International Standard on Auditing (ISA) 315 is a crucial standard that guides auditors in identifying and assessing risks of material misstatement in financial statements. It underwent significant revisions in recent years, along with changes in ISA 240, which focuses on fraud risk assessment.

In her session, Planning and Documentation & Risks and Responses, Lindsay Webber explains that ISA 315 emphasises the importance of obtaining a thorough understanding of an entity and its environment, including internal controls, to effectively assess risks.

Fraud and Error Considerations

Auditors must remain vigilant against both fraud and error when conducting risk assessments. A common bias among auditors is the tendency to focus solely on errors, assuming clients operate with integrity. Conversely, some auditors may assume all irregularities are fraudulent. A balanced approach requires acknowledging both possibilities and examining risks at both the assertion level and financial statement level.

Understanding the Entity and Its Environment

To accurately assess risk, auditors must gain comprehensive insights into their clients' businesses. This includes:

• Business operations and industry-specific factors
• Changes in operations, financial health, and management structure
• Internal control systems and IT infrastructure

Proper documentation is essential. Auditors should not merely roll forward prior-year assessments but should actively update their understanding of the entity.

Risk Assessment Procedures Under ISA 315

ISA 315 outlines three mandatory risk assessment procedures:

• Inquiry of Management and Others
  Engaging in discussions with management and relevant personnel
  Documenting meetings and tailoring meeting minutes to reflect specific client concerns

• Analytical Procedures
  Planning analytical procedures: Comparing current and prior-year trial balances and analysing changes to understand any changes at your client.
  
• Walkthrough Testing
  Tracing transactions from initiation to financial statement inclusion
  Using screenshots and documentation to provide clear evidence of processes
  Conducting annual walkthroughs for significant risks, such as revenue fraud risk

The Role of IT Systems in Risk Assessment

The revised ISA 315 places greater emphasis on understanding IT systems due to increasing reliance on technology in financial reporting. Auditors must document:

• IT software and packages used by the entity
• Access controls, including usernames, passwords, and frequency of changes
• Data backup procedures and security measures

Even for small entities with minimal IT reliance, documentation should reflect their technological environment, ensuring compliance with audit standards.

The Risk Spectrum and Significant Risks

Auditors must classify risks on a spectrum from low to significant. Certain risks, particularly those related to fraud, are always considered significant. These include:

• Revenue recognition risks
• Unusual related party transactions
• Management override of controls

Entities with complex transactions, such as cryptocurrency investments, require careful risk assessment due to high levels of uncertainty and subjectivity.

Assessing Inherent Risk and Control Risk

ISA 315 mandates separate assessments of:

• Inherent Risk: The risk of misstatement due to the nature of a balance or transaction
  

Factors indicating inherent risk include:

• Subjectivity
• Complexity of transactions
• Uncertainty, such as legal disputes or volatile investments
• Changes in operations, personnel, or financial structure
• Susceptibility to fraud or management bias

• Control Risk: The risk that internal controls fail to prevent or detect misstatements

Most audits, especially for small to medium-sized entities, rely primarily on substantive procedures rather than testing operating effectiveness of controls. In such cases, control risk defaults to inherent risk.

Professional Scepticism in Risk Assessment

A thorough risk assessment demonstrates professional scepticism, a key audit principle. Reviewers scrutinise risk assessments to ensure auditors have adequately identified potential risks.

ISA 315 establishes a structured approach to identifying and assessing risks of material misstatement. By ensuring comprehensive documentation, understanding entity operations, and applying professional scepticism, auditors can effectively conduct risk assessments that form the foundation of a robust audit. Proper implementation of ISA 315 enhances audit quality, ensuring financial statements accurately reflect an entity's financial position.

For the full session, please click here. In this course Lindsay Webber covers:

Planning and documentation;

• ISA 300 – Planning an Audit;
• ISA 250A – Consideration of Laws and Regulations in an Audit;
• ISA 320 – Materiality in Planning and Performing an Audit;
• ISA 530 – Audit Sampling.

Risks and Responses;

• ISA 240 – Auditors’ Responsibilities Relating to Fraud in an Audit;
• ISA 315 – Identifying and Assessing the Risks of Material Misstatements.
• ISA 330 – Auditors’ Responses to Assessed Risks.

The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article. The information at the time of publishing was accurate and could be subject to final changes.