Planning and risk assessment Flashcards
Content of engagement letters - clauses on
Objective and scope of the audit Management responsibility re accounts Auditors responsibilities Access to relevant records Planning of audit Agreement to provide a letter of representation Description of other letters or reports to be issued to client Basis of fees
Benefits of planning an audit
Focus on specific areas Faster resolution of potential problems Selection of appropriate audit team Coordination of work from auditor and 3rd parties Development of an audit strategy
Audit strategy
Scope of audit
Reporting objectives and requirements (listed companies have 6 months to prepare accounts and need audit report)
Levels of materiality
Initial risk assessment (including any prior client risk knowledge
Nature, timing and extent of resources to perform audit
Understanding the entity
What is needed when a new client is being audited
Matters to consider for understanding a client
New client:
Prior accounts
Meeting w/ management / internal audit team to discuss key factors of audit
Public articles online
Request permission to meet and review files of prior auditor (if one exists)
Matters to consider: Financial reporting framework Market / competition Nature of entity - revenue streams, locations, key suppliers and customers Objectives - new products, expansion Selection of accounting policies Internal controls
Audit risk - definition
2 key components
Risk of auditor giving an incorrect option
Key components
Risk of material misstatement existing in the accounts X Risk that the auditor does not discover those errors
Types of audit risks
Inherent risk, Control risk & Detection risk - inherent and control are outside the control of the auditor.
Inherent risk - the risk that something is susceptible to a material misstatement
Control risk - the risk that a material misstatement will not be prevented or detected and corrected by the internal control system
Detection risk - the risk that the auditors procedures will not detect a material misstatement
Materiality definition and quantity / quality
Its omission or misstatement could influence the economic decisions of its users
Quantity - the misstatements relative size
Quality - may be low in value but could heavily influence decision making
Schedule of unadjusted misstatements
‘Overs and unders schedule’ - various things which have been slightly misstated (transposition errors etc)
Slight misstatements are found by the auditors having a lower materiality level, known as ‘performance materiality’
Fraud - definition
Intentional misstatement or misappropriation of assets
Qualified or adverse opinion
If accounts do not show a true and fair view (depending on materiality)
Analytical procedure
Evaluation of financial information in order to spot fluctuations and relationships that are inconsistent wit other relevant information (compare current to past year)
Profitability ratios
Return On Capital Employed (ROCE)
Gross profit margin
Operating profit margin
ROCE = Profit before interest and tax / total assets less current liabilities
Gross profit margin = (gross profit / revenue) x 100
Operating profit margin = (Profit before interest and tax / revenue) x 100
Liability ratios Current ratio Quick ratio (acid test) Inventory days Receivables collection period Payables period
Current ratio = current assets / current liabilities
Quick ratio (acid test) = (current assets - inventory)/current liabilities
Inventory days = (inventories/cost of sales) x 100
Receivables collection period = (trade receivables / credit sales) x 100
Payables period = (trade payables/credit purchases) x 100
Gearing
Debt to equity
Interest bearing debit/capital plus reserves
Audit documentation
Benefits of documenting work
Content of auditors working papers
Benefits:
Evidence of work incase of litigation
Aid next audit team on that client
Useful for training staff
Content of papers Name of client and year-end date Identification of subject area being reviewed and the number of times it has been revised i.e. v4 Who performed work Who reviewed work
Generally kept for 6 to 7 years
