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Our understanding of such estimates is not to obtain a precise prediction of the most likely result for the
entity, but rather to understand their general nature (i. e what the analysts are tracking ) and whether
this may affect management’s decision as to whether tor record misstatements brought to its attention.
We read the entity’s financial information and perform analytical procedures, considering the non-
financial information, to look for indicators of risk factors, whether due to fraud or error b:
At this stage, we want to obtain a high level understanding of how management determines that the
underlying data used in the calculations of the performance indicators and measures are appropriate
and accurate.
As we obtain an understanding of the entity’s performance indicators, we consider factors, such as:
The availability of internally-generated information used by management for measuring and reviewing
financial information.
The availability of external information, such as analysts’ reports and credit rating agency reports, used
by external parties to measure and review the entity’s financial performance
Management actions that increase the risks of material misstatement, including those due to fraud, as a
result of performance indicators, particularly the pressure to achieve the performance indicators.
We perform analytical procedures on financial and non-financial information as risk identification and
assessment procedures to obtain an understanding of the entity.
We consider fluctuations:
On an account by account basis
Going concern
The role of IT
In understanding the entity and its environment, we obtain an understanding of the role of the IT in the
entity, including IT complexity.
We obtain an understanding of the entity and its environment by performing a combination of the
following risk assessment procedures:
Inquire of:
Others in the entity who may have information that is likely to assist in identifying risks of material
misstatement due to fraud and error.
Inquiry
Analytical procedures
Accounting policies
Movement analytic
Inquiry with management, those charged with governance and important internal audit function
Analytical procedures
Analytical procedures may help identify existence of unusual transactions or events, amounts, rations,
trends that might indicate matters that have audit implications such as possible risks of material
misstatements.
Change in it environment
Complexity
Competence of officers
Past history of misstatements
Accounting estimates
Whether the risk is related to recent significant economic, accounting or other developments
Whether the risk involves significant transactions with related parties within the normal course of
business
Significant risk
Complex
Voluminous
Estimation
Related party
Significant transactions with related parties that are outside the normal course of business for the entity
Likelihood of occurrence
Magnitude of misstatement
For significant risks, we are required to understand and assess the design and implementation of the
entity’s controls relevant to each risk. We obtain this understanding regardless of whether we plan a
controls reliance strategy.
UBT – identification of inherent risks from which risk of material misstatements may arise
Significant risks
Relating inherent risks to the financial statements or to the individual assertions for significant accounts and disclosures helps us
in designing and executing a risk based audit strategy, including:
Key components of our documentation include the description of risk factors and characteristics we
used in determining inherent risks, including significant risks.
The sources of information from which the understanding of the entity was obtained regarding the
above mentioned elements, including the names of individuals to whom we spoke
The inherent risks, including significant risks and their effect on the DS
The company that improperly has misstated an amount in PY may have higher inherent risk
PRIOR-PERIOD MISSTATEMENTS
If a company has made mistakes in prior years that weren’t material (meaning they weren’t
significant enough to have to change), those errors still exist in the financial statements. You
have to aggregate prior-period misstatements with current year misstatements to see whether you
need to ask the client to adjust the accounting records for the total misstatement.
Here’s an example: Suppose you’re in charge of auditing the client’s accounts receivable
balance. Going through prior-period workpapers, you note accounts receivable was understated
by $20,000 and not corrected because your firm determined any misstatement under $40,000 was
immaterial. In the current period, you determine accounts receivable is overstated by $30,000.
The same $40,000 benchmark for materiality is in place. Do you have a material misstatement?
The answer is yes. Standing alone, neither the $20,000 from last year nor the $30,000 from this
year is over the $40,000 limit. However, adding the two misstatements together gives you
$50,000, which is in excess of the tolerable level of misstatement.
You add the two figures together in this example because the difference was understated in one
year and overstated in the next. If the differences had been in the same direction, you would have
subtracted one from the other.
So if the prior year had been overstated by $20,000 instead of understated, the aggregate of your
differences would be $10,000 ($30,000 – $20,000), which is well under the tolerable limit of
$40,000, and so the misstatement wouldn’t be material.
You may think an understatement in one year compensates for an overstatement in another year.
In auditing, this assumption isn’t true. Here’s a real-life auditing example that explains why:
Suppose you’re running the register at a local clothing store. Your ending cash register draw
count is supposed to be $100. One night your register comes up $20 short, a material difference.
The next week, you somehow come up $20 over your draw count. That’s good news, right?
Well, yes and no.
Although your manager is happy to hear that the store didn’t actually lose $20, he doesn’t buy
into the notion that the second mistake erases the first. As he sees it, you made two material
mistakes. The $20 differences are added together to represent the total amount of your mistakes,
which is $40 and not zero. Zero would indicate no mistakes at all had occurred.
Additionally, the fact that the two mistakes counterbalance each other doesn’t negate the fact that
a material misstatement of your register count occurred on two different occasions, indicating a
significant recurring breakdown in controls.
