topic 4 planning engagements + topic 5 risk assessment

Question 1

business risk and audit risk

Answer 1

Business risk- risk of the company not fulfilling its objectives and strategies

(don’t talk about business risks in audit risk qs. only discuss in intenral control deficiency consequences questions)

Audit risk- Risk of expressing an inappropriate audit opinion (because the auditor has failed to spot material errors or omissions)

Question 2

subcategories of audit risk-deinition - examples

Answer 2

Inherent risk- susceptibility of an assertion to a misstatement- Areas of judgement, calculations which involve estimates, Incentives to manipulate (e.g. profit related pay)

Control risk- Risk that internal controls do not prevent, detect or correct errors- New systems, Lack of review/reconciliation

Detection risk- Risk that auditors’ procedures do not detect a misstatement- New client, Time pressure

Question 3

How to answer an audit risk question

Answer 3

1) start sentence with transaction or balance you have been asked about (e.g. Inventory)
2) choose one of the following words- overstated, understated, misstated, omitted
3) Finish sentence with a reason why. source these using: words/numbers in scenario, data from inflo software, graphs/charts in scenario, use FAR knowledge, look out for commonly occurring risk indicators such as forex, new integrated systems with untested controls to manipulate (fraud risk)

Question 4

inventory good example v bad example

Answer 4

• Inventory may be overstated if the cost of clothing is more than the net realisable value.
• Inventory may be overstated as the red area of the heat map, which indicates the highest —level of risk, has identified a particular inventory line/ transaction.
• Inventory may be overstated due to fraud. The bar chart shows A Bloggs processing -transactions outside of normal working hours increasing the fraud risk.
• Inventory may be overstated given that the account view module shows inventory lines C, F and L have increased by over 15% since last year.
• Inventory may be overstated if clothing lines are not popular and need to be sold at a discount.
• Inventory days have risen from 30 to 45 days this year indicating overstatement.
• Inventory may be misstated if the new warehouse management system is not working properly.
• Inventory may be misstated if the incorrect exchange rate has been used to translate purchases in $.

Bad example
Jolie sells clothing, with a strategy of selling high fashion items under the JLC brand name. New ranges of clothes are introduced every 8 weeks. Per IAS 2 inventory valuation is a key issue and there is a risk that inventory has not been accounted for correctly. Particular attention should be paid at the stock count to ensure that inventory is correctly valued.

Question 5

learning points from good v bad- what do to and what not to do

Answer 5

• Do relate your answer to the scenario
• Do explain what could go wrong and be specific
• Don’t repeat large chunks of text from the scenario with no explanation provided
• Don’t just say ‘there is a risk’ or ‘there is a risk this has not been accounted for correctly’
• Don’t provide definitions which have not been asked for
• Don’t provide recommendations of how to mitigate risks when not required

Question 6

Materiality

Answer 6

can be by size (below) or by nature (e.g. transactions with directors)

Revenue - 0.5% (H) 1% (L)
Assets - 1% (H) 2% (L)
PBT- 5% (H) 10%(L)

H- high risk client
L- low risk client

Question 7

profitability ratios to use when identifying risks

Answer 7

Return on capital employed (ROCE) = PBIT/ Share capital + reserves+NC liabilities

Operating profit margin= PBIT/revenue

Asset turnover= revenue/ share cap + reserves + NC liabilities

Gross margin= gross profit/ revenue

Question 8

liquidity ratios to use when identifying risks

Answer 8

• current ratio= CA/CL
• quick ratio= CA-Inv/CL

-Inventory holding period = inventories/cos x 365
or
cos/inventories= no. of times turnover

• Receivables collection period= trade receivables/credit sales x 365
• Payables payment period = trade payables/credit purchases x 365 days

Question 9

data analytics

Answer 9

use inflow software

for questions which ask you for ‘ data analytic routines’ use BRAVE

Totally-able to test- Auditors can design a software programme which is able to test all data extracted from the clients system

Breakdown- the software can breakdown or stratify data- e.g. could analyse by product line, geographic area

Reperform- software can automatically reperform controls or recalculations- e.g. 3 way matching (orders, GRNs or GDNs and Invoices)

Aged analysis- rather than relying on a client produced report, auditors’ software can produce an aging- e.g. could reperform the aged inventory analysis so that its more reliable and in a format the auditor is familiar with

Variance analysis - Software can automatically produce many calculations without human error- e.g. recalculate gross profit margin by inventory line and compare to last year or identify any negative margins/loss making lines

Exception report- soft to identify unusual trends or outliers- e.g. software could identify any suppliers who take longer than average to send invoices after delivery