
relating to property, plant and equipment pertains to
valuation assertion?
a. Properties account is overstated due to capitalization
of ordinary repairs and maintenance.
b. Properties account is overstated because it includes
properties which the entity does not own.
c. Properties account is understated because additions,
including those acquired through finance leases, have
not been recorded or have been expensed.
d. Properties account is misstated because of incorrect
depreciation methodology.
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ROMM: Liabilities ROMM: Presentation and Disclosures

38. Which of the following risks of material misstatement 40. Which of the following risks of material misstatement
relating to liabilities pertains to valuation assertion? relating to presentation and disclosures pertains to
a. Payables are understated as not all goods and services completeness assertion?
received, especially those in-transit at period end but a. Items presented and disclosed are understated
to which the entity has title, are recorded. because omission of item required to be presented and
b. Payables are misstated as they have been, or their disclosed.
payments have, recorded at incorrect amounts. b. Items presented and disclosed are misstated due to
c. Payables are overstated as payables have been incorrect information being used in valuing these items.
recorded which do not represent actual obligations of c. Items presented and disclosed are overstated because
the entity. an item has been disclosed that does not exist.
d. Payables are overstated because payments have not d. Items presented and disclosed do not provide adequate
been recorded. information in accordance with the accounting
framework.
ROMM: Equity
39. Which of the following risks of material misstatement
relating to equity pertains to valuation assertion?
a. Equity is overstated because shares issued were not
appropriately authorized.
b. Equity is misstated because share premium and
property dividends have been incorrectly calculated
c. Equity is understated because shares issued have not
been recorded.
d. None of the above

PRACTICE EXAM

1. A potential business risk created by industry developments a. of the unique classification of related-party
may most likely include transactions required on the balance sheet.
a. Increased product liability b. of the lack of independence between the parties.
b. Increased legal exposure c. of the unique classification of related-party
c. The entity does not have the personnel or expertise to transactions required on the income statement.
deal with the changes in the industry. d. it is required by generally accepted accounting
d. Loss of financing due to the entity’s inability to meet principles.
financing requirements.
6. In the audit risk model, which of the risk components can
2. The auditor uses knowledge gained from the understanding be assessed by the auditor?
of the client's business and industry to assess: a. Inherent risk. c. Detection risk.
a. Client business risk c. Inherent risk b. Control risk. d. Both A and B.
b. Control risk d. Audit risk
7. Which of the following audit risk components may be
3. Which of the following industries is usually considered high assessed in quantitative and non-quantitative terms?
risk by audit firms? Control risk Detection risk Inherent risk
a. High technology companies such as Internet firms. a. Yes Yes Yes
b. Manufacturing companies such as toy producers. b. No Yes Yes
c. Legal services such as attorney firms. c. Yes Yes No
d. Non-profit companies such as trade associations. d. Yes No Yes

4. The following events and conditions indicate the existence 8. Auditors often assess which of the risks for liabilities and
of risks of material misstatement, except. expense accounts of the entity?
a. Changes in key personnel including departure of key a. Overstatement. c. Either a or b.
executives. b. Understatement. d. Both a and b.
b. Weaknesses in internal control, especially those not
addressed by management. 9. An auditor assesses control risk because it
c. Installation of significant new IT systems related to a. Is relevant to the auditor’s understanding of the control
financial reporting. environment.
d. Operations that are subject to a low degree of complex b. Provides assurance that the auditor’s materiality levels
regulation. are appropriate.
c. Indicates to the auditor where inherent risk may be the
5. Most auditors assess inherent risk as high for related parties greatest.
and related-party transactions because:

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d. Affects the level of detection risk that the auditor may c. Touring the client’s plant and offices.
accept. d. Identifying related parties.
10. Auditors begin their assessments of inherent risk during
audit planning. Which of the following would not help in
assessing inherent risk during the planning phase?
a. Obtaining client’s agreement on the engagement
letter.
b. Obtaining knowledge about the client’s business and
industry.

- END -

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