6: Understanding of the Client / Entity

Question 1

What are the four main aspects of a client that we need to understand?

Answer 1

• Client business
• Staff
• Systems
• Finance structure

Question 2

What do we expect to obtain from Prior year audit file? (2)

Answer 2

• Issues that arose in the prior year audit and how these were resolved.
• Points brought forward for consideration

Question 3

What do we expect to obtain from Prior year financial statements? (3)

Answer 3

• Information in relation to the size of the entity
• Key accounting policies; and
• Disclosure notes.

Question 4

What do we expect to obtain from Accounting systems notes? (1)

Answer 4

-How each accounting system operates

Question 5

What do we expect to obtain from Discussions with management? (2)

Answer 5

• Important issues

- Changes to company

Question 6

What do we expect to obtain from Current year budgets and management? (3)

Answer 6

• Relevant historical financial info
• Changes to materiality
• Risk identification

Question 7

What do we expect to obtain from Permanent audit file? (1)

Answer 7

-Matters of continuing importance

Question 8

What do we expect to obtain from Entities website? (1)

Answer 8

-Press releases on recent changes

Question 9

What do we expect to obtain from Prior year report to management? (1)

Answer 9

-Internal control deficiencies in prior year

Question 10

What do we expect to obtain from Financial statements of competitors? (1)

Answer 10

-Help assessing our client’s performance in the year.

Question 11

What are the four Risk assessment procedures?

Answer 11

• Enquiries
• Observation
• Inspection
• Analytical procedures

Question 12

Describe enquiries (3)

Answer 12

• Seeking information of knowledgeable persons
• Financial or non-financial
• Within or outside entity

Question 13

Describe Observation (1)

Answer 13

Looking at processes or procedures performed by others

Question 14

Describe Inspection (1)

Answer 14

Inspecting records or documents

Question 15

What are the three types of analytical procedures?

Answer 15

• Comparison of information to prior periods
• Comparison of actual or anticipated results of the entity with budgets and/or forecasts
• Comparison to industry information either for the industry as a whole or by comparison to entities

Question 16

When are analytical procedures used?

Answer 16

• Planning stage
• Final audit
• Final review stage

Question 17

What are the ratios used for profitability?

Answer 17

Gross profit

Net profit

Question 18

What are the ratios used at planning?

Answer 18

Receivables Days
Inventory Turnover
Payables Days

Question 19

What are the ratios used at Testing?

Answer 19

Current Ratio

Acid Test / Quick Ratio

Question 20

What is the ratio used at Reporting?

Answer 20

ROCE

Question 21

What is the definition of uncorrected misstatements?

Answer 21

Misstatements that the auditor has accumulated during the audit and that have not been corrected.

Question 22

What are the three categories of misstatement?

Answer 22

No doubt
Judgemental
Projected

Question 23

What type of Misstatement category is below?

Factual misstatements are misstatements about which there is no doubt.

Answer 23

No doubt

Question 24

What type of Misstatement category is below?

Differences arising from the judgements of management
concerning accounting estimates that the auditor considers unreasonable, or the selection or application of accounting policies that the auditor considers inappropriate.

Answer 24

Judgemental

Question 25

What type of Misstatement category is below?

The auditor’s best estimate of misstatements in
populations, involving the projection of misstatements
identified in audit samples to the entire populations from
which the samples were drawn.

Answer 25

Projected

Question 26

What are four significant risks of misstatements?

Answer 26

✓ Risk of fraud
✓ Economic and accounting developments
✓ Subjectivity
✓ Complexity of transactions

Question 27

Do misstatements have to be material individually or in aggregate?

Answer 27

Either

Question 28

Give the materiality % for the below

PBT
Turnover
Net assets

Answer 28

PBT 5%
Turnover ½%
Net assets 1%

Question 29

What is the Audit risk formula and what does each part mean?

Answer 29

AR = CR x IR x DR

AR - Audit risk
CR - Control risk
IR - Inherent risk
DR - Detection risk

Question 30

What is below…

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated

Answer 30

Audit risk

Question 31

What is below…

The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other 
misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Answer 31

Control risk

Question 32

What is below…

The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Answer 32

Inherent risk

Question 33

What is below…

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Answer 33

Detection risk