Annual Audit Manual

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5028 Understand how inherent risk factors affect susceptibility of assertions to misstatement
Sep-2022

In This Section

Understand how inherent risk factors affect susceptibility of assertions to misstatement

Understand how inherent risk factors affect susceptibility of assertions to misstatement

CAS Requirement

The auditor shall perform risk assessment procedures to obtain an understanding of (CAS 315.19):

c) How inherent risk factors affect susceptibility of assertions to misstatement and the degree to which they do so, in the preparation of the financial statements in accordance with the applicable financial reporting framework, based on the understanding obtained in (a) and (b).

CAS Guidance

Understanding the entity and its environment, and the applicable financial reporting framework, assists the auditor in identifying events or conditions, the characteristics of which may affect the susceptibility of assertions about classes of transactions, account balances or disclosures to misstatement. These characteristics are inherent risk factors. Inherent risk factors may affect susceptibility of assertions to misstatement by influencing the likelihood of occurrence of a misstatement or the magnitude of the misstatement if it were to occur. Understanding how inherent risk factors affect the susceptibility of assertions to misstatement may assist the auditor with a preliminary understanding of the likelihood or magnitude of misstatements, which assists the auditor in identifying risks of material misstatement at the assertion level in accordance with paragraph 28(b). Understanding the degree to which inherent risk factors affect susceptibility of assertions to misstatement also assists the auditor in assessing the likelihood and magnitude of a possible misstatement when assessing inherent risk in accordance with paragraph 31(a). Accordingly, understanding the inherent risk factors may also assist the auditor in designing and performing further audit procedures in accordance with CAS 330 (CAS 315.A85).

The auditor's identification of risks of material misstatement at the assertion level and assessment of inherent risk may also be influenced by audit evidence obtained by the auditor in performing other risk assessment procedures, further audit procedures or in fulfilling other requirements in the CASs (see paragraphs A95, A103, A111, A121, A124 and A151) (CAS 315.A86).

The extent of susceptibility to misstatement of a class of transactions, account balance or disclosure arising from complexity or subjectivity is often closely related to the extent to which it is subject to change or uncertainty (CAS 315.A87).

Example:

If the entity has an accounting estimate that is based on assumptions, the selection of which are subject to significant judgment, the measurement of the accounting estimate is likely to be affected by both subjectivity and uncertainty.

The greater the extent to which a class of transactions, account balance or disclosure is susceptible to misstatement because of complexity or subjectivity, the greater the need for the auditor to apply professional skepticism. Further, when a class of transactions, account balance or disclosure is susceptible to misstatement because of complexity, subjectivity, change or uncertainty, these inherent risk factors may create opportunity for management bias, whether unintentional or intentional, and affect susceptibility to misstatement due to management bias. The auditor’s identification of risks of material misstatement, and assessment of inherent risk at the assertion level, are also affected by the interrelationships among inherent risk factors (CAS 315.A88).

Events or conditions that may affect susceptibility to misstatement due to management bias may also affect susceptibility to misstatement due to other fraud risk factors. Accordingly, this may be relevant information for use in accordance with paragraph 24 of CAS 240, which requires the auditor to evaluate whether the information obtained from the other risk assessment procedures and related activities indicates that one or more fraud risk factors are present (CAS 315.A89).

OAG Guidance

Understanding the entity and its environment, the applicable financial reporting framework and the entity’s accounting policies, helps us identify events or conditions which may indicate a risk of material misstatement at the financial statement level or the assertion level. The characteristics of these events or conditions which may affect the susceptibility of assertions about classes of transactions, account balances or disclosures to misstatement are inherent risk factors.

Inherent risk factors include complexity, subjectivity, change, uncertainty or susceptibility to misstatement due to management bias or other fraud risk factors insofar as they affect inherent risk. Inherent risk factors may affect susceptibility of assertions to misstatement by influencing the likelihood of occurrence of a misstatement or the magnitude of misstatement if it were to occur. As part of developing our understanding, we establish initial expectations of how inherent risk factors affect susceptibility of classes of transactions, account balances or disclosures to misstatement.

Once we have established our initial expectations about risks of material misstatement at the FSLI level, we assess these identified risks of material misstatement at the assertion level, including evaluating the degree to which inherent risk factors affect the susceptibility of assertions to misstatement. Refer to OAG Audit 5043.3 for guidance on evaluating inherent risk factors.

Example:

Sales of specialized deep sea drilling equipment used to extract crude oil is a significant revenue stream for the entity. As part of understanding the entity’s regulatory environment, newly proposed legislation is identified that, if adopted into law, will limit customer access to undertake deep sea drilling in certain reserve-rich locations.

The entity’s calculation of the provision for excess and obsolete inventory is based on future sales assumptions, the determination of which require significant judgment and this judgment will now need to take into account the potential impact of this proposed law. This new regulation may lead us to assess the inherent risk factors subjectivity, uncertainty and change as higher (i.e., moderate or high) for the valuation assertion of the risk "Method (including any model), significant assumptions and data used to estimate reserves related to slow-moving, obsolete or damaged goods are not appropriate/ reasonable" within the Inventory FSLI.