Examples- Risk of material misstatement in the F/S

Risk of material misstatement in the F/S An overview-Examples of risk

response
Fair Value
- Accounting estimate - Expert’s report
- Judgment
- Risk of biasness ( assets overstated)

Indications of provisions, - 3rd parties can be

contingent assets, contingent - Understatement of provisions contacted ( lawyers,
liabilities - Overstatement of contingent assets regulatory bodies,
- Contingent liab disclosures- missing insurance company
or inadequate etc depending on the
scenario)

Lack of skills of management/BOD - Increase substantive

- Risk of errors testing
- Review controls in
that area
Profit linked bonuses to - Overstatement of profit - Increase professional
directors/management skepticism
- Increase substantive
testing
- Review controls in
that area
Inventories - Post year end sale of
inventory to
- Might be obsolete determine NRV
- Client might not have the right - Ageing of inventory to
- Might not exist get an indication
- Might be damaged about the NRV
- Risk of overstatement - Basis of estimating
selling costs to be
reviewed

Work in progress - increase substantive

- Complicated valuation testing in this area
- misstatement - experts report

Inventory at 3rd parties - Circularize the third

- Might be obsolete party
- Client might not have the right -
- Might not exist
- Might be damaged
- Risk of overstatement

Indications of excessive Laws and

regulations - Might have been breached
- Provision for fines/penalties
understated or Contingent liab
disclosure missing or inadequate
Transactions with directors ( or
other related parties) - Disclosure missing or inadequate

Law suit being faced- decision

pending at year end. - Provision for damages understated
or Contingent liab disclosure missing
or inadequate

Redundancies made
- Provision understated

New accounting system during the

year/changes in accounting system - Chances of errors

New accounting standard - Chances of errors -

implemented

Repairs and maintenance carried

out - Incorrectly capitalized (IAS 16)
- Assets overstated

Research and development

expenditure - Incorrectly capitalized as
development expenditure (IAS 38)
- Chances of errors

Acquired patents/brands/license - Can capitalize -

- Amortization rate may be incorrect
- Although not in the syllabus, can
mention impairment as well

Existing long term loan

- Finance cost incorrectly calculated
- Covenant might exist, which might
have been breached. Either provision
for fines or the loan may be
repayable which could have going
concern implications.
- Split between current and non-
current liabilities could be incorrect
- Assets held as security for which a
disclosure might be needed
Terms of existing loan being re- - Going concern implications should be -
negotiated considered if negotiations are not
successful

Applied for a new loan/ extension

in existing loan - Going concern implications should be
considered if this doesn’t work out

Receivables struggling to pay/

receivable days increase from last - Might need to be written off
year - Receivables overstated

Assets in transit - Might have been recorded in the -

incorrect accounting period

PPE acquired during the year - Incorrect cost might have been -
capitalized ( IAS 16)
- Might not have the right over the
asset
- Depreciation method and policy
related risks

PPE disposed off during the year

- Might not have been removed from
the NCA register
- Calculation or profit/loss on disposal
might be incorrect

PPE revalued during the year - Biasness? -

- Accounted for correctly?
- Assets in same class revalued?
- Depreciation on revalued amount?
- Disclosure adequate and complete?

Loss of key customer/key staff

- Going concern implications need to
be considered

Processing of a part of F/S - Auditor might not have access to -

outsourced ( e.g. payroll complete records/information
processing) - Chances of errors

Volatile industry - Frequent changes, inventory might -

be obsolete and so overstated

Use of part time workers by client - Chances of errors -

Cash based business/ excessive

cash transactions - Greater risk of misappropriation
- Cash balance might be overstated

Aggressive management style ( - Profits might be overstated. -

excessive focus on maximizing
profits)