5042 Determine relevant assertions and significant FSLIs

Sep-2022

CAS Guidance

In identifying and assessing the risks of material misstatement, the auditor may use the categories of assertions as described in paragraph A190(a)-(b) below or may express them differently provided all aspects described below have been covered. The auditor may choose to combine the assertions about classes of transactions and events, and related disclosures, with the assertions about account balances, and related disclosures (CAS 315.A189).

Assertions used by the auditor in considering the different types of potential misstatements that may occur may fall into the following categories (CAS 315.A190):

1. Assertions about classes of transactions and events, and related disclosures for the period under audit:

   1. Occurrence—transactions and events that have been recorded or disclosed, have occurred and such transactions and events pertain to the entity.
   2. Completeness—all transactions and events that should have been recorded have been recorded, and all related disclosures that should have been included in the financial statements have been included.
   3. Accuracy—amounts and other data relating to recorded transactions and events have been recorded appropriately, and related disclosures, have been appropriately measured and described.
   4. Cutoff—transactions and events have been recorded in the correct accounting period.
   5. Classification—transactions and events have been recorded in the proper accounts.
   6. Presentation—transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

2. Assertions about account balances, and related disclosures, at the period end:

   1. Existence—assets, liabilities, and equity interests exist.
   2. Rights and obligations—the entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
   3. Completeness—all assets, liabilities and equity interests that should have been recorded have been recorded, and all related disclosures that should have been included in the financial statements have been included.
   4. Accuracy, valuation and allocation—assets, liabilities, and equity interests have been included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments have been appropriately recorded, and related disclosures have been appropriately measured and described.
   5. Classification—assets, liabilities and equity interests have been recorded in the proper accounts.
   6. Presentation—assets, liabilities and equity interests are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

The assertions described in paragraph A190(a)-(b) above, adapted as appropriate, may also be used by the auditor in considering the different types of misstatements that may occur in disclosures not directly related to recorded classes of transactions, events or account balances (CAS 315.A191).

Example: An example of such a disclosure includes where the entity may be required by the applicable financial reporting framework to describe its exposure to risks arising from financial instruments, including how the risks arise; the objectives, policies and processes for managing the risks; and the methods used to measure the risks.

Considerations Specific to Public Sector Entities

When making assertions about the financial statements of public sector entities, in addition to those assertions set out in paragraph A190(a)-(b), management may often assert that transactions and events have been carried out in accordance with law, regulation or other authority. Such assertions may fall within the scope of the financial statement audit (CAS 315.A192).

OAG Guidance

The following table shows how the assertions we use in OAG Audit map to the assertions identified in CAS 315. These OAG assertions were developed to simplify the use of financial statement assertions identified in CAS 315:

CAS assertion	OAG assertion	Abbreviation
Accuracy	Accuracy	A
Completeness	Completeness	C
Cutoff	Cutoff	CO
Existence	Existence/occurrence	E/O
Occurrence
Classification	Presentation and disclosure	PD
Presentation
Rights and obligations	Rights and obligations	RO
Valuation and allocation	Valuation	V
Authorities	Authorities	AU

CAS Guidance

Assertions—Representations, explicit or otherwise, with respect to the recognition, measurement, presentation and disclosure of information in the financial statements which are inherent in management representing that the financial statements are prepared in accordance with the applicable financial reporting framework. Assertions are used by the auditor to consider the different types of potential misstatements that may occur when identifying, assessing and responding to the risks of material misstatement (CAS 315.12a).

In identifying and assessing the risks of material misstatement, the auditor uses assertions to consider the different types of potential misstatements that may occur. Assertions for which the auditor has identified related risks of material misstatement are relevant assertions (CAS 315.A188).

Categories of assertions are used by auditors to consider the different types of potential misstatements that may occur when identifying, assessing and responding to the risks of material misstatement. Examples of these categories of assertions are described in paragraph A190. The assertions differ from the written representations required by CAS 580, to confirm certain matters or support other audit evidence (CAS 315.A1).

CAS Guidance

Paragraph 18 requires the auditor to design and perform substantive procedures for each material class of transactions, account balance, and disclosure. For significant classes of transactions, account balances and disclosures, substantive procedures may have already been performed because paragraph 6 requires the auditor to design and perform further audit procedures that are responsive to the assessed risks of material misstatement at the assertion level. Accordingly, substantive procedures are required to be designed and performed in accordance with paragraph 18 (CAS 330.A43):

• When the further audit procedures for significant classes of transactions, account balances or disclosures, designed and performed in accordance with paragraph 6, did not include substantive procedures; or
• For each class of transactions, account balance or disclosure that is not a significant class of transactions, account balance or disclosure, but that has been identified as material in accordance with CAS 315.

This requirement reflects the facts that: (a) the auditor’s assessment of risk is judgmental and so may not identify all risks of material misstatement; and (b) there are inherent limitations to controls, including management override.

Not all assertions within a material class of transactions, account balance or disclosure are required to be tested. Rather, in designing the substantive procedures to be performed, the auditor’s consideration of the assertion(s) in which, if a misstatement were to occur, there is a reasonable possibility of the misstatement being material, may assist in identifying the appropriate nature, timing and extent of the procedures to be performed (CAS 330.A44).

OAG Guidance

Significant FSLIs

CAS 315 defines significant classes of transactions, account balances or disclosures as those for which there are one or more relevant assertions. Assertions are considered relevant when they have an identified risk of material misstatement (CAS 315.12). When we identify a reasonable possibility of material misstatement at the assertion level for an FSLI, it is considered a “significant FSLI”. For further guidance on relevant assertions, refer to the block ‘Relevant assertions’ below.

