Seminar 1

Question 1

You have obtained employment in the accounting firm of Dickens & Partners as an Audit Assistant. You have heard that the firm is not very modern in its approach. On the first day at work, Mr Dickens calls you into his office and hands you a copy of an audit manual published in 2000. The Partner proudly proclaims ‘This is the Bible of auditing.’ You open the book and read the following statement on page 7:

        “….. The detection of fraud is a most important portion of the auditor’s duties. Auditors, therefore, should assiduously cultivate this branch of their activities.”

Required

Write a brief memo to the Audit Partner, Mr Dickens, discussing major changes that have occurred in the objectives of auditing since the publication of the audit manual in 2000.

(6/2,2,2,2,2,2)

Answer 1

Shift in Focus:

• While fraud detection remains important, the emphasis has shifted towards ensuring the accuracy and fairness of financial statements.
• Modern auditors aim to provide reasonable assurance that financial statements are free from material misstatement, whether due to fraud or error.

Risk-Based Approach:

• Auditing now employs a risk-based approach.
• This involves assessing the risk of material misstatements and focusing audit efforts on areas with higher risk, thereby improving the efficiency and effectiveness of the audit process.

Regulatory Changes:

• There have been significant regulatory changes, especially post-Enron and WorldCom scandals, with the introduction of the Sarbanes-Oxley Act in 2002.
• This Act has heightened the accountability of auditors and introduced stricter controls and transparency in financial reporting.

Technology Integration:

• The integration of technology in auditing has transformed the landscape.
• Tools like data analytics, continuous auditing, and the use of artificial intelligence have enhanced the auditors’ ability to analyze large datasets and identify anomalies more efficiently.

Emphasis on Corporate Governance:

• There’s a greater focus on corporate governance and internal controls.
• Auditors are now expected to evaluate the effectiveness of internal controls over financial reporting and communicate any deficiencies to those charged with governance.

Professional Skepticism and Ethics:

• There’s a reinforced emphasis on professional skepticism and ethical behavior.
• Auditors must maintain an inquisitive mind, be alert to conditions which may indicate possible misstatement, and critically assess audit evidence.

Question 2

To what extent can auditor independence affect the quality and credibility of corporate financial statements?

Answer 2

• Auditor independence is crucial for ensuring the integrity of corporate financial statements. When auditors maintain independence, they’re more likely to objectively assess the accuracy and fairness of financial statements without being influenced by management.
• If auditors lack independence, it can lead to compromised judgment, overlooked issues, or intentional misstatements. This affects the quality of the audit and undermines the credibility of financial statements, eroding trust among investors, regulators, and other stakeholders. In essence, without independence, the audit process loses its value, as the fundamental premise of providing an unbiased opinion is compromised.

Question 3

Define materiality and discuss the factors affecting its determination.

Answer 3

Materiality is a concept in accounting and auditing that refers to the significance of financial information or misstatements that could influence the economic decisions of users relying on the financial statements. Essentially, it’s the threshold above which any misstatement or omission becomes relevant.

Factors Affecting Materiality Determination:

Size and Nature of Item:

• Quantitative and qualitative aspects both matter. Even small items can be material if they arise from fraud or impact compliance with regulations.

Nature of the Entity:

• The size and complexity of the organization can influence materiality. Larger entities might have higher materiality thresholds.

Financial Statements Impact:

• How the misstatement affects various elements of the financial statements, like revenue, profit, or assets.

User Expectations:

• Understanding the primary users of financial statements (investors, regulators, etc.) and their focus areas.

Regulatory Requirements:

• Compliance with specific industry regulations or standards can affect materiality.

Question 4

Explain how the components of audit risk are interrelated.

Answer 4

Inherent Risk (IR):

• This is the susceptibility of an assertion to a material misstatement, assuming there are no related internal controls. It’s influenced by the nature of the entity and its environment.

Control Risk (CR):

• This is the risk that a material misstatement that could occur in an assertion will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Detection Risk (DR):

• This is the risk that the auditor’s procedures will not detect a material misstatement that exists. Detection risk is influenced by the nature, timing, and extent of audit procedures.

Higher inherent risk means the auditor expects more potential for misstatements. This will require the auditor to perform more rigorous procedures to achieve a low detection risk.

If control risk is high (meaning internal controls are weak), the auditor cannot rely on them to catch errors. Thus, the auditor must perform more substantive procedures, reducing detection risk.

Detection risk is the only component directly controlled by the auditor. By increasing the extent and effectiveness of their procedures, they can lower detection risk, compensating for high inherent or control risks.