Topic 6. AUDITOR RISK AND ITS RELATIONSHIP WITH MATERIALITY AND AUDITOR SAMPLE

6.1. Audit risk and its assessment

One of the main tasks of the auditor is to obtain sufficient evidence to express an opinion that the financial statements on which the auditor's report is drawn up are prepared in accordance with generally accepted practice and principles and do not contain any significant deficiencies or inaccuracies.

Given the fact that the auditor does not confirm every transaction entered into by the client, he cannot do more than simply express an opinion with a certain level of confidence in its legality. There is always a certain risk that some significant inaccuracy will not be detected.

Entrepreneurial risk in the audit is that the auditor may not receive the planned income from the audit, receive an amount less than the planned one, incur losses due to poor-quality audit. It can also be defined as the risk of claims from clients and other parties with an interest in the results of the audit, and the risk of financial loss from the practice of auditing.

In the audit regulation system, this issue is considered in the Federal Auditing Standard No. 8 "Assessment of Audit Risks and Internal Control Performed by the Audited Entity".

Audit risk refers to the risk that the auditor will express an inappropriate audit opinion when the financial statements contain material misstatements. At the same time, audit risk includes three components: inherent risk, control system risk and detection risk.

Auditor risk (audit risk) also means the likelihood that the financial statements of an economic entity may contain undetected material errors and (or) distortions after confirmation of their reliability, or recognizes that they contain significant distortions when in fact there are no such distortions in the financial statements. . It is a criterion for the quality of the auditor's work, and its assessment is based on their professional opinion. The auditor should use his or her professional judgment to evaluate audit risk and design the audit procedures necessary to reduce that risk to an acceptably low level.

Inherent risk expresses the likelihood of errors in the accounting system before they are checked by the internal control system. Depends on industry specifics, rare, atypical operations of an economic entity.

The risk of the control system expresses the likelihood of significant errors in the accounting (financial) accounting system after checking them by the internal control system, that is, it actually means the auditor's assessment of the effectiveness of the internal audit (control) system at the enterprise. It can never be absolutely high, since part of the control functions is performed by the accounting system at the enterprise.

Detection risk expresses the probability that the auditor will not detect errors. Its components may be:

▪ analysis risk (the risk that the analysis procedures will not detect significant errors);

▪ risk during substantive checks (the risk that significant errors will not be identified during the verification procedures);

▪ the risk of sampling (the danger that a sample of transactions for verification will not reflect significant errors).

The auditor must take into account that there is an inverse relationship between the level of materiality and the degree of audit risk:

▪ the higher the level of materiality, the lower the overall audit risk;

▪ the lower the level of materiality, the higher the audit risk.

The level of detection risk is directly related to substantive audit procedures. If the auditor needs to reduce the risk of non-detection, he must:

▪ modify the applied audit procedures, providing for an increase in their number and (or) a change in their essence;

▪ increase the time spent on verification;

▪ increase the volume of audit samples.

When assessing risks, the following gradations are used: high, medium, low.

The auditor may decide to apply in his activities more gradations in risk assessments than the three above, or to use quantitative indicators (percentages or fractions of a unit) for risk assessment.

The assessment of control risk, along with the assessment of inherent risk, influences the nature, timing, and extent of substantive audit procedures that are performed to reduce detection risk and, therefore, reduce audit risk to an acceptably low level. But even if the auditor were to audit all 100% of the account balances or similar transactions of a given group, there would always be some detection risk, in particular because the majority of the audit evidence only provides arguments in support of some conclusion, and is not exhaustive.

The assessed levels of inherent and control risk cannot be so low that the auditor does not need to perform any substantive procedures. Regardless of the levels of inherent and control risk assessed, the auditor should perform some substantive testing of significant account balances and group of transactions.

There is an inverse relationship between detection risk and the combined level of inherent and control risk. If the auditor considers them to be high in the aggregate, then it is necessary that the detection risk be low, if during the planning it turned out that the level of inherent risk and the risk of controls are sufficiently low, the auditor can accept a higher detection risk and still reduce audit risk to acceptable low level.

The higher the assessment of inherent and control risk, the more audit evidence the auditor needs to obtain during substantive procedures. If inherent and control risks are assessed as high, then the auditor needs to determine whether substantive procedures can provide sufficient appropriate audit evidence to reduce detection risk, and therefore audit risk, to an acceptably low level. When the auditor determines that the detection risk with respect to the financial statement assertion cannot be reduced to an acceptably low level, the auditor should express a qualified opinion or disclaim an opinion.

