Can you identify Significant Risks for an audit client?
Summary
TLDRIn this educational video, Dr. Amanda White clarifies the confusion between business risks, inherent risks, control risks, and the risk of material misstatement, which often leads to lost marks in exams. She explains the concept of significant risks, as defined by ISA 315, and provides three practical tips to help identify them. These tips include understanding the client's industry and operations, distinguishing between business and inherent risks, and linking risks to potential misstatements. The video aims to help students excel in their auditing assessments and exams.
Takeaways
- đ Dr. Amanda White discusses the confusion students face between business risks, inherent risks, control risks, and the risk of material misstatement.
- đ The video aims to untangle these concepts and provide tips for identifying significant risks, which are crucial for planning and executing audits.
- đ Significant risks are defined as the risk of material misstatement or error that could affect the audit process, originating from ISA 315.
- đ Inherent risks are linked to the nature of the client's operations, such as trading in foreign currencies or having complex bonus schemes.
- đ Control risks arise when internal controls are missing or not functioning properly, increasing the chance of misstatement or error.
- đ The new ASA 315, effective in 2021, instructs auditors to identify risks of material misstatement and evaluate their potential impact and likelihood.
- đ§ Tip 1: Understanding the client is key to identifying inherent risks; this includes knowledge of their industry, operations, corporate governance, and global economic context.
- đ« Tip 2: Business risks are not always inherent risks; they may not necessarily lead to increased accounting errors or misstatements.
- đ Tip 3: Ensure risks can be linked to an account or assertion; if not, they may not be significant risks.
- đĄ The ability to identify significant risks is foundational to auditing, as failure to do so could lead to undetected material misstatements and incorrect audit opinions.
Q & A
What is the main topic discussed in Dr. Amanda White's video?
-The main topic discussed is the concept of significant risks in auditing, particularly the confusion between business risks, inherent risks, control risks, and the risk of material misstatement.
What are the two main sources of risk of misstatement or error in financial statements according to the video?
-The two main sources are inherent risks and control risks. Inherent risks are due to the nature of the business or industry, while control risks are due to the absence or ineffectiveness of internal controls.
What does the term 'inherent risk' mean in the context of auditing?
-Inherent risk refers to the risk of misstatement or error that exists due to the nature of the client's business or industry, which is a permanent or characteristic attribute of the client.
How does the new AS 31:5 standard mentioned in the video help in identifying significant risks?
-The new AS 31:5 standard instructs auditors to identify risks of material misstatement and then consider their broad financial statement impact and evaluate the nature and extent of their effect, helping to distinguish significant risks.
What are Dr. Amanda White's three tips for identifying significant risks?
-Tip one is to know the client well, including their industry, operations, corporate governance, and global economic environment. Tip two is to distinguish between business risks and inherent risks. Tip three is to ensure the risk can be linked to an account or assertion to increase the risk of misstatement or error.
Why is it important to differentiate between business risks and inherent risks?
-Differentiating between business risks and inherent risks is important because not all business risks result in an increase in the risk of misstatement or error in accounting, and this distinction helps in accurately identifying significant risks.
What is the significance of understanding the client's industry in identifying inherent risks?
-Understanding the client's industry helps in identifying where potential mistakes or errors in accounting might occur, as certain industries may have unique or complex accounting policies that increase inherent risk.
How does the global economic environment factor into the identification of inherent risks?
-The global economic environment can introduce risks such as trade tensions, disruptions due to technological advancements, or difficulties in refinancing debts, which can affect a client's operations and thus increase inherent risks.
What is the consequence of not properly identifying significant risks during an audit?
-Failing to properly identify significant risks can lead to missing a material misstatement, providing an incorrect audit opinion, and potentially facing legal consequences such as lawsuits.
What is the call to action at the end of the video for viewers to engage with the content?
-The call to action is for viewers to select one of the companies - Apple, Airbnb, or Innisfree - and identify three significant risks they believe the company faces, then share their risks and explanations in the comments section.
Outlines
đ Understanding Significant Risks in Auditing
Dr. Amanda White introduces the concept of significant risks in auditing, highlighting the confusion students often face between business risks, inherent risks, control risks, and the risk of material misstatement. She aims to clarify these terms and provide tips for identifying significant risks. The video is divided into two parts: the first part focuses on untangling the term 'significant risk,' and the second offers three tips to master the concept. Dr. White explains that significant risks are derived from ISA 315 and pertain to the risk of material misstatement or error that could affect the audit planning and execution. She emphasizes the importance of distinguishing between inherent and control risks, with inherent risks being characteristics of the client that increase the risk of misstatement or error. The video also discusses the upcoming changes in ISA 315 and how they will help auditors identify and evaluate significant risks based on their potential impact and likelihood of occurrence.
