Chapter 4 Planning the assignment Flashcards
-Define overall audit strategy and audit plan - obtain an understanding of the entity and its environment - identify sources and understand - fraud vs error difference
What is important for the audit strategy?
- determine the development
- Understand entity
- Risk assesment
- Nature and timing of audit procedure
- Direction, supervision
How does the audit plan go ahead and ensure?
- Next step of strategy
- Attention paid to most important areas
- Potential problems are identified
- Organised and managed
- Assigned to appropriate member of audit team
- Review by more senior auditors are facilitated
Which ISA requires auditor to gain understanding entity
ISA 315
ISA 315 details which aspects as important?
- Industry, regulatory and other external factors
- Nature of the entity
- Objectives and strategies
- Measurement and review of entity financial performance
- Internal controls
ISA 315 can be fulfilled through what methods?
- Enquiries of management and other client staff
- Analytical procedures
- Observation of processes
- Inspection of documents or assets
- Prior knowledge of the client
What is Importance of materiality in audit?
- Expressed of relative significance of a matter in context of financial statements
- e.g omission or misstatement leading to economic decision
What is performane materiality?
amount set less then materiality where aggregate of all uncorrected and undected errors do not exceed materiality as a whole
How to use the materiality?
at planning stage, this factor drives the level of work e,g, test a balance at all sample sizes,
influences audit evidence
How to identify materiality?
depends on auditors judgement
e.g. size, or nature (accounts of directors and company disclosed - material regardless of size), or
What are the % materiality used for exam purpose?
5-10% PBT
0.5 -1% Rev
1-2% Total asset
What is the importance of risk assesment
- risk based approach
- used at planning stage
- ## focus on problem areas
What is the audit risk model equation?
Audit risk= Inherent risk x Control risk x Dection risk
How does Financial statement contain risk of material misstatement?
1) Misstatement occurs in the first place -> Inherent Risk (IR)
2) client controls do not prevent/detect misstatement - >Control Risk (CR)
How does auditor fails to detect risk of material misstatement
Insufficient work, Inappropriate work poor judgement -> Detection risk (DR)
What is inherent risk?
susceptibility of transaction, account balance or disclosure to material misstatement
What are the three levels of inherent risk?
1) Industry level - affect the whole e.g. highly regulated industries (bank)
2) Entity level - affect whole e.g. company maybe not going concern, senior get profit related bonuses
3) balance level - isolated to particular account balance e.g. items complex or subjective
What is control risk?
material misstatement not prevented, detected by accounting or internal control systems
What is detection risk?
Auditor’s procedures not detect a misstatement in account balance or class of transaction being material for individual or aggregate
What are significant risks?
Fraud Significant accounting Complexity Related party transactions Subjectivity Unusual transactions
What is fraud and error?
Fraud: intentional act involving use of deception to obtain unjust/illegal adv.
error: unintentional misstatement in FStats, incl. omission
What are characteristics of fraud in ISA240?
Misappropriation of assets - e.g theft of sending cash to personal account or inventory
fraudulent finance reporting - intentionally manipulating finance statements to deceive
What is the responsibility of management for fraud and error?
achievied by design and implementation of effective system of internal control
What is the responsibility of auditor for fraud and error?
assurance that free of misstatement in Fstats, e.g plan, perform, review audits
some may not be detected, this is great risk as this is organised criminal scheme
What is a related party?
individual or organisation with influence/d, non BAU transactions
What is risk of related party?
increases risk of potential manipulation of finance, as transactions done at ‘arms length’
How to identify who is related party?
Directors won’t disclose the transactions
not easy to identify in systems as its not seperate from normal transactions
transactions concealed whole or part from auditors
What are the analytical procedures?
Evaluation of finance Info through plausible relationships of finance and non finance date
What are the preliminary analytical procedures from ISA315 and ISA520?
ISA 315 used to identify risk
ISA 520 form substantive procedures to gather audit evidence & to get to a conslusion of FStat
What are the sources of information for analytical procedures?
- interim accounts
- budgets
- MI
- VAT returns
- board minutes
- industry knowledge
What is the return on capital employed formula?
(Profit before interest and tax) x 100 /(Equity + net debt)
effective use of resources
What is the return on shareholders funds formula?
(Net profit for the period) x 100/ (share capital + reserves)
Effective use of resources
What is the gross profit margin?
Gross profit/Revenue x 100
asses profitability before overheads
What is the cost of sales percentage?
Cost of sales/Revenue x 100
asses relation of costs to revenue
What is the operating cost percentage?
Operating costs or overheads/revenue x 100
assess cost to revenue
What is the net margin/operating margin?
Profit before interest and tax/revenue x 100
assess profitability after taking overheads into account
What is the current liquidity ratio?
Current asset/current liability
ability to pay CL from liquid asset
What is the quick liqudity ratio?
(Receivables+ Current Investment + Cash)/Current liablity
Ability to pay CL from most liquid asset
What is the gearing ratio?
Net debt/Equity
Asseses reliance on external finance
What is the interest cover ratio?
Profit before interest pay/Interest payable
ability to pay interest
What is the net asset turnover?
revenue/capital employed
revenue generated from asset base
What is the trade receivables collection period?
Trade receivables x 365/Credit revenue
average time taken turning receivables into cash
What is the trade payables payment period?
Trade payables x 365/Credit purchases
average time taken paying suppliers
What is the inventoy holding period?
Inventory x 365/Cost of sales
average time inventory is held
What do we look out for in evaluating the accounts using preliminary analytical procedures?
- revenue growth measure
- gross profit margin
- interest cover rate
- bank overdraft movement
- trade receivables days
- trade payables days
- The movement from one year to another.
- Is there a going concern risk
- A reduction in payables days may indicate understatement in payables
