Risk Of Material Misstatement Research Articles

Risk assessment steps and their changes due to the adoption of International Standard on Auditing (ISA) 315 (Revised 2019)

Subject. This article considers the impact of the new requirements of International Standard on Auditing (ISA) 315 (Revised 2019), Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, on the risk-based approach applying in auditing. Objectives. The article aims to disclose the new requirements affecting one of the most important steps of auditing, namely the identification and assessment of risk in accordance with the new principles of ISA 315 revised. Methods. For the study, we used a systems approach. Results. The article summarizes the innovations of the revised Standard and proposes templates for working papers reflecting a risk-based approach application in the field of material misstatement risks. Conclusions and Relevance. The updated requirements of ISA 315 have an impact on the scope and nature of risk assessment procedures. To conduct auditing in accordance with the new requirements, organizations need to train employees and modernize working papers. The proposed templates of working papers can be used by audit organizations in their practical activities to reflect a risk-based approach in the field of material misstatement risks.

Governance mediation in the era of disruptive technologies: unveiling new perspectives on the risk of material misstatements

Purpose This study aims to examine the mediating effects of corporate governance mechanisms like the board of directors on the association between disruptive technology adoption by audit clients and the risk of material misstatements, including inherent risk and control risk. In particular, the authors study the mediating effects of board characteristics such as board size, independence and gender diversity. Design/methodology/approach Based on a sample of 100 audit clients listed on the FTSE 100 from 2015 to 2021, this study uses structural equation modelling to test the research objectives. Findings The findings indicate a significant and negative association between disruptive technology adoption by audit clients and inherent risk. However, there is no significant evidence observed for control risk. The utilisation of disruptive technology by the audit client has a significant impact on the board characteristics, resulting in an increase in board size, greater independence and gender diversity. The authors also find strong evidence that board independence mediates the association between disruptive technology usage and both inherent risk and control risk. In addition, board size and gender exhibit distinct and differential mediating effects on the association and across the two types of risks. Research limitations/implications The study reveals that the significant role of using disruptive technology by audit clients in reducing the risk of material misstatements is closely associated with the board of directors, which makes audit clients place greater emphasis on the construction of effective corporate governance. Practical implications This study offers essential primary evidence that can assist policymakers and standard setters in formulating guidance and recommendations for board size, independence and gender quotas, ensuring the enhancement of effective governance and supporting the future of audit within the next generation of digital services. Social implications With respect to relevant stakeholders, it is imperative for audit clients to recognise that corporate governance represents a fundamental means of addressing the ramifications of applying disruptive technology, particularly as they pertain to inherent and control risks within the audit client. Originality/value This study contributes to the existing literature by investigating the joint impact of corporate governance and the utilisation of disruptive technology by audit clients on inherent risk and control risk, which has not been investigated by previous research.

Group Audit Risk and Component Auditor Use: A Difference-in-Differences Analysis

SUMMARY This study examines the association between group audit risk and component auditor use. The audit risk model defines audit risk as a function of the risk of material misstatement and detection risk. We use the revelation of an internal control material weakness (ICMW) as an event that increases the risk of material misstatement. Since higher risk of material misstatement requires the lead auditor to reduce detection risk, component auditor use could change after an ICMW. We find that the likelihood of starting component auditor use significantly increases after an ICMW. We also find an increase in the number of large component auditors used after an ICMW and such increase is concentrated in more pervasive entity-level ICMWs and higher-quality component auditors. Our evidence indicates that lead auditors perceive component auditor use as decreasing group audit risk. Our findings should inform the debate on the costs and benefits of component auditor use.

Risk-oriented approach in audit activity

The paper is devoted to a comprehensive study of the risk-oriented approach in auditing. Based on the analysis of research by foreign and domestic authors, the content of the materiality of audit risk is clarified. Their inextricable relationship in the practical implementation of the risk-oriented approach is shown. The special attention is paid to the application of mathematical calculations to determine materiality and audit risk. The possibilities and main directions of using mathematical calculations for determining materiality and audit risk are shown. Based on the obtained results, it was concluded that mathematical calculations of materiality and audit risk have a relative value and should be submit to the professional skepticism of the auditor. The conducted research is based on the edition of International Standards on Auditing, including ISA 315 "Identifying and Assessing the Risks of Material Misstatement" and ISA 540 "Auditing accounting estimates and related disclosures". The publications provide relevant methodological recommendations for the practical use of a risk-oriented approach in audit activity.