Our identification of significant FSLIs and relevant assertions assists us in determining the procedures needed to address the risks of material misstatement (i.e., controls and substantive tests). If we determine that an FSLI is not considered a significant FSLI, we would not need to perform further audit procedures over the FSLI, unless the FSLI is material. If an FSLI is not determined to be significant but it is material (i.e., there is no reasonable possibility of material misstatement for the FSLI and therefore no relevant assertions are identified, but it is quantitatively material), CAS 330.18 requires us to perform substantive procedures solely because the requirement of CAS 330 to perform substantive procedures for material FSLIs applies irrespective of the results of our risk assessment. For further guidance on our procedures over material but not significant FSLIs, refer to the block “FSLIs not determined to be significant but that are material” below. The following table briefly summarizes the FSLI categories we would identify as part of our risk assessment and scoping:

FSLI Category	FSLI Characteristics
Significant	Risks of material misstatement are identified at the FSLI assertion level
Not significant but material	No risks of material misstatement are identified, but the FSLI is quantitatively or qualitatively material*
Not significant and not material	No material risks of understatement are identified and the FSLI is not considered material

*- FSLIs that exceed performance materiality are generally considered for testing. In some cases, we may determine an FSLI to be qualitatively material, even if it does not exceed performance materiality. Refer to OAG Audit 2103 for guidance. If an FSLI that does not exceed performance materiality is determined to be qualitatively material, typically these qualitative considerations would also give rise to a risk of material misstatement, in which case the FSLI would be considered significant.

The following chart briefly summarizes the process of identifying significant FSLIs. The purpose of providing this chart is only to illustrate at a high level the logical flow and steps in the process. This chart does not aim to illustrate all relevant considerations that need to be taken into account in making important judgments; refer to the detailed guidance provided further in this subsection for the relevant factors to consider:

In accordance with CAS 200.A16, a risk of material misstatement exists when there is a reasonable possibility of a misstatement occurring (i.e., its likelihood) and being material if it were to occur (i.e., its magnitude). If there is a reasonable possibility the FSLI could contain a misstatement that, individually or when aggregated with other misstatements, has a material effect on the financial statements, considering the risks of both overstatement and understatement, it would be considered a significant FSLI. The determination of whether an FSLI is significant is based on our assessment of inherent risk, without regard to the effect of controls. A sufficient understanding of the FSLI and related business process is necessary to determine whether there is a reasonable possibility of a material misstatement related to the FSLI. Further guidance on ’reasonable possibility’ of misstatement is provided later in this subsection.

Level at which to identify significant FSLIs

There is no formal CAS definition of account balances, classes of transactions or disclosures. However, we generally interpret this phrase as including amounts that are separately disclosed in the financial statements (account balances presented on the balance sheet, classes of transactions presented on the income statement, and disclosures in the notes) and refer to classes of transactions, account balances and disclosures as ’FSLIs’ (see OAG Audit 5041).

Consideration needs to be given if an amount presented or disclosed comprises more than one FSLI. For example, if an entity only presents a single revenue amount, but this comprises domestic and export revenue, both of which have differing risks of material misstatement (i.e., we have identified a risk of material misstatement at the assertion level related to each of them), then these are considered as separate FSLIs.

If the entity disaggregates revenue into a number of different trial balance lines, then we may conclude this is one significant FSLI. However, there may be situations where each trial balance line for revenue would be identified as a separate significant FSLI.

We also consider if further disaggregation of a line item presented in an entity’s financial statements may help us more efficiently and effectively target our risk assessment and develop appropriate audit responses.

In some cases, the disaggregated accounts or transactions comprising a single line presented in the entity’s financial statements may have sufficiently differing risks such that we would need to evaluate each line item separately. For example, an entity may include intangible assets as a single line item within its balance sheet, but the account includes both definite-lived intangible assets and indefinite-lived intangible assets. We may determine amortizing intangible assets is a significant FSLI with relevant assertions given newly acquired assets during the year as a result of a business combination. However, we may be able to conclude indefinite-lived intangible assets is not a significant FSLI (i.e., has no relevant assertions) if no indefinite-lived intangible assets were acquired in the current year business combination and the risk of a triggering event that could lead to a material impairment is not reasonably possible. Note that if the indefinite-lived intangible assets balance is material, CAS 330.18 would still require us to perform substantive procedures over this material but not significant FSLI. For guidance on our procedures regarding not significant but material FSLIs, refer to the block “FSLIs not determined to be significant but that are material” below.

There is a risk that we may inappropriately conclude an FSLI is not a significant FSLI if our identification of FSLIs is done at too disaggregated of a level. For example, an entity may present other assets as a single line item on its balance sheet. This other assets balance may comprise several different asset balances, each of which is individually below performance materiality, but which are material when aggregated and presented on the balance sheet. Consequently, when making our judgments as to whether disaggregated line items are separate FSLIs, we consider aggregation risk. For liability accounts, this includes the risk related to completeness. When we identify FSLIs at a disaggregated level, as compared to the balances presented on the face of the financial statements, we consider a lower quantitative threshold (e.g., percentage of performance materiality) when concluding if an FSLI is a significant FSLI to allow for aggregation risk.

For further guidance on sub-account scoping, refer to OAG Audit 4024.

Relevant factors when identifying significant FSLIs

To identify significant FSLIs and the relevant assertions that give rise to the reasonably possible risks of misstatement, we evaluate both qualitative and quantitative factors and apply professional judgment. Our documentation reflects the qualitative considerations and rationale for significant judgments made, as appropriate in the engagement circumstances. We would not need to specifically document our evaluation of each of the factors below in all cases, but may consider doing so to support our risk assessment conclusions.

