Module 14: Planning 1 - Assessing Risk

Question 1

Business risks

Answer 1

1. Operational/strategic
   - market
   - organisational
   - financial
2. Reliable financial reporting
3. Compliance

Question 2

When is a business risk relevant

Answer 2

BR is only relevant as an INHERENT RISK if it could result in a material misstatement in the FS

Question 3

Account specific risk

Answer 3

• significant development
• complex
• non-routine
• judgemental

Question 4

3 types of risk

Answer 4

1. Business risk
2. Account specific risk
3. Control weaknesses

Question 5

Exam tip: Industry specific risks

Answer 5

Additional audit risks within certain industries

May arise because of:

• specific account balance
• changes in accounting policies/treatment
• increased regulatory requirements of certain sectors

Question 6

Industry specific risks

Answer 6

1. Big data
   - sig business risks as big data relevant to how client assesses risks, exercises internal control and reviews financial performance
2. insurance companies
   - potential future settlements of incurred insurance claims by customers = claim reserve = complex accounting and judgemental

Question 7

Setting overall materiality: 5 step process

Answer 7

1. Select an APPROPRIATE BENCHMARK (justify)
2. Select the appropriate RANGE to APPLY THE BENCHMARK
3. select the data to be used to CALCULATE MATERIALITY (Justify)
4. CALCULATE the materiality range based on 1-3
5. Select the FINAL MATERIALITY figure from within the range (justify)

Question 8

Which benchmark to apply to materiality in the exam?

Answer 8

In this order:

1. PBT if not volatile
2. Revenue if profit is volatile

Question 9

Appropriate % based on professional judgement but use:

In exam say: the appropriate range is…

Answer 9

PBT - 5-10%
Operating expenses - 0.5-2%
Revenue - 0.5-2%
Total assets - 0.5-2%
Net assets - 0.5-2%

Question 10

Materiality step 3: select the data to be used

Answer 10

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

Question 11

Step 4: Calculate materiality range

Answer 11

“If PBT was selected as the most appropriate benchmark, overall materiality would be between £25m and £50m (5-10%)”

Question 12

Step 5: select the final materiality figure within the acceptable range

Answer 12

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

Question 13

PM

Answer 13

• 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 %

Question 14

PM factors

Answer 14

Lower %

• many PY misstatements
• POOR controls in PY
• expectation of misstatements

HIGHER %

• low PY misstatements
• GOOD controls
• low expectation of misstatements

Question 15

Trivial threshold

Answer 15

Auditor accumulates misstatements other than those that are clearly trivial = clearly inconsequential

• firms generally use 0-5% of overall materiality

Question 16

Analytical procedure techniques

Answer 16

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

Question 17

Analytical procedures: Profitability

Answer 17

Turnover growth
GP margin
Direct costs as a proportion of revenue

Question 18

Analytical procedures: Management

Answer 18

DTR
DTP
Inventory days or turnover

Question 19

Analytical procedures: Liquidity

Answer 19

Current ratio

Quick ratio

Question 20

Analytical procedures: Risk

Answer 20

Gearing

Interest cover

Question 21

Planning analytical review exam approach checklist

Answer 21

1. read scenario, annotate key info and CREATE an EXPECTATION if info available
2. CALCULATE KEY RATIOS and movements straight onto word
3. For each relevant movement, TIE SCENARIO info and IDENTIFY the POSSIBLE AUDIT RISK

Question 22

What should you never do to balance sheet amounts

Answer 22

Pro-rate

Question 23

CAATs

Answer 23

involve using computer programs and data to perform audit procedures

Question 24

ADA - audit data analytics

Answer 24

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

Question 25

CAATS and ADA: the advantages

Answer 25

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 2. 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 3. Cost effectiveness - may be cost effective when compared to its manual alternative. - initial cost of investment and payback period should be considered 4. Elimination of repetitive work - frees the auditor to CONCENTRATE on the important JUDGEMENTAL areas of the audit 5. Increased knowledge of the client's system and procedures - CAATs greatly enhances their DETAILED knowledge of the client's processing system

Question 26

Examples of ADA tools currently being used by auditors in planning include:

Answer 26

- 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

Question 27

Emergence of big data technologies may significantly affect:

Answer 27

- 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