AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATION

Running head: AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATION
Audit Risk, Analysis and Control in Organization
Name of the Student
Name of the University
Author Note

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Table of Contents
Answer 1....................................................................................................................................2
Factors that affect the Risk of Material Misstatement...............................................................3
1. Fluctuations in the Rate of Interest.................................................................................3
2. The positioning of the majority shareholder...................................................................3
3. Management’s failure in accounting estimates...............................................................4
4. Installation of a new computer system............................................................................5
Answer 2....................................................................................................................................5
Audit Risks.................................................................................................................................6
1. Material Misstatement.....................................................................................................7
2. Revenue Recognition......................................................................................................7
3. Entity’s Control...............................................................................................................8
Auditor’s response.....................................................................................................................8
Material misstatement at the assertion level..........................................................................8
Material misstatement at the financial statement level..........................................................9
Material misstatement Due to fraud.......................................................................................9
Management overrides of control..........................................................................................9
References................................................................................................................................11

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Answer 1
Risk of Material Misstatement
Such information that has been reported incorrectly in the financial reports, and
consequently, it has a negative impact on the stakeholders for their financial decisions, is
known as a material misstatement. The misstatement in the financial reports is considered as
material when it has the ability to influence the decisions made by any stakeholder based on
such reports (Knechel and Salterio 2016). For example, a loan advanced on either small or
big amount to a company’s director is material due to the user of the financial reports will
consider the information provided for decision-making. The information provided in the
reports can be misstated due to either fraud that is intentionally done or error that is an
unintentional misstatement and does not come under fraudulent activity (Kramer 2015).
According to paragraph A136 of ASA 315, there is a possibility to be material of a potential
misstatement, which can also be judged through its extent of nature and circumstance of the
item.
The risk of material misstatement refers to such risk that exists within the financial
report, which is being audited and has the potential of being material either individually or in
aggregate. As per paragraph 25 (a) of ASA 315, an auditor has the option to proceed for risk
assessment in two different levels for material misstatement, which are Assertion level and
Financial report level. Paragraph A122 of ASA 315 states that the risks of material
misstatement at the level of the financial reports have the potential to affect several assertions
(Auasb.gov.au 2020). The material misstatement’s risk in context with the balance of the
account, transactions as well as disclosures at the assertion level requires special
consideration. In obtaining the evidence at the assertion level, the auditor will get help

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through these considerations so that to determine the time, nature, and other procedures of an
audit.
Factors that affect the Risk of Material Misstatement
There are several factors present within the entity or environment. The auditors need
these factors to obtain and assess the risk of material misstatement. J Audrey Pearce, who is
an audit partner within an accountant’s firm while planning an audit for Homes South Ltd
that is a finance company, found several risks of material misstatement at the financial
statement level. She has found several information concerns about the company’s
environment. Based on the gathered information by her, the factors that would affect the risk
of material misstatement are as follows:
1. Fluctuations in the Rate of Interest
According to the first information, the company HS is more profitable as compared to
the industry averages. The HS packages and sells the mortgages to the large investments
trusts even after there has been recent volatility in the interest rates. The external factors, in
terms of entity and environment, have the potential to affect the risk of material misstatement.
Paragraph A30 of ASA 315 states about the external factor that the auditor is required to
consider, which is financing availability, economic conditions, inflation, and interest rates.
The value of mortgages can be increased or decrease by the volatility in the interest
rate. However, HS Company has considerable growth in recent years. The differences in the
interest rates can be there while dealing with large investment trusts. The auditors thus have
to consider the value reported within the reports. If the auditor finds any misstated figure,
then it reflects the existence of a risk to material misstatement.

