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Issued 10/07 Updated 03/09 Updated 06/09 New Zealand Institute f Chartered Accuntants INTERNATIONAL STANDARD ON AUDITING (NEW ZEALAND) IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
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Issued 10/07 Updated 03/09 Updated 06/09 New Zealand Institute f Chartered Accuntants INTERNATIONAL STANDARD ON AUDITING (NEW ZEALAND) IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT THROUGH UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT Issued by the Cuncil f the New Zealand Institute f Chartered Accuntants Intrductin CONTENTS Paragraph Scpe f this ISA (NZ)... 1 Effective Date... 2 Objective... 3 Definitins... 4 Requirements Risk Assessment Prcedures and Related Activities The Required Understanding f the Entity and Its Envirnment, Including the Entity s Internal Cntrl Identifying and Assessing the Risks f Material Misstatement Dcumentatin Applicatin and Other Explanatry Material Risk Assessment Prcedures and Related Activities... The Required Understanding f the Entity and Its Envirnment, Including the Entity s Internal Cntrl... A1-A16 A17-A ISA (NZ) 315, Identifying and Assessing the Risks f Material Misstatement Thrugh Understanding the Entity and its Envirnment is drawn primarily frm Internatinal Standard n Auditing ISA 315, Identifying and Assessing the Risks f Material Misstatement Thrugh Understanding the Entity and its Envirnment issued by the Internatinal Auditing and Assurance Standards Bard (IAASB), published by the Internatinal Federatin f Accuntants (IFAC) in 2007 and is used with the permissin f IFAC. ISA (NZ) 550, Related Parties and ISA (NZ) 610, Using the Wrk f Internal Auditrs gave rise t cnfrming amendments t this ISA (NZ). See paragraphs 22a, A23a, A23b and A96a A96c. Release f ISA (NZ) 520, Analytical Prcedures included the additin f paragraphs A6a and A8a. Release f subsequent ISAs (NZ) has als given rise t minr wrding changes t this ISA (NZ). The June 2009 update includes minr editrial amendments made by the IAASB t ISA 315 as a result f the IAASB s review f clarified ISAs fr cnsistency. 1 Identifying and Assessing the Risks f Material Misstatement... A105-A130 Dcumentatin... A131-A134 Appendix 1: Internal Cntrl Cmpnents Appendix 2: Cnditins and Events that may Indicate Risks f Material Misstatement Cmpliance with this Standard is mandatry in terms f Rule 11 (paragraph 97) f the Cde f Ethics. Internatinal Standard n Auditing (New Zealand) (ISA (NZ)) 315, Identifying and Assessing the Risks f Material Misstatement thrugh Understanding the Entity and Its Envirnment is t be read in the cntext f the Explanatry Frewrd t Engagement Standards and the Framewrk fr Assurance Engagements issued by the New Zealand Institute f Chartered Accuntants and in cnjunctin with ISA (NZ) 200, Overall Objectives f the Independent Auditr and the Cnduct f an Audit in Accrdance with Internatinal Standards n Auditing (New Zealand). Intrductin Scpe f this ISA (NZ) 1. This Internatinal Standard n Auditing (New Zealand) (ISA (NZ)) deals with the auditr s respnsibility t identify and assess the risks f material misstatement in the financial statements, thrugh understanding the entity and its envirnment, including the entity s internal cntrl. Effective Date 2. This ISA (NZ) is effective fr audits f financial statements fr perids beginning n r after 1 January, Objective 3. The bjective f the auditr is t identify and assess the risks f material misstatement, whether due t fraud r errr, at the financial statement and assertin levels, thrugh understanding the entity and its envirnment, including the entity s internal cntrl, thereby prviding a basis fr designing and implementing respnses t the assessed risks f material misstatement. Definitins 4. Fr purpses f the ISAs (NZ), the fllwing terms have the meanings attributed belw: (a) (b) Assertins Representatins, explicit r therwise, that are embdied in the financial statements, as used by the auditr t cnsider the different types f ptential misstatements that may ccur. Business risk A risk resulting frm significant cnditins, events, circumstances, actins r inactins that culd adversely affect an entity s ability t achieve its bjectives and execute its strategies, r frm the setting f inapprpriate bjectives and strategies. 