Q&A Chapter 3: Risk assessment - tackling issues mid-audit (Justification and action) Flashcards
This is a new audit appointment
Risk JUSTIFICATION: - New appointment increases detection risk
- # Lack of cumulative/prior knowledge from previous audits
- # Could lead to processes taking longer
ACTIONS: - Accounting systems/controls need to be ascertained.
- Staff should be picked that may know the industry
- speak to previous auditors
- Current period audit work should have regard to opening balances and comparatives (ISA 510 ISA 710
- Careful planning – to ensure no over auditing
They operate in the fashion industry
Risk JUSTIFICATION: - High inherent risk
- Clothes and accessories do not stay in fashion
- YE inventory provisions may be inadequate
- This could lead to inventory obsolescence
ACTIONS: - Evaluate inventory count instructions for procedure to identify obsolete items.
- Review post year-end order book to establish adequacy of inventory provisions.
- Compare physical invent to book.
- review aged industry analysis - check that provision is made for slow-moving or obsolete inventory identified at the count
Purchases are paid for in forex
Risk JUSTIFICATION: - Inherent risk is increased by exposure to dollar fluctuations
- Could lead to a misstatement in purchases and payables
ACTIONS: - Review process by which gains or losses on forex transactions/year-end balances are taken to the income statement.
- Review process by which monetary items are translated at the YE rate.
- Test a sample of transactions for use of an appropriate exchange rate
Economic dependence on a principal customer
Risk JUSTIFICATION: - Pressure from the new customer may increase inherent risk due to over-reliance on them.
- If this contract was terminated, this could lead to a going concern risk
- Fear of losing customer may influence auditors judgement
ACTIONS: - Ensure the going concern assumptions remains appropriate if the new contract is terminated
- Regular review should be performed to ensure fees below recommended threshold
- Per ES4, must not exceed 10% for a listed company (15% for non-listed)
Going into the overdraft
Risk JUSTIFICATION: - Overriding risk is that the bank may withdraw the overdraft facility
- This could lead to window-dressing
- Unable to pay debts? = going concern risk
ACTIONS: - Monitor negations with the bank
- Review management plan’s and cash flows/ profit forecasts
- Obtain written evidence on funding strategy from management
Subcontractor costs
Risk JUSTIFICATION: - Potential loss of contractor goodwill if disagreement
Fire
Risk JUSTIFICATION: - Could result in fine provisions, regulator could close them down (going concern issue)
- Adverse publicity = good will
- Legal action by employees
- Provision for damages
ACTIONS: - Company policy displayed?
- Who is responsible?
- Spot checks by management to ensure adherence?
- Is policy in training?
Employment: Former employee having joined client in last 2 years
Risk JUSTIFICATION: - Familiarity threat: too much reliance on representations of former employee – too trusting
- Former self-interest threat (as manager this person may have been too sympathetic)
- Intimidation threat
ACTIONS: - Assess the composition of the audit team in light of this (remove members who had close association)
- Quality control procedures should be in place to ensure healthy professional scepticism
Company has increased locations / new side of business
Risk JUSTIFICATION:
- inherent risk
- With multiple locations there is a risk of non-adherence to management policies.
- New management – lack experience… may not yet keep track record of controls.
ACTIONS: - Perform branch visits (and cash counts)
- Review and test check procedures/controls
- Plan audit carefully to ensure no over-auditing
Large number of locations
Risk JUSTIFICATION: - Risk of breakdown in head office controls is high in multi-site locations
ACTIONS: - Year-end inventory counts should cover all material locations
- Similarly – control testing should be performed at all material locations
Cash basis
Risk JUSTIFICATION: - There is a risk of unrecorded revenue
- Risk of fraud, theft or money laundering
- Understatement of income
- Understatement of VAT and corp tax?
