Identification and Assessment of the RisIdentification and Assessment of the Risks of Material Misstatement Due to Fraud

Identification and Assessment of the Risks of Material Misstatement Due to Fraud

61 When identifying and assessing the risks of material misstatement at the financial report level, and at the assertion level for classes of transactions, account balances and disclosures, the auditor shall identify and assess the risks of material misstatement due to fraud. Those assessed risks that could result in a material misstatement due to fraud are significant risks and accordingly, to the extent not already done so, the auditor shall evaluate the design of the entity’s related controls, including relevant control activities, and determine whether they have been implemented.

62 To assess the risks of material misstatement due to fraud the auditor uses professional judgement and ordinarily:

(a) identifies risks of fraud by considering the information obtained through performing risk assessment procedures and by considering the classes of transactions, account balances and disclosures in the financial report;

(b) relates the identified risks of fraud to what can go wrong at the assertion level; and

(c) considers the likely magnitude of the potential misstatement including the possibility that the risk might give rise to multiple misstatements and the likelihood of the risk occurring.

63 It is important for the auditor to obtain an understanding of the controls that management has designed and implemented to prevent and detect fraud because in designing and implementing such controls, management may make informed judgements on the nature and extent of the controls it chooses to implement, and the nature and extent of the risks it chooses to assume. The auditor may learn, for example, that management has consciously chosen to accept the risks associated with a lack of segregation of duties. This may often be the case in small entities where the owner provides day-to-day supervision of operations. Information from obtaining this understanding may also be useful in identifying fraud risk factors that may affect the auditor’s assessment of the risks that the financial report may contain material misstatement due to fraud.

Risks of Fraud in Revenue Recognition

64 Material misstatements due to fraudulent financial reporting often result from an overstatement of revenues (for example, through premature revenue recognition or recording fictitious revenues) or an understatement of revenues (for example, through improperly shifting revenues to a later period). Therefore, the auditor ordinarily presumes that there are risks of fraud in revenue recognition and considers which types of revenue, revenue transactions or assertions may give rise to such risks. Those assessed risks of material misstatement due to fraud related to revenue recognition are significant risks to be addressed in accordance with paragraphs 61 and 65. Appendix 3 includes examples of responses to the auditor’s assessment of the risk of material misstatement due to fraudulent financial reporting resulting from revenue recognition. If the auditor has not identified, in a particular circumstance, revenue recognition as a risk of material misstatement due to fraud, in accordance with paragraph 119 the auditor is required to document the reasons for that conclusion.