2 (c) (d) (e) Internal cntrl The prcess designed, implemented and maintained by thse charged with gvernance, management and ther persnnel t prvide reasnable assurance abut the achievement f an entity s bjectives with regard t reliability f financial reprting, effectiveness and efficiency f peratins, and cmpliance with applicable laws and regulatins. The term cntrls refers t any aspects f ne r mre f the cmpnents f internal cntrl. Risk assessment prcedures The audit prcedures perfrmed t btain an understanding f the entity and its envirnment, including the entity s internal cntrl, t identify and assess the risks f material misstatement, whether due t fraud r errr, at the financial statement and assertin levels. Significant risk An identified and assessed risk f material misstatement that, in the auditr s judgement, requires special audit cnsideratin. Requirements Risk Assessment Prcedures and Related Activities 5. The auditr shall perfrm risk assessment prcedures t prvide a basis fr the identificatin and assessment f risks f material misstatement at the financial statement and assertin levels. Risk assessment prcedures by themselves, hwever, d nt prvide sufficient apprpriate audit evidence n which t base the audit pinin. (Ref: Para. A1-A5) 6. The risk assessment prcedures shall include the fllwing: (a) (b) Enquiries f thse charged with gvernance, management, and thers within the entity wh in the auditr s judgement may have infrmatin that is likely t assist in identifying risks f material misstatement due t fraud r errr. (Ref: Para. A6) Analytical prcedures. (Ref: Para. A7-A10) (c) Observatin and inspectin. (Ref: Para. A11) 7. The auditr shall cnsider whether infrmatin btained frm the auditr s client acceptance r cntinuance prcess is relevant t identifying risks f material misstatement. 8. If the engagement partner has perfrmed ther engagements fr the entity, the engagement partner shall cnsider whether infrmatin btained is relevant t identifying risks f material misstatement. 9. Where the auditr intends t use infrmatin btained frm the auditr s previus experience with the entity and frm audit prcedures perfrmed in previus audits, the auditr shall determine whether changes have ccurred since the previus audit that may affect its relevance t the current audit. (Ref: Para. A12-A13) 10. The engagement partner and ther key engagement team members shall discuss the susceptibility f the entity s financial statements t material misstatement, and the applicatin f the applicable financial reprting framewrk t the entity s facts and circumstances. The engagement partner shall determine which matters are t be cmmunicated t engagement team members nt invlved in the discussin. (Ref: Para. A14-A16) 3 The Required Understanding f the Entity and its Envirnment, Including the Entity s Internal Cntrl The Entity and Its Envirnment 11. The auditr shall btain an understanding f the fllwing: (a) (b) (c) (d) (e) Relevant industry, regulatry, and ther external factrs including the applicable financial reprting framewrk. (Ref: Para. A17-A22) The nature f the entity, including: (i) (ii) its peratins; its wnership and gvernance structures; (iii) the types f investments that the entity is making and plans t make, including investments in special-purpse entities; and (iv) the way that the entity is structured and hw it is financed, t enable the auditr t understand the classes f transactins, accunt balances, and disclsures t be expected in the financial statements. (Ref: Para. A23-A27) The entity s selectin and applicatin f accunting plicies, including the reasns fr changes theret. The auditr shall evaluate whether the entity s accunting plicies are apprpriate fr its business and cnsistent with the applicable financial reprting framewrk and accunting plicies used in the relevant industry. (Ref: Para. A28) The entity s bjectives and strategies, and thse related business risks that may result in risks f material misstatement. (Ref: Para. A29-A35) The measurement and review f the entity s financial perfrmance. (Ref: Para. A36-A41) The Entity s Internal Cntrl 12. The auditr shall btain an understanding f internal cntrl relevant t the audit. Althugh mst cntrls relevant t the audit are likely t relate t financial reprting, nt all cntrls that relate t financial reprting are relevant t the audit. It is a matter f the auditr s prfessinal judgement whether a cntrl, individually r in cmbinatin with thers, is relevant t the audit. (Ref: Para. A42-A65) Nature and Extent f the Understanding f Relevant Cntrls 13. When btaining an understanding f cntrls that are relevant t the audit, the auditr shall evaluate the design f thse cntrls and determine whether they have been implemented, by perfrming prcedures in additin t enquiry f the entity s persnnel. (Ref: Para. A66-A68) Cmpnents f Internal Cntrl Cntrl envirnment 14. The auditr shall btain an understanding f the cntrl envirnment. As part f btaining this understanding, the auditr shall evaluate whether: (a) Management, with the versight f thse charged with gvernance, has created and maintained a culture f hnesty and ethical behaviur; and 4 (b) The strengths in the cntrl envirnment elements cllectively prvide an apprpriate fundatin fr the ther cmpnents f internal cntrl, and whether thse ther cmpnents are nt undermined by deficiencies in the cntrl envirnment. (Ref: Para. A69-A78) The entity s risk assessment prcess 15. The auditr shall btain an understanding f whether the entity has a prcess fr: (a) (b) (c) Identifying business risks relevant t financial reprting bjectives; Estimating the significance f the risks; Assessing the likelihd f their ccurrence; and (d) Deciding abut actins t address thse risks. (Ref: Para. A79) 16. If the entity has established such a prcess (referred t hereafter as the entity s risk assessment prcess ), the auditr shall btain an understanding f it, and the results theref. If the auditr identifies risks f material misstatement the entity has failed t identify, the auditr shall evaluate whether there was an underlying risk f a kind that the auditr expects wuld have been identified by the entity s risk assessment prcess. If there is such a risk, the auditr shall btain an understanding f why that prcess failed t identify it, and evaluate whether the prcess is apprpriate t its circumstances r determine if there is a significant deficiency in internal cntrl with regard t the entity s risk assessment prcess. 