The following are some factors that may be relevant to our identification of risks of material misstatement and determining if the FSLI is significant, although there may be additional factors to consider depending on the engagement facts and circumstances:

• Size and composition of the account
• Susceptibility to misstatement due to errors or fraud
• Volume of activity, complexity, and homogeneity of the individual transactions processed through the account or reflected in the disclosure
• Nature of the account, class of transactions, or disclosure
• Accounting and reporting complexities associated with the account or disclosure
• Exposure to losses in the account
• Possibility of significant contingent liabilities arising from the activities reflected in the account or disclosure
• Existence of related party transactions in the account
• Changes from the prior period in account or disclosure characteristics (i.e., whether the nature and characteristics of the account are consistent with the prior period and no changes affect our evaluation of the possibility of a material misstatement in the account)
• Preliminary understanding of the complexity, uncertainty and subjectivity associated with the FSLI
• If forecasts are important to the estimate, the length of the forecast period and degree of uncertainty regarding trends affecting the forecast

We may determine an FSLI to be qualitatively significant because it is affected by inherent risks of fraud or error that have a reasonable possibility of resulting in a material misstatement, either on an individual or aggregate basis, even when the FSLI is not quantitatively material. This may be the case for a liability account where there is a reasonable possibility that the FSLI could be understated by a material amount and therefore the completeness assertion is relevant. Other FSLIs may be qualitatively significant based on the expectations of a reasonable user of the financial statements or when we are incorporating an element of unpredictability into our audit procedures at the FSLI assertion level (e.g., when we substantively test accuracy of immaterial PP&E additions at certain locations that were not otherwise included in-scope).

It is important that we consider the nature of the FSLI when determining if an FSLI is significant. This is because our judgment around the likelihood of an FSLI being significant is impacted by the factors such as level of complexity, degree of uncertainty associated with the FSLI and other relevant factors listed above. For example, in certain industries, property, plant and equipment is often an FSLI with a low level of complexity, has activity that is predictable, and in many cases, is not considered a key performance indicator by the entity’s stakeholders. By contrast, revenue is often an FSLI with varying degrees of complexity, including a presumed risk of fraud in revenue recognition, and is usually a key performance indicator for the entity’s stakeholders. Similarly, the inventory FSLI at a manufacturing entity likely has a significant level of activity and those activities directly contribute to the entity’s primary revenue stream and gross margins. In these examples, revenue and inventory would more likely be considered significant FSLIs absent any quantitative or qualitative factors to the contrary.

When concluding an FSLI is not significant or an assertion is not a relevant assertion, it is important to consider if other areas of the audit, including other FSLIs, could be impacted by the conclusion. Examples include, but are not limited to, income taxes, including deferred taxes, pension disclosures, and the statement of cash flows. This impact on other areas of the audit could influence our conclusion regarding whether or not an FSLI is significant and/or could influence the audit work we plan to perform in such other areas. For example, often the substantive work we perform over accounts payable provides audit evidence over the completeness, accuracy, and occurrence of operating expenses and therefore influences how much additional testing is needed over those expense accounts. In this case if we identify both accounts payable and operating expenses as significant FSLIs we may be able to leverage the audit work performed over accounts payable as part of the audit procedures over operating expenses.

The more an FSLI exceeds performance materiality, the greater the likelihood it would be considered significant. FSLIs that exceed performance materiality will generally present at least a normal level risk of material misstatement for one or more assertions and therefore would be considered a significant FSLI. However, an FSLI that exceeds performance materiality is not necessarily identified as significant if we do not identify a risk of material misstatement at the FSLI assertion level (i.e., there is no reasonable possibility of a material misstatement). Conversely, engagement circumstances may also lead us to consider an FSLI less than performance materiality to be significant (e.g., the FSLI balance may be below performance materiality but the FSLI includes a risk of material understatement).

We need to exercise caution when determining that a material FSLIs is not significant. In fact, we may not identify any ’not significant but material FSLIs’ on an engagement and it would not be common to identify multiple not significant FSLIs that are material. If we believe it may be appropriate to categorize multiple material FSLIs as ’not significant’ we need to carefully consider whether the likelihood of a material misstatement for all financial statement assertions is truly not even reasonably possible, including the completeness assertion. Identifying multiple FSLIs as not significant even though they are material, increases the risk that undetected misstatements in several FSLIs may, in the aggregate, be material to the financial statements as a whole.

Consider consulting Audit Services if we believe it may be appropriate to categorize multiple material FSLIs as ’not significant’ or in situations when the process of scoping and identifying significant FSLIs is particularly complex or difficult.

Reasonable possibility of a material misstatement

As explained earlier in this block, a risk of material misstatement exists when there is a reasonable possibility of a misstatement occurring (i.e., its likelihood) and being material if it were to occur (i.e., its magnitude).

CAS 315 does not provide a definition or guidance as to what would be considered a ’reasonably possible’ risk. However, there are a number of references to ’reasonably possible’ in the professional accounting standards that can be used to inform our judgment when assessing the likelihood of a misstatement. For example, IAS 37.16, Provisions Contingent Liabilities and Contingent Assets, which does not directly define ’reasonably possible’, does make a distinction between the probable, possible and remote possibility that a present obligation exists, in effect establishing a view that likelihood may range from a remote possibility to probable. In deliberating CAS 315 the AASB explicitly supported a view that, in some cases, a risk of material misstatement with more than remote likelihood of occurring may not be reasonably possible.

There is no explicit quantitative probability threshold we apply when determining that a material misstatement is reasonably possible. However, we generally recognize that ’reasonably possible’ would mean more than a remote chance of a material misstatement occurring, and therefore a material misstatement with only a remote risk of occurring would not be considered ’reasonably possible’. This would not mean, however, that any risk for which we judge the likelihood of occurrence to be higher than remote would always be considered reasonably possible. In other words, if based on evaluation of relevant factors, we consider the likelihood of a risk occurring to be only slightly higher than remote, we apply judgment and might reach a conclusion that the likelihood of a material misstatement occurring for such a risk is not reasonably possible.

