Week 3: Client evaluation and acceptance + Risk assessment

Question 1

What action helps to reduce expectation gap in the engagement letter

Answer 1

Listing out the management and auditors responsibilities (lots of people don’t know what auditors specifically do)

Question 2

What other factor can increase expectation gap in engagement letter?

Answer 2

When people don’t read Terms and conditions properly and sign it

Question 3

What two factors impact client acceptance?

Answer 3

Acceptance and continuance: The engagement partner shall be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been followed and shall determine that conclusions reached in this regard are appropriate - ASA 220.12

• quality control

Question 4

What two directions are there in client evaluation?

Answer 4

Pointing the finger at client
Pointing the finger at yourself

Question 5

What is involved in the risk assessment phase?

Answer 5

Auditors must plan the audit to reduce audit risk to an acceptably low level

• audit risk is the risk that an auditor expresses an inappropriate audit opinion when a financial report is materially misstated
• a well-planned audit ensures that sufficient appropriate evidence is gathered for accounts most at risk of material misstatement

Question 6

How do auditors reduce audit risk?

Answer 6

Ensuring the audit has sufficient appropriate evidence gathered for accounts most at risk of material misstatement

Question 7

What are some concerns when pointing the finger at the client

Answer 7

Integrity of management:
- Communication with previous auditor (more info, particular issues)
- Enquire of third parties (special circumstances)
- Review previous experience (clients in industry, with prospective client)

Special circumstances and risks:
- Who are users of the financial statements
- Legal and financial stability

Question 8

What factors would you think when pointing the finger at yourself?

Answer 8

• Evaluate independence:
  1. firm staff at all levels
  a) firm rules and ethical requirements
  b) quality control
• Assess competence to perform audit
  a) Experience - staffing
  b) skills
  c) need for experts - specialists
• Ability to use due care
  a) ensure quality - staffing, timelines, costs

Question 9

What factors are in engagement letter

Answer 9

a) the objective and scope of the audit of the financial report
b) the responsibilities of the auditor
c) the responsibilities of management
d) identification of the applicable financial reporting framework for the preparation of the financial report and
e) reference to expected form and content of any reports to be issued by the auditor
ASA 210

Question 10

What does ASA 210.9 state regarding terms of the audit engagement?

Answer 10

The auditor shall agree terms of audit engagement with management or those charged with governance as appropriate

Question 11

What does ASA 210.13 state regarding recurring audits?

Answer 11

On recurring audits, the auditor shall assess
whether circumstances require the terms of the
audit engagement to be revised and whether
there is a need to remind the entity of the
existing terms of the audit engagement.
– ASA 210.13

Question 12

What is involved in the risk response stage?

Answer 12

Risk response involves detailed tests of controls and substantive testing of transactions and accounts

• Tests of Controls
  – Understanding processes and controls in the risk assessment phase
  – Understand the company response to risks
  – Respond by assessing company response to risks
• Substantive Procedures
  – Understand the risks to financial reporting in the risk assessment phase
  – Understand the risks of specific misstatements
  – Respond by evaluating transactions, accounts and disclosures

Question 13

What are the stages of an audit in order?

Answer 13

risk assessment, risk response and reporting and concluding

Question 14

What happens in concluding and reporting

Answer 14

Reporting involves evaluating results of detailed testing in light of the auditor’s understanding of their client
and forming an opinion on the truth and fairness of the client’s financial report.
* Concluding audit procedures
* Technical evaluation
* Audit report

Question 15

Why is understanding the client important

Answer 15

impact on whether auditors take on the client or not

Question 16

What levels are there when understanding a client

Answer 16

• entity level
• industry level
• economy level.

Question 17

How is the entity level important?

Answer 17

risk of company losing business falling corrupt etc
Entity level:
* major suppliers
* major customers
* international transactions
* capacity to adapt to changes in technology
* warranties and discounts
* client reputation and operations
* client relations with employees
* sources of financing
* ownership structures

Question 18

what is the industry and economy level

Answer 18

Industry level:
* level of competition
* client reputation
* level of government support
* level of government regulation
* level of demand for client goods/services

Economy level:
* How do overall economic conditions affect
client?
– interest rate changes
– financial crises
– shareholder expectations of increasing profits
in good times.
* What are specific pressures on client to
understate or overstate profits in these
conditions?

Question 19

what does ASA 570 state regarding going concern

Answer 19

Auditor must consider whether it is appropriate to
assume that client will remain a going concern

Question 20

What justification does the going concern assumption provide?

