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9-1
Chapter 9
Assessing the Risk of Material Misstatement
Concept Checks
P. 268
1. The risk of material misstatement exists at two levels: the overall financial
to plan the audit in response to those assessed risks.
2. To obtain an understanding of the entity and its environment, including the
entity’s internal controls, the auditor performs risk assessment procedures to
identify and assess the risk of material misstatement, whether due to fraud or
error. Risk assessment procedures include the following:
Inquiries of management and others within the entity
P. 284
1. The audit risk model is as follows:
PDR = AARR
IR x CR
Where PDR = Planned detection risk
AAR = Acceptable audit risk
IR = Inherent risk
CR = Control risk
should such misstatements exist.
Acceptable audit risk A measure of how willing the auditor is to accept that
the financial statements may be materially misstated after the audit is
effectiveness of internal control.
9-2
Concept Check, P. 284 (continued)
Auditing standards note that the combination of inherent risk and control risk
2. An increase in planned detection risk may be caused by an increase in
acceptable audit risk or a decrease in either control risk or inherent risk. A
Review Questions
significant risks, including fraud risks), part six (assess inherent risk), and part
seven (control risk).
9-2 The risk of material misstatement at the overall financial statement level
9-3 A number of overarching factors may increase the risks of material
misstatement at the overall financial statement level. For example, deficiencies in
management’s integrity or competence, ineffective oversight by the board of
directors, or inadequate accounting systems and records increase the likelihood
statement level.
9-4 Concern about the client potentially recording revenues that did not occur
9-3
Copyright © 2017 Pearson Education, Inc.
9-5 The auditor performs risks assessment procedures to identify and assess
the risk of material misstatement, whether due to fraud or error. Risk assessment
procedures include the following:
1. Inquiries of management and others within the entity: Because
number of inquiries of these individuals to understand the entity and its
2. Analytical procedures: As noted in Chapter 8, auditors are required to
3. Observation and inspection: Auditors observe the entity’s operations
organizes key business functions and leaders in the oversight of day-
to-day operations.
4. Discussion among engagement team members: Auditing standards
about the susceptibility of the client’s financial statements to fraud, in
5. Other risk assessment procedures: The auditor may perform other
9-6 In addition to making inquiries of individuals involved in financial reporting
positions, auditors benefit from obtaining information or different perspectives
through inquiries of others within the entity and other employees with different
levels of authority. Additionally, inquiries of those charged with governance, such
as the board of directors or audit committee, may provide important insights
9-7 Auditing standards require the engagement partner and other key
engagement team members to discuss the susceptibility of the client’s financial
statements to material misstatement. Discussion among the engagement partner
and other key members of the engagement team provides an opportunity for
more experienced team members, including the engagement partner, to share
9-4
9-7 (continued)
engagement partner, all members of the engagement team become better
informed about the potential for material misstatement of the financial statements
misstatement due to fraud, this can be held concurrently with the discussion
about the susceptibility of the financial statements to material misstatement due
to error. These discussions should include an exchange of ideas or brainstorming
9-9 While auditors perform risk assessment procedures to assess the risk of
material misstatement due to fraud or error, auditing standards require the
auditor to explicitly consider fraud risk because the risk of not detecting a
auditor, and they may try to conceal the transaction through collusion with others.
As a result, explicitly focusing on the risks of material misstatements due to fraud
9-5
9-10 (continued)
conclusion in the working papers.
9-11 Auditing standards require the auditor to inquire of management about
their assessment of the risk that the financial statements may be materially
misstated due to fraud. As part of those inquiries, the auditor should ask
management has communicated any information about fraud risks to those
charged with governance.
9-12 A significant risk represents an identified and assessed risk of material
9-13 Three types of characteristics of transactions and balances that might
1. Nonroutine Transactions: Significant risks often relate to significant
nonroutine transactions, which represent transactions that are unusual,
collection and processing, and they can involve complex calculations
or unusual accounting principles not subject to effective internal
considered significant risks.
2. Matters Requiring Significant Judgment: Significant risks also
relate to matters that require significant judgment because they include
on assumptions about future events. As a result, those types of
transactions or balances frequently are identified as significant risks.
