Audit Risk Analysis And Control in Organizations

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

1AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Table of Contents
Answer to Question 1.................................................................................................................2
Risk of Material misstatement...............................................................................................2
Factors that would affect the risk of material misstatement..................................................3
Answer to Question 2.................................................................................................................5
Audit Risks and Response of Auditors to assessed risks.......................................................5
References................................................................................................................................10

2AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Answer to Question 1
Risk of Material misstatement
A material misstatement refers to the incorrect information reported in the financial
statements, which may have a negative impact on the users on making economic decisions
(Knechel and Salterio 2016). Misstatements in reports are material when it influences the
decision-making, which is based on these reports. As per para A136 of ASA 315, potential
misstatement can be material and judged through its magnitude or the item’s nature and
circumstances. Material misstatement occurs due to an error or fraud (Backof, Bowlin and
Goodson 2014). An error occurs on the time when the misstatement has done unintentionally
while misstatement that has made intentionally comes under then category of fraudulent
activity. Material misstatements can be factual and judgmental.
The risk of material misstatement denotes to those risks that the organization has
misstated in its financial reports to a degree of material (Knechel and Salterio 2016).
According to Para 25(a) and 25(b) of ASA 315, the auditors can do the risk assessment for
material misstatement in two different levels that are at assertion level and at the financial
statement level.
According to para A122 of ASA 315, at the financial report level, risk of material
misstatement relates to the financial statement as a whole and has the potential to affect
several assertions. Para A123 states that risk may derive in specific from a poor control
environment (Auasb.gov.au 2020). As per ASA 315 Paragraph A126, risk of material
misstatement in respect with the transactions, disclosures, and account balance at the
assertion level are necessary to be considered. Considering will assists the auditors in
determining timing, nature and other audit processes so that to obtain enough proper audit
proof at the assertion level.

3AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Factors that would affect the risk of material misstatement
ASA 315 states the entity and Its Environment consists of numerous factors that an
auditor has to consider in respect to the risk of material misstatement. Along with the internal
factors, ASA 315 discusses with Paragraph A25 that states about Industry factors, para A27
states about Regulatory factors, and para A30 says other external factors.
According to the given information, J Audrey Pearce as an audit partner of Pearce
Green is considering risk of audit at the entire financial statement level for Homes South Ltd
that is a finance company. The factors that are likely to affect the risk of material
misstatement are as follows:
I. Volatility in the Interest Rates
First factor is related to interest rates. Homes South Ltd is constantly gaining
additional profits than the industry average by means of marketing mortgages on properties in
wealthy rural areas. Homes South Ltd packages and sells mortgages to large investment
trusts. In spite of being volatility in the interest rates, Homes South Ltd is able to sell its
mortgages on a continuous basis.
The external factors related to the entity and its environment can affect the risk of
material misstatement. According to Para A30 of ASA 315 related to the external factors, the
auditor has to consider the general economic condition, availability of financing, interest
rates, currency revaluation or inflation.
Volatility in the interest risk has the capability to increase or decrease the value of
mortgages. However, Homes South Ltd has considerable growth in recent years. Thus, there
may be a possibility to have differences in the interest rate dealt with the large investment
trusts (Bhattacharjee, Maletta and Moreno 2015). The auditor may have to consider the

4AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
amount represented in the financial report is misstated or not. The situation can give rise to
material misstatement that has to be found by the auditor if any.
II. The majority shareholder is also the Chief Executive officer who also control the
Board of Directors
George Watson, who is the principal shareholder of Homes South Ltd, controls the
Board of Directors and has the power as a Chief Executive Officer. Management at the
branch offices of the company has the authority for directing and controlling the operations of
the Homes South Ltd and compensated a per the branch profitability.
The company’s performance measure indicates the unusual growth or profitability
when it is compared to the other companies working under the same industry (Awadallah and
El Said 2018). If such information is combined together with the factors like compensation,
incentive or bonus, then it may indicate the risk related with the management bias while
preparing the financial report (Bentley-Goode, Newton and Thompson 2017). Therefore, the
auditor may take internal measures as stated in Para A48 of ASA 315, which may highlight
the unexpected outcomes or trends. It also indicates to the auditor that the risk of
misstatements does exist with the related reports.
III. Failure of management to provide reliable accounting estimates
During the year 2019, the company has opened a branch office in a much bigger area
than its principal business place. However, the branch is not yet profitable, but management
has believed that it will generate profit by the year 2021.
The possible entity risk that may arise is from the expansion of the business.
Therefore, as per Para A40 of ASA 315, an auditor may consider the entity's risk that may
result into the material misstatement includes services, new product and industry

5AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
developments as well as expansion of the business (Auasb.gov.au 2020). It is possible here
that demand has not been assessed correctly.
IV. Installation of new Computer System
During the year 2019, the company improved the efficiency of its operations through
setting up a new computer system. Homes South Ltd indicates the risk related with the
operating style of operating management. The personnel of the computer system may reduce
the risk, but it cannot mitigate bias by the management within the company so that to
overstate earnings (Mosier and Skitka 2018). As per Para A82, an active or independent
board of directors may influence the management, and there may be the possibility of
misstatement.
An auditor should not undervalue the significance of ASA 315 as the requirement
stated under this related to the assessment of risk. When the risk related with the material
misstatement is high, and then the level of detection risk becomes lower due to increase in
evidence obtained from the essential processes (Mayes Jr, Landes and Hasty 2018). An
auditor can ensure that audits are responsive to an individual audit client and with the proper
application of such standards, the risks can be reduced.
Answer to Question 2
Audit Risks and Response of Auditors to assessed risks
Darfield electronics have a considerable increase of 27% in its revenue during the
year 2021. It is required to follow up the cost of sales and inventory within the period.
Darfield electronics have a 31% increase in its inventory and a 10% increase in its cost of
sales. However, Darfield electronics has shown their increment of 33% in its trade payables,
including reducing their cash to nil along with $206000 as their bank overdraft. Nevertheless,
it is questionable to Darfield electronics about the requirement of cash and overdraft at the

6AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
same time (Yeong and Liang 2017). A certain increase in the trade payables and timings also
need to be verified.
After certain possible increment in their inventories, its operating expenses have also
increased by 79% during the year, and then their gross profit is resulting in an increase of
50% during the year. The cost of operating expense (1718) is low as compared to the revenue
of 5267. As compared to the previous year, the operating expenses have been increased. It is
to be detectable about the deterioration in the efficiency of the operation during the year.
The reported profitability of Darfield electronics is to be crosschecked by the auditor.
As it may be possible that the entity has shown its profits as not as same as their actual one so
that to influence the others to have a positive view about them (Moroney and Trotman 2016).
The information provided by the company can be misrepresented, and they might have the
possibility for material misstatements.
Financial Information for Darfield Electronics
Particulars % increase (↑) or decrease (↓) in
the year 2021 compared
to 2020
Revenue ↑ 27%
Cost of Sales ↑ 10%
Gross Profit ↑ 50%
Operating expenses ↑ 79%
Profit Before Interest and tax ↑ 17%
Cash ↓ 100%
Trade Receivables ↑ 58 %
Inventory ↑ 31%

7AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Trade Payables ↑ 33%
The following are the risk related to the audit within the given financial information:
Risk of material misstatement: Darfield electronics has an outcome of 50% increase
in gross profit as from the previous year. The company has shown an increased amount to
58% of receivables. There may be a possibility of risk related to material misstatement so that
the company can show a better side of them. However, it is required to check all the
transactions and confirmations so that to confirm their report as true or there is any error or
fraud as material misstatement (Kachelmeier, Schmidt and Valentine 2017). According to
ASA 240 (paragraph 26), following accordingly ASA 315, the risks related with material
misstatements because of fraud at the financial report level as well as for disclosures, account
balances and transactions at the assertion level, shall be identified and assessed by the
auditor. The risk in audit in material misstatement may occur due to lack of professional
scepticism or an intention to give favourable support to the company.
Risk of Revenue recognition: it is not possible for any organizations to exist without
cash flow. Therefore, revenue plays an important part in the existence of a company. The
amount $1030 of profit before interest and tax is stated by the company whereas its revenue
reached to $5267 after during the year. It seems that company may have risk for misstatement
due to fraud or management control (Wright 2016). According to ASA 240 (para 27), on the
presumption based that there is risk of fraud in terms with the revenue recognition, an auditor
shall evaluate the type of revenue, transactions of revenue or any assertions that gives rise to
such risks while identifying and assessing the revenue recognition risks related to the material
misstatement. As per para A31 of ASA 240, the risk related to the audit is about rebutting
about the fraud in the revenue recognition.

8AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Risk of entity’s control: As per ASA 315 (para A54 and A55), the effectiveness of
internal control just provide a reasonable assurance in order to attain their purposes of
financial reporting. It may have the risk to get affected due to limitations of the
management’s or internal control (Donelson, Ege and McInnis 2016). The decision-making
can be faulty, or there may be an occurrence of human error. Additionally, there may be a
situation to override of internal control by inappropriate management (Ruhnke and Schmidt
2014). There is a possibility that management may enter in agreements with the clients
separately that can modify the terms and conditions of the company's sales contract, thereby
resulting in improper revenue recognition.
Response to the assessed Risk of Material Misstatement at the financial report level
As per paragraph A1 of ASA 330, an auditor response to address such risk is through
emphasizing to the audit team so that to sustain professional scepticism (Auasb.gov.au 2020).
The response includes assigning experienced staffs with high skill as well as to provide more
supervision. There may be the incorporation of additional elements of unpredictability or may
make general changes related to the timing, nature and extent of the audit procedures.
Response to the assessed Risk of Material Misstatement at the Assertion level
According to Paragraph 6 of ASA 330, the auditor shall plan and perform audit
processes whose timing, extent and nature are responsive to or based on the assessed risks
related with the audit risks of material misstatement. To plan and perform the audit
procedure, an auditor is guided by ASA 330 (para 7) that audit shall consider the reasons for
each class of transactions that include its likelihood and its characteristics, accounts and
disclosure by obtaining evidence.

9AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Response to the assessed Risk of Material Misstatement due to fraud
According to ASA 330, the auditor determines the overall response to the assessed
risks by assigning and supervising personnel with responsibilities and evaluating accounting
policies that are to be indicative of fraudulent activity while preparing the reports. Further, an
auditor has to incorporate audit procedures, including element of unpredictability as well as
to presume revenue recognition risk (Fortvingler 2016).
Response to the assessed Risk of Management Overrides of Control
The risk of management overrides of control also results in improper revenue
recognition. According to ASA 240 para 33(a), in order to mitigate this risk, auditor shall
design and perform some audit procedures relate to it. The initial step is to Test
appropriateness of the journal entries into the ledger. While identifying the journal entries, an
auditor shall concern the matter that is relevant to reach an appropriate conclusion (Sanderson
2014). As per ASA 240 (para A44), the matter includes the risks of material misstatement
because of fraud, controls that have been implemented over the journal entries, financial
reporting process and nature, nature of complexity to accounts and so on. The next step is to
review and evaluate the accounting estimates fir any biases that have been mentioned under
para A46 to A48 of ASA 240. Then the auditor has to evaluate the business rationale for the
significant transactions, and at last, they may perform any other additional audit procedures.

10AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
References
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 11 Jan. 2020].
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 11 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 11 Jan. 2020].
Awadallah, A. and El Said, H.M., 2018. Auditors’ Usage of Non-Financial Data and
Information during the Assessment of the Risk of Material Misstatement for an Audit
Engagement: A Field Study. Accounting and Finance Research, 7(1).
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.
Bentley-Goode, K.A., Newton, N.J. and Thompson, A.M., 2017. Business strategy, internal
control over financial reporting, and audit reporting quality. Auditing: A Journal of Practice
& Theory, 36(4), pp.49-69.
Bhattacharjee, S., Maletta, M.J. and Moreno, K.K., 2015. The role of account subjectivity and
risk of material misstatement on auditors' internal audit reliance judgments. Accounting
Horizons, 30(2), pp.225-238.

11AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
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.
Kachelmeier, S.J., Schmidt, J.J. and Valentine, K., 2017. The disclaimer effect of disclosing
critical audit matters in the auditor’s report. Working paper.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
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.
Mosier, K.L. and Skitka, L.J., 2018. Human decision makers and automated decision aids:
Made for each other?. In Automation and human performance (pp. 201-220). Routledge.
Ruhnke, K. and Schmidt, M., 2014. Misstatements in financial statements: The relationship
between inherent and control risk factors and audit adjustments. Auditing: A Journal of
Practice & Theory, 33(4), pp.247-269.
Sanderson, J., 2014. Audit issues. SMSF Guide: Current Issues and Strategies for the Self-
Managed Superannuation Funds Adviser, p.377.
Wright, W.F., 2016. Client business models, process business risks and the risk of material
misstatement of revenue. Accounting, Organizations and Society, 48, pp.43-55.

12AUDIT RISK, ANALYSIS AND CONTROL IN ORGANIZATIONS
Yeong, L.C. and Liang, F.S., 2017. Financial reporting risks in relation to financial
instruments. In The Routledge Companion to Accounting and Risk (pp. 49-63). Routledge.