3 - Process of assurance - planning the assignment Flashcards
What are the objectives of planning?
Ensure appropriate attention is devoted to important areas of the audit
Identify potential problems and resolve them on a timely basis
Ensure that the audit is properly organised and managed
Assign work to engagement team members
Facilitate direction and supervision of engagement team members
Facilitate review of work
What is the difference between the audit strategy and plan?
The strategy is a broad document - contains general background info about client and you need it every year, but there is only one plan
The plan is more specific - detailed info as to how each area will be tested etc
What does the audit strategy include?
Understand locations, company structure, experience and integrity of management. Also look at past and present results of analytical procedures
Understand the entity’s environment - Understand economic and industry conditions. PESTEL factors that affect the company. Political, environmental, social, technological, economic and legal factors
Understand the entities accounting and related IC systems - Client accounting policies choices and the reliability of client systems for detecting and preventing fraud and error
Materiality and risk - The basis and calculation of materiality and results of risk assessment
Resources - Team members involved, budgeted hours, timing and fee
Why understand the entity and its environment?
How is it done?
What is involved?
To identify risk which will influence our approach on the audit
Done through AEIO - Analytical procedures, Enquiry, Inspection and observation of the IC’s
Nature of entity - The structure, integrity of management, sources of finance and key customers/suppliers etc.
Objectives and strategies - Products/markets. Anything new?
Entities financial performance - Analytical procedures
IC’s - Quality or corporate governance
External factors - PESTEL factors
What is professional scepticism
It is an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
It doesn’t mean that auditors should disbelieve everything they are told but you must have a questioning mind
When must analytical procedures be used?
At the risk assessment stage as part of understanding the entity and its environment
The aim is to look for relationships between sets of data both financial and non financial
What are the performance ratio formulas and purposes?
- Return on capital employed - Profit before interest and tax / capital employed. CE is Total assets less current liabilities. TALCL. The purpose is to tell us about the effective use of resources
- Gross profit margin - Cost of sales / Revenue x 100. It is an assessment of profitability. A change in GPM could mean overstated sales, understated purchases or overstated closing inventories.
- Cost of sales percentage - Cost of sales / revenue x 100
- Operating cost percentage - Operating costs / revenue x 100
- Net profit margin - Profit before interest and tax / revenue x 100. It is an assessment of profitability
What are the liquidity ratio formulas and purposes?
- Current ratio - Current assets / current liabilities. If it is over 1 this means that it is at lower risk of being liquidated as its assets can cover its liabilities
- Quick ratio - CA - Inventory / current liabilities. This is basically how quick you can get cash to cover liabilities if something goes wrong
What are the Long term solvency ratio formulas and purposes?
- Gearing - Net debt / equity x 100. Assess reliance on external finance. Your risky finance / your unrisky finance
- Interest cover - Profit before interest payable / interest payable. How many times over you can pay your interest
What are the efficiency ratio formulas and purposes?
- Net asset turnover - Revenue / Capital employed. This is to assess revenue generated by assets
- Inventory period - YE inventory / COS x 365. Assesses inventory levels held
- Trade receivable period - YE trade receivable / revenue x 365. How long it takes you to get your receivables
- Trade payable period - Trade payable period / COS x 365. Assess how long it takes you to pay your suppliers etc
When is something material?
If its omission or misstatement could influence the economic decisions of users taken on the basis of the FS
How can you calculate materiality?
Prof before tax : 5-10%
Revenue: 0.5 - 1%
Total assets: 1-2%
Only has to be material to one of these to be considered material.
If operating on high risk client, you use lower boundary. This is as you want to be sure everything looks fine.
Materiality is a matter of judgment as it is qualitative and quantitative.
Review of materiality?
The level must be reviewed constantly as the audit progresses and changes may be required
Draft accounts are altered (due to material error) and so overall materiality changes
External factors may cause changes in risk estimates.
When you identify new risks, the company becomes higher risk which means the materiality figure will decrease.
What is the definition of audit risk?
The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. So we say they are true and fair when they are not
What is inherent, control and detection risk? And examples
Inherent risk - A factor that increases the susceptibility of an assertion to misstatements.
Cash based business, regulated industry, management under pressure, company being sold, company trying to raise finance, estimates by management, remuneration of management and risk of not complying with accounting standards
Control risks is a risk that a misstatement won’t be prevented or detected by the entity’s internal control.
Control environment:
Integrity and competence of employees, Active role of management, Existence of policies and procedures
Control activities are things put into place to prevent and detect fraud. Make sure one person don’t have too much power, segregation of duties, reconciliations, general IT controls
Detection risk - Fails to detect a misstatement. In the auditors control. Broken down into sampling and non sampling risk. Non would be maybe we done a rushed job or that we have the wrong people on the audit or a brand new client we take the wrong approach. Or do an audit that lacks scepticism as we aren’t subjective. Sampling risk is that we don’t test everything
