L4 Audit risk and materiality Flashcards
What are the 5 factors that affect inherent risk at the financial report level?
- Integrity of management
- Management experience, knowledge and changes during the period
- Unusual pressure on management
- Nature of the entity’s business
- Factors affecting the industry in which the entity operates
What are factors related to IT that affect overall inherent risk?
- Significant changes in IT
- Insufficient IT skills and resources
- Lack of entity support and focus
- High dependence on IT
- Reliance on external IT
- Reliability and complexity of IT
For inherent risk at the assertion level, what will auditors normally focus on?
- accounts likely to require adjustment
- complexity of underlying transactions
- judgment involved in determining account balances
- susceptibility of assets to loss or misappropriation
- occurrence of unusual and complex transactions, particularly at or near year-end
- transactions not subject to ordinary processing.
What is fraud?
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.
What are the two types of fraudulent misstatement that are relevant to the auditor?
- misstatement resulting from fraudulent financial reporting
- misstatement resulting from misappropriation of assets.
Who has the primary responsibility of preventing and detecting fraud?
It rests with those charged with governance of the entity and management.
What is the auditors responsibility in detecting and preventing fraud?
Auditors have to proactively consider fraud. Auditors have to:
- specifically consider risks of material misstatement in a financial report due to fraud
- discuss an entity’s susceptibility to fraud with other members of the audit team
- make more extensive enquiries of management with respect to fraud.
What should an auditor do if they suspect fraud, regardless of materiality?
Report it to an appropriate level of management.
Seek legal advice if unsure about the next steps.
Auditor is generally protected from defamation by qualified privilege if reporting is done in good faith and without malice to those with a proper interest.
What is earnings management?
- Occurs when judgement in financial reporting and in structuring transactions is used to alter financial reports to influence the perceptions of stakeholders.
- It involves those who are responsible for preparing the financial report such as the CFO and the CEO.
- Incentives to manage earnings can be either behavioural or market-based.
What does ASA/ISA 250 require an auditor to consider regarding illegal acts (noncompliance with laws and regulations)?
- The auditor must understand the legal and regulatory framework applicable to the entity and industry.
- An audit does not typically include procedures designed to detect illegal acts.
- The auditor must recognize circumstances requiring special attention (e.g., compliance with specific requirements in agreements like debenture deeds) and incorporate these considerations into the audit program.
What is a related party?
When one entity has the ability to significantly influence or control the operating, financing or investing decisions of another; or
If several entities are subject to control from the same entity; or
If the party is a joint venture in which the entity is venturer
Then they are related parties.
What does ASA/ISA 550 require an auditor to assess regarding related parties and related-party transactions?
The auditor must assess the risk that related parties and related-party transactions will not be identified, appropriately disclosed, and/or measured.
The auditor must identify all related parties when planning the audit because:
- The existence of related parties or related-party transactions can affect the financial information.
- The reliability of audit evidence depends on the source of that evidence.
- The initiation of a related-party transaction might be motivated by reasons other than ordinary business conditions, such as fraud.
What are 3 examples of related party fraud?
- Creating fictitious terms of transactions with related parties
- Fraudulently transferring assets at prices far above or below market value
- Engaging in complex transactions (e.g. with special purpose entities) to misrepresent the entity’s financial position or performance
What procedures can an auditor perform to identify related parties (ASA/ISA 550)?
- Review prior period’s working papers for known related parties
- Ask management to list all related parties
- Review the entity’s procedures for identifying related parties
- Ask management and directors about affiliations with other entities
- Review minutes of meetings
- Enquire with other auditors involved in the audit
What types of transactions may indicate the existence of unidentified related parties?
- Transactions that are overly complex (e.g. involving multiple parties within a group)
- Transactions with abnormal terms (e.g. unusual prices, interest rates, repayment terms, or guarantees)
- Transactions lacking a clear business reason
- Transactions processed in an unusual or suspicious manner
What is the going concern basis?
Entity is viewed as continuing in business for the foreseeable future without any intention or necessity to liquidate or otherwise cease its operations.
What does ASA/ISA 570.10 require auditors to consider regarding going concern?
Auditors must assess going concern at the planning stage.
Imminent business failure could affect how the financial report is presented or lead to management misrepresentations.
Early identification of going concern issues helps:
- Focus audit effort on relevant assertions
- Allow early communication with management
The auditor primarily considers anticipated events over a period of approximately 12 months from the current audit report date to the expected date of the next audit report.
What is materiality?
Defined as information, individually or in aggregate, that if misstated or omitted from a financial report may adversely affect decisions about the allocation of scarce resources made by financial report users.
Auditors must determine materiality level for the:
- …
- …
- Financial report as a whole
- Particular classes of transactions, account balances and disclosures.
What qualitative factors should an auditor consider when assessing materiality?
The significance of the item to the specific entity
The pervasiveness of the misstatement (e.g. it affects many items in the financial report)
The overall effect of the misstatement on the financial report as a whole