The auditor's assessment of the components of audit risk may change during the course of the audit. In such cases, the auditor needs to make changes to planned substantive procedures based on revised assessments of inherent and control risk.

If the auditor determines that he is unable to reduce the risk of detection to an acceptably low level with respect to significant balance sheet items or a similar group of business transactions, he should express a conditionally positive opinion or disclaim an opinion.

In practice, it is quite difficult to correctly calculate audit risk, especially since the standard contains too many uncertainties and does not provide specific calculation methods, the most acceptable and constructive interpretation of audit risk is its interpretation as the probability of an auditor's error during the audit.

There is no ideal way to reduce audit risk to zero, but the auditor should always strive to reduce it as much as possible by taking into account all sorts of factors when planning the audit.

6.2. Assessment of materiality (materiality) in the audit

The purpose of the audit of financial statements is to express an opinion by the auditor on the reliability of financial statements and the compliance of the procedure for compiling accounting reports with the legislation of the Russian Federation. When expressing his opinion, the auditor uses the phrase: "the financial statements reflect fairly in all material respects." The assessment of materiality is the subject of the auditor's professional judgment, which is considered in the Federal Auditing Standard No. 4 "Materiality in Audit", according to which materiality (materiality) is the maximum allowable amount of an erroneous amount that can be shown in the statements and considered as insignificant, i.e. e. not misleading reporting users.

Materiality is understood as the property of accounting information to influence the economic decisions of a qualified user of such information.

Information about individual assets, liabilities, income, expenses and business transactions, as well as components of capital, is considered material if its omission or distortion may affect the economic decisions of users taken on the basis of financial (accounting) statements. Materiality depends on the value of the indicator of financial (accounting) statements and (or) errors, assessed in case of their absence or distortion. The significance of violations and deviations made by the client is a criterion for the auditor as to whether he can confirm the reliability of the financial statements of the audited organization.

Materiality has two sides: qualitative and quantitative. From a qualitative point of view, the auditor must determine whether the deviations in the procedure for financial and business transactions by the audited organization from the requirements of regulations in force in the Russian Federation, noted during the audit, are or are not material. From a quantitative point of view, the auditor must evaluate whether, individually and in total, the detected misstatements in the financial statements (taking into account the predicted value of unreported errors) exceed the materiality level adopted for the audited organization.

Examples of qualitative distortions are:

▪ insufficient or inadequate description of accounting policies, when there is a likelihood that the user of financial (accounting) statements will be misled by such a description;

▪ failure to disclose information about violations of regulatory requirements when there is a likelihood that the subsequent application of sanctions could have a significant impact on the results of the audited entity.

Materiality may be influenced by regulatory legal acts of the Russian Federation, as well as factors related to individual accounting accounts of financial (accounting) statements and the relationships between them.

The auditor needs to consider the possibility of misstatements in relation to relatively small amounts, which together can have a significant impact on the financial (accounting) statements. For example, an error in a month-end procedure could indicate a possible material misstatement if such an error were repeated every month.

Thus:

1) materiality does not imply the obligation of the auditor to check the financial statements of the organization and give an opinion on its reliability up to the unit of measurement in which these statements are drawn up;

2) materiality is a parameter of a possible change in information that can affect the opinion of its competent user;

3) materiality cannot be expressed in a permanently existing absolute figure;

4) in each specific case, for each organization, the materiality may be different;

5) the criterion for assessing materiality can only be the limit value of a possible error in the financial statements, which can change it to a state that does not allow a qualified user to draw correct conclusions on its basis and make economically sound decisions.

The auditor considers materiality both at the level of financial (accounting) statements as a whole, and in relation to the balance of funds on individual accounting accounts of groups of similar transactions and cases of information disclosure. Materiality may be influenced by regulatory legal acts of the Russian Federation, as well as factors related to individual accounting accounts of financial (accounting) statements and the relationships between them. Depending on the considered aspect of the financial (accounting) statements, different levels of materiality are possible.

The auditor should consider materiality when determining the nature, timing and extent of audit procedures, and when evaluating the effects of misstatements.