đ Analyzing Inherent Risks and Business Risks
In the second paragraph, Dr. White delves into the specifics of inherent risks, explaining that they are often misunderstood as being the same as business risks. She clarifies that business risks are challenges faced by management that do not necessarily lead to accounting errors, while inherent risks are more about the potential for mistakes in financial reporting due to the nature of the client's operations. Dr. White provides examples to illustrate the difference, such as the focus of mining firm CEOs on geological surveys rather than accounting issues. She stresses the importance of separating business risks from inherent risks and offers a third tip: to ensure that identified risks can be linked to an account or assertion to be considered significant. She uses the example of competition and sales incentives to demonstrate how certain risks can directly impact the financial statements. Dr. White concludes by emphasizing the foundational role of identifying significant risks in conducting a successful audit and encourages viewers to apply her tips to real-world companies like Apple, Airbnb, or Innisfree to practice identifying significant risks.
Mindmap
Keywords
đĄSignificant Risks
đĄInherent Risks
đĄControl Risks
đĄMaterial Misstatement
đĄAudit Planning
đĄISA 315
đĄBusiness Risks
đĄGlobal Economic Environment
đĄAccounting Policies
đĄAssertions
Highlights
Dr. Amanda White discusses the confusion between business risks, inherent risks, control risks, and the risk of material misstatement.
Provides three tips to help identify significant risks for students.
Explains the term 'significant risk' from ISA 315 and its importance in the audit process.
Differentiates between inherent and control risks, emphasizing their distinct nature.
Describes inherent risks as characteristics that increase the risk of misstatement or error.
Mentions the upcoming changes in ISA 315 in 2021 that will provide more detailed guidance on identifying significant risks.
Outlines the process of brainstorming potential inherent risks and evaluating them for potential impact and likelihood of occurrence.
Emphasizes the importance of knowing the client to identify where potential accounting errors might occur.
Discusses the role of industry-specific accounting policies in identifying inherent risks.
Highlights the need to understand the client's operations to identify risks associated with transactions and valuations.
Explains how the global economic environment can influence the inherent risks of a client.
Clarifies that business risks are not always inherent risks and should be separated for accurate risk assessment.
Advises on linking risks to accounts or assertions to determine their significance.
Stresses the foundational role of identifying significant risks in the audit process to avoid material misstatement.
Encourages students to apply the three tips to identify significant risks for companies like Apple, Airbnb, or Innisfree.
Invites students to share their risk assessments in the comments for further discussion.
Reminds viewers of the importance of understanding significant risks to prevent legal issues such as lawsuits for wrong audit opinions.
Transcripts
what's up what it fans dr. Amanda white
here and today we're going to talk about
significant risks now students are often
confused between business risks inherent
risks controllers significant risks and
the risk of material misstatement and
this results in a lot of lost marks in
ordered exams today I'm going to
untangle these concepts and give you
three tips to help you identify
significant risks so let's get into it
[Music]
a big welcome back to all my regular
subscribers and hi if you're new to the
channel my name is Amanda I'm a former
auditor I've got a PhD in behavioral
auditing and I teach auditing at
university here in Australia now today's
video is in two parts part one is
untangling the term significant risk and
part two will be my three tips to help
you become a significant risk master the
term significant risk comes from a si is
a three one five about understanding the
client and it really means what is the
risk of misstatement or error this
material and likely to affect the
planning and the execution of the audit
but what does that mean in plain English
where do I find these risks how do i
generate them for my standards well we
need to start with sources of risk of
misstatement or error in the financial
statements and there are really two main
ones either from areas that are more
risky because of their nature all
because internal controls are missing or
not working appropriately now these two
sorts of risks are called inherent and
control risks and it's important to be
able to distinguish between them the
word inherent is in the clue here the
definition of inherent according to the
Oxford English Dictionary is existing in
something as a permanent essential or
characteristic attribute so that really
means some characteristic of the client
increases the risk of misstatement or
error for example if you trade overseas
in foreign currencies there's a much
greater risk of making a mistake in your
foreign currency translation reserve if
you have a bonus plan based on the level
of sales you may have fraudulent
manipulation by salespeople for
companies that have lots of subsidiaries
then there's a greater chance of making
a mistake when you're consolidating all
of those subsidiaries double-whammy if
you're also got subsidiaries in
different countries so you might be
thinking inherent risks are significant
risks right and you'd sort of be correct