When evaluating the likelihood of a potential misstatement occurring, we consider the same quantitative and qualitative risk factors that formed the basis for our identification of significant FSLIs and relevant assertions. Our assessment of the likelihood of a potential misstatement considers whether such a misstatement individually or in combination with others, could result in a material misstatement to the financial statements. The list of factors reflected on the likelihood graphic below does not include the previously listed factors related to size of the account, composition, volume and homogeneity of transactions because they do not, in all cases, increase or decrease the likelihood of a misstatement occurring:

Nature of transactions is normal/recurring	Nature of transactions is unusual/non-recurring or new
Transactions with low complexity	Transactions with high complexity
Less susceptible to misstatement due to error or fraud	More susceptible to misstatement due to error or fraud
Accounting or reporting complexity is low	Accounting or reporting complexity is high
Does not give rise to risk of losses	Gives rise to risk of losses
Does not give rise to risk of contingent liabilities	Gives rise to risk of contingent liabilities
No related party transactions present	Related party transactions present
No changes from the prior period in the characteristics of the transactions	Changes from the prior period in the characteristics of the transactions

Accounting estimates

When identifying and assessing risks at the assertion level, we are focused on the risk of material misstatement. Assessing the risk of material misstatement associated with an accounting estimate (and the development of further audit procedures to address that risk) is therefore performed in respect of FSLIs that represent a risk of material misstatement and are considered significant FSLIs. Estimates relating to FSLIs that are not considered significant would not be subject to the specific requirements of CAS 540. We would not, for example, perform CAS 540 risk assessment and execution procedures on the allowance for doubtful debts for an accounts receivable FSLI that is not, itself, considered to be a significant FSLI (i.e., the valuation assertion for the accounts receivable FSLI was determined not to be relevant as a result of our risk assessment procedures).

Inventory

As CAS 501.4 requires us to attend physical inventory counting if inventory is material, we would need to perform appropriate procedures over the physical inventory observations even when an inventory FSLI is determined not to be significant.

Documentation

We document the identified significant FSLIs and relevant assertions, based on the evaluation of the factors explained above and our assessment of the misstatement likelihood and magnitude. We are not required to separately document our evaluation of the misstatement likelihood, however we may document the rationale if the basis for our conclusion is not already evident. Examples of identifying significant FSLIs and their relevant assertions are provided in the block “Significant FSLIs and relevant assertions—examples” below.

For significant FSLIs we document our evaluation of the impact of inherent risk factors on the level of inherent risk, expected controls reliance and planned substantive evidence. Refer to the block “FSLIs not determined to be significant but that are material” below for further guidance related to FSLIs that are determined to be not significant but material.

CAS Guidance

Determining relevant assertions and the significant classes of transactions, account balances and disclosures provides the basis for the scope of the auditor’s understanding of the entity’s information system required to be obtained in accordance with paragraph 25(a). This understanding may further assist the auditor in identifying and assessing risks of material misstatement (CAS 315.A202).

The auditor may use automated techniques to assist in the identification of significant classes of transactions, account balances and disclosures (CAS 315.A203).

Example: An entire population of transactions may be analyzed using automated tools and techniques to understand their nature, source, size and volume. By applying automated techniques, the auditor may, for example, identify that an account with a zero balance at period end was comprised of numerous offsetting transactions and journal entries occurring during the period, indicating that the account balance or class of transactions may be significant (e.g., a payroll clearing account). This same payroll clearing account may also identify expense reimbursements to management (and other employees), which could be a significant disclosure due to these payments being made to related parties. By analyzing the flows of an entire population of revenue transactions, the auditor may more easily identify a significant class of transactions that had not previously been identified.

Significant disclosures include both quantitative and qualitative disclosures for which there is one or more relevant assertions. Examples of disclosures that have qualitative aspects and that may have relevant assertions and may therefore be considered significant by the auditor include disclosures about (CAS 315.A204):

• Liquidity and debt covenants of an entity in financial distress.
• Events or circumstances that have led to the recognition of an impairment loss.
• Key sources of estimation uncertainty, including assumptions about the future.
• The nature of a change in accounting policy, and other relevant disclosures required by the applicable financial reporting framework, where, for example, new financial reporting requirements are expected to have a significant impact on the financial position and financial performance of the entity.
• Share-based payment arrangements, including information about how any amounts recognized were determined, and other relevant disclosures.
• Related parties, and related party transactions.
• Sensitivity analysis, including the effects of changes in assumptions used in the entity’s valuation techniques intended to enable users to understand the underlying measurement uncertainty of a recorded or disclosed amount.

OAG Guidance

Assertions are considered relevant when they have an identified risk of material misstatement (CAS 315.12). To identify relevant assertions, determine the most likely ways that the given class of transactions, account balance and disclosure could be misstated by considering the nature of the transactions, the volume and complexity of transactions, and other relevant factors. For example, the gross balance of accounts receivable could be misstated if:

• one or more individual receivables did not exist at the balance sheet date (existence), or
• the entity failed to record a receivable that did exist at the balance sheet date (completeness), or
• a long-term receivable was presented as a current asset (presentation and disclosure), or
• a long-term receivable was not accurately reported, for example, by inappropriately discounting the receivable (valuation).

When assessing the identified risks at the assertion level, evaluate whether they relate more pervasively to the financial statements as a whole and potentially affect many assertions, in which case we may determine that there is a risk of material misstatement at the financial statement level, which would need to be assessed and addressed, as appropriate.

When determining if an assertion is relevant, we need to consider if there is a reasonable possibility of material misstatement associated with this assertion. For guidance on what constitutes a reasonable possibility, refer to the block “Significant FSLIs” above.

For certain FSLIs, an assertion may inherently not be relevant, for example the valuation assertion is not an assertion that is relevant to payroll expense. Some assertions may not be relevant given the particular circumstances of the entity, for example, valuation of cash balances held in accounts at well-established, regulated banks where all transactions are conducted in the entity’s functional currency.

