Specific Requirements and Application of ISA 450
The term ‘Application’ is an important step of applying the specific requirement. This can be simplified as a decision making process. The auditors shall make the initial assessment using the knowledge is gathered including the preliminary understanding the internal control. If the aggregate assessment indicate that is the misstatement in relevant assertion either individually or when aggregated with others is higher than the IR, then apply the condition of control risk assessment. This can be also implemented if the auditors identify the inherent risk is high at certain relevant assertion on the financial statement to detect misstatement. After that, the auditors have to re-evaluate the condition of control risk assessment and repeat this step until there’s compatibility between the misstatement condition and the risk of the misstatement. This decision making process will be the basic fundamental to determine the management of the detection misstatement procedure with all the things related to the control.
The term ‘specific requirement’ is a basic known requirement that the auditors shall cumulatively assess as minimum the component of the essentially all the relevant assertion relating to each objective of the control including those concerning the possibility of the misstatement due to fraud, evaluate the design effectiveness of the control and determine whether or not the control has been implemented. Specific requirement also emphasized the auditors to test control rely. This means the auditors have to perform the test whether or not the control has been implemented if the control was designed effectively and the control is the relevant control toward the objective of the control.
- Understanding the Entity and Its Environment
The objective of the auditor is to make an evaluation of the entity’s financial statements and to assess the risk of material misstatement. The understanding of the entity and its environment is a set of the establishment of a clear understanding of the definition of internal control and an assessment of the risks that the financial statements may be misstated. The standard very clearly outlines a link between the understanding of the entity and its environment and the assessment risk of material misstatement. This is an area that has been identified as being crucial to audit quality and in recent years it is an area that negligence on the part of the auditor has led to various accounting scandals. These accounting scandals have occurred because of incorrectly stated financial statements. But the auditors have failed to highlight these misstatements to the directors and thus end up giving a wrong impression for the users of the financial statement, i.e. shareholders and potential investors. It is, therefore, important that the misstatements are highlighted, as the final outcome of an audit engagement could be questioned where the auditors have given a ‘clean opinion’, when the financial statements have been incorrectly stated. In rare circumstances, the audit opinion may be the cause of management fraud where the aim is to mislead, leaving the auditors unaware of the actual financial position of the entity. This too may lead to an incorrect opinion and wrong impression for users. This standard has specific requirements, which if followed should prevent any poor assessment of risk and should ensure when misstatements are found, the auditors are able to effectively communicate with the directors.
- Assessing Risks of Material Misstatement
Material misstatement at the financial statement level and assertion level occurs when the financial statements are expressed in a misleading manner. In assessing risks of material misstatement at the financial statement level, the auditor shall determine whether significant risks inherent in the account balances, classes of transactions, and disclosures in relation to the financial statement overall, whether taken singly or in combination, give rise to material misstatement. This can be performed by identifying such risks and then considering the types of potential errors or misstatements, their nature, and the significance when taken in aggregate.
After obtaining an understanding of the entity and its environment, the auditor shall then proceed to assess the risks of material misstatement at the financial statement level and assertion level. The understanding of the entity, its environment, and internal control helps the auditor to identify the inherent and control risks. The linkage between the understanding of inherent and control risk can be the foundation for assessing the risk of material misstatement at the financial statement level, while any differences between the level of inherent and control risk at the assertion level can be the causes of assessed risk at this level (ISA 450.6).
- Responding to Identified Risks
The need to change the overall audit strategy and in the audit plan can arise due to the assessed risk that there may be a possible bias in management judgments in accounting for a particular item. This may cause the management to be unreceptive to the contradictory audit evidence. If the risk of material misstatement as a result of this is assessed as low, the auditor’s response may be to increase the level of substantive audit procedures. This can be done by changing a reliance strategy to a substantive strategy.
The auditor’s response to the assessed risks is also required to be appropriate to the specific risk and is required to consist of: (a) A change in the overall audit strategy and in the audit plan (Ref: A450.06) (b) An overall response which relates to all financial statement assertions.