17. If the entity has nt established such a prcess r has an ad hc prcess, the auditr shall discuss with management and thse charged with gvernance whether business risks relevant t financial reprting bjectives have been identified and hw they have been addressed. The auditr shall evaluate whether the absence f a dcumented risk assessment prcess is apprpriate in the circumstances, r determine whether it represents a significant deficiency in internal cntrl. (Ref: Para. A80) The infrmatin system, including the related business prcesses, relevant t financial reprting, and cmmunicatin 18. The auditr shall btain an understanding f the infrmatin system, including the related business prcesses, relevant t financial reprting, including the fllwing areas: (a) (b) (c) The classes f transactins in the entity s peratins that are significant t the financial statements; The prcedures, within bth infrmatin technlgy (IT) and manual systems, by which thse transactins are initiated, recrded, prcessed, crrected as necessary, transferred t the general ledger and reprted in the financial statements; The related accunting recrds, supprting infrmatin and specific accunts in the financial statements that are used t initiate, recrd, prcess and reprt transactins; this includes the crrectin f incrrect infrmatin and hw infrmatin is transferred t the general ledger. The recrds may be in either manual r electrnic frm; 5 (d) (e) (f) ISA (NZ) 315 Hw the infrmatin system captures events and cnditins, ther than transactins, that are significant t the financial statements; The financial reprting prcess used t prepare the entity s financial statements, including significant accunting estimates and disclsures; and Cntrls surrunding jurnal entries, including nn-standard jurnal entries used t recrd nn-recurring, unusual transactins r adjustments. (Ref: Para. A81-A85) 19. The auditr shall btain an understanding f hw the entity cmmunicates financial reprting rles and respnsibilities and significant matters relating t financial reprting, including: (a) (b) Cmmunicatins between management and thse charged with gvernance; and External cmmunicatins, such as thse with regulatry authrities. (Ref: Para. A86-A87) Cntrl activities relevant t the audit 20. The auditr shall btain an understanding f cntrl activities relevant t the audit, being thse the auditr judges it necessary t understand in rder t assess the risks f material misstatement at the assertin level and design further audit prcedures respnsive t assessed risks. An audit des nt require an understanding f all the cntrl activities related t each significant class f transactins, accunt balance, and disclsure in the financial statements r t every assertin relevant t them. (Ref: Para. A88-A94) 21. In understanding the entity s cntrl activities, the auditr shall btain an understanding f hw the entity has respnded t risks arising frm IT. (Ref: Para. A95- A97) Mnitring f cntrls 22. The auditr shall btain an understanding f the majr activities that the entity uses t mnitr internal cntrl ver financial reprting, including thse related t thse cntrl activities relevant t the audit, and hw the entity initiates remedial actins t deficiencies in its cntrls. (Ref: Para. A98-A100) 23. If the entity has an internal audit functin, 4 the auditr shall btain an understanding f the fllwing in rder t determine whether the internal audit functin is likely t be relevant t the audit: (a) (b) The nature f the internal audit functin s respnsibilities and hw the internal audit functin fits in the entity s rganisatin structure; and The activities perfrmed, r t be perfrmed, by the internal audit functin. (Ref: Para. A101-A103) 4 The term internal audit functin is defined in ISA (NZ) 610, Using the Wrk f Internal Auditrs, paragraph 7(a), as: An appraisal activity established r prvided as a service t the entity. Its functins include, amngst ther things, examining, evaluating and mnitring the adequacy and effectiveness f internal cntrl. 6 24. The auditr shall btain an understanding f the surces f the infrmatin used in the entity s mnitring activities, and the basis upn which infrmatin is cnsidered t be sufficiently reliable fr the purpse. (Ref: Para. A104) Identifying and Assessing the Risks f Material Misstatement 25. The auditr shall identify and assess the risks f material misstatement at: (a) (b) the financial statement level; and (Ref: Para. A105-A108) the assertin level fr classes f transactins, accunt balances, and disclsures, (Ref: Para. A109-A113) t prvide a basis fr designing and perfrming further audit prcedures. 