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Auditing
Planning continued:
- Overall audit strategy
- Materiality in planning and performing
- Assessment of risks of material misstatement at the financial statement level
and at the assertion level
Candice De Nobrega CA(SA)
[email protected]

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Recap of understanding the entity, its environment

and internal control
• Gain an understanding of the entity and it’s internal control by performing risk
assessment procedures and using information gathered during the pre-
engagement stage

• This understanding will assist us to identify risks of material misstatements in

the financial statements

Question: Why do we want to identify risks of material misstatement?

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Recap of understanding the entity, its environment

and internal control
Answer: Because our audit objective is to obtain reasonable assurance about
whether the financial statements as a whole are free from material
misstatement, thereby enabling the auditor to express an opinion on whether the
financial statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework.

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Planning
1. Obtaining an understanding of the entity and its environment including
internal control;

2. Develop the audit strategy

- Calculate materiality
- Identify and assess the risks of material misstatement at the overall financial
statement level and at the assertion level
- Respond to risks of material misstatement at the overall financial statement level

3. Develop the audit plan

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Overall audit strategy

ISA 300: Planning an audit of financial statements

Definition of strategy: “a plan of action designed to achieve a long-term or overall aim”

1. long-term or overall aim

2. A plan of action

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Overall audit strategy

ISA 300: Planning an audit of financial statements

Direction
Timing of
of the
the audit
audit

Auditors
Scope of
Resources
the audit
Audit needed
strategy

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Overall audit strategy

ISA 300: Planning an audit of financial statements
NB!!! Appendix
Scope
Everything we gathered from
understanding the entity, it’s

Resources
environment and internal control

Timing
Audit deadline
Taking into account when critical
events take place

Direction
Risks of material
misstatement
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Overall audit strategy

ISA 300: Planning an audit of financial statements
NB!!! Appendix

Types of questions specific to overall audit strategy:

• Discuss the matters in the scenario that affect the audit strategy

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Planning
1. Obtaining an understanding of the entity and its environment including
internal control;

2. Develop the audit strategy

- Calculate materiality
- Identify and assess the risks of material misstatement at the overall financial
statement level and at the assertion level
- Respond to risks of material misstatement at the overall financial statement level

3. Develop the audit plan

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Materiality in planning and performing

LISA 320: Materiality in planning and performing an audit

What is materiality?
Materiality is the benchmark for significance to the users of the financial
statements as determined by the auditors of a company

Why do we need it?

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Materiality in planning and performing

LISA 320: Materiality in planning and performing an audit

Misstatements including omissions, are considered to be material if they,

individually or in aggregate, could reasonably be expected to influence the
economic decisions of users taken on the basis of the financial statements.

Misstatement – A difference between the amount, classification, presentation, or

disclosure of a reported financial statement item and the amount, classification,
presentation, or disclosure that is required for the item to be in accordance with
the applicable financial reporting framework.

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Materiality in planning and performing

LISA 320: Materiality in planning and performing an audit

Materiality

Quantitative Qualitative

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Materiality in planning and performing

Planning an audit solely to detect individual misstatement in excess of the
maximum amount acceptable overlooks the fact that the aggregate of individual
misstatements below this maximum amount may cause the financial statements
to be materially misstated.

Quantitative

Planning Performance

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Materiality in planning and performing

Planning Performance
• Total quantitative material • Smaller quantitative amount auditor
misstatements acceptable in AFS uses during the audit to identify
• Calculated in the planning stage to areas where there could be
set the benchmark and used in the misstatements in excess of
concluding stage to asses the performance materiality.
misstatements identified during the
audit.

