SAS No. 122, AU 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement

Overview

If you do not understand the entity that you are auditing, you won’t know what type of transactions they should be entering into.  As a result, you won’t recognize those transactions they should not be there.  In other words, you will be performing the audit without having any idea of what you should be looking at.  This statement requires that the auditor document their understanding of the entity and its environment that it operates in as well as assessing the risks of material misstatement.

Prior to this statement, auditors often assessed risk at maximum and did not evaluate internal controls.  A big change made by this statement is that, while it allowed the auditor to continue to assess risk at maximum, they now must first evaluate internal controls in order to have a basis for making such an assumption.  As a result, auditors are now required to document their evaluation of internal controls on every financial statement audit.

This presentation is an overview of the many procedures auditors are now required to perform and document on every audit related to their understanding of the entity and its environment and the basis for assessing the risk of material misstatement.

Objectives

• Determining Risk
• Identify and assess the risk of material misstatement either due to error or fraud
• Distinguishing between an error of a fraud
• Understanding intent
• Evaluating the internal control process – When it begins and when it stops
• Developing risk assessment procedures
• Understanding the dangerous of complex transactions

Highlights

• How the effect of a misstatement due to error effects the scope of our audit vs a misstatement due to fraud
• Inquires of management …….. and others
• The audit planning process; when we start and when we stop
• The importance of brainstorming and what two things should a talk about
• Revisions of our risk assessment
• Determining materiality