We may also determine that an assertion is not relevant because there is no reasonable possibility of material misstatement for that assertion. Consider the following examples:

Example 1: Revenue Cut‑Off

Based on an understanding of customer sales arrangements, including contractual shipping terms shipping method and historical order fulfillment time and prior audit experience, the engagement team determined the at-risk period for the revenue cut-off testing to be one week before and after the period end.

Total revenue during the at-risk period is less than performance materiality, and therefore the engagement team determined that the risk of a material misstatement arising from a cut-off error associated with these transactions would be remote based on the magnitude of potential misstatement and therefore concluded that cut-off does not present a reasonable possibility of material misstatement (i.e., cut‑off is not a relevant assertion).

In this case, after testing the completeness and accuracy of the sales register during the at-risk period to check that the aggregate value of revenue transactions is less than performance materiality, and performing risk assessment procedures to identify any significant or unusual sales transactions during the at-risk period, we might conclude there is only a remote risk of material misstatement for such period and no additional substantive procedures are necessary. In this example, an integral aspect of this evaluation is an assessment of the at‑risk period for the cut‑off.

Example 2: Revenue Cut‑Off

Entity XYZ’s performance obligation is satisfied and revenue recognition occurs at the time that the customer’s order is shipped from entity XYZ’s warehouse. Based upon the engagement team’s understanding of the revenue business process obtained during a walkthrough performed as part of the current period audit and review of the revenue testing performed in the prior year audit, the engagement team is aware that the status in the system is changed to ’shipped’ by warehouse personnel once the shipments are picked up by the carrier. The carrier pick up normally occurs on the same day the customer order is assembled by XYZ warehouse personnel for shipment.

The engagement team considered the following in their risk assessment:

• Average daily sales are $22.5M. Results of risk assessment procedures have supported the engagement team’s understanding that daily sales are consistent throughout the period.
• Based upon the average revenue transaction size of $100K, average number of shipments to customers are 225 per day.
• It would take an over or understatement of the number of shipments in excess of approximately 400 shipments (performance materiality of $40M divided by the average revenue transaction size of $100K) to cause a material misstatement of revenue due to an error in cut‑off.

Assume that the engagement team has concluded that there is no risk of material misstatement due to fraud with respect to cut-off and is therefore only considering the risk of error (further details of the fraud risk assessment and documentation are not provided for the purposes of this example).

Based on these facts, it would take an additional 400 erroneous shipments to generate a material error, which is not considered reasonably possible considering the average volume of 225 shipments per day and considering the at-risk period is only one day. Additionally, in order for revenue to be recognized without an actual product shipment, warehouse personnel would have to take action to erroneously reflect over 400 unshipped orders as “shipped” in the system during the at-risk period, which is also considered to have low likelihood of occurring. The engagement team updated their risk assessment procedures as of year end, including understanding of the revenue business process. Also, no unusual or unexpected relationships relevant to risk assessment for revenue cut-off were identified as a result of risk assessment analytics.

Given these considerations, the engagement team concluded there is no reasonable possibility of the risk of material misstatement associated with the Cut‑off assertion.

Throughout the audit, it is important to document judgments in support of our risk assessment procedures and conclusions. We are not necessarily required to document the rationale for our conclusion that an assertion is not relevant for a significant FSLI. Instead, we document the rationale if the basis for our conclusion is not already evident. When determined necessary, we document the rationale in sufficient detail to enable an experienced auditor, having no previous connection with the engagement, to understand the conclusions reached.

OAG Guidance

These examples illustrate a broad range of factors considered by the engagement team in determining the significant FSLIs and relevant assertions. The considerations illustrated do not reflect the documentation that engagement teams are expected to include in their workpapers. For example, even though each example identifies factors that do not contribute to the significant FSLI conclusion, it would not typically be necessary to document such factors.

Spare parts

Scenario A—Spare parts is determined not to be significant but is a material FSLI

Background and preliminary risk assessment The spare parts balance is $150 million and consists of purchased spare parts (e.g., copper wiring, transformers, cable, pipes) that are consumed through infrastructure improvement (PP&E) or maintenance projects (i.e., not inventory for resale) There have not been any significant changes since the prior year to the business, the nature of the items that comprise the account balance, the number of warehouses that hold spare parts or the concentration of the spare parts account within each of the warehouses Total additions (purchases) of spare parts were $335 million in the prior year, and total usage of spare parts in the prior year was $340 million. Current year activity is expected to be consistent with prior year. Performance materiality is $70 million There is no history of errors or control deficiencies related to the spare parts account The engagement team performed substantive testing to address the accuracy of the spare parts account in prior years and has a sufficient understanding of the business process which has been included in the planning documentation The engagement team performs expense classification testing, which includes maintenance expense Balance is comprised of a high volume of low value items Due to the nature of the spare parts account, which primarily comprises items that are frequently used and not subject to obsolescence due to technological changes in the industry, there have not been significant write-offs due to obsolescence in the current or prior year The balance of the spare parts account has not fluctuated significantly year over year (PY—$148 million; PY‑1—$152 million; PY‑2—$159 million) Spare parts are held at 45 warehouses. In the prior year, the largest warehouse held $60 million of spare parts. Spare parts held at the largest five warehouses accounted for approximately $105 million of the balance. The remaining balance was held across 40 different warehouses. The additions and usage of spare parts are also disaggregated across a significant number of warehouses. The concentration of balances maintained at each warehouse, and additions and usage of spare parts, are expected to be relatively consistent with prior year. The engagement team performed risk assessment procedures over (1) maintenance expense, including a scanning analytic over the maintenance detail to scan for unusual activity, including costs that should have been charged to a PP&E project and (2) spare parts balances by warehouse. No unusual items or balances were noted through these procedures. Preliminary Conclusion The engagement team has concluded there is no reasonable possibility that the spare parts account could contain a material misstatement, and therefore, the spare parts FSLI is not identified as a significant FSLI. Although spare parts is not a significant FSLI it is quantitatively material and therefore, as required by CAS 330.18, the engagement team will still need to perform substantive procedures over this FSLI. For an example of substantive procedures that could be performed over selected assertions for this FSLI, as required by CAS 330.18, refer to the block “FSLIs not determined to be significant but that are material” below. Note that we would, in any event, also need to perform appropriate physical inventory observation procedures for this material FSLI, as CAS 501.4 requires us to attend physical inventory counting, if inventory is material. The engagement team also considered the potential impact on other areas in the audit. As an example, in the prior year, PP&E additions that included parts used from spare parts were agreed to spare parts records that were subject to substantive testing. Given that the spare parts account is not determined to be a significant FSLIs, testing over spare parts will be less extensive in the current year The engagement team will obtain source documents (e.g., invoice, PO) for all PP&E additions selected for testing, including audit evidence supporting transfers to the PP&E project from spare parts.

