ASA 315: Identifying And Assessing Risks Of Material Misstatement

Methodology

Introduction

Name of ASA 315 is “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment”. This auditing standard issued by Auditing and assurance standard board is regarding the responsibility of auditor to identify the material misstatements in financial statement of a company by overviewing the entity and business environment in which such business organisation is operating. It also deals with issues in relation to corporate governance of the business organisation (Bhaskar, Schroeder and Shepardson, 2018).

Methodology

Methodology used in this section of the report is qualitative methodology as details regarding ASA 315 are extracted from the documents issued by AUASB. Secondary sources of data has been used for the purpose of research.  

Findings and Discussion

Primary objective of this auditing standard issued by AUASB is to identify major misstatement in financial statement of the company whether such misstatements are fraud or error. There is a significant distinction between fraud and error. Fraud is an intentional action taken by management of the company to receive shareholders for the purpose of personal gain whereas error is misstatement occurred in financial statement due to negligence of Management.

Both of these contact are covered in this accounting standard. These misstatements are to be identified by evaluating internal environment of management of the company. For this purpose internal control of the company is required to be checked by the auditor of the company. There are certain duties and responsibilities of Auditor in relation to this auditing standard that will help auditor to identify such misstatements.

Essential requirement for the auditing standard-

Auditor of the company has to apply some risk assessment procedures to identify material misstatement in financial statement of the company. This auditing standard has issued some requirements that an auditor has to comply with while applying these risk assessment procedures. These requirements are as follows-

1. Auditor should enquire person in charge with internal control of the company. If there is no internal control department in the organisation then auditor should interview employees that can have essential information in relation to material misstatement.
2. Auditor has to apply analytical procedures while performing risk assessment procedures (Amiram et.al, 2018). These analytical procedures should be according to the experience of the auditor and nature of operations undertaken by organisation.
3. Detailed observation and inspection of operations of organisations is an essential requirement of this auditing standard as material misstatement are to be identified by evaluating business environment.
4. Auditor should also assess whether the financial statements provided by the management of the company can be helpful in identification of material misstatement or not (Simunic, Ye & Zhang¸2015).
5. In a scenario where auditor is identifying material misstatement by evaluating the work of previous auditor, then auditor should first examine whether there has been any significant changes in business in comparison with the previous year.
6. Proper discussion should be conducted by partners and team members of audit firm in relation to material misstatement that can be evaluated with the help of financial statement and financial framework that is applicable on the company.

In addition to above mentioned risk assessment procedures, there are some specific areas that auditor of the company should assess for the purpose of identifying material misstatements (Knechel & Salterio, 2016). The specific areas of inspection are as follows-

Internal and external environment of business organisation

Internal and external environment of business organisation can explain a lot of information about business organisation. ASA 315 as considered this concept especially mentioned that an auditor should assess internal and external environment of business to identify material misstatement.

Specific areas that auditor of the company should asses are nature of organisation, business structure of organisation, business industry in which organisation is operating, governance structure of the company, major investments made by the company, financial and capital structure of the company. Auditor of the company should also assess whether business organisation has followed all applicable accounting policies and principles in accordance with the financial framework applied by regulatory accounting authority (Carson, Fargher & Zhang, 2016). Goals and strategies on the business organisation can also be evaluated for identification of areas prone to risk.

Findings and Discussion

Internal control applied by the company

Business rates are integral part of operation in an organisation this organisation will face business risk while operating at business. It is primary duty of management of the company to apply controls on business processes mitigate or control the risk generated in operating a business (Simunic, Ye & Zhang, 2017). Auditor of the company should examine the internal controls applied by business organisation to mitigate business risk. Majority of control the applied on financial reporting requirements.

It is not essential that all the controls applied by business organisation are significant for the process of auditing, therefore it is at the discretion of auditor to select appropriate and effective internal control procedures (Louwers, Ramsay, Sinason, Strawser and Thibodeau, 2015). In addition to that auditor of the company should also asses the design of controls applied by management to evaluate its effectiveness and efficiency.

Other specific areas that should be evaluated by the auditor are risk assessment procedures, information technology system, areas prone to risk, previous year material misstatements etc.

Conclusion

It can be concluded that there are various factors that should be considered by auditors while identifying the material misstatements in financial statements of a company. It is essential to asses environment of business organisation before actually commencing the process of auditing engagement. 

Recommendations

Following are the recommendations that were made by ASIC on the issues identified in governance of Commonwealth Bank. This report has also provided recommendations on the manner in which suggestions made by ASIC can help the company.   

ASIC identified Commonwealth Bank governance issues

Issue	Impact on raising audit risk	Recommendation	Reduction in audit risk because of recommendation
Lack of involvement of board of directors and committees made by BOD in the process of identifying non-financial risk that can affect overall business organisation operationally and financially	The non-financial are directly related to audit risk as lack of internal controls will increase the chances of non-identification of material misstatement in the process of auditing (Cohen & Simnett, 2014)	Active participation of BOD and various committees for identifying non-financial risk.	Effective oversight on part of management of the company will help auditor to reduce the risk of non-identification of material misstatement.
The process of identifying issues, incidents and risk was not effective and urgent matters that should have been addressed immediately were ignored by the management	Urgent matter that requires immediate attention of management can have significant financial impact on the compliance procedures to be applied in the process of auditing.	Management should adopt the best practices in the area of risk identification and management.	Following best practices in risk identification and management will help auditor to ensure that appropriate actions are taken by management to mitigate all risks that has severe impact on financial position of company.
The process of detection of material risks is ineffective due to complex and bureaucratic decision making process adopted by the management.	It will have a negative impact on process of risk assessment procedure adopted by auditor to identify material misstatements (Bradbury, Raftery & Scott, 2016).	Every decision making process undertaken by the management of the company should include the question “Should we”.	If management of Commonwealth bank of Australia will include the question of Should be in all business decisions then they would be able to identify the risk involves in a particular decision in more effective manner
Practical application of operational risk assessment procedures adopted by management of CBA was not effective but the plan was better on paper as it was supported by under developed compliance structure.	This will have questionability on operational structure of company in future and it can also affect going concern concept.	Committee recommended that management of the company should reassess the operational risk management and compliance functions and upgrade these function in accordance with current business environment.	This will help auditor of the company to assess whether operational structure of the company is effective or not. This will also help audit to comment on the going concern concept of accounting.

