Audit and the Risk of Material Misstatement in Financial Statements – A Critical Analysis
Introduction
The International Standard on Auditing (ISA) 315 (Revised) is an important tool for auditors, as it
helps them to identify a risk in a company’s financial statements. There are different types of
risks such as inherent, control and detection risks. An inherent risk is a risk that items will be
materially misstated due to industry specific circumstances, control risk is when an internal
control fails to prevent or detect material misstatement. Detection risk is a risk when an auditor
fails to detect the material misstatement that exists in the financial statements (Accountinguide
2020). Auditors need to gain a clear understanding of an entities’ internal control system,
internal auditing helps prevent and detect fraud, therefore helping a business run effectively
and reducing risks to a business. This report will briefly highlight some of the key elements of
the ISA 315 and explain how important it is for auditors to identify risks and determine how to
approach them depending on its magnitude. This report will also examine the relevance of ISA
315 in real world auditing contexts using the companies J Sainsbury plc and Berkeley Group
Holdings as well as using critical analysis to identify the challenges the companies are facing
and gathering examples from their audited financial statements. Ratio analysis will be used as a
quantitative method to evaluate the performance of both companies and compare their
financial statement figures.
ISA 315
The ISA 315 is used by auditors in order to guide them and give them knowledge on what to do
about different entities. Auditors must understand the industry and be able to identify different
types of risks whether they are inherent or control risk as well as any other that relate to the
overall risk of material misstatement in financial statements. The entity and the environment
has to be understood to assess these risks, while considering different general economic
factors for the specific industry sector. External factors may include analysing market
conditions and the competitive aspect of the industry. Another critical component of the ISA
315 is to help assess the risk of material misstatements and identifying them using financial
statements, this is done to find the risks in advance, allowing auditors to find different
approaches to attack the risk. If significant risks are identified, the whole design and new
implementations of control would need to be evaluated. This is due to significant risks requiring
more specialised procedures, for example, revenue recognition, inventory valuation and fraud
risks. Auditors respond to risks after having identified them, by planning and testing controls,
they do this by carrying out different procedures. Focusing on significant risks, auditors have a
higher chance of identifying misstatements that could possibly have impacts on financial
statements. Some of these analytical procedures may include ratio analysis of financial
statements. Sufficient evidence such as tests of controls or tests of details need to be acquired
by auditors in order to draw reasonable conclusions about risks. Depending on the risk and the
magnitude of it, it might be helpful for auditors to carry out more elaborate procedures, done by
confirming balances with third parties. Although, it can be harder to find audit required
evidence for smaller entities including detailed testing and substantive analytical procedures.
Analysis / discussion of J Sainsbury’s plc
J Sainsbury plc is one of the largest supermarket chains in the UK, they have been focusing on
enhancing its digital platforms and expanding its online grocery business. Sainsbury’s has faced
Introduction
The International Standard on Auditing (ISA) 315 (Revised) is an important tool for auditors, as it
helps them to identify a risk in a company’s financial statements. There are different types of
risks such as inherent, control and detection risks. An inherent risk is a risk that items will be
materially misstated due to industry specific circumstances, control risk is when an internal
control fails to prevent or detect material misstatement. Detection risk is a risk when an auditor
fails to detect the material misstatement that exists in the financial statements (Accountinguide
2020). Auditors need to gain a clear understanding of an entities’ internal control system,
internal auditing helps prevent and detect fraud, therefore helping a business run effectively
and reducing risks to a business. This report will briefly highlight some of the key elements of
the ISA 315 and explain how important it is for auditors to identify risks and determine how to
approach them depending on its magnitude. This report will also examine the relevance of ISA
315 in real world auditing contexts using the companies J Sainsbury plc and Berkeley Group
Holdings as well as using critical analysis to identify the challenges the companies are facing
and gathering examples from their audited financial statements. Ratio analysis will be used as a
quantitative method to evaluate the performance of both companies and compare their
financial statement figures.
ISA 315
The ISA 315 is used by auditors in order to guide them and give them knowledge on what to do
about different entities. Auditors must understand the industry and be able to identify different
types of risks whether they are inherent or control risk as well as any other that relate to the
overall risk of material misstatement in financial statements. The entity and the environment
has to be understood to assess these risks, while considering different general economic
factors for the specific industry sector. External factors may include analysing market
conditions and the competitive aspect of the industry. Another critical component of the ISA
315 is to help assess the risk of material misstatements and identifying them using financial
statements, this is done to find the risks in advance, allowing auditors to find different
approaches to attack the risk. If significant risks are identified, the whole design and new
implementations of control would need to be evaluated. This is due to significant risks requiring
more specialised procedures, for example, revenue recognition, inventory valuation and fraud
risks. Auditors respond to risks after having identified them, by planning and testing controls,
they do this by carrying out different procedures. Focusing on significant risks, auditors have a
higher chance of identifying misstatements that could possibly have impacts on financial
statements. Some of these analytical procedures may include ratio analysis of financial
statements. Sufficient evidence such as tests of controls or tests of details need to be acquired
by auditors in order to draw reasonable conclusions about risks. Depending on the risk and the
magnitude of it, it might be helpful for auditors to carry out more elaborate procedures, done by
confirming balances with third parties. Although, it can be harder to find audit required
evidence for smaller entities including detailed testing and substantive analytical procedures.
Analysis / discussion of J Sainsbury’s plc
J Sainsbury plc is one of the largest supermarket chains in the UK, they have been focusing on
enhancing its digital platforms and expanding its online grocery business. Sainsbury’s has faced
