ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 46  October 2023 CPA Licensure Examination AT-09

AUDITING (Auditing Theory) J. IRENEO  E. ARAÑAS  F. TUGAS  C. ALLAUIGAN

IDENTIFYING AND ASSESSING

THE RISKS OF MATERIAL MISSTATEMENT
Audit Risk and Risk Assessment Procedures

Audit Risk- the risk that the financial statements may contain material misstatements (i.e., inherent
risk and control risk) that the auditor may fail to detect (i.e., detection risk) that may lead the auditor
to express an inappropriate audit opinion.
a. Risk of Material Misstatements (RMM)
- Inherent Risk
- Control Risk
b. Detection Risk

RISK ASSESSMENT PROCEDURES (RAP)

I. Objective:
The auditor shall design and perform risk assessment procedures to obtain audit evidence that
provides an appropriate basis for:
(a) The identification and assessment of risks of material misstatement, whether due to
fraud or error, at the financial statement and assertion levels; and
(b) The design of further audit procedures in accordance with PSA 330.
I. The RAP include the following:
a. Inquiries
-management
-those charged with governance
-internal audit personnel
-employees involved in capturing complex or unusual transactions
- in-house legal counsel
b. Analytical procedures
-develop expectations about plausible relationships
-help identify inconsistencies, unusual transactions or events, and amounts,
ratios, and trends that may have audit implications
-include both financial and non-financial information
c. Observation and inspection
-may support, corroborate or contradict inquiries of management and
others, and may also provide information about the entity and its environment
During the risk assessment, the Auditor shall also consider information from other sources such as
those obtained from previous audits.
II. The auditor shall document:
⚫ discussion among the engagement team and the significant decisions reached;
⚫ key elements of the auditor’s understanding of the RMM
⚫ evaluation of the design of identified controls, and determination whether such controls
have been implemented
⚫ identified and assessed risks of material misstatement at the financial statement level and
at the assertion level
III. The auditor uses professional judgment to determine the extent of RAP.
-size and complexity of the entity
-the auditor’s experience with the entity
IV. RAP is a continuous and dynamic process.
PART I: Obtaining an Understanding of the Entity and Its Environment &
the Applicable Financial Reporting Framework
The auditor shall:
A. perform RAP to obtain an understanding of:
(a) The following aspects of the entity and its environment:
-Organizational structure
-Ownership
-Governance
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
IDENTIFYING & ASSESSING the RISKS of MATERIAL MISSTATEMENT AT-09
-Business model (extent of use of IT)
-Industry, regulatory and other external factors;
-The measures used, internally and externally, to assess the entity’s financial performance
(b) The applicable financial reporting framework, and the entity’s accounting policies and the
reasons for any changes thereto; and
The members of the engagement team should discuss the:
a. Applicable Financial Reporting Framework
b. susceptibility of the entity’s FS to material misstatements
The team’s discussion may include:
✓ Changes in financial reporting requirements that may result in significant new or
revised disclosures;
✓ Changes in the entity’s environment, financial condition or activities that may
result in significant new or revised disclosures (e.g. a significant business
combination in the period under audit)
✓ Disclosures for which obtaining sufficient appropriate audit evidence may have
been difficult in the past; and
✓ Disclosures about complex matters, including those involving significant
management judgment as to what information to disclose.
(c) How inherent risk factors affect susceptibility of assertions to misstatement and the
degree to which they do so, in the preparation of the FS in accordance with the applicable
financial reporting framework, based on the understanding obtained in (a)&(b).
*The auditor shall evaluate whether the entity’s accounting policies are appropriate and
consistent with the applicable financial reporting framework.
Inherent Risk Factors - characteristics of events or conditions that affect susceptibility to
misstatement, whether due to fraud or error, of an assertion about a class of transactions,
account balance or disclosure, before consideration of controls. These factors may be
qualitative or quantitative.