Question 2- Business Ethics   

Facts

Facts of the situation defected in a study is that a team is working very hard for project that will assess their position in the company. One of the team members asked for sick leave from manager of the company and that was allotted to him on the last day of the completion of the project. Rest of the team worked very hard on that day after completion of the work manager of the team i.e. David came to know that John was not sick that day and he was on a date with his girlfriend (Karaibrahimoglu & Cangarli, 2016).

Ethical issue

Both John and David are very good friend and ethical issues in this case is that whether David should tell the partners that John has contributed less as compared to other team members or he should ignore the situation as John is his friend?

Conclusion

Major principle

Integration of ethics in business practices is very essential requirement and the managers should implement policies for ethical requirements in his team. The role of manager is of a team leader and motivator for other members of the team. In this scenario it would not be fair for other two members of the team to get same recognition as John as they have put more effort in the project as compared to John (Trevino & Nelson, 2016). According to principle of Business Ethics, David should report to the partners of the company that John has put less efforts as compared to other team members in the project.  

Alternatives

Alternative 1- First alternative before David is that he should report to the partners of the company about the absence of John and the reason of such absence. This would have a vital impact on friendship of john and David

Alternative2- Other alternative available before David is that he does not disclose anything to management but this would not be fair to other team members of the project management team (Crane & Matten, 2016).

Comparison of alternatives and consequences      

If ethical requirements are considered then then the alternative 1 should be followed as it is ethical duty of manager to report the incident to partners and sat an example of a leader and motivator. On the other hand taking alternative 1 should ruin the friendship between David and John. In addition to that alterative 1 can also affect the professional relationship and working environment of the team (Bowie, 2017).

Decision

David should report the whole incident to the partners of the company as it is ethically correct decision and it would be fair to other team members.

Question 3- Statutory cap on auditor’s liability  

With the help of statutory cap on auditor’s liability, auditor of a company would be able to limit their liability in relation to audit conducted by them on business organisation by contract. One particular condition of this contact is that it should be approved by shareholders of the company. Following are the impact that cap on auditors liability would have on limitation of auditors liability.

1. This cap on liability of the auditor can increase the level of negligence on part of auditors as they are protected by the contract that they cannot be held responsible for the frauds and errors taken by the company (Laitinen, 2014). For this purpose a clause is added in company law that auditors of the company can only be protected if the court finds the action of auditors are free from gross negligence.
2. This action of cap on auditor’s liability is taken to protect the interest of Big Fours as they are conducting audits for more than 90% of large organisations in Australia. This would help in protection of the interest of auditors where management has conceived vital information from auditors which are not apparent from examination of financial statements.
3. This would increase the number of corporate audit firms as this is applicable only on audit firms that are incorporated as company (Samsonova-Taddei & Humphrey, 2015).
4. The fees changes by audit firms are also expected to decrease as auditors have limited liability.
5. Company would not be able to their losses from auditors of the company under “Joint and several liability” principle (Pettersson, 2016).

Conclusion

This report is based on three different topics that are related to audit of a corporate organisation. It is expected that this report is able to shed light on the problems identified in each of the topics discussed in this report.

References

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Bhaskar, L.S., Schroeder, J.H. and Shepardson, M.L., 2018. Integration of Internal Control and Financial Statement Audits: Are Two Audits Better than One?. The Accounting Review.

Bowie, N. E. (2017). Business ethics: A Kantian perspective. Cambridge University Press.

Bradbury, M. E., Raftery, A., & Scott, T. (2018). Knowledge spillover from other assurance services. Journal of Contemporary Accounting & Economics, 14(1), 52-64.

Carson, E., Fargher, N., & Zhang, Y. (2016). Trends in auditor reporting in Australia: a synthesis and opportunities for research. Australian Accounting Review, 26(3), 226-242.

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Crane, A., & Matten, D. (2016). Business ethics: Managing corporate citizenship and sustainability in the age of globalization. Oxford University Press.

Karaibrahimoglu, Y. Z., & Cangarli, B. G. (2016). Do auditing and reporting standards affect firms’ ethical behaviours? The moderating role of national culture. Journal of Business Ethics, 139(1), 55-75.

Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.

Laitinen, J. (2014). Auditor Liability Caps, Client Business Risk, and Audit Quality.

Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C. (2015). Auditing & assurance services. McGraw-Hill Education.

Pettersson, K. (2016). Auditor liability caps, auditing enforcement and asymmetric economic consequences.

Samsonova-Taddei, A., & Humphrey, C. (2015). Risk and the construction of a European audit policy agenda: The case of auditor liability. Accounting, Organizations and Society, 41, 55-72.

Simunic, D. A., Ye, M., & Zhang, P. (2015). Audit Quality, Auditing Standards, and Legal Regimes: Implications for International Auditing Standards. Journal of International Accounting Research, 14(2), 221-234.

Simunic, D. A., Ye, M., & Zhang, P. (2017). The joint effects of multiple legal system characteristics on auditing standards and auditor behavior. Contemporary Accounting Research, 34(1), 7-38.

Trevino, L. K., & Nelson, K. A. (2016). Managing business ethics: Straight talk about how to do it right. John Wiley & Sons.