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2. The positioning of the majority shareholder
In the second information, she has found that George Watson controls the Board of
Directors of HS Ltd. He is the majority shareholder who also acts as the power of Chief
Executive Officer. The branch office’s management has the authority for directing and
controlling the operation of the company and compensate as per the profitability of the
branch. The information collected here can be combined so that to get an extent to the truth of
the reporting.
The performance measure of the company, Homes South Ltd., shows unusual
profitability or growth in its business while working within the same industry. There is a
possibility of risk existing in terms of the biases of the management while maintaining the
financial report. This is due to the factors combined with the data, such as incentives and
bonuses. It is reflecting an unexpected outcome or trend. There may be a possibility to be bias
in context to the company’s profitability or putting data in the reports (Cao, Chychyla and
Stewart 2015). Thus, these factors may also affect the risk of material misstatement. As per
Paragraph A48 of ASA 315, the auditor shall take internal measures that highlight the
unexpected result or trend.
3. Management’s failure in accounting estimates
The company’s accounting department in the last five years has experienced a minor
turnover in personnel. J Audrey Pearce has involved in these auditing processes. During her
past five years auditing HS Ltd., she has found that the company’s formula generally
underestimates the allowances for loan losses. However, its financial controller always tends
to increase its allowance (Backof, Bowlin and Goodson 2014). Further, the company has an
open branch office, which is not yet profitable. Nevertheless, they believe to earn profit by
the year 2021.

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There is an existing factor of risk of material misstatement due to the failure of
accounting estimation. As J Audrey Pearce has been the witness for the last five years. The
company’s reporting can also have an entity risk that is arising from the business’s
expansion. It may be possible that demand has not been weighed accurately while deciding
on an expansion. Therefore, these are contributing to the risk of material misstatement.
Paragraph A40 states some components included in the material misstatement that is new
products or services, industry development, and expansion of the business as well. The
auditor shall consider the risk related to the entity that may have resulted in a material
misstatement.
4. Installation of a new computer system
In the last information collected by J Audrey Pearce, she mentions that the company
has increased its operation’s efficiency by installing a new computer system during the year
2019. The company has the risk associated with the operating style of the management’s
operations. The personnel handling the computer system may reduce the risk, but they cannot
mitigate the management from being bias within their operations to increase their earnings.
The high risk involved in the material misstatement results in the lower level of detecting risk
because of sufficient evidence collected from the audit processes.
According to Paragraph A82, independent boards of directors of the company have
the potential to influence the decision of the management, which includes a maximum chance
of the risk of material misstatement (Auasb.gov.au 2020). An auditor must not ignore the
importance of ASA 315 as the standard mentions different requirements for assessing the risk
of material misstatement. The auditor can reduce the risk by ensuring responsive auditing to
the client or an individual audit through proper use of standards (Defond, Lim and Zang
2016).

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Answer 2
There is a significant increase in the revenue of the Darfield electronics of about 27%
during the year. There is a 31% increase in the inventory, as well as a 10% growth in the cost
of sales. The auditors shall go by evaluating the cost of sales as well as inventory within the
period. However, the business has represented an increase of 33% in the net payables, which
is included in deceasing the cash to zero. The reduction of cash od done along with a certain
amount of bank overdraft. The actions arose a question about the requirement of cash and
bank overdraft at the same time. The operating expense also increases after inventories. The
cost of operating expenses is less concerning its revenue. Comparing the operating expense to
the previous year, it shows a certain increase that seems to be detectable for the deterioration
in the operation’s efficiency during the year. There is the possibility of misstatement in the
reports so that the company can reflect a positive side of it rather than the actual one. The
auditor shall investigate the profitability declared by Darfield Electronics. It is because there
is the possibility of declaring the profits and the business’s current position different from the
actual one. Therefore, Darfield electronics may have the existence of the risk of material
misstatement through which the business can show a positive view of them.
Financial Data for Darfield Electronics

