Audit Risk Alert 2007/08

This Audit Risk Alert is intended to provide auditors with an overview of recent economic, industry, technical, regulatory, and professional developments that may affect the audits and other engagements they perform. This alert can also be used by an entity’s internal management to address areas of audit concern. This alert is an important tool in helping you identify the significant risks that may result in the material misstatement of financial statements. Moreover, this alert delivers information about emerging practice issues and current accounting and auditing developments that may affect all industries and all audit engagements.

Specifically, in this alert you will find information on recently issued accounting and auditing standards such as:

• Risk Assessment Standards
• SAS No. 112
• SAS No. 114
• Fair Value Accounting Standards (FASB Nos. 157 and 159)

You will also find information on emerging issues such as:

• The ASB’s Clarity Project including convergence with international standards
• The FASB Codification Project
• Business Combinations

This publication is an other auditing publication as defined in AU section 150. Other auditing publications have no authoritative status; however, they may help the auditor understand and apply the Statements on Auditing Standards. The auditing guidance in this document has been reviewed by the AICPA Audit and Attest Standards staff and published by the AICPA and is presumed to be appropriate. This document has not been approved, disapproved, or otherwise acted on by a senior technical committee of the AICPA.

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How This Alert Helps You

.01 This Audit Risk Alert (alert) helps you plan and perform your audits. This alert can also be used by an entity's internal management to address areas of audit concern. This alert provides information to assist you in achieving a more robust understanding of the business, economic, and regulatory environment in which your clients operate. This alert is an important tool in helping you identify the significant risks that may result in the material misstatement of financial statements. Moreover, this alert delivers information about emerging practice issues and current accounting, auditing, and regulatory developments.

.02 To help auditors understand relevant industry, economic, and regulatory factors affecting their clients, the AICPA offers industry and topic-specific alerts to be used in conjunction with this alert. These alerts can be obtained by calling the AICPA at (888) 777-7077 or going online to www.cpa2biz.com. You should refer to the full text of accounting and auditing pronouncements as well as the full text of any rules or publications that are discussed in this alert.

.03 References to Professional Standards. When referring to the professional standards, this alert cites the applicable sections as codified in the AICPA Professional Standards and not the numbered statements, as appropriate. For example, Statement on Auditing Standards (SAS) No. 54, Illegal Acts by Clients, is referred to as AU section 317 of the AICPA Professional Standards. Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement

.04 An auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures. An auditor's understanding of the entity and its environment consists of an understanding of the following aspects:

• Industry, regulatory, and other external factors
• Nature of the entity
• Objectives and strategies and the related business risks that may result in a material misstatement of the financial statements
• Measurement and review of the entity's financial performance
• Internal control, which includes the selection and application of accounting policies
  

.05 The client financial statements you audit will be subject to specific risks of material misstatement arising from the nature of the business, the degree of regulation, or other external forces (for example, political, economic, social, technical, and competitive forces).

.06 The auditor should obtain an understanding of the entity's objectives and strategies and the related business risks that may result in material misstatement of the financial statements. Business risks result from significant conditions, events, circumstances, actions, or inactions that could adversely affect the entity's ability to achieve its objectives and execute its strategies, or through the setting of inappropriate objectives and strategies. Just as the external environment changes, the conduct of the entity's business is also dynamic,of business risks increases the likelihood of identifying risks of material misstatement. However, the auditor does not have a responsibility to identify or assess all business risks. Most business risks will eventually have financial consequences and, therefore, an effect on the financial statements. However, not all business risks give rise to risks of material misstatement.

.07 After obtaining a sufficient understanding of the entity and its environment, including its internal control, an auditor should identify and assess the risks of material misstatement at the financial statement level and at the relevant assertion level related to classes of transactions, account balances, and disclosures based on that understanding.

.08 Understanding and properly addressing, as necessary, the matters presented in this alert will help you gain a better understanding of your client's environment, better assess risks of material misstatement of the financial statements, and strengthen the integrity of your audits.

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