Acca aaa s21 Notes

September 2021 to June 2022 exams
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2. Business risk
It is, of course, not the auditor’s duty to manage a business and its risks or even to warn audit clients 
about business risks. It is the directors’ and management’s responsibility to run the business for the 
benefit of shareholders. Auditors cannot be expected to have expertise in the huge variety of business 
risks that are suffered by their many clients. Provided the financial statements properly report on what 
has happened in the business (eg that inventory of a poorly selling product has been written down 
appropriately) the audit opinion is not affected: the financial statements are presented fairly, in all 
material respects. 
So why is business risk important to auditors? Well, it is important because business risk will often 
often influence inherent risk (ie the susceptibility of a financial statement assertion to the risk of 
material misstatement). If misstatements which are not prevented or detected and corrected by 
internal controls (control risk) are not detected by the the auditor (detection risk), the auditor will 
express an inappropriate opinion (audit risk).
The following examples illustrate just some of the possible risks of material misstatement arising from 
business risk:
Business risk
Possible ROMM
Strategic: out-of date products
Strategic: operations in a country where the 
currency has devalued
Operational: a batch of products has been poorly 
manufactured
Operational: computer virus in the accounting 
system that deletes customers' records
Financial risk: significant rise in interest rates
Financial risk: significant bank loans with 
covenants attached
Compliance risk: improper recruitment of staff 
that contravenes equality legislation
Compliance risk: failure to comply with health 
and safety legislation
Inventory might not sell at above cost and 
should be written down to net realisable value 
(risk of overstated inventory/profit)
Subsidiary's assets and liabilities should be 
retranslated at the reporting date (risk of 
overstated net assets and understated exchange 
losses)
Sales returned (risk of overstated revenue), 
goods scrapped (risk of overstated inventory/
profit), compensation to be paid (risk of 
understated liabilities)
What are the receivables balances? (risk of 
misstated receivables)
Material uncertainty relating to going concern 
(disclosure risk) 
As well as going concern (above), management 
bias increases inherent risk at the financial 
statement level
Actual fines/penalties (risk of understated 
liabilities) or possible fines/penalties (disclosure 
risk for contingent liabilities)
Fines/penalties and going concern (as above)