Qualitative inherent risk factors

Financial Reporting Framework
• Complexity;
• Subjectivity;
• Change;
• Uncertainty; or
• Susceptibility to misstatement due to
management bias or other fraud risk factors
B. Identify Risks of Material Misstatement
(a) at the financial statement level; and
(b) at the assertion level for classes of transactions, account balances and disclosures.
C. Assess Risks of Material Misstatement
at the Financial Statement Level
The auditor shall assess the risks and:
(a) Determine whether such risks affect the assessment of risks at the assertion level; and
(b) Evaluate the nature and extent of their pervasive effect on the financial statements
at the Assertion Level
1. The auditor shall assess inherent risk by assessing the likelihood and magnitude of
misstatement. In doing so, the auditor shall take into account how, and the degree to which:
(a) Inherent risk factors affect the susceptibility of relevant assertions to
misstatement; and
(b) The risks of material misstatement at the financial statement level affect the
assessment of inherent risk for risks of material misstatement at the assertion level.
2. The auditor shall assess if risks of material misstatement are significant risks.
3. Determine whether substantive procedures alone cannot provide sufficient appropriate audit
evidence for any of the risks of material misstatement at the assertion level.
D. And evaluate whether the audit evidence obtained from the RAP provides an appropriate basis
for the identification and assessment of the risks of material misstatement.
E. Revise Risk Assessment, as necessary.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
IDENTIFYING & ASSESSING the RISKS of MATERIAL MISSTATEMENT AT-09
1. In PSA 315 (Revised 2019), there are broad distinct areas that requires for the auditor’s
understanding:
A. The entity and its environment, the applicable financial reporting framework and the
entity’s system of internal control.
B. The entity and its environment, the applicable financial reporting framework, relevant laws
and regulations, and the entity’s system of internal control.
C. The entity and its environment, the applicable financial reporting framework, and the
relevant laws and regulations.
D. The entity and its environment and the entity’s system of internal controls.
2. Which of the following is reason/s why the auditor understands an audit client in the context of PSA
315?
I. Assess the risks of material misstatement of the financial statements.
II. Establish materiality using professional judgment.
III. Develop the engagement letter.
IV. To identify areas where special audit consideration may be necessary, for example, related
party transactions, the appropriateness of management’s use of the going concern
assumption, or considering the business purpose of transactions

A. I, II C. III only
B. I, II and IV D. II and III
3. Evaluate the following statements:
I. An auditor obtains knowledge about a new client’s business and its industry to understand
the events and transactions that may have an effect on the client’s financial statements.
II. An auditor obtains knowledge about a new client’s business and its industry to be able to
express an opinion as to the effectiveness of internal controls and make suggestions to
improve such.

A. Only statement I is true. C. Both statements are true.

B. Only statement II is true . D. Neither statement is true.
4. An understanding of a client’s business and industry and knowledge about operations are essential
for performing an adequate audit. For a new client, most of this information is obtained:
A. from the predecessor auditor.
B. from the previous annual reports
C. from the permanent file.
D. at the client’s premises.
5. Which of the following statements is/are true?
I. Obtaining an understanding of the entity and its environment, including the entity’s
internal control, is a continuous, dynamic process of gathering, updating, and analyzing
information throughout the audit.
II. The understanding of the entity establishes a frame of reference within which the auditor
plans the audit and exercises professional judgment throughout the audit.
III. The depth of the overall understanding that is required by the auditor in performing the
audit is less than that possessed by management

A. I & II only C. I, II & III

B. II & III only D. I & III only
6. To obtain an understanding of a continuing client’s business, an auditor most likely would:
A. Perform tests of details of transactions and balances.
B. Review prior year working papers and the permanent file for the client.
C. Read current issues of specialized industry journals.
D. Reevaluate the client’s internal control environment.

7. Which of the following procedures would an auditor least likely perform while obtaining an
understanding of a client in a financial statement?
A. Coordinating the assistance of entity personnel in data preparation.
B. Discussing matters that may affect the audit with firm personnel responsible for non-audit
services to the entity.
C. Selecting a sample of vendor’s invoices for comparison to receiving reports.
D. Reading the current year’s interim financial statements.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
IDENTIFYING & ASSESSING the RISKS of MATERIAL MISSTATEMENT AT-09
8. Which below is/are areas of the auditor’s understanding, in the context of PSA315?
I. Relevant industry, regulatory, and other external factors including the applicable
financial reporting framework.
II. Economic conditions affecting the practice of the auditor.
A. I only C. Both
B. II only D. Neither
9. On an audit engagement performed by a CPA firm with one office, at the minimum, knowledge of
the relevant professional accounting and auditing standards should be held by:
A. The auditor with final responsibility for the audit.
B. All professionals working upon the audit.
C. All professionals working upon the audit and the partner in charge of the CPA firm.
D. All professionals working in the office.
10. A risk resulting from significant conditions, events, circumstances, actions or inactions that could
adversely affect an entity’s ability to achieve its objectives and execute its strategies, or from the
setting of inappropriate objectives and strategies.
A. Inherent risk
B. Business Risk
C. Inherent risks factors
D. Management Risks
11. Which below is/are areas of the auditor’s understanding, in the context of PSA315?
I. Nature of the entity
II. Entity’s objectives and strategies, and those related business risk that may result in
risks of material misstatement.