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Materiality in planning and performing

ISA 320: Materiality in planning and performing an audit
Planning materiality calculation:
1) Determine annual figures (NB! Justify)
2) Select benchmark (NB! Justify)
3) Calculate range
4) Conclude on an amount (NB! Justify)

Performance materiality calculation:

1) Percentage of planning materiality
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Materiality in planning and performing

Annual figures - AFS
Factors to consider: Availability, significant changes
1. Unaudited current year (12 months)
2. Unaudited current year to date (not entire year)
3. Audited prior year
4. Budgeted/ Forecast
Benchmark & Range
Factors to consider: Nature of business (income generating/asset intense), stability
❖Revenue ½% - 1%
❖Gross profit 1% – 2%
❖Net profit 5% – 10%
❖Assets 1% – 2%
❖Equity 2% – 5%
Conclude
• Remove outliers
• If inherent risk is high – select benchmark with the lowest materiality calculation
• If inherent risk is low, select benchmark with highest materiality calculation
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Materiality in planning and performing

ISA 320: Materiality in planning and performing an audit

Types of questions specific to materiality:

Calculate planning materiality

Calculate performance materiality
Analyse the materiality calculation

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Class example 1

Refer to the class example document for the class question

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Planning
1. Obtaining an understanding of the entity and its environment including
internal control;

2. Develop the audit strategy

- Calculate materiality
- Identify and assess the risks of material misstatement at the overall financial
statement level and at the assertion level
- Respond to risks of material misstatement at the overall financial statement level

3. Develop the audit plan

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Assessment of risks of material misstatement at the financial

statement level & assertion level
ISA 315: Identifying and assessing the risks of material misstatement

• Misstatement – A difference between the amount, classification, presentation,

or disclosure of a reported financial statement item and the amount,
classification, presentation, or disclosure that is required for the item to be in
accordance with the applicable financial reporting framework.

• Risks of material misstatement: Risk that there could be a misstatement, and if

that misstatement was to materialise then it would be material to the users

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Assessment of risks of material misstatement at the financial

statement level & assertion level
ISA 315: Identifying and assessing the risks of material misstatement

Examples:
▪ Amount recorded is incorrect

▪ Item classified incorrectly

▪ Item presented incorrectly

▪ Notes to the financial statements contain incorrect statements/statements are not

included

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Assessment of risks of material misstatement at the financial

statement level & assertion level

ISA 315: Identifying and assessing the risks of material misstatement

Audit risk = Inherent risk x Control risk x Detection risk

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Assessment of risks of material misstatement at the financial

statement level & assertion level
The entity and it’s
environment Potential inherent risks?
1.Organisational structure A
2.Ownership, governance &
business model
3.Industry and regulations
4.Measures to assess financial
performance
5.Financial reporting
framework
6.Accounting policies
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Assessment of risks of material misstatement at the financial

statement level & assertion level

Internal control Potential control risks?

▪Control environment A
▪Entity’s risk assessment
process
▪Information system
▪Control activities
▪Monitoring of controls
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Assessment of risks of material misstatement at the financial

statement level & assertion level

Identify risk of material

misstatement

Does the risk affect

the financials as a
whole?
Are specific
assertions
affected?

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Assessment of risks of material misstatement at the financial

statement level & assertion level
Risk of material misstatement at the Risk of material misstatement at the
financial statement level assertion level
➢Risk relates pervasively to the AFS as a ❑Risk relates to specific class of
whole and potentially affects many transactions, account balance or
assertions disclosures

➢Auditor is required to: ❑Auditor is required to:

➢ Assess the nature and extent of the ❑Assess inherent risk by assessing the
pervasive effect on the AFS and likelihood and magnitude of the potential
➢ Determine whether it affects the misstatement
assessment of risks at the assertion level ❑Only assess the control risk if the auditor
intends testing the operating effectiveness
of the controls
For examples refer to Appendix 2
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Class example 2
Refer to the class example document for the class question

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Assessment of risks of material misstatement at the financial

statement level & assertion level
Risk of material misstatement at the assertion level

Factors to consider when assessing inherent risk:

- Complexity – In a calculation
- Subjectivity - Judgement involved in an estimate
- Susceptibility - To fraud/error
- Change - In accounting treatment
- Uncertainty – In accounting treatment
- Risk of material misstatement at the financial statement level