Calculation of the level of materiality can be done in two ways: deductive (according to the methodology of the relevant auditing standard or intra-company methodology) or inductive.

In the most general case, the level of materiality is determined by the basic indicators of financial statements (deductively), in respect of which it is necessary to express an opinion on reliability, based on criteria established in accordance with the standards of auditing.

To calculate the materiality level, both indicators of the current period and average indicators of the current and previous periods can be used. The indicators of the current period can be used in the case when in the current period there have been significant changes in the business of the organization and the indicators for the current period and the period preceding the reporting period turned out to be incomparable. In the event that any value deviates strongly up and (or) down from the rest, adjustment is allowed by applying a coefficient with a value of not more than 2. If the adjusted value does not fall into the aggregate, the auditor can discard such a value. On the basis of the remaining indicators, the materiality level is calculated as the arithmetic mean of the values ​​of the basic indicators used for this purpose. For convenience in further work, the calculated value of the materiality level can be rounded within 20%.

The level of materiality affects another indicator - the level of accuracy, which is used in determining the volume of the audit sample, amounting to 75% of the materiality level.

There is an inverse relationship between materiality and the level of audit risk, i.e. the higher the level of materiality, the lower the audit risk, and vice versa. The inverse relationship between materiality and audit risk is taken into account by the auditor when determining the nature, timing and extent of audit procedures. For example, if, after planning specific audit procedures, the auditor determines that the acceptable level of materiality is lower, then audit risk is increased. The auditor compensates for this:

▪ either by reducing the predetermined level of control risk where possible and maintaining the reduced level by performing enhanced or additional tests of controls;

▪ or reducing the risk of non-detection by changing the nature, timing and scope of planned substantive testing procedures.

One of the most understandable ways to reduce audit risk is to reduce such components of it as the risk of non-detection.

6.3. Audit sample

When planning work, the auditor must decide whether he should apply a selective check or a complete check when checking this section of accounting.

The auditor may check the correctness of accounting for balances or account transactions in a complete manner if the number of elements of the audited population is so small that the use of sampling methods is not legitimate, or if the use of audit sampling is less effective than conducting a complete check. The procedure for conducting a spot check may not always be strictly formalized.

The issue is regulated by Federal Auditing Standard No. 16 "Auditor's Sample". An audit sample is conducted with the aim of applying audit procedures to less than 100% of the items in the audited population, which are understood to be the elements that make up the balance of the accounts, or transactions that make up the turnover on the accounts, in order to collect audit evidence to form an opinion on the entire audited population. To build a sample, the audit organization must determine the procedure for checking a particular section of the financial statements, the audited population from which the sample will be made, and the sample size.

The use of the sampling method in audit, as in other areas of human activity, consists in replacing the continuous observation of any general set of objects with the study of some part of it, followed by the distribution of the results of the study to the entire set of objects. The sampling method is a well-developed and repeatedly tested construction of probability theory in various applications.

The audit sample is:

1) in a broad sense: a method of conducting an audit, in which the auditor checks the accounting documentation of an economic entity not in a continuous manner, but selectively, while following the requirements of the relevant Rules;

2) in a narrow sense: a list of selected elements of the tested population in a certain way with the aim of drawing a conclusion about the entire tested population based on their study.

The sampling planning process includes determining:

▪ a set of data that will be subject to random checking;

▪ elements of the highest value and key elements;

▪ the number of elements that should be selected for verification;

▪ method of selecting elements.

The auditor decides which particular set of data he will check in the course of a spot check. Typically, the auditor checks a set of items that correspond to the balance or turnover of a particular accounting account.

When conducting a sample, the audit organization may break the entire study population into separate groups (“sub-populations”), the elements of each of which have similar characteristics. The criteria for partitioning the population should be such that for any element it is possible to clearly indicate to which sub-population it belongs. This procedure, called stratification, reduces the spread (variation) of data, which can facilitate the work of the audit organization. When checking fixed assets, it is usually convenient to separate buildings and structures, vehicles, production equipment, etc. into separate groups for checking. When checking materials, it is convenient to divide materials into groups according to sub-accounts. When testing implementation, it is sometimes possible to classify clients into groups depending on the types of services.

The sample size is determined by the amount of error that the auditor considers acceptable. The lower the value, the larger the required sample size.