Scenario B - Spare parts is a significant FSLI

Consider the fact pattern above, with the following relevant changes: There is a major capital project planned during the year and total additions (purchases) of spare parts are expected to be $750 million in the current year, or While the total additions (purchases) of spare parts are expected to be consistent with prior year, the majority of them are focused within a given warehouse, or A significant error and associated control deficiency are identified in the spare parts account, or There is an expected technology change within the industry whereby certain parts included within the spare parts account may be at risk for obsolescence. Conclusion Given any of these alternative fact patterns, the engagement team may conclude there is a reasonable possibility of material misstatement within the spare parts account, and accordingly spare parts would be identified as a significant FSLI. In this case, controls (if applicable) and substantive testing would be performed to address the relevant assertions.

Accounts receivable—Valuation

Scenario A—Valuation is not a relevant assertion

Background and preliminary risk assessment Accounts receivable FSLI with a balance of $90 million is a significant FSLI Allowance for doubtful accounts is $2 million Performance materiality is $6 million The entity operates in a stable industry, has a relatively consistent customer base, has low value, high volume revenue transactions recognized upon shipment from the entity’s warehouse, and generally allows customers 30 to 45 day payment terms Historically, most of the accounts receivable balance has been current and write offs have been clearly immaterial (i.e., below de minimis SUM posting level) The company has a process in place to evaluate the creditworthiness of customers and extend credit accordingly, and the company does not offer significant discounts or promotions that affect selling prices. The engagement team obtained a sufficient understanding of this process during the Understand phase of the risk assessment process which included a walkthrough. As part of performing risk assessment procedures in the current year, the engagement team obtained and reviewed the accounts receivable aging to check that virtually all customer accounts receivable balances remained current (i.e., inconsequential amounts were past due), consistent with prior years. Appropriate procedures were performed to assess completeness and accuracy of the aging report. Given the size of the average accounts receivable balance by customer of $25,000, with the largest balance being $1 million, it would take non-payment from approximately 100 customers to cause a material misstatement (which is deemed to have a remote chance of occurring) Updating risk assessment procedures and other considerations The engagement team will update their risk assessment procedures as of year end, including: Obtaining and reviewing the accounts receivable aging to check that virtually all customer accounts receivable balances remain current (i.e., inconsequential amounts were past due) and to review the composition of the account. To obtain sufficient evidence over the completeness and accuracy of the accounts receivable aging as of year end for use in risk assessment procedures, the engagement team agreed the accounts receivable aging to total accounts receivable in the general ledger and agreed the invoice date per the accounts receivable confirmation to the accounts receivable aging for a sample of invoices. The engagement team will also perform sufficient controls testing (if we plan to test controls) and substantive testing over the assertions that are relevant for accounts receivable (e.g., Accuracy, Existence/Occurrence). Preliminary Conclusion The engagement team has concluded that there is no reasonable possibility that Valuation of accounts receivable could contain a material misstatement, and therefore, Valuation is not a relevant assertion for this client’s $90 million accounts receivable balance, and therefore, no controls testing or substantive testing will be performed over the allowance for doubtful accounts (see the block “Significant FSLIs” above for relevant guidance). Given the facts and circumstances of this example, the engagement team documented judgments related to the determination that valuation is not a relevant assertion (including the risk assessment procedures performed and the quantitative and qualitative factors considered).

Scenario B—Valuation is a relevant assertion

Consider the fact pattern above, with the following relevant changes: The average customer balance is $500,000, which is more significant in comparison to materiality, or The company operates in an industry where non-payment from customers is much more likely in the current period given a significant economic downturn for the industry which has impacted the operations of most of the entity’s customers, or The accounts receivable aging reflects a higher concentration of past due accounts receivable, which amount to $2.5 million in total. Conclusion Given any of these alternative fact patterns, the engagement team may conclude there is a reasonable possibility of material misstatement within the allowance for doubtful accounts, and therefore, valuation would be a relevant assertion for accounts receivable. In this case, controls (if applicable) and substantive testing would be performed to address this assertion.

