Chapter 3 Flashcards
What is the audit strategy?
determines scope, timing and direction of audit and determines the development of the audit plan
What is the audit plan?
- more detailed than audit strategy
- shows how the overall strategy will be implemented
what are the key components of the audit strategy?
- understanding entity and its environment
- materiality
- risk assessment
- nature, extent and time of audit procedures
- direction, supervision and review of work
what is the common content between the audit strategy and the audit plan?
- results of risk assessment
- determination of materiality
- special audit considerations
- deadlines
what does the audit plan ensure?
- attention paid to important areas
- problems identified
- audit is properly organised and managed
- work assigned to appropriate members of the team
- reviews by senior auditors are faciliatated
Why does the ISA (UK) 315 require the auditor to understand the entity?
- to assess risk
- help design and perform audit
- help develop audit plan and strategy
What does the ISA (UK) 315 require the auditor to understand about the entity?
- industry, regulatory and external factors, including the applicable financial reporting framwork
- nature of the entity, including entity selection and applicable financial reporting framework
- entity objectives and strategies and related business risks
- entity financial performance
- internal controls
What things would the audit firm need to understand with regards to financial reporting frameworks?
- accounting principles and industry specific practices
- revenue recognition
- accounting for financial instruments
-foreign currency assets, liabilities and transactions
What things would the audit firm need to understand with regards to accounting policies?
- methods used to measure, present and disclose significant and unusual transactions
- accounting policies in controversial or emerging areas
- changes in the environment e.g. tax changes that necessitate a change in accounting policies
- law and reporting standards that are new to the entity
How does the ISA (UK) 315 expect the auditor to gain all the infomation?
- enquiries of management
- analytical procedures
- observation of processes
- inspection of documents
- prior knowledge of client
- discussion among audit team
what is materiality?
an expression of the relative significance of a particular matter in the context of the financial statements as a whole
- An item is material if its omission or misstatement could reasonably be expected to affect the economic decision of users
what does materiality influence?
drives the level of work to be carried out
what makes something material or not?
- size
- nature i.e. transactions between company and director are material in nature no matter the size
what are the thresholds of size for materiality?
If an error is greater than the upper then it would be material:
0.5%- 1% of revenue
1-2% total assets
5-10% profit before tax
what is performance materiality?
If auditing a large number the materiality make come out as a large number so in these situations a smaller number is given called performance materiality:
an amount, less than materiality, to reduce the probability that aggregate of uncorrected misstatements exceed materiality as a whole
When is risk assessed?
in the planning stage but re-assessed continually throughout the audit
An effective risk assessment should:
- make audit more efficient with work directed to problem areas
- lead to fewer inappropriate opinions
- few negligence claims against auditor
what is audit risk?
the risk that the auditor gives an inappropriate opinion on the financial statements
what is the audit risk calculation?
inherent risk X control risk X detection risk
what is inherent risk?
the susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be a material
what is control risk?
the risk that a material misstatement would not be prevented, detected or corrected by the accounting and internal control systems
what is detection risk?
risk that auditors procedures will not detected a misstatement
what are the 3 levels inherent risk can be considered at?
- industry level
- entity level
- balance level- isolated to a particular account
what does the ISA (UK) 315 require auditors to determine with inherit risk?
determine where on the spectrum an item lies. upper end may be significant risks
How can the detection risk figure be kept low?
- more audit work
- increased sample size
- more reviews
What does the ISA 315 define significant risk as?
an identified and assessed risk of material misstatement which, in the auditor’s judgement, requires special audit consideration.
What are the inherent risk factors that should be used to determine the significance of risk according to the ISA 315?
- complexity
- subjectivity
- change
- uncertainty
- susceptibility to misstatement
Auditor’s must consider whether climate related risks have any influence on:
- the entities business model (supply chain)
- industry factors (competitor environment, supplier and customer relationships)
- regulatory factors (climate related laws and regulations)
- external factors (economic conditions, interest rates etc)
what are the 2 types of risk in relation to climate change to businesses?
- physical risks- flooding, wildfires
- transactional risks- social and economic shifts to low carbon economy i.e. policy changes
what are examples of some of the climate change risks to businesses?
- not complying with climate change regulations
- sectorial risk i.e. crop failure
- loses major investors if not climate change friendly business
- business unable to adapt i.e. car manufacturing business
What are examples of climate related MATERIAL misstatements that an auditor could assess?
- adverse weather- manipulate of financial statements to avoid reporting losses
- greenhouse gas emissions from livestock- uncertainty over asset values for agricultural producers
-consumer demand for more renewable forms of energy- existing inventory and manufacturing equipment may not be viable leading to possible overstatement if not reviewed.
what is meant by error?
an unintentional misstatement in financial statements, including the omission of amounts or disclosures
what is meant by fraud?
an intentional act involving the use of deception to obtain an unjust or illegal advantage
What are the 2 fraud characteristics the ISA 315 identify?
- misappropriation of assets: theft, i.e. ghost employees
- fraudulent financial reporting
what is the auditors responsibility in relation to fraud and error?
provide reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error
what is the auditors first line of defense against fraud?
professional scepticism
- auditor can accept documents as genuine but remain alter for conditions that indicate the report may not be authentic (ISA 240)
What is meant by a related party?
an individual or organisation who is influenced by, or has influence over the entity
- they can be difficult to identify in practice
What is the risk with related parties?
- increased change of financial results to be manipulated as transactions may be carried out on a basis other than ‘arms length’
what is meant by analytical procedures?
involve the evaluation of financial information through analysis of plausible relationships among both financial and non-financial data
What is stated in the ISA about analytical procedures?
- must be used at planning to identity risks (ISA 315)
- used as a form of substantive procedure to gather audit evidence (ISA 520)
- Used to assist in overall conclusion (ISA 520)
What are the limitations to analytics procedures at the planning stage?
- require knowledge and experience of entity which is limited first year of audit
- experienced staff may have to carry them out
- quality depends on reliability of data
What are possible sources of information to perform analytical procedures?
- interim accounts
- budgets
- management accounts
- VAT returns
- board minutes
- non-financial information
- discussion or correspondence with client
- industry knowledge
Which THREE of the following statements, relating to fraudulent financial reporting, are true?
a)Fraudulent financial reporting is the intentional misrepresentation of a business’s financial statements with the aim to give a mistaken impression about the operating performance and profitability.
b)Companies that commit financial statement fraud are often experiencing net losses or have profits less than expectations.
c)Fraudulent reporting can be controlled with external auditing, regulations and an independent board of directors.
d)Unlike other types of fraud, financial statement fraud is usually not concealed and is therefore relatively easy to spot.
a, b, c
Which of the following transactions requires separate disclosure in the financial statements?
a) Sale of a company car to the finance director’s son at its market value of $15,000.
b) An agreement to purchase all stationery from a company owned by the commercial director.
c) Allowing the marketing director’s husband to use office space free of charge to run his business.
d) Sale of an item of inventory to the CEO’s wife for $200, where company revenue is $8bn.
all of them