A. I only C. Both
B. II only D. Neither
12. What does business risk include?
A. Economic factors.
B. Competitive factors.
C. Regulatory risk.
D. All of the above
13. Which is/are considerations when the continuing auditor intends to use information about the
entity and its environment obtained in prior periods?
I. Determine whether changes have occurred that may affect the relevance of such
information in the current audit.
II. Seek permission with the client in using the prior period information obtained by the
auditor.
A. I only C. Both
B. II only D. Neither
14. Which is/are included in relevant industry conditions, in the context of an auditor’s understanding?
I. The market and competition, including demand, capacity and price competition.
II. Cyclical or seasonal activity.
III. Product technology relating to the entity’s products.
IV. Regulatory framework for a regulated industry.

A. All of these only C. I, II & III only

B. I, II, & IV only D. II, III & IV only
15. In the context of an auditor’s understanding, the following are included in the nature of the entity
except
A. The entity’s operations, its ownership, and governance.
B. The way that the entity is structured and how it is financed.
C. General economic conditions.
D. The types of investments that it is making and plans to make.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
IDENTIFYING & ASSESSING the RISKS of MATERIAL MISSTATEMENT AT-09
16. Match the following statements with the corresponding terms:
Statement Term
I. These are the operational approaches by which 1.Business Risks
management intends to achieve its objectives.
II. These result from significant conditions, events,
2.SignificantRisks
circumstances, actions or inactions that could
adversely affect the entity’s ability to achieve its
objectives and execute its strategies.
III. These risks requirespecial audit consideration, 3.Strategies
such as those that involve fraud or complex
transactions.
4.AuditRisk
A. 1,2,3, respectively C. 3,1,2, respectively
B. 3,2,1, respectively D. 2,1,4, respectively
17. Which poses as a business risk in the context of understanding the client?
I. The entity has the personnel or expertise to deal with the changes in the industry.
II. Demand cannot be accurately estimated.
A. I only C. Both
B. II only D. Neither

18. Which is/are true?

I. Business risk is more specific in scope than the risk of material misstatement.
II. Most business risks have financial consequences and they may have an effect on the
financial statements of an entity.
A. I only C. Both
B. II only D. Neither

19. You have the following audit notes regarding Microcosmos Company, an audit client:
I. The entity has no significant unusual transactions for the year.
II. Some portion of the CFO’s compensation is tied to the achievement of an audited net
income balance.
Which can be sources of the risk of material misstatement?
A. I only C. Both
B. II only D. Neither
20. Which of the following nonfinancial information would an auditor most likely consider in performing
analytical procedures during risk assessment?
A. Turnover of personnel in the accounting department.
B. Objectivity of audit committee members.
C. Square footage of selling space.
D. Management’s plans to repurchase stock.
21. The form and extent of documentation is influenced by the following:
A. Nature, size and complexity of the entity and its internal control
B. Availability of information from the entity
C. Specific audit methodology and technology used in the course of the audit.
D. All of these factors affect the form and extent of documentation.
22. The degree to which inherent risk varies is referred to in this PSA as
A. Inherent risk
B. Control Risk
C. Spectrum of inherent risk
D. Spectrum of control risk
23. According to PSA 315, the auditor should document:
A. The discussion among the engagement team
B. Key elements of the understanding obtained regarding each of the aspects of the entity
and its environment, including each of the internal control components
C. The identified and assessed risks of material misstatement at the financial statement
level and at the assertion level, the risks identified and related controls evaluated
D. All of the choices
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