Cash

Background and preliminary risk assessment
The entity’s financial statements include a Cash and cash equivalents FSLI balance of $13.8 million. Overall materiality is $8 million, and performance materiality is $6 million. The following trial balance shows the accounts for the Cash and cash equivalents FSLI balance:
	(in $000s)
Current account xx1768—ABC Bank	9,100
Payroll account xx4569—ABC Bank	1,700
Deposits at cal—XYZ Bank	3,000
Cash and cash equivalents - total	13,800
With respect to this FSLI we considered the following: The Cash and cash equivalents FSLI balance exceeds performance materiality and, therefore, the FSLI is quantitatively material. The balance has an inherently higher susceptibility to misstatement due to the risk of misappropriation of cash. However, there is a low level of physical cash handled by the entity (almost all cash transactions are settled electronically), reducing the magnitude of potential misstatements were a misstatement due to misappropriation of cash to occur. There is a high volume of transactions going through the current and payroll bank accounts during the financial year. While they are generally routine, recurring transactions with low accounting and reporting complexities, they are not fully homogeneous as there are several types of transactions (e.g., customer receipts, supplier payments, payroll, other operating expenses). Cash and cash equivalents is an asset account, for which there is an inherent risk that the balance could be overstated. Based on the above, we have determined that there is a reasonable possibility (i.e., more than remote) of a material misstatement related to the existence of account balances included in the financial statements (Existence/Occurrence) and whether the entity had title to the cash reported on its balance sheet (Rights & Obligations). A reasonable possibility of a material misstatement also exists as to whether cash transactions were properly authorized (Existence/Occurrence), whether all cash balances and transactions that should have been recorded have been recorded (Completeness), whether cash transactions were accurately recorded (Accuracy) and whether cash transactions were recorded in the correct period (Cut-off). There are presentation and disclosure considerations for the Cash and cash equivalents FSLI, specifically in relation to the classification of the call deposit as a current asset (i.e., the underlying investment of the cash has a maturity of three months or less and is repayable with 24 hours’ notice with no loss of interest) (Presentation & Disclosure). The bank accounts are held with the country’s significant institutions and no concerns exist over either bank’s liquidity/other conditions that may make it difficult for the entity to access its funds. Also, there are no accounts denominated in a foreign currency. As a result, Valuation is not considered a relevant assertion as there is no reasonable possibility of a material misstatement. Other factors which do not indicate a higher likelihood of misstatement in this FSLI are: No related party transactions in the balance. No changes from the prior period in account or disclosure characteristics. No accounts were opened or closed during the year. No significant changes since the prior year in the nature of the transactions included in the accounts making up the balance. No forecasts or estimates relevant to the FSLI. No history of errors or control deficiencies related to the FSLI. Conclusion Based on the factors above, we determine Cash and cash equivalents to be a significant FSLI. We determined the following relevant assertions: Accuracy; Completeness; Cut-off; Existence/Occurrence; Rights & Obligations; Presentation & Disclosure. For this significant FSLI we will identify risks of material misstatement at the assertion level and assess the level of inherent risk as normal, elevated, or significant.

Prepaid Expenses

Back ground and preliminary risk assessment The entity’s financial statements include a Prepaid expenses FSLI balance of $9 million. Overall materiality is $8 million, and performance materiality is $6 million. With respect to this FSLI we considered the following: The Prepaid expenses FSLI balance is greater than performance materiality and, therefore, the FSLI is quantitatively material. As part of our risk assessment procedures, we obtained the entity’s listing of prepaid expenses with prior year comparatives. There are a small number of prepaid expenses making up the balance and all items are recurring and consistent with the prior year. There is a low volume of activity and the individual prepaid expense balances are not complex to calculate as they are mostly recurring prepayments for annual insurance premiums and office rent. The two largest prepaid balances relate to insurance, comprising 11 of the 12 months of the annual premiums that have been prepaid, and rent for office space where rental payments are due one month in advance. Accounting for this balance is not complex and represents the unamortized balance of the prepayments. The FSLI balance is not impacted by estimation uncertainty and does not include accounting estimates. The entity’s long-term office space leases are unchanged since the prior year and the entity did not open any new offices or otherwise lease any new office space. The entity’s insurance coverages and providers have not changed since the prior year audit and the only change in premiums reflects inflationary increases. Given that the balance largely comprises a fixed number of annual insurance premiums and monthly rent prepayments pursuant to the terms of insurance policies and formal leases, respectively, for which there has been virtually no change in the current period, there is not a reasonable possibility of a material misstatement related to the Completeness, Accuracy, Cut-Off, and Valuation assertions. The nature of the account is an asset, for which there is normally an inherent risk of an overstatement. Based on our scanning of the listing provided, however, most of the prepaid balances on the listing would need to be misstated or not exist for a material misstatement in this prepaid expenses FSLI to occur. The likelihood of that occurring is remote, based on our understanding of the business and risk assessment procedures performed. As a result, there is not a reasonable possibility of a material misstatement related to the Existence/Occurrence and Rights & Obligations assertions. Given the limited extent of disclosures of prepaid expenses in the financial statements, there is not a reasonable possibility of a material misstatement related to the Presentation & Disclosure assertion. There is no history of write-offs related to prepaid expenses and therefore the exposure to losses in the account is considered low. Other factors which do not indicate a higher likelihood of misstatement in this FSLI are: No sources that potentially give rise to contingent liabilities (i.e., prepayments according to contractual terms do not give rise to contingent liabilities). No related party transactions in the balance. A low susceptibility to misstatement due to fraud or error. No history of errors or control deficiencies related to the FSLI. Conclusion After consideration of the factors above and the related risk assessment procedures performed, we conclude that prepaid expenses is a not significant but material FSLI (i.e., no assertions for which there is a risk of material misstatement, but the account balance exceeds performance materiality). Although there are no assertions for which we assessed there to be a reasonable possibility (i.e., more than remote likelihood) of a material misstatement occurring, CAS 330 requires that we perform substantive procedures for all material FSLIs. To fulfill this requirement, we will select assertions where we have concluded, if a misstatement were to occur in the Prepaid expenses FSLI, it could be material and we will direct any substantive procedures to these selected assertions. Based on our understanding of the Prepaid expenses FSLI, including the factors noted above, the selected assertions for this FSLI for which we plan to obtain substantive audit evidence are Existence/Occurrence and Accuracy. The rationale for not selecting other assertions for testing is as follows: Given that there is no separate disclosure of categories of prepaid expenses in the financial statements, a material misstatement related to the Presentation & Disclosure assertion is not possible. Given that the balance largely comprises a fixed number of annual insurance premium and monthly rent prepayments pursuant to terms of insurance policies and formal leases, respectively, for which there has been virtually no change in the current period, if a misstatement were to occur, it is not expected that it could be material with respect to the Valuation, Completeness, Cut-Off, and Rights & Obligations assertions. We will consider the evidence we obtain from our procedures over other significant FSLIs, including cash and accounts payable. We will also perform targeted testing of the two largest items on the prepaid expenses listing to address the risk that they may not exist or are inaccurately calculated. The testing comprises tracing to the supporting documentation (e.g., prepaid invoice, proof of payment) and recalculating the prepaid balance. This testing will cover 30% of the period end balance. Although the untested balance is above performance materiality, we likely would not perform additional testing for this FSLI if our testing is completed without noting exceptions.