ACTIONS:
- Reconcile till records with banking
- check locks on tills etc
- Analytical procedures
o Inter-branch comparisons (month by month)
o Comparison of actual with expected margins (price and cost details)
o Anomalies in PAYE calculations
Check compliance with PAYE regulations
- ensure dual control (opening and counting)
- prompt banking
New computer system
Risk JUSTIFICATION: - IF the new system does not function properly there may be systematic errors, leading to unreliable accounting records
- The non-current asset may be materially misstated
ACTIONS: - Review process of setting up (training / data transfer)
- Confirm parallel run (old tech and new system at same time)
- Confirm post implementation review
- Consider use of CAATS
- Inspect invoice and contract
Temporary staff
Risk JUSTIFICATION:
- insufficient experience/ training = this could lead to errors
- higher risk of fraud if handling cash
ACTIONS: - more substantive testing - confirm qualifications - speak to management about recruitment process -
Profit related bonus scheme (or selling shares in company based on profit)
Risk JUSTIFICATION: - Increases risk that profit could be overstated due to management manipulation of the figures
- risk of window dressing/misstatement/bias
ACTIONS: - Focus on the occurrence of revenue, being alert to areas where it could be manipulated
- Focus on completeness of purchases, reviewing cut-off carefully to ensure all items up to YE are included correctly (hidden invoices)
- increase professional scepticism
- less reliant on management rep
- arrange quality control review
Lag time
Risk JUSTIFICATION: - If the company buy sell abroad – exposes company to movements in exchange rates, interest rates, and inflation
ACTIONS: - Discuss management approach to minimise exposure
Intercompany transactions
JUSTIFICATION: - Could overstate profit – these should not be included in consolidated FS`
ACTIONS: - Check to see if intercompany transactions are eliminated from FS
- Identify any unrealised profit
Annual subscriptions
Risk JUSTIFICATION: - Tesco – have these subscriptions been accounted for on an accrual basis? Wrong accounting year? ACTIONS: - Ensure that they are distributed fairly over time
- Test subscriptions close to year end
Adverse publicity (e.g. sweatshops)
Risk JUSTIFICATION: - Could damage reputation of company – affect customer and supplier good will
- Going concern threat
ACTIONS: - Audit work should attempt to assess the effect of the publicity on Jog’s business
- Consider cost implications of alternative suppliers
Depreciation
Risk JUSTIFICATION: - Different categories of assets being depreciated appropriately
- Useful lives/residual values may not be updated
- Compliance with companies act requirements
- Depreciation policies may not be consistent
ACTIONS: - Agree on appropriate depreciation policy
- Recalculate
- Compare rates to competitors/same industry
- Recalculate profits and losses for disposals
- Inspect sample of assets
Slow moving obsolete inventories
Risk JUSTIFICATION: - Previous year provisions may need to be recalculated.
- Could have poor process for identifying
- Maybe they don’t comply to the company’s ~Act
ACTIONS: - Review working papers
- Obtain copies of exception reports (inventories sold for less than cost)
- Review credit notes, and reasons for return
- Review indication for decline in sales
- Calculate inventory turnover and compare to previous year
Provisions for damages (returns from customers)
Risk JUSTIFICATION: - Lots of different types of damages
- Needs to comply with accounting standards
ACTIONS: - Review correspondence with legal advisor
- Review terms and conditions for customers
- Once claims are settled – has it been accounted for (if material – disclosed as exceptional)
Suspected fraud
Risk Justification:
- fraud is illegal
- difficult to spot
ACTIONS:
- increase scrutiny/pro scepticism
- look for evidence
- test controls over specific area (e.g. payrool)
- substantive testing (sample wages, payroll costs)
- consider impacts on other areas
Use of a new expert
Risk Justification:
Dont know about his competence, capabilities, objectivity
ACTIONS
check assumptions, method, source data, results of work in light of auditors knowledge, reasons for change
New internal audit team
Risk Justification:
Don’t know about his competence, capabilities, objectivity
- old team can’t be held accountable
ACTIONS
- new people: training? qualified? check recruitment
- conduct own checks
- substantive procedures