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Audit Risks
The risks that have been identified by the auditors are discussed below.
1. Material Misstatement
The gross profit of the business has increased by 50% with respect to the previous
year. The receivables are also showing an increase of 58% during the year. The significant
increase in the profitability of the business has the possibility of a risk of material
misstatement so that to create a good image in the minds of the stakeholders. The auditor
shall check the overall transactions and the confirmations to confirm that the report prepared
is correct or have some material misstatement due to error or any fraudulent activity.
As per Paragraph 26 of ASA 240, the auditor shall follow ASA 315 to assess the risk
related to the material misstatement due to fraud or error at the financial statement level. The
auditor shall also identify and assess the risk for disclosures, balances, and transactions at the

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assertion level (Kassem and Hugson 2016). Professional Scepticism is one of the important
factors that are necessary for an efficient audit of a financial report of the company. The lack
of professional scepticism can also be a factor that leads to the risk of material misstatement.
It can also be to provide favorable support to the company.
2. Revenue Recognition
Cashflow is the lifeblood of any business. For the effective working of the business,
there is a need for cash flow. Thus, the role of revenue is very essential for a company’s
existence. The amount shown by the Darfield of its PBIT is $1030 and revenue of $5267
during the year. There may be the possibility of a risk of material misstatement due to fraud
or control of the management. Paragraph 27 of ASA 240 states that the company shall have a
risk of fraud-related with the revenue recognition that an auditor shall evaluate based on
presumption. The evaluation process includes identifying and assessing the risk of revenue
recognition through evaluating the type of revenue, revenue transactions, or assertions that
have the potential to give rise to the risk of material misstatement.
3. Entity’s Control
It may be possible to have some risk of being affected due to certain limitations of
internal control of the management. Paragraph A54 of ASA 315, the internal control’s
effectiveness provides a reasonable assurance so that to avail the purpose of financial
reporting. Therefore, the risk if material mistreatment can arise due to the management’s
internal control. The decision made within the entity can have some fault or human error.
Further, a situation may arise to override of internal control by not an appropriate
management (Donelson, Ege and Mcinnis 2016). The company may have a possibility that its
management had entered into a separate agreement with the clients. This can be for

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modifying the terms and conditions of the sales contract, which is resulting in poor revenue
recognition.
Auditor’s response
The response of the auditors consisting of assigning experienced staff or highly
skilled staff so that it provides keen supervision. (Auasb.gov.au 2020) The auditor's response
to address and assessed risk is through highlighting to the audit team so that to maintain the
sustainability of professional scepticism. The auditor shall incorporate some additional
elements of unpredictability or can make general changes concerning the time, nature, and
audit process to a suitable extent.
Material misstatement at the assertion level
The risks at the assertion level are included in inherent risk and controlled risk.
Inherent risk is considered as an assertion to misstatement due to error or fraud before
considering controls. Control risk of the misstatement will not be prevented through reporting
the internal control of an entity. Paragraph 6 of ASA 330 states that the auditor shall plan and
proceed with the process of audit, which is responsive to the time, nature, and extent or based
on the assessed risk of material misstatements (Fortvingler 2016). ASA 330 guides the
auditor to plan and perform the process of audit. The auditor shall consider every transaction,
which is included in its similarity, characteristics, accounts, and disclosure through attaining
evidence.
Material misstatement at the financial statement level
The financial statement of a company is such a report that has several users who make
their economic decisions based on such reports. Therefore, any misstatement incurred to that
can affect the economic conditions of users or nation (Moroney and Trotman 2016).
Paragraph A1 of ASA 330 states that the response of an auditor shall address the risk through

