Academic journal article Journal of Accountancy

Assessing and Responding to Risks in a Financial Statement Audit: Auditors Must Leave a Clear Record in Private Company Audits

Academic journal article Journal of Accountancy

Assessing and Responding to Risks in a Financial Statement Audit: Auditors Must Leave a Clear Record in Private Company Audits

Article excerpt


* The new audit risk standards require the auditor to understand and respond to risks of material misstatement, whether due to errors or fraud. In reaching that understanding, auditors should identify risks to the entity's business and the controls in place to mitigate them.

* These standards use the more sharply defined terms must, should and may from SAS no. 102, Defining Professional Requirements in Statements on Auditing Standards.

* Because these standards address many issues at the core of auditing, they may significantly affect the formality of the risk assessment process and documentation of the assessment details, depending on how this has been done in the past.

* Entities and auditors will maximize their effectiveness and efficiency if they carefully plan their responses to the new requirements. The documentation and assessment of controls over financial reporting is a good place for them to begin such efforts,

* The AICPA is creating a number of educational products designed to help auditors implement the new standards.


This is the first of two articles describing the requirements of--and implementation suggestions for--new guidance from the Auditing Standards Board (ASB). This article discusses the process of assessing risks and controls, leading to the concept of the risk of material misstatement. A subsequent JofA article will discuss how the auditor responds to the risk of material misstatement.

These eight standards (see exhibit 1, and "The New World of Auditing Standards," JofA, May05,) are designed to help auditors plan and perform audit procedures that will address assessed risks, enhance the auditor's response to audit risk and materiality, facilitate planning and supervision and clarify the concept of audit evidence.

Exhibit 1

The Audit Risk

* SAS no. 104, Amendment to
Statement on Auditing Standards No.
1, Codification of Auditing
Standards and Procedures ("Due
Professional Care in the Performance
of Work")

* SAS no. 105, Amendment to
Statement on Auditing Standards No.
95. Generally Accepted Auditing

* SAS no. 106, Audit Evidence

* SAS no. 107, Audit Risk and
Materiality in Conducting an Audit

* SAS no. 108. Planning and

* SAS no. 109, Understanding the
Entity and Its Environment and
Assessing the Risks of Material

* SAS no. 110, Performing Audit
Procedures in Response to Assessed
Risks and Evaluating the Audit
Evidence Obtained

* SAS no. 111, Amendment to
Statement on Auditing Standards No.
39, Audit Sampling


The standards are designed to result in more effective audits as a result of better risk assessments and improved design and performance of audit procedures to respond to the risks. Auditors will be able to focus on those areas where the risk of misstatement is the greatest.

The new standards also clarify the phrase "sufficient knowledge of internal control to plan the audit" as used in the professional literature. A resulting benefit is that the auditor will have a better basis for determining the nature, timing and extent of further procedures and assessing potential fraud risks.

In addition, the standards emphasize the use of assertions to link the risks, controls, audit procedures and conclusions. Auditors can use this technique to determine whether audit procedures are responsive to identified risks

SAS no. 107 makes it clear that the overall objective of an audit is to provide reasonable assurance that the financial statements are free of material misstatement. The term reasonable assurance has been subject to varying interpretations, but has now been clarified by the ASB as meaning a high, although not absolute, level of audit assurance.

To ensure that management, those charged with governance and the auditor agree on what the audit will involve, SAS no. …

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