Chapter 8 and 19.

Question 1

What are the Preconditions for an audit.

Answer 1

1. AFRF is acceptable.

2. MGT agree to the premise on which audit is conducted.

Question 2

How an auditor evaluates whether preconditions for an audit exist.

Answer 2

1. Auditor shall determine whether AFRF used for preparation of F/S is acceptable (considering nature of entity, nature of F/S, purpose of F/S and legal requirements).
2. Auditor obtain agreement from MGT that it understand and acknowledge its responsibilities:
   i. For the preparation and presentation of F/S.
   ii. For the operating effectiveness of internal controls which MGT and TCWG determine necessary for preparation of F/S that are free from Material Misstatement.
   iii. To provide auditor with all relevant information, additional information and unrestricted access to the persons within the entity.

Question 3

Auditor’s course of action if any of the Precondition is not Present.

Answer 3

Auditor shall explain to MGT:

1. What preconditions are.
2. Preconditions are necessary to comply with ISA’s
3. Preconditions are necessary to avoid misunderstanding about responsibilities of MGT and Auditor.

Question 4

What shall auditor do if MGT doesn’t agree on Premise of Audit.

Answer 4

Auditor shall not accept this engagement.

Question 5

What shall auditor do if AFRF is not acceptable.

Answer 5

Auditor shall not accept this engagement unless required by law to do so.

If AFRF is not acceptable but auditor is required by law to perform this engagement, he shall accept this only when following conditions are met:

1. MGT agree to provide additional disclosure to prevent the F/S from being misleading.
2. Engagement letter shall state:
   i. Auditor report shall include EOM Paragraph to draw user attention towards additional disclosure.
   ii. Auditor report shall not include words “ True and Fair View”.

If above conditions are not met, auditor may still accept this engagement but auditor shall:

1. Evaluate the possible impact on auditor’s report.
2. Include appropriate reference of this effect in engagement letter.

Question 6

Define Engagement Letter.

Answer 6

Engagement Letter is a written agreement b/w auditor and client ( through authorized representative e.g: MGT and TCWG) on terms and conditions of audit engagement.

Question 7

Essential contents of Engagement Letter

Answer 7

1. Purpose and scope of Audit.
2. Identification of AFRF.
3. Responsibilities of auditor.
4. Responsibilities of MGT.
5. Reference to the expected form and content of report to be issued by the auditor, and a statement that report may differ due to change in circumstances.

Question 8

Additional contents of Engagement Letter

Answer 8

1. Elaboration of the scope of audit.
2. Inherent limitation of audit and internal control system
3. Arrangement regarding the planning and performance of audit.
4. Fee or Basis of fee.
5. Agreement that MGT will inform auditor about significant subsequent events.
6. Expectation that MGT will provide written representation and other information at the end of audit.
7. Arrangements concerning involvement of predecessor auditor, component auditor, expert, internal auditor and quality control reviewer.
8. Reference to any further agreement b/w auditor and entity.
9. Obligation to provide working papers.
10. Reference to any other communication as a result of audit engagement.

Question 9

Circumstances that may lead to change in terms of Audit Engagement.

Answer 9

1. A change in circumstances affecting the need for audit engagement.
2. A misunderstanding as to nature of service originally requested.
3. A restriction on the scope of audit engagement by MGT.

Question 10

What is required to be done if change in terms of Engagement is reasonable and auditor accept the change.

Answer 10

1. Revised terms of engagement shall be agreed.
2. Procedures to be performed and report to be issued shall be according to revise engagement.
3. Report shall not refer to :
   i. Original audit engagement.
   ii. Any procedures performed in original audit engagement.

Question 11

What is required to be done if change in terms of Engagement is not reasonable and auditor doesn’t accept the change.

Answer 11

1. Auditor shall continue to perform the audit engagement as per original terms of engagement.
2. If MGT doesn’t permit auditor to continue original engagement, it will be a Scope Limitation by MGT whose effect is pervasive. Auditor shall withdraw from engagement and shall consider whether is an obligation to report to TCWG, owners and regulators.
3. If withdrawal is not possible or practicable, auditor shall express disclaimer of opinion in auditor reprot.

Question 12

When a new Engagement Letter shall be issued on a recurring audit.

Answer 12

1. Indication of client misunderstanding of objectives and scope of audit.
2. Recent change in Senior MGT.
3. Significant change in ownership.
4. Change in legal or regulatory requirements.
5. Significant change in nature or size of entity business.
6. Change in reporting requirements.
7. Change in AFRF.
8. Revised or special terms of Engagement.

Question 13

Difference b/w Fraud and Error.

Answer 13

Fraud : An intentional act by one or more individuals involving the use of deceptions to obtain an unjest or illegal advantage.
Error: An un-intentional misstatement in F/S.

Question 14

Types of FRAUD.

Answer 14

1. Misappropriation of Assets.

2. Fraudulent Financial Reporting.

Question 15

Define Misappropriation of Assets with Examples.