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sustaining professional scepticism. The staff involved in the audit procedure shall be
experienced or skilled personnel (Czerney, Schmidt and Thompson 2014). There may be
some extent, and an auditor can bring some relevant changes in the audit procedures
according to the requirement.
Material misstatement Due to fraud
An intentional doing that leads to material misstatement within the report of an entity
is considered fraudulent activity and misstatement by fraud. As per ASA 330, the auditor shall
be responsible for determining the entire response to the risk assessed through a proper
assignment and supervision of the personnel involved in the audit. The personnel shall have
responsibilities and evaluating accounting policies that are indicating any fraudulent activity
while preparing the reports (Bhattacharjee, Maletta and Moreno 2016). Moreover, the auditor
shall be needed to incorporate the processes of the audit with unpredictability and revenue
recognition risk.
Management overrides of control
Management overrides of control are the intervention by management in handling the
data related to the financial statements and in making economic decisions as contrary to the
internal control policy. The risk of management override of internal control leads to
inadequate revenue recognition. As per ASA 240 Paragraph 33(a), the auditor shall design
and perform the audit [processes in order to mitigate the risk. The basic step that the auditor
shall take is related to the test appropriateness of the journal ledger that reflects whether the
journal entries are correctly recorded into the ledger. The suitor shall identify the entries in
order to reach an appropriate conclusion of its doubts (Mayes, Landes and Hasty 2018). The
auditor shall review and evaluate the estimation of accounting so that to get any point of
being bias. He/she shall evaluate the rationale for significant transactions and can add any
additional audit procedures.

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1.

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References
Auasb.gov.au 2020. [online] Auasb.gov.au. Available at:
https://www.auasb.gov.au/admin/file/content102/c3/ASA_330_Compiled_2015.pdf Accessed
23 Jan. 2020.
Auasb.gov.au 2020. online Auasb.gov.au. Available at:
https://www.auasb.gov.au/admin/file/content102/c3/ASA_315_Compiled_2015.pdf Accessed
23 Jan. 2020.
Auasb.gov.au 2020. online Auasb.gov.au. Available at:
https://www.auasb.gov.au/admin/file/content102/c3/ASA_240_Compiled_2019-FRL.pdf
Accessed 23 Jan. 2020.
Backof, A., Bowlin, K. and Goodson, B., 2014. The impact of proposed changes to the
content of the audit report on jurors' assessments of auditor negligence. Available at
SSRN, 2446057.
Bhattacharjee, S., Maletta, M.J. and Moreno, K.K., 2016. The role of account subjectivity and
risk of material misstatement on auditors' internal audit reliance judgments. Accounting
Horizons, 30(2), pp.225-238.
Cao, M., Chychyla, R. and Stewart, T., 2015. Big Data analytics in financial statement
audits. Accounting Horizons, 29(2), pp.423-429.
Czerney, K., Schmidt, J.J. and Thompson, A.M., 2014. Does auditor explanatory language in
unqualified audit reports indicate increased financial misstatement risk?. The Accounting
Review, 89(6), pp.2115-2149.

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DeFond, M.L., Lim, C.Y. and Zang, Y., 2016. Client conservatism and auditor-client
contracting. The Accounting Review, 91(1), pp.69-98.
Donelson, D.C., Ege, M.S. and McInnis, J.M., 2016. Internal control weaknesses and
financial reporting fraud. Auditing: A Journal of Practice & Theory, 36(3), pp.45-69.
Fortvingler, J., 2016. Different approaches to fraud risk assessment and their implications on
audit planning. Periodica Polytechnica Social and Management Sciences, 24(2), pp.102-112.
Kassem, R. and Higson, A.W., 2016. External auditors and corporate corruption: implications
for external audit regulators. Current Issues in Auditing, 10(1), pp.P1-P10.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Kramer, B., 2015. Trust, but verify: Fraud in small businesses. Journal of Small Business and
Enterprise Development.
Mayes Jr, C.R., Landes, C.E. and Hasty, H., 2018. Taking the Risk out of Risk Assessment:
Properly Considering a Client's Risks Is Essential to a Quality Audit. Journal of
Accountancy, 226(2), p.38.
Moroney, R. and Trotman, K.T., 2016. Differences in auditors' materiality assessments when
auditing financial statements and sustainability reports. Contemporary Accounting
Research, 33(2), pp.551-575.