26. Fr this purpse, the auditr shall: (a) (b) (c) (d) Identify risks thrughut the prcess f btaining an understanding f the entity and its envirnment, including relevant cntrls that relate t the risks, and by cnsidering the classes f transactins, accunt balances, and disclsures in the financial statements; (Ref: Para. A114-A115) Assess the identified risks, and evaluate whether they relate mre pervasively t the financial statements as a whle and ptentially affect many assertins; Relate the identified risks t what can g wrng at the assertin level, taking accunt f relevant cntrls that the auditr intends t test ; (Ref: Para. A1169- A118) and Cnsider the likelihd f misstatement, including the pssibility f multiple misstatements, and whether the ptential misstatement is f a magnitude that culd result in a material misstatement. Risks that Require Special Audit Cnsideratin 27. As part f the risk assessment as described in paragraph 25, the auditr shall determine whether any f the risks identified are, in the auditr s judgement, a significant risk. In exercising this judgement, the auditr shall exclude the effects f identified cntrls related t the risk. 28. In exercising judgement as t which risks are significant risks, the auditr shall cnsider at least the fllwing: (a) Whether the risk is a risk f fraud; (b) Whether the risk is related t recent significant ecnmic, accunting r ther develpments and, therefre, requires specific attentin; (c) The cmplexity f transactins; (d) Whether the risk invlves significant transactins with related parties; (e) (f) The degree f subjectivity in the measurement f financial infrmatin related t the risk, especially thse measurements invlving a wide range f measurement uncertainty; and Whether the risk invlves significant transactins that are utside the nrmal curse f business fr the entity, r that therwise appear t be unusual. (Ref: Para. A119-A123) 7 29. If the auditr has determined that a significant risk exists, the auditr shall btain an understanding f the entity s cntrls, including cntrl activities, relevant t that risk. (Ref: Para. A124-A126) Risks fr Which Substantive Prcedures Alne D Nt Prvide Sufficient Apprpriate Audit Evidence 30. In respect f sme risks, the auditr may judge that it is nt pssible r practicable t btain sufficient apprpriate audit evidence nly frm substantive prcedures. Such risks may relate t the inaccurate r incmplete recrding f rutine and significant classes f transactins r accunt balances, the characteristics f which ften permit highly autmated prcessing with little r n manual interventin. In such cases, the entity s cntrls ver such risks are relevant t the audit and the auditr shall btain an understanding f them. (Ref: Para. A127-A129) Revisin f Risk Assessment 31. The auditr s assessment f the risks f material misstatement at the assertin level may change during the curse f the audit as additinal audit evidence is btained. In circumstances where the auditr btains audit evidence frm perfrming further audit prcedures, r if new infrmatin is btained, either f which is incnsistent with the audit evidence n which the auditr riginally based the assessment, the auditr shall revise the assessment and mdify the further planned audit prcedures accrdingly. (Ref: Para. A130) Dcumentatin 32. The auditr shall include in the audit dcumentatin: 5 (a) The discussin amng the engagement team where required by paragraph 10, and the significant decisins reached; (b) (c) (d) Key elements f the understanding btained regarding each f the aspects f the entity and its envirnment specified in paragraph 11 and f each f the internal cntrl cmpnents specified in paragraphs 14-24; the surces f infrmatin frm which the understanding was btained; and the risk assessment prcedures perfrmed; The identified and assessed risks f material misstatement at the financial statement level and at the assertin level as required by paragraph 25; and The risks identified, and related cntrls abut which the auditr has btained an understanding, as a result f the requirements in paragraphs (Ref: Para. A131-A134) *** 5 ISA (NZ) 230, Audit Dcumentatin, paragraphs 8-11, and paragraph A6. 8 Applicatin and Other Explanatry Material Risk Assessment Prcedures and Related Activities (Ref: Para. 5) ISA (NZ) 315 A1. Obtaining an understanding f the entity and its envirnment, including the entity s internal cntrl (referred t hereafter as an understanding f the entity ), is a cntinuus, dynamic prcess f gathering, updating and analysing infrmatin thrughut the audit. The understanding establishes a frame f reference within which the auditr plans the audit and exercises prfessinal judgement thrughut the audit, fr example, when: Assessing risks f material misstatement f the financial statements; Determining materiality in accrdance with ISA (NZ) 320; 6 Cnsidering the apprpriateness f the selectin and applicatin f accunting plicies, and the adequacy f fi
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