Identification and assessment of risks of material misstatement by the auditor

Identification and assessment of risks of material misstatement by the auditor

Goodwill Impairment Losses and Audit Fees

This paper examines whether goodwill accounting is related to auditor compensation. Specifically, it investigates whether goodwill impairment losses reported by auditees are associated with audit fees they have to pay their auditors. I predict a positive link between the amount of goodwill impairments reported by client firms and audit fees that auditors charge them. Goodwill impairment charges are likely to diminish financial reporting quality because they are susceptible to managerial opportunism and, thus, auditors are likely to consider them posing higher audit risk. Responding to higher risk of material misstatements in the financial statements of auditees, auditors are likely to increase audit effort as well as audit fees. Consistent with the prediction, the results show that goodwill impairment losses are positively associated with audit fees.

Behaviorism in auditing and its influence on the legal content of international standards on auditing

The paper is devoted to behaviorism in the field of audit activity, which in the form of the theory of behavior is widely used in scientific research and practice in foreign countries, especially in the USA. The least the problem of behaviorism is studied in Ukraine and then in rather general terms. It is shown that the main source of behaviorism is the philosophy of positivism and pragmatism. Its external manifestation is considered to be an individual reaction on stimuli of an external environment. In connection with this, the motives of the behavior of individuals are assigned a leading role in determining the normative regulation of activity of participants in accounting and auditing. It should also be noted that the precedents for assessing the subjects' behavior in this aspect constitute the system of Anglo-American law. The specified legal system has significant differences from the continental or European law to which Ukraine belongs. The dominance in conceptual law of normativism leads objectively to difficulties on introduction of International Standards on Auditing (ISA) based on the Anglo-American legal system in European countries and Ukraine. The paper also considers how a behavioral approach is used in specific ISA. As the example the ISA 315 "Identification and Assessment of Risks of Material Misstatement" and the ISA 240 "Auditor's Responsibilities Regarding Fraud in the Audit of Financial Statements" are taken. In particular, ISA 315 proposes to assess the risks of material misstatement through an understanding of the entity and its environment. It is emphasized that such an understanding of the business entity should not be a formal act as a legal entity, but from the position of the real behavior of management personnel. According to the ISA 240, the auditor should exercise professional skepticism throughout the audit, with recognizing the possibility of significant distortion due to fraud or error regardless of management's positive assessment. Based on professional skepticism, regarding the identification by the auditor of specific opportunities to commit fraud, the ISA 240 recommends to analyze the motives of the management personnel's behavior, pressure from the external environment, opportunities to commit fraud, attitudes and logical justification of wrongdoing. The final part of the paper gives relevant recommendations for harmonizing the ISA with domestic regulatory and legal acts and the practical activity of auditors on the territory of Ukraine.

Is expanded auditor reporting meaningful? UK evidence

In 2013, the United Kingdom (UK) Financial Reporting Council (FRC) mandated independent auditors to provide an expanded audit report to disclose the risks of material misstatement and application of materiality. This paper examines the information content and economic consequences of the expanded auditor’s report and offers three main results. We first investigate the usefulness of auditor reporting regime change and find evidence that the new reporting regime has some influence on market indicators. Second, we document that firms receiving an expanded audit report with a higher level of disclosure on risks of material misstatement (materiality) exhibit significantly higher (lower) idiosyncratic risk, beta, and cost of equity. That is, the expanded auditor’s disclosure meaningfully affects firms’ risk fundamentals. Third, we find that information conveyed by the expanded auditor’s report impacts bid-ask spread, trading volume, volatility of market returns, and analyst forecast dispersion. Collectively, our analyses suggest that auditors provide information that meaningfully reflects the risks that the audited companies face. Furthermore, this information is associated with significant economic consequences for capital market participants, implying that it is not generic. This firm-specific and useful disclosure supports the FRC (followed by International Auditing and Assurance Standard Board (IAASB) and Public Company Accounting Oversight Board (PCAOB)) decision mandating the expanded audit report and provides evidence-based insights to major recent structural reforms aiming at proposing remedies to audit and capital market problems in the UK, and beyond.