Perhaps, the most important aspect of understanding entity-level controls in non-complex entities
is understanding management’s day-to-day involvement in the financial aspects of the business
and its ability to influence or participate in activities and transactions.
We only obtain further understanding of those controls that we consider relevant to our audit.
For the information system and control activities, we obtain an understanding as we obtain an
understanding of the significant class of transactions (SCOTs)
We recognized however that when management is actively involved in the financial aspects of
the business, the risk of material mi sstatements due to fraud involving management is
increased
Control environment
Risk assessment
Business risk
Significance
Likelihood of occurrence
How to address
It is more likely that management will identify risks through direct personal involvement in the
process
We may identify risks of material misstatement at the financial statement or assertion level from any
internal control components (control environment, risk assessment, communication, and monitoring)
In doing so, we consider the size, complexity and ownership characteristics of the entity when
evaluating the factors that increase the likelihood of risks of material misstatements
Usually, ung mga less complex entities or NCEs, wala silang ineemploy na formal written code of
conduct, walang written accounting code or procedures, so based lang sya sa direct involvement ng
management sa operation ng business (so mas prone sya sa risk of material misstatement due to fraud).
Ayun lang yung procedure nila tska usally, wala silang formal risk assessment.They usually discover risk
as they perform procedures.
Such conditions may not adversely affect our assessment of the risks of material misstatement.
However, when non-complex entities have complex transactions or are subject to legal and regulatory
requirements frequently found in larger entities, they may need more formal means of achieving the
objectives of internal control.
Throughout the audit, we are alert for information or conditions (significant changes in the entity’s
internal control, exceptions in testing transaction-level controls or error identified through our
substantive procedures) that cause us to reevaluate our assessment of the risks of material
misstatement.
Entoty level controls – pervasive yung effect nya – more on control environment and monitoring, we
consider whether the components of entity-level control are operating effectively.
Positive factors relating to the integrity, ethical values and behavior of management are especially
important in determining that the control environment supports the prevention, or detection of
material misstatements.
Segregation of duties, authorization, asset safeguarding, asset accountability and other policies
The oversight along with other appropriate controls may allow management to compensate for the lack
of segregation of duties and achieve the objectives of asset and safeguarding and asset accountability.
Integrity of management
Risk assessment
Monitoring
Identify risk
Control environment
Monitoring
Communication – SCOTs
If may deficiency or material weakness in internal control, we communicate such deficiencies in writing
to those charged with governance on a timely basis.
Inquiry
Inspection of documents
Observation
Procedures
Even a properly planned and performed audit may not detect a material misstatement due to fraud
because of:
Concealment of fraudulent activity. Fraud may be disguised by sophisticated and carefully organize
schemes (forgery, deliberate failure to record transactions). Collusion may make such a concealment
even more difficult to detect.
Professional judgement involved in identifying and evaluating risks that cause a material misstatement
due to fraud and other conditions
Difficulty in determining whether misstatements in judgemental areas such as accounting estimates, are
caused by fraud or error.
Degree of collusion
Size of amounts manipulated
Degree of collusion
Pressure/Incentive
Declining margin
Vulnerability
Risk factors
Threats to the personal worth of management due to the entity’s financial performance
Misappropriation of assets
Adverse relationsji
Poor oversight
Incompetent
As exhibited by:
A history of violations of securities law or other laws and regulations or claims against the entity, its
senior management or those charged with governance alleging fraud or violations of securities or other
laws and regulations.
Ineffective
Unrealistic goals
Dispute between
Disregard for the need for monitoring or reducing risks related to misappropriation of assets
Disregard for internal control by overriding existing controls or by failing to correct control deficiencies
Behavior indicating displeasure or dissatisfaction with the entity or its treatment of the employees
Changes in behavior or lifestyle
Influence
Frequent disputes
Limited access
Past experience
Certain assertions, accounts and classes of transactions that have a higher inherent risk, because they
involve a high degree of management judgement and subjectivity, may present risks of material
misstatements due to fraud because they are susceptible to management manipulation.
Incentive/Pressure
Opportunity
Walang controls
Adverse relationship
Rationalization
Unrealistic
Di kinorrect
Change of lifestyle
Actions to address those risks, including programs and controls the entity has established
Any risks of fraud that have been identified by the management or brought to management’s attention
Management’s communication if any to those charged with governance regarding its processes for
identifying and responding to risks of fraud.
Management’s communication to employees regarding its views on business practices and behaviors
Risk assessment
Actons
Communication to employees
Allegations of fraud and actions
Whether the entity has entered into any significant unusual transactions if so, the nature terms and
business purposes of those transactions and whether such transactions involved related parties
Management
Risk of assessment
Internal control
Risk assessment
Communication to employees
Internal audit
Suspected
We evaluate:
The likelihood that the risk will result in a material misstatement in the financial statements
The pervasiveness of the risk
The likelihood that the risk will result in a material misstatement in the financial statement in the
financial statements
Collective knowledge
The partner in charge of the audit evidences his or her review and approval by signing the APT form
Avoid inadvertent communication among the audit team of additional risks of material misstatement
due to fraud
In some entities, management may view the business as a extension of their own personal.