Salaries/Payroll Expenses

Background and preliminary risk assessment The entity’s financial statements include a Salaries/payroll expenses FSLI of $30 million. Overall materiality is $8 million, and performance materiality is $6 million. With respect to this FSLI we considered the following: The Salaries/payroll expense FSLI balance exceeds performance materiality and, therefore, the FSLI is quantitatively material. The volume of activity and nature of expenses comprising this FSLI have not changed since the prior year. The FSLI includes payroll expenses, payroll related tax and employee cost expenses. All salaries/payroll expenses are in the same jurisdiction as in the prior year. The FSLI is susceptible to misstatements due to fraud or error given the varying pay schemes for the different groups of employees. The number and nature of pay schemes results in a level of complexity in calculating and processing salaries/payroll expenses. The pay schemes for the different groups of employees are as follows: Production - hourly rates, paid weekly on Friday. Warehouse - fixed annual salaries, paid at month end. Drivers/transporters - fixed annual salaries, paid at month end, plus per diem depending on duration of travel paid one month in arrears. Sales - commission-based, paid at month end. Administrative staff - fixed annual salaries, paid at month end. Overtime costs are also calculated differently for the various groups (e.g., administrative staff are not paid overtime while production and warehouse staff are paid overtime at a multiple of their respective hourly rates, paid one month in arrears). The FSLI also includes expenses related to accrued bonuses and accrued vacation, both of which require management to make accounting estimates. This means that the FSLI is impacted by estimation uncertainty as movements in the estimates are reflected in profit or loss. Procedures to test these estimates, including evaluating the assumptions used by management, will be addressed as part of our work on the Accruals, provisions, and other liabilities FSLI. As this is an expense FSLI there is an inherent risk that the balance may be understated. Based on the above, we have determined that there is a reasonable possibility (i.e., more than a remote likelihood) of a material misstatement relating to whether salaries/payroll expenses are accurately calculated (Accuracy), whether all transactions recorded have occurred and were appropriately authorized (Existence/Occurrence), whether all transactions that should have been recorded have been recorded (Completeness) and whether transactions are recorded in the correct period (Cut-off). As noted above, warehouse staff, drivers/transporters, sales staff, and administrative staff are all paid on the last day of the month, while production staff are paid weekly. Our review of the salaries/payroll accrual at period end indicates that management has recognized an accrual of $1.5 million related to salaries/payroll expenses not settled at period end (i.e., production wages, drivers/transporters per diems, overtime and vacation and bonus accruals). Procedures to test these accruals will be addressed as part of our work on the Accruals, provisions, and other liabilities FSLI. While the entity presents expenses by function in its Statement of Profit or Loss, the payroll expense total is still required to be separately disclosed in the expenses by nature section in the notes (Presentation & Disclosure). Other factors which do not indicate a higher likelihood of misstatement in this FSLI are: No sources that potentially give rise to contingent liabilities. No related party transactions in the FSLI. No changes from the prior period in account characteristics. No history of errors or control deficiencies related to the FSLI. Conclusion Given the above factors, we determine the Salaries/payroll expenses FSLI to be a significant FSLI. We determined the following relevant assertions: Accuracy; Completeness; Existence/ Occurrence; Cut-off; Presentation & Disclosure. For this significant FSLI we will identify risks of material misstatement at the assertion level and assess the level of inherent risk as normal, elevated, or significant.

CAS Guidance

As explained in CAS 320, materiality and audit risk are considered when identifying and assessing the risks of material misstatement in classes of transactions, account balances and disclosures. The auditor’s determination of materiality is a matter of professional judgment, and is affected by the auditor’s perception of the financial information needs of users of the financial statements. For the purpose of this CAS and paragraph 18 of CAS 330, classes of transactions, account balances or disclosures are material if omitting, misstating or obscuring information about them could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements as a whole (CAS 315.A233).

There may be classes of transactions, account balances or disclosures that are material but have not been determined to be significant classes of transactions, account balances or disclosures (i.e., there are no relevant assertions identified) (CAS 315.A234).

Example: The entity may have a disclosure about executive compensation for which the auditor has not identified a risk of material misstatement. However, the auditor may determine that this disclosure is material based on the considerations in paragraph A233.

Audit procedures to address classes of transactions, account balances or disclosures that are material but are not determined to be significant are addressed in CAS 330. When a class of transactions, account balance or disclosure is determined to be significant as required by paragraph 29, the class of transactions, account balance or disclosure is also a material class of transactions, account balance or disclosure for the purposes of paragraph 18 of CAS 330 (CAS 315.A235).

Not all assertions within a material class of transactions, account balance or disclosure are required to be tested. Rather, in designing the substantive procedures to be performed, the auditor’s consideration of the assertion(s) in which, if a misstatement were to occur, there is a reasonable possibility of the misstatement being material, may assist in identifying the appropriate nature, timing and extent of the procedures to be performed (CAS 330.A44).