9-6
9-13 (continued)
3. Fraud Risk: Because fraud generally involves concealment, detecting
material misstatements due to fraud is difficult. As a result, when
9-14 Inherent risk and control risk relate to the risk of material misstatement at
the assertion level. Inherent risk measures the auditor’s assessment of the
susceptibility of an assertion to material misstatement, before considering the
9-15 An increase in planned detection risk may be caused by an increase in
acceptable audit risk or a decrease in either control risk or inherent risk. A
9-16 Inherent risk is a measure of the auditor’s assessment of the
Factors affecting assessment of inherent risk include:
Nature of the client’s business
Results of previous audits
Initial vs. repeat engagement
Related parties
9-17 Inherent risk is set for audit objectives for segments rather than for the
overall audit because misstatements occur at the objective level within a
those segments.
When inherent risk is increased from medium to high, the auditor should
9-7
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9-18 Extensive misstatements in the prior year’s audit would cause inherent
risk to be set at a high level (maybe even 100%). An increase in inherent risk
would lead to a decrease in planned detection risk, which would require that the
auditor increase the level of planned audit evidence.
9-19 Acceptable audit risk is a measure of how willing the auditor is to accept
that the financial statements may be materially misstated after the audit is
9-20 When the auditor is in a situation where he or she believes that there is a
high exposure to legal liability, the acceptable audit risk would be set lower than
amount of inventory tested and/or the number of audit procedures performed.
9-22 Exact quantification of all components of the audit risk model is not
required to use the model in a meaningful way. An understanding of the
9-23 The auditor should revise the components of the audit risk model
when the evidence accumulated during the audit indicates that the auditor’s
original assessments of inherent risk or control risk are too low or too high or
the original assessment of acceptable audit risk is too low or too high.
9-24 Audit risk is a measure of how willing the auditor is to accept that the
financial statements may be materially misstated after the audit is completed
and an unmodified opinion has been issued. An auditor cannot assess the risk
of material misstatement without first deciding the size of misstatements that
9-8
Multiple Choice Questions From CPA Examinations
9-25 a. (2) b. (1) c (4)
9-28 a. (2) b. (2) c. (1)
Discussion Questions And Problems
professional judgment:
Preliminary judgment about materiality
Control risk
Risk of fraud
judgment:
Estimated total misstatement in a segment
Estimate of the combined misstatement
Known misstatement
95% completed. For example, the performance materiality or
acceptable audit risk would not be raised at the end of the audit
9-9
Copyright © 2017 Pearson Education, Inc.
9-30 a. PCAOB Auditing Standard No. 12 (paragraph .07) notes that the
auditor, when obtaining an understanding of the company and its
environment, should obtain an understanding of the following:
1. Relevant industry, regulatory, and other external factors,
including the competitiveness of the environment, technological
organizational structure, management personnel, sources of
3. The company's selection and application of accounting
principles, including related disclosures, including an evaluation
of whether they are appropriate for its business and consistent
In obtaining an understanding of the company, the auditor
should evaluate whether significant changes in the company from
b. Paragraph .17 of PCAOB Auditing Standard No. 12 provides two
examples of performance measures that create incentives or
pressures for management to manipulate certain accounts or
action, including the correction of misstatements.
9-10
9-30 (continued)
be done either as part of the discussion regarding risks of material
misstatement due to error or separately. Communication about
significant matters affecting the risks of material misstatement should
continue throughout the audit.
environment that enables management to rationalize committing
fraud. The team should also discuss the potential for management
override of controls.
d. When determining whether an identified and assessed risk is a
factors should be considered:
The effect of the quantitative and qualitative risk factors on the
likelihood and potential magnitude of misstatements
Whether the risk is a fraud risk (i.e., a fraud risk is a significant
risk)
The degree of complexity or judgment in the recognition or
uncertainty, and
Whether the risk involves significant unusual transactions
e. Paragraph .74 of PCAOB Auditing Standard No. 12 notes that the
auditor’s assessment of the risks of material misstatement, including
