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

EXECUTIVE SUMMARY * new 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. documentation and assessment of controls over financial reporting is a good place for them to begin such efforts, * 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 procedures that will address assessed risks, enhance the auditor's response to risk and materiality, facilitate planning and supervision and clarify the concept of evidence. Exhibit 1 Audit Risk Standards * 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 Standards * SAS no. 106, Audit Evidence * SAS no. 107, Audit Risk and Materiality in Conducting an Audit * SAS no. 108. Planning and Supervision * SAS no. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement * 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 EXPECTED BENEFITS OF THE STANDARDS standards are designed to result in more effective audits as a result of better risk assessments and improved design and performance of procedures to respond to the risks. Auditors will be able to focus on those areas where the risk of misstatement is the greatest. 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, procedures and conclusions. Auditors can use this technique to determine whether procedures are responsive to identified risks SAS no. 107 makes it clear that the overall objective of an is to provide reasonable assurance that the financial statements are free of material misstatement. 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 assurance. To ensure that management, those charged with governance and the auditor agree on what the will involve, SAS no. …