Moranda andSills, LLP, has served for over 10 years as the auditor of the financial statements of Highland Bank and Trust. The firm is conducting its audit planning for the current fiscal year and is in the process of performing risk assessment procedures.

Based on inquiries and other informationobtained, the auditors learned that the bank is finalizing an acquisition of a smaller community bank located in another region of the state. Management anticipates that the transaction will close in the thirdquarter, and, while there will be some challenges in integrating the IT systems of the acquired bank with Highlandsystems, the bank should realize a number of operational cost savings over thelong-term.

During the pastyear, the bank has expanded its online service options forcustomers, who can now remotely deposit funds into and withdraw funds from checking and savings accounts. The system has been well received by customers and the bank hopes to continue expanding those services. The challenge for Highland is that they are struggling to retain IT personnel given the strong job market for individuals with those skills.

Credit risk management continues to be a challenge for allbanks, includingHighland, and regulators continue to spend a lot of time on credit evaluation issues. The bank has a dedicated underwriting staff that continually evaluates the collectibility of loans outstanding.Unfortunately, some of the credit review staff recently left the bank to work for a competitor. Competition in the community banking space istough, especially given the slow loan demand in the marketplace.

The bank has expanded its investment portfolio into a number of new types of instruments subject to fair value accounting. Management has engaged an outside valuation expert to ensure that the valuations are properly measured and reported.Fortunately, thebank's capital position is strong and it far exceeds regulatory minimums. Capital is available to support growth goals in thebank's three-year strategic plan.

a.

Describe any risks of material misstatement at the financial statement level.

1.

The integration of the pending acquisition of the small community bank intoHighland's operations and financial reporting processes may trigger the potential for misstatements across a number of accounts that must be integrated into the financial reporting system. The accounting for assets and liabilities acquired can be complex and there are a number of valuation and disclosures issues that may lead to increased risks of misstatements in those accounts and disclosures.

2.

Challenges associated with retaining key personnel with IT skills could have a pervasive effect on a number of financial statementaccounts, if those individuals leave Highland and there are issues related to the performance of IT systems that impact financial reporting.

3.

The acquisition of another bank was not a recommendation from theauditor; therefore, it is a risky investment.

4.

The expansion into new types of investments subject to fair value accounting where the bank does not have employees with the appropriate valuation skills and competencies increases the risks of material misstatement related to the accuracy and realizable value balance related auditobjectives, which impact the valuation and allocation assertion. Risks of material misstatements may also affect several of the presentation and disclosure assertions for investments.

5.

Any challenges associated with the integration of IT systems of the acquired bank withHighland's systems could trigger errors in a number of financial statementaccounts, if the IT systems affected impact financial reporting.

6.

The expansion of online service options for customers could trigger risks across a number ofaccounts, given customers use online options to make deposits and withdraw funds from both checking and savings accounts. As online service optionsincrease, more financial statement accounts may be impacted.

7.

Challenges related to credit evaluation may ultimately lead to misstatements in the allowance for loan lossreserves, impacting the realizable valuebalance-related audit objective(the valuation and allocationassertion). Risks of material misstatements may also affect several of the presentation and disclosure related assertions for loansoutstanding, including disclosures related to loan loss reserves.

8.

The bank should not have dedicated underwriting staff. The evaluation of the collectibility of loans outstanding should be performed by the bank presidentonly, in order to reduce the risk of error.

9.

The integrity and competency of personnel from the acquired bank who join Highland could have a pervasive impact on the quality of financial reporting of the combinedbank, if they lack integrity or competency.

10.

The expansion of online service operations may affect theoccurrence, completeness, and accuracy of checking and savings account transactions. If there are flaws in the onlinesystem, deposits might be overstated due to fictitious deposits or errors in the amountsrecorded, thereby affecting the occurrence and accuracy assertions related to those transactions. If transactions are not properly posted to the correct customeraccounts, misstatements related to the posting and summarizationtransaction-related audit objective may occur.

b.

Describe any risks of material misstatement at the assertion level.

c.

Which, ifany, risks would be considered a significantrisk?