Answer 20

Going concern justifies valuing assets on basis
they will continue to be used in business and
liabilities paid when due

Question 21

In real life, how do auditors validate and make assumptions about going concern risk?

Answer 21

• Auditor must obtain sufficient appropriate
  evidence to assess validity of going concern
  assumption
• Auditor makes professional judgement about
  going concern risk, based on risk indicator

Question 22

What are some going concern risk indicators

Answer 22

• significant debt/equity ratio
• long term loans due, no alternative finance
  prolonged losses, inability to pay debts when
  due
• loss of significant customer, supplier problems
• high staff turnover, loss of key personnel or
  strikes
• problems obtaining raw materials, inputs
• poor growth planning, inadequate risk
  management
• being under investigation for non-compliance
• competitive pressures, drought etc.

Question 23

What is corporate governance?

Answer 23

Corporate governance is the rules, systems and processes within companies used to guide and control
activities.
* Used to monitor actions of staff and assess level of risk faced.
* Controls used to reduce identified risks and ensure future viability of the company.
ASX principles and recommendations for listed companies.
* Companies required to disclose their compliance

Question 24

what does ASA 315 state regarding IT problems

Answer 24

Auditor should consider particular risks faced by client
related to IT

• Unauthorised access to computers, software and data:
  – need security, passwords to prevent distorted data.
• Errors in programs:
  – Can occur if not thoroughly tested before
  implementation, or mistakes made when changing
  programs
  – Program change rights to authorised personnel.
  – Programs need to be suitable for client requirements.
  – Lack of backup and loss of data.

Question 25

What paragraph defines relo between fraud and error (misstatement)?

Answer 25

Misstatements in the financial report can arise from either fraud or error. The distinguishing factor between
fraud and error is whether the underlying action that results in the misstatement of the financial report is
intentional or unintentional.
– ASA 240.2

Question 26

how do auditors mitigate fraud risk and what standards ensure no material misstatement in financisl report

Answer 26

The primary responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management.
– ASA 240.4
An auditor conducting an audit in accordance with Australian Auditing Standards is responsible for obtaining
reasonable assurance that the financial report taken as a whole is free from material misstatement, whether
caused by fraud or error.
– ASA 240.5

Question 27

What leads to fraud

Answer 27

• Incentives / pressures
  – Within the organisation
  – Outside of the organisation
• Opportunities
  – Internal controls – missing or poor controls
  – Monitoring – lack of monitoring
• Attitudes / rationalisation
  – Ethics
  – Management focus

Question 28

what does ASA 240.12 and ASA 240.24 state about auditor’s fraud response

Answer 28

… the auditor shall maintain professional scepticism throughout the audit, recognising the possibility that a
material misstatement due to fraud could exist …
– ASA 240.12
The auditor shall evaluate whether the information obtained from the other risk assessment procedures and
related activities performed indicates that one or more fraud risk factors are present.
– ASA 240.24

Question 29

What does ASA 240.4 and ASA 240.43 state when fraud is found?

Answer 29

If the auditor has identified a fraud or has obtained information that indicates that a fraud may exist, the
auditor shall communicate these matters on a timely basis to the appropriate level of management
– ASA 240.40
If the auditor has identified or suspects a fraud, the auditor shall determine whether there is a responsibility
to report the occurrence or suspicion to a party outside the entity … the auditor’s legal responsibilities may
override the duty of confidentiality in some circumstances
– ASA 240. 43

Question 30

What are some examples of fraud in the attitudes, incentives and opportunities section

Answer 30

Attitudes: management doesn’t want to focus on improving internal controls
- lack of monitoring

Incentives (in and outside of organisation):
- Financial stabiity of profitability is threatened by economic, industry or entity operating conditions (high competition/market saturation)
- Excessive pressure exists for management to meet requirement or demand of third party (a need to obtain additional debt to remain competitive)
- information available indicates that personal financial situation of management or those charged with governance is threatened by the entity’s financial performance (signifcant financial interests in the entity)

**Opportunities: **
- The nature of the industry or the entity’s operations provide opportunities to engage in fraudulent financial reporting arising from significant related party transactions not in the ordinary course of business (etc)
- The monitoring of engagement is not effective due to those charged with oversight of internal control isn’t effective
- Complex or unstable organisation structure: high turnover of staff/senior management or those charged with governance
- Deficient internal control components: high turnover rates

Question 31

What are the differences in the client acceptance and client continuation stage

Answer 31

Client continuation stage involves confidential info