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Assessment of risks of material misstatement at the financial

statement level & assertion level
Class of transaction assertions
▪ Completeness – Risk that transactions that should have been recorded have not been
recorded

▪ Occurrence – Risk that transactions recorded, shouldn’t have been recorded

▪ Accuracy – Risk that the transaction is not recorded at the correct amount

▪ Cut off – Risk that the transaction is not recorded in the correct period

▪ Classification – Risk that the transaction is not recorded in the correct account

▪ Presentation and disclosure – Risk that the transaction is not presented or disclosed
correctly in the AFS
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Assessment of risks of material misstatement at the financial

statement level & assertion level
Account balance assertions
▪ Completeness – Risk that an account balance that should have been recorded has not been
recorded
▪ Existence – Risk that an account balance recorded, doesn’t exist
▪ Accuracy, Valuation and allocation – Risk that an account balance is not reflected at the correct
value
▪ Rights and obligations – Risk that they don’t have the right to assets or the obligation for
liabilities
▪ Classification – Risk that an account balance is not recorded in the correct account
▪ Presentation and disclosure – Risk that an account balance is not presented or disclosed correctly
in the AFS
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Class example 3
Refer to the class example document for the class question

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Assessment of risks of material misstatement at the financial

statement level & assertion level
• Once the auditor has assessed the risk of material misstatement at the
assertion level, the auditor is required to consider whether any of those
risks are significant risks

• These are risks where the inherent risk was assessed as high as a result
of the likelihood and magnitude of the misstatement

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Assessment of risks of material misstatement at the financial

statement level & assertion level
Significant risks
• Where a degree of subjectivity is involved:
• Transactions with multiple acceptable accounting treatments
• Accounting estimates with high estimation uncertainty/complex models
• Accounting principles subject to different interpretations
• Complexity in data collection and processing to support account balance
• Account balances or quantitative disclosures that involve complex calculations
• Changes in the entity’s business that involve changes in accounting
(mergers/acquisitions)

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Planning a group audit of financial statements

ISA 600: Audit of group financial statements

1. Apply ISA 315 to the audit of consolidated AFS

• Group auditors need to obtain an understanding of the group, its components,
their environments and internal controls by performing risk assessment
procedures
2. Apply ISA 300 to the audit of consolidated AFS
• Group auditors will establish the overall group audit strategy
3. Apply ISA 320 to the audit of consolidated AFS
• Group auditors will calculate the group materiality and component materiality
4. Apply ISA 315 to the audit of consolidated AFS
• Group auditors will assess the risks of material misstatement at the financial
statement and assertion level of the group financial statements

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Class example 4
Refer to the class example document for the class question

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Summary
1. Gain an understanding of the entity and it’s internal control by performing
risk assessment procedures and using other information gathered

2. This understanding allows us to determine the scope and timing of the audit
strategy
3. Calculate materiality

4. Our understanding together with materiality allows us to determine the

direction (Risks of material misstatements) of the audit strategy

What else do we establish from this understanding?

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Questions you can expect

• Discuss the factors in the scenario that will affect the audit strategy
• Calculate planning materiality and apply planning materiality to a given
scenario; and
• Identify weaknesses in the calculation of materiality presented to you in
the scenario.
• Identify and assess the risks of material misstatements at the financial
statement level and at the assertion level;
• Identify and assess the significant risks
• Identify and assess the business risks

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Assessment of risks of material misstatement at the financial

statement level & assertion level

Often you are required to identify Business risks instead of the risk of material
misstatement.
Business risks are the risks the business faces because of their
operations/industry/environment.

Most of these risks will affect the financial statements, and will therefore also be
risks of material misstatements, however some business risks do not impact the
financial statements and will therefore not be risks of material misstatements.

TIP: When you are asked for business risks, you must include all risks of material
misstatement and then any additional risks that the business faces that are not
risks of material misstatements.

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Lecture preparation
Next lecture pre-reading:

- Responding to risks of material misstatement

- Audit Plan

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Copyright © CA Campus

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