Auditing Week 3

Question 1

What are the core components of a letter of engagement?

Answer 1

• objective and scope of work
• responsibilities of auditor
• responsibilities of management and those charged with governance
• audit reporting
• fees
• recurring audit

Question 2

Limitations of external audit

Answer 2

1. Sampling
2. Subjectivity
3. Inherent limitations of internal control systems
4. Evidence is persuasive but not conclusive
5. Audit report format
6. Historic information

Question 3

What are the 3 types of audit risk?

Answer 3

1. Inherent risk
2. Control risk
3. Detection risk

Question 4

What are the 5 examples of inherent risk?

Answer 4

1. Management risk
2. Management experience and competence
3. Pressures on management
4. Nature of entity’s business
5. Complexity

Question 5

Explain “sample” as a limitation of external audit

Answer 5

Cannot test 100% of transactions and there maybe an error in an item not selected for testing

Question 6

Explain “subjectivity” as a limitation of external audit

Answer 6

Financial statements include judgemental/subjective areas. Auditors are required to use judgement in assessing whether financial statements are true and fair

Question 7

Explain “inherent limitations of internal control system” as a limitation of external audit

Answer 7

An internal control system is liable to human error. Possibility of controls override by management results in collusion or fraud. Impossible to remove all these inherent limitations as audit relies on the internal control system this can reduce usefulness of audit

Question 8

Explain “evidence is persuasive but not conclusive” as a limitation of external audit

Answer 8

Opinion is based on audit evidence gathered. Evidence involves estimates and judgements and hence does not give a definite conclusion

Question 9

Explain “audit report format” as a limitation of external audit

Answer 9

Format of the opinion is determined by international standards on auditing. However the terminology is usually not understood by accountants. This means that users may not actually understand the audit opinion, resulting in an audit expectation gap

Question 10

Explain “historic information” as a limitation of external audit

Answer 10

The audit report often issues sometime after year end. Financial information can be quite different to current position. In the current market place where companies financial position change quickly the audit opinion may no longer be relevant as it is out of date