Chapter 3 - Process of assurance: planning the assignment

Question 1

What does ISA (UK) 300, Planning an Audit of Financial Statements state about the objective of the auditor?

Answer 1

The objective of the auditor is to plan the audit so that it will be performed in an effective manner.

Question 2

Define audit strategy.

Answer 2

The formulation of the general strategy for the audit, which sets the scope, timing and direction of the audit and guides the development of the audit plan.

Question 3

Define audit plan.

Answer 3

An audit plan shows how the overall audit strategy will be implemented

An audit plan is more detailed than the strategy and sets out the nature, timing and extent of audit procedures (including risk assessment procedures) to be performed by engagement team members in order to obtain sufficient appropriate audit evidence.

Question 4

What are six things audits are planned to do:

Answer 4

• 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 properly
• facilitate direction and supervision of engagement team members
• facilitate review of work

Question 5

Do all audit procedures remain the responsibility of the external auditors?

Answer 5

Yes.

All audit procedures remain the responsibility of the external auditors.

Question 6

What are the four steps towards a structured approach to planning?

Answer 6

Ensuring that ethical requirements continue to be met

Ensuring the terms of the engagement are understood

Establishing the overall audit strategy

Developing an audit plan including risk assessment procedures, audit tests and any other procedures necessary to comply with ISAs

Question 7

What are five key contents of an overall audit strategy?

Answer 7

Question 8

With respect to ISA (UK) 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding of the Entity and Its Environment, which five procedures must be used in understanding the entity and its environment?

Answer 8

• Inquiries of management and others within the entity.
• Analytical procedures
• Observation and inspection
• If recurring audit, information from previous year audits
• The audit team is also required by ISA 315 to discuss the susceptibility of the financial statements to material misstatement.

Question 9

Define analytical procedures.

Answer 9

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

Question 10

What does ISA (UK) 520), Analytical Procedures require?

Answer 10

ISA (UK) 520, Analytical Procedures requires auditors to apply analytical procedures in the overall review at the end of the audit and as substantive procedures, to obtain audit evidence directly.

Question 11

What do analytical procedures include?

Answer 11

The consideration of comparisons with comparable info for prior periods, anticipated results of the entity and similar industry information.

Consideration of relationships between elements of financial information and financial information and relevant non-financial information.

Question 12

Should analytical procedures be used at the risk assessment stage?

Answer 12

Yes.

Analytical procedures should be used at the risk assessment stage.

Question 13

Regarding analytical procedures, what do possible sources of information about the client include?

Answer 13

• interim financial information
• budgets
• management accounts
• non-financial information
• bank and cash records
• VAT returns
• board minutes
• discussions or correspondence with the client at the year-end

Question 14

Define materiality.

Answer 14

An expression of the relative significance or importance of a particular matter in the context of financial statements as a whole. The IFRS Conceptual Framework for Financial Reporting states that a matter is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.

Question 15

Define performance materiality.

Answer 15

The amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.

The concept of performance materiality focuses on the difference between the level of tolerable misstatement and the level of actual misstatements detected.

Question 16

When should materiality be calculated during audits?

Answer 16

Materiality must be calculated at the planning stages of all audits.

Materiality must be reviewed during the audit.

Question 17

Define tolerable misstatement.

Answer 17

Tolerable misstatement is the maximum misstatement that an auditor is prepared to accept in a class of transactions or balances in the financial statements.

Often expressed as a proportion of its profits.

Question 18

Is materiality always quantative?

Answer 18

materiality has qualitative, as well as quantitative, aspects - some transactions (i.e. share capital directors loans) are always material regardless of their value

Question 19

Define audit risk.

Answer 19

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.

Question 20

What three aspects make up audit risk?

Answer 20

• Inherent risk
• Control risk
• Detection risk

Question 21

What is a crude mathematical formula for audit risk?

Answer 21

Audit risk = Inherent risk x Control risk x Detection risk

Question 22

Define inherent risk.

Answer 22

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.

Question 23

Outline the common inherent risk aspects of a company with regards to auditing

Answer 23

Question 24

What is the level of inherent risk when no information to assess inherent risk is available?

Answer 24

The auditors must use their professional judgement and all available knowledge to assess inherent risk. If no such information or knowledge is available then the inherent risk is high.

Question 25

Define control risk.

Answer 25

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.

Question 26

Outline the common control risk aspects of a company with regards to auditing

Answer 26

Question 27

Define detection risk.

Answer 27

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.
Detection risk is made up of 2 components:
- Sampling risk: due to the fact that the auditor does not sample 100% of transactions
- Non sampling risk: risk that material misstatement is not discovered due to other factors

Question 28

Outline the common detection risk aspects of a company with regards to auditing

Answer 28

Question 29

What does ISA (UK) 315 say?

Answer 29

ISA (UK) 315 paragraph 3 says that ‘the objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment…’.

Question 30

What are the four steps that the auditor is required to take when identifying and assessing risks?

Answer 30

Identify risks throughout the process of obtaining an understanding of the entity and its environment

Assess the identified risks and relate them to what can go wrong at the assertion level

Consider whether the risks are of a magnitude that could result in a material misstatement

Consider the likelihood of the risks causing a material misstatement

Question 31

According to ISA 315, which factors indicate that a risk may be a significant risk?

Answer 31

Risk of fraud

Related to recent significant economic, accounting or other development

The complexity of the transaction

It is a significant transaction with a related party

The degree of subjectivity in the financial information

It is an unusual transaction

Question 32

Define fraud

Answer 32

An intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage.

Question 33

Define error

Answer 33

An unintentional misstatement in financial statements, including the omission of an amount or a disclosure.

Question 34

What are the management and auditors individual resposibilites with regards to fraud?

Answer 34

Management are responsible for both preventing and detecting fraud and error. They do so by putting in place internal controls and creating a culture of honesty and ethical behaviour

The auditor is responsible for obtaining reasonable assurance that the financial statements are free from material misstatement. The auditors’ objectives in relation to fraud are:
* Identify and assess the risks of material misstatement due to fraud
* Design and implement appropriate tests in response
* Respond appropriately to actual or suspected fraud identified