Exam Techniques

Question 1

Exam techniques

Answer 1

Exam Technique: Identifying Risks

When presented with an audit scenario in the exam, follow these steps:

Identify Clues
Look for matters that impact the auditor’s assessment of inherent, control, and detection risks.

Explain Risks
Demonstrate your understanding of why these clues represent risks.

Key Points to Consider
1. Inherent risks: Industry, entity, or transaction characteristics that increase misstatement likelihood.
2. Control risks: Weaknesses in internal controls that could lead to material misstatements.
3. Detection risks: Factors that might prevent auditors from detecting material misstatements.

Answer Structure
1. Identify the clue (risk factor).
2. Explain why it represents a risk (inherent, control, or detection).
3. Provide relevant audit implications or procedures that may be necessary.

Identifying Risks in an Audit Scenario
To identify risks in an audit scenario, follow these steps:

1. Read the scenario carefully: Pay attention to details about the company, its operations, and any specific events or circumstances.
2. Identify potential clues: Look for matters that could impact the auditor’s assessment of inherent, control, and detection risks.
3. Categorize the clues: Determine whether each clue relates to inherent risk, control risk, or detection risk.
4. Explain why each clue represents a risk: Provide a clear and concise explanation for each clue, stating why it increases the risk of material misstatement.

Example Scenario
Your audit firm is auditing Green Earth, a company that specializes in recycling and waste management. Green Earth has recently expanded its operations to include a new recycling facility, which has increased its revenue by 20%. However, the company has also experienced significant turnover in its accounting department, with three different accountants in the past year. The company’s financial statements are complex, with multiple related-party transactions.

Identifying Clues and Explaining Risks
1. Inherent Risk:
- Complex financial statements: The complexity of the financial statements increases the risk of material misstatement due to the potential for errors or misinterpretation.
- Related-party transactions: Related-party transactions can be difficult to account for and may lead to material misstatements if not properly disclosed or valued.
2. Control Risk:
- High turnover in accounting department: The frequent changes in the accounting department may indicate inadequate training, poor internal controls, or lack of continuity, increasing the risk of material misstatement.
3. Detection Risk:
- New recycling facility: The new facility may introduce new and complex accounting issues, such as depreciation, inventory valuation, or revenue recognition, which may be difficult to detect and audit.

Calculating Audit Risk
Using the identified risks, calculate the audit risk:

Audit Risk (AR) = Inherent Risk (IR) x Control Risk (CR) x Detection Risk (DR)

Assuming:

IR = 0.6 (complex financial statements and related-party transactions)
CR = 0.5 (high turnover in accounting department)
DR = 0.2 (new recycling facility)

AR = 0.6 x 0.5 x 0.2
= 0.06

The calculated audit risk indicates a moderate risk of material misstatement.

By following these steps and providing clear explanations for each clue, you can demonstrate your ability to identify and assess risks in an audit scenario.