Answer 15

Misappropriation of assets involves the theft of an entity’s assets and is often committed by employees
Example;
1. Embezzling receipts.
2. Stealing Physical assets or intellectual property.
3. Causing an entity to pay for goods or service when are not received.
4. Using an entity’s asset for personal use.

Question 16

Define Fraudulent Financial Reporting with Examples.

Answer 16

Fraudulent Financial Reporting involves intentional misstatements in F/S to deceive F/S users’

Examples include:

1. Reporting fictitious journal entries, particularly close to year end to achieve targets.
2. Inappropriately changing assumptions and judgments used to estimate account balance.
3. Advancing or delaying recognition of events and transactions.
4. Altering records and terms related to significant transactions.
5. Engaging in complex transactions that are structured to misrepresent the F/S.
6. Concealing the facts that could affect amounts recorded in F/S.

Fraudulent Financial Reporting is committed by MGT override of control.

Question 17

Responsibilities of MGT regarding Fraud.

Answer 17

Primary responsibility to prevent and detect fraud rests with MGT and TCWG.

1. MGT should establish system and controls to prevent and detect fraud.
2. TCWG should monitor the system and control, and should also consider possibility for MGT override of control.

Question 18

Responsibility of Auditor regarding Fraud.

Answer 18

Auditor’s primary responsibility is to express an opinion on F/S. Auditor is not primarily responsible to prevent and detect fraud because fraud may involve sophisticated techniques and collusions.

Regarding Fraud Auditor is responsible to :

1. Perform procedures to identify risk of material misstatement due to fraud.
2. Maintain professional skepticism throughout audit to identify circumstances indicating fraud.
3. Perform procedures on identification on fraud.

Question 19

Explain Risk Assessment procedures to identify Fraud.

Answer 19

1. Make inquires of MGT in respect of :
   i. their process to identify fraud.
   ii. any specific risk of fraud identified or likely to exist.
   iii. their assessment of risk of fraud.
   iv. any communication within entity in respect of fraud
2. Make inquiries of MGT and others whether they have knowledge of any actual, suspected or alleged fraud.
3. Make inquiries of internal audit and TCWG whether they have knowledge of any suspected or alleged fraud.
4. Evaluate any unusual or unexpected relationships identified in performing analytical procedures which may indicate risk of fraud.
5. Evaluate information obtained from other risk assessment procedures whether any fraud risk factors are present.

Question 20

Auditor course of action when there is a risk of fraud or Fraud Risk Factor.

Answer 20

Auditor shall follow overall approach.

1. Increased level of professional skepticism specially during audit of judgmental areas.
2. Adequate planning, and reduced materiality level.
3. Assigning more experienced and specialized staff e.g. use of experts if necessary.
4. Increased supervision and review of the audit work performed.
5. Incorporating unpredictability in nature, timing and extent of audit procedures.
6. Making changes to audit procedures.
7. More audit procedures at period end rather than at interim date.
8. Obtaining more reliable audit evidence.
9. Evaluate whether selection and application of accounting policies is appropriate, and significant estimates are reasonable

Question 21

Auditor course of action if a fraud is identified or suspected to exist.

Answer 21

1. Auditor shall communicate fraud to appropriate level of MGT on timely basis
2. Auditor shall communicate fraud to TCWG if amount involved is significant, or MGT is involved.
3. Auditor shall communicate fraud to regulatory authority only if such communication is required by law.
4. If due to involvement in fraud , there is doubt over integrity of MGT, auditor may consider withdrawal.
5. If fraud result in a misstatement in F/S, auditor shall also consider its impact on report.

Question 22

Define MGT Override of Control.

Answer 22

It means the ability of MGT to overrule prescribed policies and procedures to prepare fraudulent F/S, even when controls are appearing to be operating effectively.
Risk of MGT Override of Control exist in every entity.

Question 23

Techniques of MGT Override of Control.

Answer 23

1. Reporting fictitious journal entries, particularly close to year end to achieve targets.
2. Inappropriately changing assumptions and judgments used to estimate account balance.
3. Advancing or delaying recognition of events and transactions.
4. Altering records and terms related to significant transactions.
5. Engaging in complex transactions that are structured to misrepresent the F/S.
6. Concealing the facts that could affect amounts recorded in F/S.

Question 24

What are audit procedures to address risk of MGT override of Control.

Answer 24

1. Test the appropriateness of journal entries.
   Auditor shall:
   i. Make inquiries about inappropriate or unusual activity relating to processing of journal entries.
   ii. Select journal entries and other adjustments made at the end of reporting period.
   iii. Consider the need to test journal entries and other adjustments throughout the period.
2. Review accounting estimates for possible biases.
   In performing this review, auditor shall:
   i. Evaluate whether the judgments and assumptions used by MGT in making estimates, indicate a possible bias. If so auditor shall re-evaluate the accounting estimates taken as whole.
   ii. Perform retrospective review of MGT judgments and assumptions relating to significant accounting estimates .
3. Evaluate the business rational of significant transactions outside normal course of business.