Implementasi ATLAS dalam Prosedur Penilaian Risiko Audit (Studi Kasus pada KAP Luthfi Muhammad & Rekan)

This study aims to determine the implementation of ATLAS in audit risk assessment at the Public Accounting Firm Luthfi Muhammad & Partners. The research method used is descriptive qualitative including theoretical studies, previous research, and interview results. Then the results of the theoretical review, previous research and interviews will be analyzed, and conclusions drawn. Until now ATLAS has become a tool used by auditors in carrying out audit procedures. This is because ATLAS has been systematically arranged to make it easier for auditors to carry out their work. In addition, ATLAS will also speed up the audit implementation process and improve audit quality. Based on the results of the interviews conducted, the implementation carried out by the Public Accounting Firm Luthfi Muhammad & Partners is in accordance with auditing standards. The auditing standard in question is Auditing Standard 315 regarding the identification and assessment of the risks of material misstatement through an understanding of the entity and its environment. The renewal of this research is to present the implementation of ATLAS, especially the risk assessment stage, whereas previous research only discussed the implementation of ATLAS in general.

Applying Benford’s law to examine earnings management: evidence from emerging ASEAN-5 countries

Purpose This study aims to apply Benford’s law to examine the earnings management of companies listed in emerging ASEAN-5 countries: Indonesia, Malaysia, Philippines, Thailand and Vietnam. Design/methodology/approach The authors follow Amiram et al. (2015) to measure deviations from Benford’s law of the first digits of numbers reported in financial statements. The authors use the Jones-modified performance-match model (Jones, 1991; Dechow et al., 1995; Kothari et al., 2005) to estimate accrual earnings management. The authors use a sample of 47,389 observations of listed companies in ASEAN-5 countries from 2006 to 2019. The authors also run ordinary least squares (OLS) regressions to test the hypotheses. Findings The authors find that the first digits of numbers reported in the financial statements of companies in the sample closely conform to Benford’s law. Further evidence shows that the deviation from Benford’s law is positively related to abnormal accruals. The relationship between deviation from Benford’s law and abnormal accruals is more pronounced for the post-international financial reporting standards adoption period. The results survive for some robustness checks. Research limitations/implications The authors show that Benford’s law holds for financial statements of companies listed in the emerging ASEAN-5 countries. Practical implications Auditors could use Benford’s law as an analytical procedure to assess the risks of material misstatements. Also, other users could apply Benford’s law on audited financial statements to foresee undetected misstatements. Originality/value The authors provide original evidence that financial statements of ASEAN-5 countries follow Benford’s law. The evidence supports the usefulness of Benford’s law in developing markets.

A Critical Analysis on The Impact of Australian Natural Gas Price Cap Policy on Asset Value and Income

This paper provides an in-depth critical analysis on the impact of the Australian government's natural gas price cap policy on the asset values and income of major energy companies like Santos. It begins with detailed background information on Santos, examining its business operations, revenue streams, products and services, competitive landscape, and regulatory environment. A comprehensive financial analysis of key ratios from Santos' annual reports is then presented to evaluate liquidity, profitability, efficiency, and leverage trends. The paper highlights several salient business risks posed to Santos from commodity price volatility, operational risks in exploration and development activities, intense competitive pressures, and stringent regulatory compliance requirements. It then rigorously analyzes the significant effects of government-imposed price caps on gas prices on asset valuation and revenue recognition as two key audit matters, delving into the relevant accounting assertions and suggested audit procedures. The implications for the audit report and opinion are also discussed in-depth with regard to properly assessing risks and obtaining sufficient appropriate audit evidence as per Australian Auditing Standards. Overall, this paper conclusively demonstrates how the introduction of gas price controls can profoundly impact asset carrying values and revenues for major energy companies like Santos, posing critical risks of material misstatement that must be thoroughly evaluated and addressed in independent financial statement audits.