and this is where things get a little
bit complicated in 2021 new a sa 31:5
will come into force it's more detailed
than what we see right now but it's
actually going to help us understand and
unpick this situation paragraph 45
instructs auditors to identify
because of material misstatement and
then do two things number one consider
whether they have a broad financial
statement impact or an impact on just a
small part of the accounts or assertions
number two evaluate the nature and
extent of their effect that is what is
the potential impact and what's the
possibility or likelihood of occurring
so how exactly does that help us well it
means that we need to brainstorm all of
the potential inherent risks for the
client then we're going to need to
evaluate them against their potential
impact and the likelihood of occurrence
and link them to an account or an
assertion our highest ranking risks will
become our significant ones now I know
your next question is going to be well
how do I actually generate this list of
inherent risks that will then become my
significant risks well this is where my
three tips are going to come into play
tip number one we start by knowing our
client and that's the whole point of
three one five know the client their
industry their operations their
corporate governance the company and how
it fits within the global economic
environment once you know your client
you'll be able to identify where the
potential mistakes or errors in the
accounting might occur the exact areas
that a SI 3 1 5 requires you to
understand about the client can actually
be used to help structure your analysis
for example industry are their
accounting policies within that industry
that are unique or excessively
complicated for example pharmaceutical
companies and their R&D costs and how
they could be accounted for mining
companies have real difficulties in
valuing natural resources stuck in the
ground we also need to know about the
operations of the client are they
multinational do they use foreign
currencies do they use hedges do they
have an increased risk of using the
wrong rate or making a calculation
mistake they're due to the volume of
their transactions clients that have
lots of intangible assets have an
increased risk around the valuation and
impairment of those assets if management
received big bonuses linked to key
performance indicators then they're more
likely to manipulate those indicators
and those accounts become greater at
risk we also need to think about the
global environment
if you're an American come
that deals with China then there may be
some risk due to trade tensions between
the cup two countries if they can't get
the supplies or products they need that
could be an issue of going concern
another example might be when a client
is trying to refinance their debts we
saw that in Thomas Cook the global
economy had moved on from traditional
travel agencies and the internet
disrupted their business they weren't
able to refinance and restructure now
these are a few types of different
inherent risks but there are endless
possibilities depending on the industry
and the company and you can only
generate them by understanding the
client really well now tip number two is
that business risks are not always
inherent risks business risks are those
faced by management things aren't going
to stop them from achieving their
business objectives and they don't
necessarily result in an increase in a
mistake or an error in the accounting an
example might be in the mining firms
mining firms CEOs aren't really
interested in the accounting issues
around exploration and development costs
they are interested in what do the
geological survey say about where the
next places to dig so we need to make
sure that we separate our business risks
and inherent risks this is really really
important some will cross over but quite
often they don't tip number three see if
you can explain why your risk increases
the risk of misstatement or error if you
can't link the risk to an account or an
assertion then it's not likely to be a
good risk now an example here is
competition if you can't explain why
competition in your industry for your
client increases the possibility of
error or manipulation then it's not a
risk if salespeople received a bonus of
60% related to their monthly sales
targets then boom you've got a clear
risk because there's cause and effect
the incentive structure will cause or
incentivize salespeople to manipulate
the accounts and that's going to affect
sales revenue commissions with the
occurrence and cutoff assertions now
identifying the important significant
risks is the foundation of the audit if
you don't identify the risks properly at
the
of the audit then you risk missing out
on detecting a material misstatement and
giving the wrong opinion and of course
nobody wants to get sued for giving the
wrong opinion so now it's over to you
select one of the following three
companies Apple Airbnb or Innisfree and
see if you can identify three risks that
you would think would fall under the
significant risk category put your risks
and your explanations for why you think
there are risks in the comments in a
later video I'll share my analysis my
answers and also your responses
I hope my three tips will help you
identify significant risks and stop you
from getting caught out and losing marks
in your exams and assessments as always
I'd appreciate a thumbs up on the video
if you haven't already please consider
subscribing to the channel and you can
catch me on Twitter Facebook and
Instagram where I post and chat daily
otherwise I'll see you next time
5.0 / 5 (0 votes)