Module 14: Planning 1 - Assessing Risk Flashcards
Business risks
- Operational/strategic
- market
- organisational
- financial - Reliable financial reporting
- Compliance
When is a business risk relevant
BR is only relevant as an INHERENT RISK if it could result in a material misstatement in the FS
Account specific risk
- significant development
- complex
- non-routine
- judgemental
3 types of risk
- Business risk
- Account specific risk
- Control weaknesses
Exam tip: Industry specific risks
Additional audit risks within certain industries
May arise because of:
- specific account balance
- changes in accounting policies/treatment
- increased regulatory requirements of certain sectors
Industry specific risks
- Big data
- sig business risks as big data relevant to how client assesses risks, exercises internal control and reviews financial performance - insurance companies
- potential future settlements of incurred insurance claims by customers = claim reserve = complex accounting and judgemental
Setting overall materiality: 5 step process
- Select an APPROPRIATE BENCHMARK (justify)
- Select the appropriate RANGE to APPLY THE BENCHMARK
- select the data to be used to CALCULATE MATERIALITY (Justify)
- CALCULATE the materiality range based on 1-3
- Select the FINAL MATERIALITY figure from within the range (justify)
Which benchmark to apply to materiality in the exam?
In this order:
- PBT if not volatile
- Revenue if profit is volatile
Appropriate % based on professional judgement but use:
In exam say: the appropriate range is…
PBT - 5-10% Operating expenses - 0.5-2% Revenue - 0.5-2% Total assets - 0.5-2% Net assets - 0.5-2%
Materiality step 3: select the data to be used
Relevant data depends on what is available. Select the most representative
See Tolley book (PY, year to date and forcast/budget)
Forecasts - don’t use directly, they are a good sense checking tool
Prudent to go with the lower number
Data should be adjusted to show normalised figures - adjust for exceptional one off items
Step 4: Calculate materiality range
“If PBT was selected as the most appropriate benchmark, overall materiality would be between £25m and £50m (5-10%)”
Step 5: select the final materiality figure within the acceptable range
If risk factors high => materiality % is low
Risk factors to consider:
- whether entity is LISTED or a PIE
- FIRST YEAR AUDIT
- GC issues
- SIG audit risks
- MATERIAL MISSTATMENT in PAST
- HIGH FRAUD risk
PM
- set at less than overall materiality to reduce the probability that the aggregate of individually immaterial uncorrected/undetected misstatements exceeds overall materiality
- professional judgement
- firms commonly apply % between 50-75%
The riskier the client, the lower the %
PM factors
Lower %
- many PY misstatements
- POOR controls in PY
- expectation of misstatements
HIGHER %
- low PY misstatements
- GOOD controls
- low expectation of misstatements
Trivial threshold
Auditor accumulates misstatements other than those that are clearly trivial = clearly inconsequential
- firms generally use 0-5% of overall materiality
Analytical procedure techniques
Used to gain understanding of the entity with COMPARISON, RATIO ANALYSIS and REASONABLENESS TESTS being the most common techniques
revenue or payroll expectation = reasonableness test
The ratios used will depend on the client or industry
Analytical procedures: Profitability
Turnover growth
GP margin
Direct costs as a proportion of revenue
Analytical procedures: Management
DTR
DTP
Inventory days or turnover
Analytical procedures: Liquidity
Current ratio
Quick ratio
Analytical procedures: Risk
Gearing
Interest cover
Planning analytical review exam approach checklist
- read scenario, annotate key info and CREATE an EXPECTATION if info available
- CALCULATE KEY RATIOS and movements straight onto word
- For each relevant movement, TIE SCENARIO info and IDENTIFY the POSSIBLE AUDIT RISK
What should you never do to balance sheet amounts
Pro-rate
CAATs
involve using computer programs and data to perform audit procedures
ADA - audit data analytics
more recent term
- describe the use of CAATs and the use of computer-based techniques to perform audit procedures
IAASB defined ADA as the art of discovering and analysing PATTERNS, DEVIATIONS and INCONSISTENCIES
CAATS and ADA: the advantages
used where the volume of transactions to be tested is significantly large and processing of transactions is automated:
Following ads:
1. Improvement in extent of audit testing
- speed and accuracy of processing large volumes => increase extent of audit verification => reduce/eliminate sampling risk
- Performance of manually impossible procedures
- where manual methods are impossible, CAATs make it possible. Normally occurs in MORE SOPHISTICATED computer systems where no audit trail - Cost effectiveness
- may be cost effective when compared to its manual alternative.
- initial cost of investment and payback period should be considered - Elimination of repetitive work
- frees the auditor to CONCENTRATE on the important JUDGEMENTAL areas of the audit - Increased knowledge of the client’s system and procedures
- CAATs greatly enhances their DETAILED knowledge of the client’s processing system
Examples of ADA tools currently being used by auditors in planning include:
- analysing 100% of transactions in a population, stratifying the population and then identifying outliers for further examination (revenue analytics)
- comparing entity data with externally obtained data
- semantic or sentiment monitoring of textual information e.g. such as contained in emails or social media => external commentary can highlight reputational damage or fraud
- mapping of core processes to check accounting transactions against expected accounting patterns (e.g. revenue being recorded through sales ledger) to identify any deviations
- monitoring data to assess compliance with ‘Benford’s Law’ and deviations investigated as indicative of fraudulent manipulation
- supporting analytical procedures e.g. visualisation techniques to assist in trend analysis
Emergence of big data technologies may significantly affect:
- TIMELINESS and DYNAMISM of analysis. Velocity of big data = analyse in NEAR-REAL TIME
- emergence of INTUITIVE VISUALISATION AND DASHBOARD PLATFORMS greatly increases the accessibility and user friendliness of data analysis tools
- consequent UPTAKE of methods. With the right TRAINING = expand the range of audit team members who can usefully perform such analyses
ANOTHER BENEFIT:
- value that can be added back to the client through ad-hoc advice and mgmt letter => competitive advantage when tendering (good for small-med businesses who wouldn’t be able to afford their own analytical tools => benefit from the auditor’s)
DRAWBACK:
- concerns over how these new techniques sit within the auditing standards