The two sides of corporate social responsibility and the quality of internal control audit opinions

Although corporate social responsibility (CSR) activities provide a strong signal of management integrity, the involvement of the client in irresponsible CSR should alert the auditor to the risk of material misstatement. Framing management integrity assessments by relying on responsible CSR activities can lead to auditors' unintended alignment with their clients' preferred outcomes. Motivated by the increasing frequency of clean internal control opinions (ICOPs) regarding clients that subsequently misstate, we explore whether auditors' overreliance on responsible CSR influences the quality of ICOPs. We find that clients' CSR involvement is associated with fewer adverse ICOPs, but this CSR effect is asymmetric because it is only explained by responsible CSR activities and not by irresponsible CSR activities. Importantly, the ‘good side of CSR’ is associated with fewer adverse opinions being issued to misstated clients. Additional analyses show that only irresponsible CSR activities increase the risk of financial misstatements. Our findings provide support for the Public Company Accounting Oversight Board's warning that certain conditions inherent in the audit environment, such as the assessment of management integrity, can lead to auditors unconsciously favouring confirming evidence (represented by responsible CSR activities) instead of relying on disconfirming evidence (represented by irresponsible CSR activities) that could raise issues about management's integrity and ethical commitment.

Выявление рисков существенного искажения: информация в аудиторском файле

The article presents the author’s methodology for identifying the risks of material misstatement, based on the requirements of regulatory legislation in the fi eld of audit. Th e process of reflecting the results of the audit survey in the working documentation is considered. Attention is focused on the individual components of the audit file in order to detail the data obtained and combine them into a single information flow. The main problematic aspects in the formation of the auditor’s working documentation in terms of identifying and assessing the risks of material misstatement are analyzed.

Auditors' interpretation of risk and the quality of analysts' earnings forecasts: Evidence from textual analysis of key audit matters

This study examines the impact of key audit matters (KAMs) on the quality of analysts' earnings forecasts in the emerging Chinese market. The nature of KAMs is auditors' interpretations of the risk of material misstatements. Based on a quasi‐natural experimental environment created by the phased adoption of communicating KAMs in the emerging Chinese market, we find that communicating KAMs can improve the quality of analysts' earnings forecasts by increasing forecast accuracy and decreasing dispersion. We also find that the extent of auditors' interpretations of the risk of material misstatements is positively related to the quality of analysts' earnings forecasts. The positive relationship between the extent of auditors' interpretations of the risk of material misstatements and the quality of analysts' earnings forecasts is more pronounced for firms with less information transparency and less skilled analysts.

Ted's Teas: A Two‐Part Accounting and Audit “Crossover Case”*

AbstractThis fictional case is based on a real specialty tea company in Nova Scotia. Ted's Teas is a two‐part crossover case that illustrates the integration of financial accounting and audit learning outcomes applied to real‐world scenarios. In Part 1, students assume the role of an internal accountant and apply knowledge of the Chartered Professional Accountants (CPA) of Canada's CPA Way to identify how to treat leases, changes in policy, and estimates as part of accounting knowledge under both Accounting Standards for Private Enterprises and IFRS frameworks. In Part 2, students “cross over” and change roles, so they are now external auditors for Ted's Teas, tasked to provide an analysis of risk of material misstatement, recommend an audit approach, and develop substantive procedures. This two‐part case presents opportunities for students to demonstrate technical competence in multiple areas, either separately in two different courses or combined in one “capstone” or case course. The case and teaching notes, including the marking rubrics, were adapted from principles used to train and evaluate CPA Professional Education Program candidates, tailored to an appropriate level for undergraduate and graduate learners.

International standards of audit: update of implementation practice in Ukraine

Methods. The methodological basis of the study was the work of domestic and foreign scientists and international audit standards. The results were obtained through the application of methods of analysis and synthesis to generalize the directions of development and existing shortcomings in the activities of audit subjects, to develop the forms of the auditor's working documents; historical and logical when establishing audit quality as a strategic direction of its development; general and special when determining specific steps in response to overcoming current shortcomings and future challenges; system approach for summarizing statements considered by the auditor when identifying risks of material misstatement. Results. The article summarizes the scientific and methodological approaches to determining the quality of audit services as a strategic direction of audit development in Ukraine and the world. Current vectors of audit development and its weaknesses at the organizational and practical levels, in particular, the shortcomings of auditors' activities in assessing the risks of material distortion, are analyzed. The specific steps that should be implemented by the subjects of audit activity within the framework of harmonization with the EU requirements have been determined. Examples of audit procedures (execution of actions in response to assessed risks) in the format of the auditor's working documents are offered. The categories of assertions considered by the auditor when identifying risks of material misstatement are systematized. Novelty. The strategic, scientific-methodical, and organizational-practical foundations of improving the quality of audit activity in the conditions of the European integration of the Ukrainian economy and the implementation of European legislation are summarized. Practical value. The results of the research are of an applied nature since they allow the implementation of relevant strategic directions and scientific and methodological developments, eliminate organizational shortcomings of auditing activities, and form a modern approach to improving the quality of auditing firms in Ukraine, which ensures the confidence of users of financial information.