To check randomly, there are several methods for selecting elements:

▪ random sampling method (computer programs or tables of random numbers can be used for this);

▪ method of quantitative sampling by intervals;

▪ method of monetary sampling by intervals.

The interval value is defined as the ratio of the entire range of values ​​(for example, serial numbers of documents or other objects being checked) to the number of sample elements.

To build a monetary sample by intervals, the objects under study must have a value expression, but it must be possible to determine the cost on an accrual basis.

Before the auditor begins to select elements randomly, he should select a number of elements in a certain way. Such elements are called elements of the greatest cost and key.

The elements of the highest cost without fail include those whose cost value exceeds the degree of accuracy determined in the course of audit planning. Besides, the auditor has the right to include in number of checked and other elements which have the greatest cost value.

The key elements include those elements of the audit in which the auditor considers errors and misstatements to be the most likely, guided by his professional judgment, as well as additional information that came to his disposal during the audit.

When forming a sample, one should describe the specific goals for which it is being carried out, as well as evaluate the errors present in the sample in relation to the goal. If the audit objectives have not been achieved through sampling, the audit firm may perform alternative audit procedures.

Evaluation of the sample results includes the following types of work:

a) analysis of each error in the sample;

b) extrapolation of the results obtained during the sampling to the entire tested population;

c) sampling risk assessment.

Errors found in the elements of a representative sample are subject to distribution to the entire tested population. Errors found on the elements of the highest value and key elements are taken into account in the amount actually found and are not subject to distribution. The total estimated error from the sample test results is the sum of the estimated error from the representative sample, added to the actual error found for the highest value and key elements.

If the total expected value of the error obtained from the results of the sample is close in order of magnitude to the level of materiality or degree of accuracy, and especially if the selective checks carried out in different areas of the client’s accounting give an error that is comparable in size or exceeds level of materiality, the auditor is advised to take the following actions:

▪ require the client to correct actually detected errors;

▪ analyze the causes of errors and estimate the possible volume of undetected errors;

▪ modify audit procedures to obtain more reliable data (for example, increase the sample size);

▪ attempt to perform any alternative audit procedures in relation to this section of the accounting;

▪ require the client to correct not only the detected errors, but also other possible errors in this area of ​​accounting, and then selectively check other elements of this section of accounting again.

The audit organization must necessarily reflect in the working documentation of the auditor all stages of the audit sample and analysis of its results.

6.4. The concept of affiliates in the audit

This issue is considered in the Federal Auditing Standard No. 8 "Affiliates", compiled taking into account the International Auditing Standards.

Affiliates are individuals and legal entities capable of influencing the activities of legal entities and (or) individuals engaged in entrepreneurial activities. A transaction between an audited entity and an affiliate is any transaction involving the transfer of any assets or liabilities between the audited entity and an affiliate.

The auditor must perform audit procedures in order to obtain sufficient appropriate audit evidence regarding affiliates and disclosure of information about them, as well as the impact of transactions between the audited entity and an affiliate on the financial (accounting) statements of the audited entity. However, an audit should not be expected to reveal all transactions with affiliates.

The management of the audited entity is responsible for determining the affiliation of the parties and transactions with them, as well as disclosing relevant information in the financial (accounting) statements.

The auditor needs to have knowledge of the activities of the audited entity and the industry as a whole, allowing him to identify events, transactions and existing practices that may have a significant impact on the financial (accounting) statements. The presence of affiliates and transactions with them is considered normal in business practice, but the auditor should be aware of them.

During the course of the audit, the auditor should look for unusual transactions and transactions that may indicate the existence of previously unidentified affiliates, including:

▪ transactions involving atypical situations and conditions (for example, the presence of non-standard prices, interest rates, guarantees, etc.);

▪ operations carried out for no apparent reason in terms of business logic;

▪ operations, the content of which differs from their form;

▪ transactions reflected in documents and accounting in an unusual way;

▪ large volume of transactions or significant transactions with individual consumers or suppliers (compared to others);

▪ unaccounted transactions, including gratuitous receipt or provision of management services.

When reviewing transactions with affiliates, the auditor should obtain sufficient audit evidence that these transactions have been properly accounted for and disclosed. If the auditor cannot obtain such evidence, or concludes that information about them is unclear or incomplete in the financial (accounting) statements, the auditor should modify the auditor's report accordingly.

Authors: Erofeeva V.A., Piskunov V.A., Bityukova T.A.

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