Overview
The Risk of material misstatement requires that the auditor must identify and assess the risk of material misstatement at the financial statement level, individual account level, and provide disclosure of performing different audit procedures.
Risk of material misstatement basically includes both inherent risk and control risk. Hence, the impact of RMM for investment will be subject to the intensity of inherent risk and the intensity if that impact is controllable by adopting different procedures or not. The risk is controllable before it impacts the financial statement of the company.
Inherent Risk:
Economic conditions in the jurisdictions in which resources are invested which may have an impact on the assessments of auditor’s Inherent risk of relevant assertions in the financial statements of an investment firms. The level of inherent risk is based on the nature and kind of business dealings/contracts. As we know if the inherent risk of investment is high, then the level of risk of material misstatement is totally depend upon control risk.
Some of the important factors from which auditors can evaluate includes:
- Stability of the Government
- Rate of inflation
- Tax rates
Some of the Important Examples of Inherent Risk Investments are as follows:
- Revenues generated from investments are overstated.
- Recording of fabricated investments.
- Classification of investment (lack of knowledge of staff on accounting principles)
- Recording incorrect values of investments.
- Incorrectly use of accounting Principles.
Control Risk:
The investment advisors or decision makers maintains extensive controls which includes the following:
Portfolio management controls:
- To separate trading functions and portfolio management
- Do frequently reconciliation of portfolio holding and cash to custodian records
- Reviews of journal entries
- Monitoring the activity on dormant shareholders accounts
Controls to prevent, deter, and detect fraud:
- Use of system control like security admittance
- Develop many channels for employees to report any kind of fraud or fraud-related concerns.
- Periodic recording of an investment company’s compliance with its investment goals and restrictions
- Many compliance programs
Risk of Material misstatement due to Fraud:
In the Investment Company or industry, the unusual or unexpected risk of misstatement due to the reason of fraud are as follows:
Investment performance substantially higher (or lower) when compared with industry peers or
other relevant benchmarks, which cannot be readily attributed to the performance of specific
securities when prices are readily available in an active market. Particular considerations include
the following:
- Significant gains (or losses) from securities held for extremely short periods of time
- Significant gains (or losses) from instruments not typically acquired by the fund
Unusually high levels of acquisitions and sales of investments in comparison to overall net assets of funds without an obvious economic intent.
Expense ratios that change frequently after the year and next year with insufficient justifications. Expense ratios and the transaction cost increased the company’s norms.
Examples of internal controls procedures that can reduce risk.
- Do internal audit on periodic bases.
- Review of investments occasionally
- Adequate policies on valuation and classification of investment
- Proper physical controls of investment to prevent from loss.
It is valuable to note that when auditors evaluate that the investment control risk is low and that they want to rely on internal controls to minimize some of their substantive work, they need to carry out a control test in order to obtain adequate audit evidence to support their assessment.
On the other hand, if they determine that the risk of control is high, they would actually skip the control test and go straight to substantive testing (by doing more work). There is no point in attempting to show after all that internal monitoring is inadequate and Ineffective in preventing or identifying the possibility of material misrepresentation that may occur in investment accounts.