Does Corporate Social Responsibility Affect the Timeliness of Audited Financial Information? Evidence from “100 Best Corporate Citizens”

Companies are under immense pressure to integrate activities that will improve society and the environment with their business objectives. Such integration is likely to introduce complexity into the firms’ activities and impact the timeliness of the financial statements. Audit report lag is significant to investors as it directly impacts investor decision-making and investment fortunes. This study examines the association between corporate social responsibility (CSR) and audit report lag. We measure CSR activities using a composite variable representing a firm’s inclusion on or exclusion from the annual list of “100 Best Corporate Citizens.” In the robust regression analyses with a sample of 3661 firm-year observations from 2011 to 2016, we found a positive and significant association between CSR activities and audit report lag after controlling for extraneous variables potentially influencing audit report lag. Furthermore, the additional results with the six CSR components in the list confirm our finding that, except for governance, all the other components, such as environment, climate change, human rights, employee relations, and philanthropy, have a positive and significant association with audit report lag. Our findings suggest that CSR activities introduce audit complexities and risks that compel auditors to assess a high risk of material misstatements, translating into more audit effort and longer times to complete audits.

Identification of Material Misstatement and Specific Risk Factors in an Audit of Financial Statements

Recently, due to the changing geopolitical situation, economic instability and vulnerability, practicing auditors are facing new challenges that affect the identification and assessment of risks of material misstatement of financial statements. The purpose of the research is to identify the main factors affecting the risk of material misstatement and specific risks (fraud, accounting estimates, and going concern) that auditors should consider when deciding on the level of the risk of material misstatement of financial statements. To achieve the goal, two tasks were set: to compile lists of factors affecting the risk of material misstatement and specific risks; conduct a questionnaire survey to confirm the compiled lists. The following research methods were used during the research: content analysis and systematization of scientific and normative literature, comparison, logical analysis, questionnaire survey and summarization. As a result of the research, lists of the main factors determining the risk of material misstatement and specific risks were compiled, the completeness of which was confirmed during a questionnaire survey of auditors and auditor assistants working in Lithuanian audit companies. The results of the research show the necessary need for a more thorough assessment of specific risks. Compiled lists of factors determining the risk of material misstatement and specific risks can be useful for auditors of audit companies to assess the risk of material misstatement of financial statements.

Transformation of ISA 315 as a response to the changing operating environment and the introduction of digital technologies

Subject. This article examines the revised requirements and recommendations of the current ISA 315 Standard – Identifying and Assessing the Risks of Material Misstatement, and compares them with the provisions of the previous redrafted Standard – Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment. Objectives. The article aims to analyze the new edition of the ISA 315 Standard, which reflects important changes that have been made in response to the changing operating environment of the organization and the use of information technology and financial reporting structure. Methods. For the study, we used classification, synthesis, and induction and deduction. Results. The article identifies the most important changes made to the revised ISA 315 Standard and describes a case of an internal control system assessment based on the relationship between the control environment, risk assessment process, information system, control activities and control procedures. Conclusions. The article concludes that the improvements and clarifications provided by the current ISA 315 Standard – Identifying and Assessing the Risks of Material Misstatement, help auditors to apply audit risk models in identifying and assessing risks of material misstatement.

Does extended auditor disclosure deter managerial bad-news hoarding? Evidence from crash risk

We examine how the mandatory adoption of extended auditor's reports (EARs) affects managerial bad-news hoarding through the lens of stock price crash risk. Relying on the UK's auditing standard change in 2013 as a quasi-natural experiment, we document a crash risk reduction for firms that were required to adopt EARs, relative to firms that were not so required. The crash risk reduction is related to EARs' disclosure of risks of material misstatement in revenue recognition. The negative effect of EARs adoption on crash risk is more pronounced for firms with scant public information and firms with non-Big-4 or non-industry-specialist auditors. EARs adoption induces firms to disclose more smaller pieces of negative information without changing firms' accruals management. Taken together, our results suggest that EARs adoption dampens bad-news hoarding by managers.