Understanding a Client to Identify the Risk of Material Misstatements

This article discusses the process of understanding a client to identify the risk of material misstatements in their financial statements. It covers the results of analytical procedures, the risk of material misstatement at the financial report level, and the risk of material misstatement at the assertion level. The article also provides relevant substantive audit procedures and internal controls.

Running head: UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Understanding a Client to Identify the Risk of Material Misstatements
Name of the Student
Name of the University
Author’s Note

1UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Executive Summary
It can be seen from the findings of the analytical procedures that there are certain areas in the
financial statements of Nine Entertainment that are at the risk of material misstatement. As per the
outcome of the simple comparison, major fluctuations are there in the revenue and net profit of the
company. The analysis of ratios shows that there are risks in the liquidity, efficiency, gearing and
profitability position of Nine Entertainment and the auditors are needed to consider these aspects in
the audit planning stage. After that, it can be seen from the analysis of inherent risk at the financial
report level that the company does not face any inherent risk from management’s integrity and
experience and knowledge of the management. However, inherent risk is high due to the unusual
pressure on management, nature of the business of Nine Entertainment and the major factors
affecting the media entertainment industry in Australia. The last part shows that three accounts are
at the risk of material misstatement; they are revenue, interest bearing loans and borrowings and
trade and other receivables. The main assertions related to these accounts are occurrence for
revenue; completeness, classification and obligation for interest bearing loans and borrowings; and
existence and valuation for trade and other receivables.

2UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Table of Contents
Requirement 1 – Results of Analytical Procedures................................................................................3
Simple Comparison............................................................................................................................3
Ratio Analysis.....................................................................................................................................3
Requirement 2 – Risk of Material Misstatement (Inherent Risk) at the Financial Report Level............6
Requirement 3 – Risk of Material Misstatement (Inherent Risk) at the Assertion Level.......................8
References...........................................................................................................................................11
Appendix.............................................................................................................................................13

3UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Requirement 1 – Results of Analytical Procedures
Simple Comparison
The following discussion shows the comparison of the main balances of the income
statement and balance sheet of Nine Entertainment.
Income Statement – fluctuation can be seen in the revenue of the company which decreases from
2016 to 2017 that is from $1,286,360,000 to $1,244,955,000; and then again increases in the year
2018 that is $1,403,945,000. This is a significant fluctuation which needs to be considered in the
audit planning for investigation (prod.static9.net.au, 2019). Significant fluctuations can also be seen
in the net profit which became negative from 2016 to 2017 that is from $57,049,000 to
($190,854,000); and then again massively increases in the year 2018 that is $274,978,000 which
indicates towards possible material misstatement regarding net profit (prod.static9.net.au, 2019).
This aspect needs to be investigated in the audit planning stage.
Balance Sheet – The presence of a decreasing trend can be seen in case of total assets which
decrease from 2016 to 2018 that is $2,148,040,000, $1,901,561,000 and $1,853,625,000 from 2016
to 2018 respectively. The reason for this continuous decrease in the total assets should be
investigated in the audit planning stage. Certain fluctuations can be seen in the case of total
liabilities which increases from 2016 to 2017 that $927,861,000 from$914,201,000; and it again
decreases in 2018 that is $744,586,000 (prod.static9.net.au, 2019). Major fluctuation can also be
seen in the balance of net assets since decrease in net assets can be seen in 2017 from 2016 that is
$973,700 from $1,233,839,000; and it again increases in the year 2018 that is $1,109,039,000
(prod.static9.net.au, 2019). The same fluctuation can be seen in case of the value of total equity of
Nine Entertainment. This value decreases from 2016 to 2017 and then increases in 2018. Since these
fluctuations can be seen in the major balances in the balance sheet, these balances need to be
tested in the audit planning stage.
Ratio Analysis
Liquidity Ratios

4UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
The above table shows the presence of fluctuation in both the liquidity ratios from 2016 to
2018 which indicates towards the instability in Nine Entertainment’s liquidity position. Main
accounts involved with these ratios are current assets, current liabilities, inventories and
prepayments. The examination of these accounts needs to be considered in the audit planning stage
(Plumlee, Rixom & Rosman, 2014).
Efficiency Ratios
The above table shows an increasing trend in the asset turnover ratio of Nine Entertainment
from 2016 to 2018 when there are fluctuations in the values of sales and average total assets. In
addition, fluctuations can also be seen in accounts receivable turnover ratio from 2016 to 2018.
Thus, the balances of the accounts related to these ratios need to be taken into consideration in the
audit planning stage (Jans, Alles & Vasarhelyi, 2014).
Gearing Ratios
The presence of major fluctuation can be seen in debt to equity ratio which is associated
with the balances of total liabilities and total equity. Thus, the investigation of the balance of debt
needs to be taken into consideration at the audit planning stage. On the other hand, there is a major
increasing trend in the interest coverage ratio and it needs to be considered in the audit planning
stage due to this continuous increasing trend (Pike, Curtis & Chui, 2013).

5UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Profitability Ratios
The above table shows major fluctuation in the net profit ratio of Nine Entertainment which
is a significant matter in the audit planning stage. After that, in the presence of a continuous
increasing trend in return on capital employed ratio, the associated accounts balances with this ratio
needs to be considered at the audit planning stage (Glover, Prawitt & Drake, 2014).
As per the above discussion, the outcome of the analytical procedures of simple comparison
and ratio analysis shows the crucial areas that are at the risk of material misstatement such as
revenue, net profit, net assets and ratios such as net profit ratio, liquidity ratios and others. These
aspects have major influence in the audit planning procedure since it is needed to decide which
fluctuations are significant and need to be tested through substantive audit procedures.

6UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Requirement 2 – Risk of Material Misstatement (Inherent Risk) at the Financial Report Level
The following discussion shows the inherent risk of Nine Entertainment at the financial
statement level.
a. Integrity of Management – Management integrity is considered as a key determinant of the risk
structure of the clients since it is the foundation of the internal control. The same aspect is also
applicable in the case of Nine Entertainment because of the fact that the lack of integrity of the
management can affect the base of the organizational internal control. It can be seen that the
majority portion of the directors of Nine Entertainment are non-executive as well as independent in
nature. In addition, the presence of both People & Remuneration Committee and Audit and Risk
Committee can be seen in Nine Entertainment that ensures the presence of integrity of the
management in the company. In the presence of this reasons, inherent risk related to integrity of
management can be considered as low in Nine Entertainment (prod.static9.net.au, 2019).
b. Management Experience, Knowledge and Changes during the Period – Proper experience as well
as knowledge of the management of the companies is also considered as a crucial aspect for the
inherent audit risk since lack of knowledge and experience of the directors can affect the company’s
internal control. It can be seen from the 2018 Annual Report of Nine Entertainment that all the six
directors of the company are well-skilled as well as experience. They also have major past
experience. However, it needs to be mentioned that two independent non-executive directors of
Nine Entertainment have recently changed in the year 2017. This can lead to the development of
inherent risk related to the material misstatements in the financial statements of Nine
Entertainment (nineentertainmentco.com.au, 2019).
c. Unusual Pressure on Management – It needs to be mentioned that the unusual pressure on the
management of the companies can create inherent risk of material misstatement in the financial
statements and there is no exception in Nine Entertainment. Nine Entertainments operates in the
highly competitive Australian media industry where the directors are always under pressure to
perform well in this industry (gfk.com, 2019). At the same time, the directors always have to deal
with the ever increasing demand of the company’s shareholders and other investors for higher
return. Under this pressure, the directors of Nine Entertainment may manipulate the financial
statements of their business to show good financial performance and position in manipulative
manner. This can lead to the development of inherent audit risk in the financial statements of Nine
Entertainment.

7UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
d. Nature of Entity’s Business – Nature of the business entity is considered as a crucial aspect for the
determination of the inherent risk for the companies and the same is applicable for Nine
Entertainment. It needs to be mentioned that Nine Entertainment operates in the Australian media
industry which is considered as one of the most competitive industry of Australia. In addition, digital
transformation is redefining this entertainment and media industry and there is increasing demand
of the users of this industry (pwc.com.au, 2019). This nature of industry creates demand on the
management of the company for sustaining in the competition. This increases the chance of
fraudulent activities in the company’s financial statements for artificially improving their financial
position. This leads to the increase in the inherent risk of the company related to the material
misstatement in the financial statements.
e. Factors Affecting the Industry in which the Entity Operates – It needs to be mentioned that the
media entertainment industry of Australia is exposed to certain risks such as political factors,
economic factors, social factors and others. Thus, the company is needed to comply with these rules
and regulations for staying in this industry. In addition, Nine Entertainment is also required to
comply with the regulations as well as rules related to environment as well as sustainability. The
presence of these kinds of rule and regulations of this industry put pressure on the management of
the company (abc.net.au, 2019). All these aspects lead to the development of inherent risk in the
financial statements.
As per the above discussion, there is not any inherent audit risk due to the lack of integrity
of management and management’s knowledge, experience and changes during the period.
However, other three factors lead to the inherent audit risk because the management of Nine
Entertainment has additional pressure to make the company’s performance better. In addition, the
nature of Nine Entertainment and the industry in which it operates also lead to inherent risk.

8UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Requirement 3 – Risk of Material Misstatement (Inherent Risk) at the Assertion Level
Specific Account Balance: Revenues ($1,403,945,000 in 2018)
(a) Explanation on the risk of
material misstatement
There is major fluctuation in the revenue over the last three
years and significant rise in it can be seen in the current year.
Thus, the account of revenue is at risk of material
misstatements in the presence of the possibilities that the
management of Nine Entertainment can intentionally
overstate the revenue or the recognition criteria has not be
properly followed by the management. This can be due to the
presence of extra pressure on the management of the
company to perform well (Wright, 2016).
(b) Explanation on key assertion The main assertion involved in this case is Occurrence. This
particular assertion helps in testing whether the revenue
related transactions that have been recorded in the financial
statements actually took place. This is considered as one of
the most crucial assertions for revenue and this assertion is at
the risk of not being valid (Kurniawan, 2013).
(c) Relevant substantive audit
procedure
One most relevant substantive audit procedure for addressing
this assertion at risk is to check the fact that whether the
revenues of Nine Entertainment in 2018 have met the criteria
for valid sales or not. Under this procedure, it is required to
examine all the documents associated with revenue along
with the examination of journal entries related to revenue.
This procedure will be helpful in identifying the material
misstatements in the balance of revenue (Knechel & Salterio,
2016).
(d) Relevant practical internal
control
One practical as well as crucial relevant internal control in this
situation is the implementation and use of an Integrated
Application System for performing the activities like sales,
cash register receipts and inventory management processing.
In the presence of this integrated application system, general
ledger will be automatically updated through the application
system. This will help in reducing the chance of material

9UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
misstatement in revenue (Feng et al., 2014).
Specific Account Balance: Interest Bearing Loans and
Borrowings ($157,646,000 in 2018
(a) Explanation on the risk of
material misstatement
As per the Consolidated Statement of Financial Position of
2018 and 2017, interest bearing loans and borrowings
increased from 2016 to 2017; but it majorly decreases in 2018
from 2017 that is $157,646,000 from $291,175,000. The
balance of interest bearing loans and borrowings is at the risk
of material misstatements in the presence of the major
possibility that the management of Nine Entertainment has
intentionally understated the debts or has omitted them
(Titera, 2013).
(b) Explanation on key assertion The key assertions that are at risk in this case are
Completeness, Classification and Obligation. Completeness
and classification mean that the company has correctly
completed the debts and they are classified in the correct
manner. Obligation means that Nine Entertainment owes the
debts, not other company. These three assertions are not
being valid in the case of Nine Entertainment (Kharisova &
Kozlova, 2014).
(c) Relevant substantive audit
procedure
In this situation, the most relevant substantive audit
procedure for these debts is the summarising and testing the
covenants related to interest bearing loans and borrowings
along with confirming all significant long term loans and
borrowings with the lenders. In this process, it is required to
determine the fact that whether the management of Nine
Entertainment has classified all the interest bearing loans and
borrowings in appropriate manner such as current or non-
current basis. This procedure will help the auditor in
ascertaining any understated interest bearing loans and
borrowings (Cannon & Bedard, 2016).
(d) Relevant practical internal
control
A relevant practical internal control related to this interest
bearing loans and borrowings is to appoint an external trustee

10UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
for monitoring the debt covenants and investors relations.
This can reduce the change of debt-understatement by the
company (Achtziger et al., 2015).
Specific Account Balance: Trade and Other Receivable
($285,469,000 in 2018)
(a) Explanation on the risk of
material misstatement
It can be seen that there is a fluctuation in the trade and other
receivable and it increases in 2018 from 2017 that is
$285,469,000 from 261,339,000. Thus, the account of trade
and other receivable is at the risk of material misstatement
due to the fact that the management of Nine Entertainment
can overstate the trade and other receivable (Hribar, Kravet &
Wilson, 2014).
(b) Explanation on key assertion The key assertions at risk for trade and other receivable are
existence and valuation because these assertions mean that
the trade and other receivable exist and they have been
properly valued (Bumgarner & Vasarhelyi, 2018).
(c) Relevant substantive audit
procedure
The relevant substantive audit procedure is to ensure
confirmation of the balances of trade and other receivables
along with vouch subsequent period collections in order to
makes sure that subsequent collections are related to period
end balances (Elder et al., 2013).
(d) Relevant practical internal
control
One most relevant internal control for trade and other
receivable is the review of the accounts receivable journal
entries. It is needed to test these journal entries carefully
(Osadchy & Akhmetshin, 2015).
It can be seen from the above discussion that three accounts that are at the risk of material
misstatements are revenue accounts, interest bearing loans and borrowings and trade and other
receivables. These accounts have been considered at the risk of material misstatement in the
presence of vast possibilities that the management of Nine Entertainment could misstate these
accounts for various reasons.

11UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
References
Achtziger, A., Hubert, M., Kenning, P., Raab, G., & Reisch, L. (2015). Debt out of control: The links
between self-control, compulsive buying, and real debts. Journal of Economic
Psychology, 49, 141-149.
ASX Announcements - Nine. (2019). Nineentertainmentco.com.au. Retrieved 22 May 2019, from
https://www.nineentertainmentco.com.au/investor-centre/asx-announcements
Australian entertainment & media industry must make ‘frenemies’ to grow. (2019). PwC. Retrieved
22 May 2019, from https://www.pwc.com.au/press-room/2017/entertainment-media-
outlook.html
Bumgarner, N., & Vasarhelyi, M. A. (2018). Continuous auditing—a new view. In Continuous
Auditing: Theory and Application (pp. 7-51). Emerald Publishing Limited.
Cannon, N. H., & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence from
the field. The Accounting Review, 92(4), 81-114.
Content and competition in a changing media world. (2011). ABC News. Retrieved 22 May 2019,
from https://www.abc.net.au/news/2011-11-25/scott-content-in-a-changing-media-world/
3695084
Elder, R. J., Akresh, A. D., Glover, S. M., Higgs, J. L., & Liljegren, J. (2013). Audit sampling research: A
synthesis and implications for future research. Auditing: A Journal of Practice &
Theory, 32(sp1), 99-129.
Feng, M., Li, C., McVay, S. E., & Skaife, H. (2014). Does ineffective internal control over financial
reporting affect a firm's operations? Evidence from firms' inventory management. The
Accounting Review, 90(2), 529-557.
Glover, S. M., Prawitt, D. F., & Drake, M. S. (2014). Between a rock and a hard place: A path forward
for using substantive analytical procedures in auditing large P&L accounts: Commentary and
analysis. Auditing: A Journal of Practice & Theory, 34(3), 161-179.
Hribar, P., Kravet, T., & Wilson, R. (2014). A new measure of accounting quality. Review of
Accounting Studies, 19(1), 506-538.
Jans, M., Alles, M. G., & Vasarhelyi, M. A. (2014). A field study on the use of process mining of event
logs as an analytical procedure in auditing. The Accounting Review, 89(5), 1751-1773.

12UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Kharisova, F. I., & Kozlova, N. N. (2014). Applying the category of «Assertions (or preconditions)» In
audit of financial statement. Mediterranean journal of social sciences, 5(24), 180.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.
Kurniawan, A. (2013). The effect of earnings management and disclosure on information
asymmetry. International Journal Of Scientific & Technology Research, 2(8), 98-107.
Media and Entertainment. (2016). Gfk.com. Retrieved 22 May 2019, from https://www.gfk.com/en-
au/industries/media-and-entertainment/
Osadchy, E. A., & Akhmetshin, E. M. (2015). Development of the financial control system in the
company in crisis. Mediterranean Journal of Social Sciences, 6(5), 390.
Pike, B. J., Curtis, M. B., & Chui, L. (2013). How does an initial expectation bias influence auditors'
application and performance of analytical procedures?. The Accounting Review, 88(4), 1413-
1431.
Plumlee, R. D., Rixom, B. A., & Rosman, A. J. (2014). Training auditors to perform analytical
procedures using metacognitive skills. The Accounting Review, 90(1), 351-369.
Prod.static9.net.au. (2019). Annual Report 2018 . Retrieved 22 May 2019, from
http://prod.static9.net.au/_/media/Network/NineEntertainmentCo/PDF-Downloads/
Annual-Report-FY-2018-Final.pdf
Titera, W. R. (2013). Updating audit standard—Enabling audit data analysis. Journal of Information
Systems, 27(1), 325-331.
Wright, W. F. (2016). Client business models, process business risks and the risk of material
misstatement of revenue. Accounting, Organizations and Society, 48, 43-55.

13UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Appendix
Balance Sheet for 2018

14UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Balance Sheet for 2017

15UNDERSTANDING A CLIENT TO IDENTIFY THE RISK OF MATERIAL MISSTATEMENTS
Balance Sheet for 2016