Week 5

Question 1

Phase 1

Answer 1

Perform risk assessment procedures
* identify financial statement assertions, understand the entity and its environment, make decisions about materiality, perform analytical procedures, identify risks of material mis-statement including understanding the internal control system

Question 2

Phase 2

Answer 2

Assess the risk of material mis-statement
* assess risk factors relating to potential financial report mis-statements, determine size of mis-statements, and likelihood of mis=statement and significant inherent risks

Question 3

Phase 3

Answer 3

Respond to assessed risks
* include audit staffing, nature, timing and extent of audit tests

Question 4

Phase 4

Answer 4

Perform further risk assessment procedures
* include tests of controls and substantive tests, quantitative methods to use

Question 5

Phase 6

Answer 5

** Communicate audit findings**
* communicate via audit report opinion to intended users of the report and to other parties including the audit committee

Question 6

Phase 5

Answer 6

Evaluate audit evidence
* evaluate evidence including journals, ledgers, source documentation

Question 7

What are the three main steps in accepting an audit engagement?

Answer 7

1. Client evaluation
2. Ethical and legal considerations
3. Engagement

Question 8

What should be evaluated during client evaluation?

Answer 8

• Integrity of management
• communication with existing auditors
• inquiries of third parties
• Reviewing previous experience with existing clients.

Question 9

What are the main limitations of a financial report audit?

Answer 9

• A time lapse – by the time the audit report is released, the information is relatively ‘old’.
• Audit testing on selective samples - which has limitations due to sampling risk.
• The assessment of materiality - with both quantitative and qualitative considerations, requires a high degree of professional judgement. There are, however, some guidelines, although by their nature they are necessarily arbitrary.
• Forming professional judgements in highly specialised areas - can often result in disagreements between auditors and clients.
• Report format limitations - and the consequent “expectation gap” often arises with users of financial reports.

Question 10

What are the benefits of a financial report audit?

Answer 10

1. Obtain access to capital markets. Financial Statement audits are required by all the major world securities markets.
2. Have a lower cost of capital. Given the reduced risk resulting from audited financial reports, potential creditors may offer low interest rates and potential investors may be willing to accept a lower rate of return on their investment.
3. Be a deterrent to inefficiency and fraud. Knowledge that an independent audit is to be performed is likely to result in fewer errors in the accounting process and reduce the likelihood of employee misappropriation of assets.
4. Control and operational improvements. Based on observations made during the financial report audit, the independent auditor can suggest how controls could be improved and how greater operating efficiencies within the entity’s organisation may be achieved.

Question 11

How does the relationship that independent auditors have with shareholders compare with their relationship with management?

Answer 11

• Shareholders of the company are the primary beneficiaries of the audit function. Shareholders rely on the audited financial statements for assurance that management has properly discharged its stewardship responsibility. The auditor, therefore, has an important responsibility to shareholders of the company.
• During an audit, there is extensive interaction between the auditor and management. To obtain the evidence needed, the auditor often requires confidential data about the entity. The typical approach that the auditor should take towards management is characterised by one of professional scepticism.
• In summary, the relationship with management is much more direct than the relationship with shareholders. The auditor must be careful to remember the true beneficiaries of the audit as he or she is reminded in the title of the audit report.

Question 12

What are the duties of an independent auditor engaged to perform a financial report audit?

Answer 12

When an auditor accepts an appointment, he or she enters into a contractual relationship with the company. The audit engagement letter, agreed to and signed by the auditor and the client, details some of the duties of an auditor for a company (the client).

There are express or implied terms in such contracts that the auditor will:
* exercise a reasonable degree of care and skill.
* be independent of the company.
* report to members his or her opinion, based on the audit, as to whether the financial reports are properly drawn up so as to give a true and fair view of the company’s financial position and performance, in accordance with the law and applicable accounting standards