We thererfore consider the risks of material misstatements due tofraud involving management, whether
performed directly by them or under their direction
Inflating expenses
VAT declaration
Under-overstating reserves
Personal use
Payment to family
The existence of related parties with a dominant influence over the entity and its management could
result in a risk of material misstatement due to fraud being identified
Unauthorized
Material adjustment
Photocopied original
Missing
Missing
Altered
Photocopied
Unexplained
Vague explanation
Unavailable or missing electronic device, inconsistent with the entity’s control retention practices
No available evidence of key systems development and program in-charge testing and implementation
activities
Unusual balance sheet changes or changes in trends or important financial statement ratios or
relationships
Large number of credit entries and other adjustments made to accounts receivable
Unexplained differences between the accounts receivable subsidiary ledger and the general ledger
Fewer responses to confirmation requests than anticipated or a greater number of responses than
anticipated
Not authorized
Manage access
Missing
Photocopied
Discrepancies
Vague explanation
Fewer responses
Denied access to records facilities from whom we can obtain audit evidence
Management’s unwillingness to add or revise disclosures in financial statements to make them more
complete and transparent
Intimidation/Complaint
Denied access
Unusual delays
Limited access
Accounting recrods
Not recorded appropriately
Material adjustment
Not authorized
Missing docs
Photocopied
Vague explanation
Changes
AR credit
Confirmation vs Record
GL vs SL
Limited access
Galit sila
Deadline
Unsual delays
Unwillingness to acess
Management’s ace
Accounting policies that appear inconsistent with industry practices that are widely recognized and
prevalent
Frequent changes in accounting estimates that do not appeato result from changing circumstances
Deadlines
Access
Limited access
Time constraints
Management intimidation
Complaints
Unusual delays
Fraud risk factors may be present at the entity, yet due to the circumstances and nature of its business
these may not present risks of material misstatement due to fraud.
We evaluate information obtained throughout the audit to determine of conditions indicate risks of
material misstatement due to fraud.
Analytical procedures
UTB
Inquiry
Inspection
Observation
Analytical Procedures
Organizational structure
We may consider incorporating an element of unpredictability into the NTE of audit procedures.
Susceptibility of FS
Pressure
Unpredictability
Presence of Controls
Management oversight
Management override
The nature and extent of management involvement in setting accounting policies developing significant
accounting estimates and preparing financial statements
Judgement
Segregation of duties
The nature of significant transactions outside the normal course of business including those with related
parties
Where in the FS
Where in the FS
Vague words
How may fraud occur in significant accounts where there is inherent risk
Vague words
Consideration of fraud risk factors
GTAC
Recurring misstatements
In what areas did we identify exceptions in our test of controls and substantive procedures
In what ways could management originate and post inappropriate journal entries or other adjustments
How to steal
UTB
ELC
Analytics
Subject to udgment
GTAC
Subject to judgment
ELC
Review of interim
GTAC
ELC
The nature of the account
Subject to judgement
If we have not identified a risk of material misstatement due to fraud relating to revenue recognition,
we document the reasons supporting this conclusion for each type of revenue transaction.
However, if the revenue processes are non-complex with little subjectivitin meeting revenue recognition
criteria, we may conclude that there is not a material misstatement due to fraud relating to revenue
recognition.
The higher likelihood of management override of controls, the greater the extent our testing, for
example by including more journal entries in the population for testing.
There may be higher risks of management overriding controls over the processing of JEs and other
adjustments as there may be fewer controls in this area, and they may be able to
Direct less senior personnel to process or record a transaction in a way that I outside normal processes
and controls
Manipulate FSCP with the intention to materially misstate the financial statements
Management override
As e identify significant unsusua transactions, we also consider that transactions with related parties
We determine whether to communicate the risk of material misstatement due to fraud to those charged
with governance when it is relevant to the oversight of the financial reporting process.
When we identify or suspect fraud, we communicate these matters to management and those charged
with governance as appropriate.
Revenue recognition
Related party
Management Override
APT
Ususally from inquiry lang naman froma management, those charged wiith governance, internal audit
and others
If we have not identified a risk of material misstatement due to fraud relating to revenue recognition,
the reasons supporting this conclusion – involves little judgment and is less complex
For each risk – how and where could fraud occur, in sufficient detail
The controls related to each identified risk of material misstatement due to fraud
Risks – where and how to determine its effect on the financial statements
The controls related to the identified risk of material misstatement due to fraud
Documenting sufficient detail of how and where fraud could occur includes:
How the entity’s financial statements might be susceptible to material misstatement due to fraud
Appropriate assets
The controls
Misappropriate
Susceptibility