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ABA368 Advanced Auditing
Chapter 8 Planning, Materiality, and Risk Assessment
Topic Summary

Name Student No.

Chan Man Keung 201222211H
Pun Chi Hon 201222209H
Tang Tsz Long 201222056H
Lau Ka Fung 201222246H

Content
1. Definition of Audit Risk
2. Assessing the risks General Procedure
3. Assessing the risks of material misstatement
4. Financial Statement Level vs. Assertion Level - Differences
5. Business risk
6. Significant risk
7. Automation risk
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Audit risk
1. Inherent risk x control risk x detection risk
2. Risk that auditor expression an inappropriate audit opinion when financial statement in materially
misstated.
3. Risk is a function of risk of material misstatement and detection risk
4. Risk refer to the chance of an error shipping through audit review resulting in a flawed report
5. Is fundamental to the audit process because auditor cannot check all transactions
6. Plan and perform audit with professional skepticism (Attitude)
7. Assess audit risk: 3 levels
i. High/ ii. moderate/ iii. low
8. Audit risk: model~ allow auditor to take various circumstance into accounts in selecting audit
approach.
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Assessing the risks of material misstatement

Risk Assessment

Material Misstatement

Procedure

Overall
(Inherent risk + control risk)

Step
1 Identify risk throughout the process of obtaining an understanding of the entity and its
environment.
2 Assess the identified risk, and evaluate whether they relate more pervasively to the
financial statements as a whole. (Reduce: Material level ---> Acceptable level)
(Overall business risk)
(Business risk ---> Going concern)
3 Relate the risks to what can go wrong at the assertion level.
(Assertion level: Accounts, transactions, and assets)
Specific risk
Test of control
4 Consider the likelihood of the Risks causing a material misstatement.
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Financial Statement Level vs. Assertion Level - Differences

Financial Statement Assertion Level
Level
1. Financial statement as a whole? Yes No
2. Reduce to audit risk to acceptable level? Yes No
3. Can or cannot reduce risks of material misstatement to Can Cannot
an acceptable level?
4. Affect many assertions or one assertion? Many One
5. Significant or insignificant business risk (e.g. fraud)? Significant Insignificant
Can identify Cannot identify
6. Can or cannot focus on specific risk? Cannot Can
7. Concern going concern (survival in long-run) or not? Concern Not concern
8. Perform test of control or not? Not perform Perform
9. Comprise inherent risk and control risk? Not comprise Comprise
10. All classes of transactions or specific class? All classes Specific class
11. Comparatively not able to identify or able to identify Not Able Able
control to prevent, detect or correct material
misstatement?

Accounts Judgement? Warranty, provision.

Susceptibility? Estimated previous audit / adjustment
Transactions near year end?
Ordinary? Usually change.
Complex?
Assets Misappropriation? Owners personal assets record in the companys books.
Susceptibility?
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Business risks
- Loss of customers -> Decrease in sales revenue
- Increase in production costs -> Decrease in cost of sales
- Cash flow problem -> Bad debts
- Decrease in profitability (Net profit)
Expenditure
-> E.g. rental, litigation / court expenses
- Fraud

Types of risks
1. Audit risk
2. Detection risk
3. Inherent risk
4. Control risk
5. Business risk
6. Financial risk Factor: interest rate
7. Operational risk Factor: machinery breakdown
8. Compliance risk Factor: regulations

Business risk is the summation of financial risk, operational risk and compliance risk

Significant risk
Definition
1. Capable to create risks for health and safe
2. Relate to significant non-routine transactions
3. Risks that require special audit consideration
4. High likely significant impact
5. Non-routine transactions: management intervention or overriding accounting treatment (Example)
6. Significant transaction to related party
7. Auditors should evaluate and decide entity related control.

A. Related to non-routine transaction? Yes.

B. Related to judgemental matters?
Accounting principles / Accounting estimates
Interpretations of revenue recognition
Subjective or complex judgement
Assumptions about the effects of future events
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Automation risk
- Test of Control highly emphasis

Summary table of the topic

Audit Strategy Audit Documentation

Audit Planning

Audit Procedures

1. Nature
Auditors use test of control (the whole process) and substantive procedure to
assess risks.
2. Timing
- Further: Interim stage
Later stage
- Identify significant matter
- Risk level -> Higher risk level, more substantive procedure required. (Account
Balance, Transaction, Disclosure)
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3. Extent
- Risk level
- Sampling size
- Increase in risk level, Increase in extent
- Quantity